By Jason Simpkins

Is gold ready to break out?

Gold broke through the psychologically important $1,000-an-ounce level for the first time in 18 months yesterday (Tuesday) as the U.S. dollar slumped against key foreign currencies, exacerbating investor fears that loose fiscal and monetary policies will spur inflation as the U.S. economy recovers.

The thinly traded September futures contract for gold traded as $1,006.90 an ounce on the COMEX division of the New York Mercantile Exchange, or NYMEX (Nasdaq: CME), the highest level for a short-term futures contract since March 18, 2008, MarketWatch.com reported. The contract closed the day yesterday at $997.90, up $3, or 0.3% for the trading session.

The London gold fixing – a global benchmark – traded as high as $1,000.75 an ounce yesterday. Its previous high was also on March 18, 2008.

Now that gold has pierced that technical barrier, some analysts are looking for the yellow metal to return to its all-time-record high of $1,033.90 an ounce – a record set last March.

“The higher the price, the higher the volatility, but this market is so concerned with inflation possibilities and dollar weakness that momentum is bringing more investors to the ‘Buy’ side,” George Gero, a precious-metals trader for RBC Capital Markets (NYSE: RY), told MarketWatch.com.

Gold struggled to breach the $1,000 price level last week. Yesterday’s surge corresponded with a drop in the value of the U.S. dollar, which fell to its lowest point versus the euro this year.

“We had a good technical break higher last week and now the weaker dollar is helping gold progress higher,” Saxo Bank senior manager Ole Hansen told Reuters. “We are finally taking out some levels we haven’t seen for a while, especially in the currencies. On that basis, I would assume we will go up to test the highs from last year.”

The dollar fell as low as $1.45 per euro in morning trading yesterday, its weakest level since Dec 18, 2008, according to Bloomberg News. The euro has risen by about 15% against the dollar in the past six months.

Analysts have warned for months that the combination of a soaring budget deficit and expansive monetary policy could weaken the dollar and spur inflation.

The federal budget deficit for 2009 will reach a record $1.6 trillion, more than three times 2008’s record deficit of $455 billion, the White House’s Office of Management and Budget (OMB) and the Congressional Budget Office (CBO) said last month.

From 2010 to 2019, the deficit will balloon to $7.14 trillion, the CBO says, while the White House paints an even uglier, $9 trillion picture for the same period.

Meanwhile, the U.S. Federal Reserve has injected more than $2 trillion into the U.S. financial system and its benchmark lending rate remains at a record low range of 0.00%- 0.25%.

U.S. Federal Reserve Chairman Ben S. Bernanke has provided few clues about exactly what his so-called “exit strategy” will involve, or when it will be implemented. However, the Fed chairman has said that the Federal Funds rate will remain “exceptionally low” for “an extended period” of time, as the U.S. economy trudges toward recovery.

Few analysts believe Bernanke will even start to rein in the Fed’s fiscal stimulus before he’s absolutely certain an economic recovery is underway. Now, with the belief that inflation is hiding around the corner, investors are piling back into gold to hedge against the dollar’s decline. 

“In the last year alone, the U.S. Federal Reserve has actually doubled the U.S. monetary base,” said Peter Krauth, a Money Morning contributing editor who is also the editor of the Global Resource Alert trading service. “That can only lead to serious inflation, perhaps even hyperinflation.  This will cause the value of the U.S. dollar – which has been eroding since 2001 – to decline at an even-more-frenetic pace.”

Krauth expects that gold prices will shoot even higher in the months and years to come, not just because of the dollar’s devaluation, but because demand is on the rise and global mining output is in decline. Global mine output has decreased at an annual compound rate of 0.8% from 1999 through 2008, according to GFMS Ltd.

In the meantime, demand for the yellow metal has skyrocketed. During the fourth quarter of 2008, for instance, North American and European purchases of gold coins and gold bars rose 811% over the same period the year before. And while demand for jewelry has flattened, new investment vehicles have made purchasing gold much easier for the average investor.

“Exchange-traded funds (ETFs) have been a tremendous catalyst for swelling gold demand,” said Krauth, noting that the SPDR Gold Trust (NYSE: GLD) – the largest physically backed ETF on the planet – is now the sixth-biggest holder of gold bullion in the world.

The SPDR Gold Trust fund held 1,077.63 metric tons of gold totaling more than $34 billion in value as of yesterday, according to its Web site.
 

“Indeed, the fund’s influence on the market is such that it actually seems as if every year or so it moves up past year another nation in the global rankings of gold-bullion holders,” said Krauth.

Buying the SPDR Gold Shares is one way to get in on the gold rush. The fund’s price fluctuates in concert with the price of gold and it’s more convenient than buying gold bars directly.

For investors who are looking to hedge against the enormous inflationary pressures that are believed to be filtering through the U.S. economy, buying stakes in gold miners is another potential strategy to follow.

In this case, the Market Vectors Gold Miners ETF (NYSE: GDX) – composed chiefly of major gold miners – offers both company and geographic diversification, while including substantial leverage to the price of gold.  Market Vectors is based on the AMEX Gold BUGS Index (HUI), which represents a portfolio of 15 major gold mining companies that do not hedge their gold production beyond a year and a half.