March 30, 2009 / 8:58 PM / in 10 years

Inflation a boon for gold, but frenzy unlikely

NEW YORK (Reuters) - Buying gold remains atop a short list of investment portfolio protection strategies against resurgent inflation as the Federal Reserve cranks up the printing press to jolt the economy out of recession.

Still, a frenzied gold rally because of hyperinflation panic is unlikely as the Fed has the ability to rein in money supply when the economy recovers. The bull run of gold may not be a one-way street.

“This Fed is not an inflation biased... but a measured, well reasoned, rational central bank that knows that it has injected a huge sum of permanent bank reserve into the system, and that it will remove them eventually,” said Dennis Gartman, independent investor and publisher of the Gartman Letter.

“And hence, gold has not gone to $2,000 an ounce,” Gartman said.

On Monday, spot gold traded at about $920 an ounce, about $50 below its one-month high $966.70 on March 20.

On March 18, gold rose nearly $70 in a one-day knee-jerk rally after the Fed said it would buy a combined $1.75 trillion in Treasuries and other government bonds. Last week, the Obama administration said it would buy up to $1 trillion in toxic bank assets, sparking inflation fears.

Fund managers said the Fed’s strong resolve to boost the economy should quash deflation worries, which surfaced in recent months to dampen gold every time it attempted to rally above its all-time high of $1,030.80 on March 17, 2008.

“That was a fairy tale for yesterday. Deflation is not going to happen on Bernanke’s watch,” said Axel Merk, portfolio manager of the $310 million Merk Hard Currency and Asian Currency Funds in California.

Indeed, a closely-watched gauge on inflation expectations in the government bond market also shows that long-term inflation expectations are rising.

The “break-evens,” or yield differences between regular U.S. government bonds and Treasury Inflation-Protected Securities, known as TIPS, have sharply widened following the Fed’s move to buy long-dated government debt.

“There are just not a lot of alternatives for global investors. You will see more and more investors moving into gold as a safe haven, and you will see more institutions putting money into commodities indexes,” said Brian Hicks, a portfolio manager at Texas-based U.S. Global Investors, which manages over $2 billion fund assets.

NO HYPERINFLATION GOLD RALLY

While gold stands to benefit from higher long-term inflation, the metal’s price action will most likely be a tug of war between inflation aversion and recovering risk appetite as governments vowed to boost the global economy.

Indeed, gold has become increasingly correlated with the U.S. Treasuries market, which is also considered a safe haven investment, and Treasuries prices showed that investors needed time to contemplate the long-term implications of the Fed’s moves.

Benchmark 10-year Treasury Bond yield, which moves inversely to its price, has now partially erased losses after it plunged nearly 50 basis points on March 18 — the biggest one-day fall since 1987 — in the shock and awe following the Fed’s announcement.

Market watchers noted that the Fed was able to curb inflation by hiking interest rates after the 1981-1982 recession.

Jeffrey Christian, managing director of CPM Group in New York, said a sharp increase in printed money now did not necessarily mean hyperinflation later. He expected gold prices to trade between $800 and $1,200 this year.

“When the Fed sees inflationary pressure, it will start selling bonds and suck the money out of the system, and we probably will be able to avoid hyperinflation,” Christian said.

Reporting by Frank Tang, editing by Alden Bentley and Marguerita Choy

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