Gold Futures Surge Most in 16 Months on Inflation Concerns

By Pham-Duy Nguyen

June 26 (Bloomberg) -- Gold surged the most in 16 months on speculation the Federal Reserve won't rush to raise borrowing costs to curb inflation. Silver jumped the most since March.

The Fed yesterday kept its benchmark interest rate at 2 percent, even as policy makers acknowledged heightening inflationary expectations. An OPEC official said crude oil may reach $170 a barrel soon. Gold reached an all-time high of $1,033.90 an ounce in March as fuel, corn and other commodities soared and the dollar fell to a record against the euro.

``The Fed said that inflation is a major concern, but they're not going to do anything about it, which made gold go ballistic,'' said Leonard Kaplan, president of Prospector Asset Management in Evanston, Illinois. ``The dollar is going to get slammed again.''

Gold futures for August delivery jumped $31.10, or 3.5 percent, to $913.40 an ounce at 12:18 p.m. on the Comex division of the New York Mercantile Exchange. A close at that price would mark the biggest percentage gain for a most-active contract since Feb. 21, 2007.

Silver futures for September delivery soared 75.3 cents, or 4.5 percent, to $17.36 an ounce. A close at that price would mark the biggest increase since March 5.

Before today, silver advanced 11 percent this year, while gold climbed 5.3 percent.

Traders trimmed bets on a rate increase in the next three months after the Fed's announcement yesterday. Interest-rate futures show a 26 percent chance the Fed will keep borrowing costs at 2 percent in September, compared with a 2 percent chance a week ago.

Iran Tensions

Chakib Khelil, Algeria's oil minister and the president of the Organization of Petroleum Exporting Countries, said in an interview on France 24 television that a conflict involving Iran might push oil prices over $200 and as high as $400.

Oil rose as much as 3.3 percent today to $138.95. The record was $139.89 on June 16. Iran has the second-biggest proved oil reserves and is OPEC's second-largest producer.

``Gold rose on the comments from OPEC,'' said Narayan Gopalakrishnan, a trader at MKS Finance, one of Switzerland's four bullion refiners.

Investors traditionally buy gold to hedge against a loss of purchasing power. Gold rallied 39 percent from Sept. 17 to March 17 as the Fed slashed rates from 5.25 percent after a housing slump and credit crisis threatened to push the U.S. economy into recession.

Analysts say the economy is too feeble for the Fed to raise rates any time soon. The U.S. gross domestic product expanded at an annual rate of 1 percent in the first quarter, capping the weakest six months of growth in five years.

Commodity Rally

The Reuters/Jefferies CRB Index of 19 raw materials rose to a record today and has gained 29 percent this year. In May, U.S. consumer costs climbed at an annual rate of 4.2 percent and wholesale prices rose 7.2 percent, according to data from the Labor Department.

``The Fed seems to have decided to protect growth by holding rates low and to accept the fact that this period of inflation is inevitable and unstoppable,'' said Patrick Chidley, an analyst at Barnard Jacobs Mellet in Stamford, Connecticut. ``Inflation is the lesser of two evils. Investors will increase their positions in gold, and it's likely to continue upward.''

The Fed has been more aggressive in cutting rates and slower to raise borrowing costs than other central banks, eroding the value of the dollar, analysts said.

`Major Problem'

``The Fed's decision to not fight inflation is having a direct impact on gold prices along with many other commodities,'' said Tom Hartmann, an analyst at Altavista Worldwide Trading Inc. in Mission Viejo, California. ``Interest rates will not rise, though that would be a quick way to combat high commodity prices. The Europeans and other central banks seem keenly aware that inflation is a major problem.''

The European Central Bank has held its benchmark rate unchanged at 4 percent since June 2007. The Bank of England's key lending rate is at 5 percent.

Investment in the SPDR Gold Trust, the biggest exchange- traded fund backed by bullion, has climbed every day since May 21, when the amount was 583.9 metric tons. The fund reached 628.2 tons yesterday. The record 663.8 tons was on March 17.

Russia's oil funds may invest in gold, Moscow-based agency RIA Novosti said, citing a finance ministry official. Russia's Reserve Fund and the National Wellbeing Fund were worth a combined $161.9 billion on June 1.

Still, gold's rally may be limited after seven straight annual gains, some analysts said.

``Gold's time in the limelight appears to be drawing to a close, unless the macroeconomic outlook worsens considerably and investor demand rebounds from its recent sell-off,'' analysts at Barclay Capital said today in a report.

To contact the reporter on this story: Pham-Duy Nguyen in Seattle at pnguyen@bloomberg.net.

Last Updated: June 26, 2008 12:22 EDT

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