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Gold May Rise on Speculation Fed to Struggle Curbing Inflation

July 23, 2006

Gold may resume its rally on speculation that the Federal Reserve will halt interest-rate increases too soon to curb inflation, as fuel costs remain near record highs.

Eighteen of 42 traders, investors and analysts from Sydney to Chicago surveyed by Bloomberg News on July 20 and July 21 advised buying gold, which fell 7.2 percent to $620.20 an ounce in New York last week. Fifteen respondents said to sell and nine were neutral.

Gold jumped 46 percent in the past year, partly on signs of accelerating inflation. Fed Chairman Ben S. Bernanke said last week economic growth is slowing and hinted the central bank may halt two years of rate increases, even after oil rose to a record $78.40 a barrel this month.

``Rising inflation is in the cards with $70-plus crude oil,'' said James Turk, founder of GoldMoney.com, which stores gold for investors and is based in Jersey, British Channel Islands. ``The Fed is losing grip of its attempt to control inflationary expectations. Gold is probably going to trade in a $600 to $700 range until September.''

Gold futures for August delivery on the Comex division of the New York Mercantile Exchange lost $47.80 last week, the biggest percentage drop since May 19. The decline surprised the majority of analysts who expected a gain when surveyed July 13 and July 14. The Bloomberg survey has accurately forecast prices in 72 of 117 weeks, or 62 percent of the time.

Inflation Hedge

Some investors buy gold to preserve purchasing power in times of accelerating inflation. Gold futures surged to $873 in 1980, when a jump in the cost of oil led to a 13 percent annual rise in U.S. consumer prices.

Oil prices are up 22 percent this year, fueling a 36 percent increase in U.S. retail gasoline prices, to near $3 a gallon. Gold is up 20 percent during the same period.

Consumer prices excluding food and energy rose 2.6 percent from June 2005, the biggest year-over-year rise since 2002, the Labor Department said last week.

The Fed raised its inflation forecast on July 19. Its preferred price gauge, which excludes food and energy, will rise by 2.25 percent to 2.5 percent in the fourth quarter from a year earlier, the central bank said in its semi-annual report to Congress. Its previous forecast was a 2 percent gain.

Spot gold may rise about 8 percent to $670 this week, said Peter Schiff, president of Darien, Connecticut-based brokerage Euro Pacific Capital Inc.

Fed `In a Box'

``The short-term outlook for gold is good,'' Schiff said. ``What's driving gold is inflation. The economy, in fact, is slowing but inflation is accelerating and the Fed is in a box. A weaker economy is going to hurt the dollar,'' boosting the appeal of gold, he said.

Manufacturing growth in the Philadelphia area decelerated this month more than economists estimated. The Federal Reserve Bank of Philadelphia's general economic index fell to 6 in July from 13.1 in June. Economists had expected a decline to 12, the median forecast in a Bloomberg News survey. Ford Motor Co., the world's No. 2 automaker, said it will cut output after an unexpected second-quarter loss.

Bernanke told U.S. lawmakers last week that there is ``moderation in economic growth,'' after 17 straight Fed rate increases since June 2004. The housing market's slowdown this year has so far been ``orderly,'' though central bankers are monitoring the situation ``very carefully'' for the economic effects, he said.

Not Too Tight

The Fed raised its key lending rate to 5.25 percent from a four-decade low of 1 percent in June 2004 to curb inflation. Sales of new U.S. homes probably fell to an annual rate of 1.16 million in June from 1.234 million, according to the median forecast of 53 economists in a separate survey. The Commerce Department is scheduled to release the report on July 27.

Since Bernanke told Congress last week that policy makers don't want to ``tighten too much,'' traders of interest-rate futures have more than halved bets the Fed will raise rates at its Aug. 8 meeting.

Fed funds futures show traders see a 41 percent chance the central bank will lift its lending rate a quarter-percentage point to 5.5 percent on Aug. 8, down from a 90 percent chance before Bernanke spoke.

Hedge-fund managers and other large speculators increased their holdings of Comex gold futures in the week ended July 18, government figures show. Speculative net-long positions, or bets that gold will rise, increased 5.3 percent to 107,374 contracts, the highest since the week ended May 23, the government said.

Mideast Violence

Gold also may get a boost from Israeli-Hezbollah clashes in Lebanon. Some investors buy gold as a hedge against declines in other investments in times of political unrest.

``With the escalation in the Middle East tension and with the market thinking perhaps the Fed is going to stop raising rates, gold will go higher,'' said Leonard Kaplan, president of Prospector Asset Management in Evanston, Illinois. ``It looks like Israel is preparing for a ground war.''

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Investing in foreign securities involves risks, such as currency fluctuation, political risk, economic changes, and market risks. Precious metals and commodities in general are volatile, speculative, and high-risk investments. As with all investments, an investor should carefully consider his investment objectives and risk tolerance as well as any fees and/or expenses associated with such an investment before investing. International investing may not be suitable for all investors.

Dividend yields change as stock prices change, and companies may change or cancel dividend payments in the future. The fluctuation of foreign currency exchange rates will impact your investment returns. Past performance does not guarantee future returns, investments may increase or decrease in value and you may lose money.

Our investment strategies are based partially on Peter Schiff's personal economic forecasts which may not occur. His views are outside of the mainstream of current economic thought. Investors should carefully consider these facts before implementing our strategy.