What's Behind the Gold Price Surge

Some analysts cite inflation fears and increased Chinese demand, while others say the market is ready for a correction

By David Bogoslaw

Editor's Note: This story was updated Tuesday, Sept. 8.

After spending the summer in the doldrums, the price of gold has started to perk up in September—enough to push the yellow metal near the $1,000-per-ounce mark. Last week, gold jumped 3.6% in just two days, peaking at $997.80 an ounce on Sept. 3. By the end of the week, it had pulled back slightly—the December futures contract on the New York Mercantile Exchange settled $1.60 lower, at $996.10 on Sept. 4. On Sept. 8, the December contract moved above $1,000—gold's highest level since March, 2008—amid a further decline in the U.S dollar.

There's no shortage of rationales that investment strategists and economists have offered for the biggest price spike in gold in six months—from increased purchases by China's central bank to inflation fears—but these seem like mostly after-the-fact justifications for what's occurred, according to Philip Klapwijk, chairman of Britain-based metals consulting firm Gold Fields Minerals Service (GFMS).

If gold fails to decisively break through $1,000 an ounce, it will be the third time since February that the metal has fallen short, and that could lead to a fairly quick reversal in investor sentiment, says Klapwijk. The retracing of crude oil prices back to $67 a barrel since failing to break through $75 the week of Aug. 24 augurs a similar pattern for gold if it can't break above $1,000, says Jacob Oubina, currency strategist at Forex.com.

Rumors of Chinese Demand

Klapwijk at GFMS says he's bullish about gold in the medium term and believes the "very lax" fiscal and monetary policies of governments trying to lift their economies out of recession eventually will result in inflation and lead to a much broader group of investors pushing gold prices above $1,000. But he doesn't see anything to justify such a move right now. "I'm a bit skeptical about this move, I must say, because I believe speculative positioning is already long. Commodity prices in general are overbought," he says. "There's room for a correction. I don't sense this is the long-awaited, decisive push through $1,000 an ounce."

What's driving the current rally? First, there's demand for the metal tied to its monetary value in times of uncertainty. The Chinese government is allegedly trying to diversify away from its massive U.S. dollar reserves by buying physical gold, but from its own production, not on the world market.

Some argue that gold is reacting to the likelihood of sustained deflationary pressure, with real interest rates remaining below zero, rather than any hint of inflation related to the ballooning federal deficit. It's hard to make the case for a looming inflation threat with the consumer price index down 0.2% in July (before seasonal adjustment), and 2.1% lower than a year ago, thanks to a 28% decline in the energy component of the CPI that has trumped a 0.9% rise in food and a 1.5% increase in the index for all items excluding food and energy.

Gold Could Hit $1,200

There was scant hint of any spiraling wage concerns in the August nonfarm payrolls report released on Sept. 4, which accompanied news that the U.S. unemployment rate hit a 26-year high of 9.7%. In August, average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls rose by 6¢, or 0.3%, to $18.65. Over the past 12 months, average hourly earnings have climbed 2.6%, while average weekly earnings have risen by only 0.8%, due to declines in the average workweek, according to the Bureau of Labor Statistics.

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