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As enthusiasm for gold returns, all eyes turn to Fed

After a long summer slumber, the gold market looks set to re-awaken, thanks to some powerful jolts from central banks that could launch the precious metal to record highs.

Market watchers said the European Central Bank's announcement of a bond-purchase quantitative easing (QE) program Thursday, together with the U.S. Federal Reserve Board edging closer to unveiling a new QE program of its own as early as next week, have injected life into gold after a sluggish six months of sideways trading.

Bullion topped $1,700 (U.S.) an ounce in New York for the first time since early March, extending a run that has lifted the metal $100 in the past three weeks.

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"The fundamental argument behind it is monetary policy in Europe and the United States. [Quantitative easing] is basically printing money," said Aaron Fennell, futures specialist at ScotiaMcLeod.

Since printing money is considered both inflationary and currency-debasing, and gold is traditionally considered a hedge against both inflation and currency devaluation, the QE moves are providing traders with a strong argument to return to gold.

"It's sort of an old-fashioned argument, but enough people believe it that it's sort of self-fulfilling," Mr. Fennell said.

Old-fashioned or not, experts believe the moves toward QE could be the catalyst that sends gold toward $2,000 an ounce by the end of the year. (Gold peaked a year ago at $1,923 an ounce in intraday trade. It's record close in New York was $1,891.90 in August, 2011.)

Bart Melek, head of commodity strategy at TD Securities, said gold suffered from a lack of buyers over the summer, as the "fast money" – speculative investors – unwound holdings in the metal. Last month, speculative long positions in gold futures contracts in the U.S. market were at their lowest level in more than three years. The speculative longs have bounced back since mid-August as talk of QE heated up, but are still low by historical standards.

"Any fundamental catalyst could bring the fast money back in a hurry," Mr. Melek said.

Mr. Fennell said that during gold's longer-term bull run, it has gone through similar slowdowns as over-extended speculators stepped away, often squeezing other investors on the way down and casting a chill over the gold market.

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"It can take a year to 18 months before traders feel comfortable and come back to the market," he said.

Given that a year has now passed since gold hit its record highs and speculators began reducing their long positions, he said, the timing may be right for the speculators to make their return – and the QE developments, together with gold's sudden rebound above $1,700, may give them ample reason.

"I would say $1,700 is significant, because it's been a long time since we've been up here," he said. "It puts gold back on the radar screen for many traders."

Meanwhile, speculative positions in U.S. dollar futures have turned negative (i.e. short positions outnumbering long positions) for the first time in more than two years. This is a bullish indicator for gold, which typically trades against the U.S. currency; when traders go short on the greenback, they often go long on gold on the other side of the trade.

"In the three previous instances [since 2007] where speculative positions turned short [the U.S. dollar], bullion gained more than 30 per cent in the following year," said Stéfane Marion, chief economist and strategist at National Bank Financial, in a research note this week.

Mr. Melek cautioned, however, that any momentum gold has gained from the ECB move could be quickly unwound if the Fed doesn't announce its own QE measures when its policy-setting committee meets next Friday. A string of better-than-expected U.S. economic indicators recently, including Thursday's Institute for Supply Management service-sector index and the monthly employment survey from private-sector payroll services firm ADP, have raised doubts about the Fed's need to launch another round of QE right now.

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"[The ECB] wasn't the big game [for gold]," Mr. Melek said. "I think the Fed on Sept. 13 is the big one."

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