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Gold surges 2.5% to above $1,700 on Fed news

Gold surged 2.5 per cent to above $1,700 (U.S.) an ounce on Wednesday, as the U.S. Federal Reserve extended its promise of near-zero interest rates through 2014, much longer than its previous forecast.

Bullion's rally dwarfed the size of the slight gains in equities and other commodities as the U.S. central bank affirmed a view that the pace of U.S. economic recovery remained sluggish.

Silver also rose nearly 4 per cent on gold's coattails, while U.S. equities measured by the S&P 500 index and the euro – which gold had traded in lockstep in late 2011 – climbed less than 1 per cent.

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"From an equity standpoint, it's not a good story as the Fed was anticipating a much slower rate of growth than the market was," said Frank McGhee, head precious metals trader at Integrated Brokerage Services LLC.

"Gold was reacting to the Fed's guidance of historically low rates all the way until 2014, which suggests that there will be plenty of investment money around for an extended period of time," he said.

The metal also received a boost after the central bank appeared more sanguine on the inflation outlook, suggesting prices were now rising at a pace consistent with policymakers' goals.

Low interest rates particularly benefit zero-yielding gold, unlike stocks and bonds. Minimal borrowing costs also tends to fuel a gradual increase in commodity prices, supporting the metal's traditional role as an hedge against inflation.

Spot gold was up 2.5 per cent at $1,706.80 an ounce by 3:03 p.m. EST (2003 GMT), after rising to a session peak of $1,707.80, the highest since Dec. 12.

U.S. February gold futures settled up $35.60 at $1,700.10 an ounce.

Trading pace was hectic as volume rose toward 300,000 lots, set to be one of the highest turnover since September and nearly double its 30-day average.

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Gold was up 9 per cent for the year, after the metal briefly entered a bear market and fell 10 per cent in December as the metal had appeared to lose its safe-haven status.

COMEX OPTIONS EXPIRE THURSDAY

With the gold market already more choppy than usual at the end of a two-day meeting of the Fed Open Market Committee, Thursday's expiry of February gold options <0#GCG2+> could further increase volatility in the gold market.

Prior to the FOMC, the gold options market showed that investors would like to protect against downside risk in underlying futures, as most open interest is clustered around puts with lower strike prices.

Put options give the holder the right, but not the obligation to sell gold at set price by a set date.

George Gero, vice president of RBC Capital Markets, said that Wednesday's gains could be partly attributed to huge short covering ahead of Thursday's option expiration.

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Silver rose 3.8 per cent on the day to $33.23 an ounce.

Platinum group metals also rose, with platinum up 2.1 per cent at $1,577 an ounce, while palladium rose 2.1 per cent to $691.50 an ounce.

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