Gold hit $1,700 an ounce before closing at $1,696 on Tuesday in a continuation of a sharp three-day climb and a significant move from May's low of $1,540. The surge was triggered last week when Federal Reserve Chairman Ben Bernanke sounded like he was inclined to start a new round of stimulus.
After Bernanke called the economy "far from satisfactory" and noted "the stagnation of the labor market … is a grave concern," analysts concluded that a new round of stimulus is likely from the Federal Reserve. And as the European Central Bank meets Thursday, investors are also expecting a hint there that more stimulus is on the way.
In other words, the expectation is for central banks in the U.S., Europe and possibly also China to pour billions into the economy in the hope that businesses and consumers will use low-cost money to make purchases and get growth moving. Gold investors are attracted to gold under such circumstances because they assume that a lot of money sloshing through the system will debase the value of paper money and ignite inflation.
So far, those concerns have not materialized as the Federal Reserve has fought a struggling economy with two earlier rounds of stimulus known as quantitative easing.
But gold investors tend to buy gold whenever there is significant speculation that stimulus is coming, and a new round of stimulus looks like it could be widespread.
"Investors are seeing stimulus across the board, not just the U.S., but Europe and China," said David Meger, director of metals trading at Vision Financial Markets. "Every time there is a hint of stimulus, there is an immediate reaction and gold prices move higher."
As European countries such as Spain and Italy have struggled with unmanageable debt and recession, and European Central Bank President Mario Draghi has suggested a possible bailout through buying sovereign bonds, gold prices have drifted upward. Gold has moved significantly from May's low, although prices remain below the all-time high of $1,900, set in September 2011, or of February's $1,784.
Gold has a reputation for being a volatile investment, and when financial leaders have appeared to have lost interest in stimulating, gold investors have dumped it. That was the case after February, when Bernanke told a congressional committee that there were some signs of strength in the economy and analysts concluded that there would be no new round of quantitative easing.
Then, just three weeks ago, Ned Davis Research commodities strategist John LaForge wrote that many considered "gold dead." Yet he cautioned investors to be aware of how quickly sentiment can change in gold. He noted that gold has a tendency to "play possum" and "will spring back on all fours."
In particular, he noted that betting against gold during the months from September to December has been a losing proposition for 12 straight years. During the end of the year, jewelry purchases climb as people in Europe and the U.S. buy holiday gifts and China approaches its new-year celebration.
Lately, jewelry buying has been less prominent; especially in India, where the country's currency has lost a fifth of its value compared with the dollar, and made gold purchases expensive. In addition, the World Gold Council reported that Chinese jewelry demand had declined 9 percent as the economy has weakened.
Yet, while the decline in gold purchases by consumers has been a concern, demand has continued as individuals lately have invested in gold exchange traded funds and China has added gold to its reserve funds.
LaForge notes that the Chinese government is adding gold to its reserves. In June, the Chinese imported 67 times the gold they imported in June 2009.
Gold makes up just 2 percent of China's reserves, while it is 70 percent in the West, LaForge said, so "Chinese buying should wake up gold."
Still, the recent rally has been strong, and Meger said gold sometimes pauses or pulls back after a strong move.
Regardless, the next few weeks could be a crossroad, since the Federal Reserve is meeting Sept. 12 and may send signals about whether it will or won't stimulate. And a German court will rule then whether Germany, which is the powerhouse of the European economy, can participate in certain bailouts of struggling countries such as Spain and Greece.
Without Germany behind stimulus, the rest of Europe is not likely to do it.