Gold Prices Climb After Historic Sale By IMF

The dollar, weakened by the Federal Reserve’s lack of restraint, is losing ground to the euro — which has spurred central banks and investors to turn to hard …

The dollar, weakened by the Federal Reserve’s lack of restraint, is losing ground to the euro — which has spurred central banks and investors to turn to hard assets instead. This is driving gold futures to record prices, and there is speculation of prices hitting $1,125 an ounce in 2010. Leading the recent price rally was the International Monetary Fund gold sale — the largest single sale in decades — which doubled the reserves held by the Bank of India, creating a sense of urgency over supply among investors and sending a signal to the rest of the world’s banks. For more on this, see the following article from Money Morning.

Gold prices soared to another fresh record Wednesday, driven mainly by speculation that central banks would continue to ramp up purchases of the precious metal.

Gold futures jumped as high as $11.30, or 1%, to $1,096.20 an ounce in morning trading on the New York Mercantile Exchange (NYMEX). And most analysts believe gold prices are bound to shoot even higher.

“Everything is pointing to the price of gold going higher,” Mike Sander, an investment adviser at Seattle-based Sander Capital Advisors, wrote in an e-mailed report.

And “a whopping budget deficit continuing to balloon, a Federal Reserve in no place of raising rates, and central banks all over the world diversifying away from the dollar,” will be the main catalysts for gold’s continued rise, he said.

The U.S. Federal Reserve’s loose monetary policy has put the dollar under duress. The Fed has pumped more than $2 trillion into the U.S. economy since the financial crisis began more than two years ago. It has lowered its benchmark federal funds rate to near zero and stepped up purchases of U.S. Treasuries and mortgage-backed securities.

More recently, the return of investor risk appetite and the widespread belief that the Fed will have to keep its stimulus measures in place as the U.S. economy struggles out of a long and deep recession have put downward pressure on the greenback.

The dollar has tumbled by more than 17% against the euro since early March, and the Dollar Index – which measures the greenback against the euro and five other currencies – is down 6.4% this year.

With the dollar in freefall, central banks and hedge funds have sought shelter in hard assets, particularly gold.

Indeed, this week’s record rally began Tuesday, when the International Monetary Fund (IMF) said it sold 200 metric tons of gold to the Reserve Bank of India (RBI) from Oct. 19 to Oct. 30.

The IMF said in September that it would sell 403.3 metric tons of the metal to shore up its finances and lend at reduced rates to low-income countries. That announcement led some analysts, who worried the market might be flooded, to turn bearish on gold. But now there’s a question of whether or not there will be enough gold to go around – even with the IMF sale.

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Investors around the world are betting that purchases such as this mark a new era for central banks around the world, one in which they will seek greater diversification from the U.S. dollar.

“The market realized…that there are enough central banks which are looking to buy the gold from the IMF direct and so it is not coming into the market, so the shorts had to cover,” Michael Kempinski a senior trader at Commerzbank told Reuters. “We should see $1,100 soon.”

Central Banks Driving the Gold Bull

The RBI paid $6.7 billion for the 200 metric tons of metal, or about 8% of the world’s annual mine production.

The move surprised many analysts, as India, for the past 15 years, had largely neglected its gold reserves. India’s gold holdings peaked in 1994 at 20% of its foreign exchange reserves. But up until Tuesday, those holdings had dropped to just 3.6% of the nation’s estimated $285.5 billion in foreign reserves.

Last month’s purchase nearly doubled India’s gold holdings, which now stand at 558 metric tons, or 6.2% of the nation’s foreign exchange reserves.

Asia’s third-largest economy now has the world’s 10th-largest gold reserve, behind Russia, which has about 568 metric tons.

India’s gold holdings as a percentage of foreign reserves are now higher than even China’s. The People’s Bank of China holds about 1,054 metric tons of gold, equal to roughly 2% of its $2.3 trillion in foreign currency reserves.

“Our Reserve Bank decided to buy some gold. I think about 400 tonnes. That’s normally something we do from time to time. The IMF wanted to sell gold and we wanted to buy gold,” Pranab Mukherjee, India’s finance minister, said in an interview with the Financial Times.

However, analysts have been far less flippant about the purchase.

Timothy Green, the author of “The Ages of Gold,” described India’s purchase to Bloomberg News as “the biggest single central-bank purchase that we know about for at least 30 years in such a short period.”

“The only comparable event was the U.S.’s steady purchases in the 1930s and 1940s,” he said.

“This is a landmark trade,” Jonathan Spall, a director at Barclays Capital and a gold specialist, told the FT. “Central banks are conservative institutions and India’s move is a sign for other central banks and sovereign wealth funds that were contemplating buying gold.”

Analysts believe India’s highly publicized purchase – which was made when prices were near record highs – will spawn a chain reaction in which other countries and investors ramp up their gold purchases.

And with 203.3 metric tons still on sale at the IMF, it wouldn’t come as a surprise if China wanted to build on its gold holdings. China, the sixth-largest holder of gold, has increased its gold reserves by 76% since 2003. But as stated earlier, its 1,054 metric tons equal just 2% of its massive reserve holdings.

“It is but a matter of time until China and the IMF announce much of the same,” said Dennis Gartman, an economist and the editor of The Gartman Letter told Bloomberg.

Gold prices may average $1,125 an ounce in 2010, “with strong investment demand anchored by a negative real interest-rate environment and probable central bank purchases,” analysts at Desjardins Securities Inc. said in a report.

Got the Gold Bug?

There are a number of ways an investor could profit from gold’s record-breaking run.

In a September “Buy, Sell or Hold” column, Money Morning Contributing Editor Horacio Marquez reiterated his suggestion that investors buy the SPDR Gold Trust ETF (NYSE: GLD) – an exchange-traded fund that mimics gold’s price movement.

Holdings in the SPDR Gold Trust increased 4.88 tons – the most in nearly a month – to 1,108.4 tons Tuesday after India revealed its massive purchase.

Meanwhile, another Money Morning contributor, Martin Hutchinson, suggested the iShares Silver Trust (NYSE: SLV).

“This fund invests directly in silver bullion, which has been left behind somewhat in its relationship to gold’s price rise – and which can be expected to move up as gold does, possibly by an even greater percentage,” he said.

Hutchinson also advised investors to look at the Market Vectors Gold Miners ETF (NYSE: GDX).

This article has been republished from Money Morning. You can also view this article from
Money Morning, an investment news and analysis site.

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