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(Kitco News) - Gold traders are awaiting the outcome of a meeting of the Federal Open Market Committee this week to gauge whether growing optimism about further monetary accommodation is warranted.

The market was boosted in recent weeks by a combination of safe-haven buying due to eurozone debt issues, as well as expectations that Fed policy-makers may undertake further action to spur on the U.S. economy as data turned softer than earlier in the year.

“If there is further accommodation, then the gold market is likely to be supported,” said one trader.

If not, some disappointed bulls could exit from the market.

“If they do nothing, I think gold is going to sell off rather sharply,” said Jeffrey Wright, managing director and research analyst with Global Hunter Securities. “The market is anticipating further measures to provide liquidity—not to the extent of quantitative easing—but something.”

Market views appear mixed on whether the Fed will act, but if it does, more Operation Twist may be the most likely outcome, analysts said. Should this occur, observers expect a more muted move by gold than would be the case if policy-setters either do nothing at all or undertake something more aggressive, such as a third round of quantitative easing, known as QE3.

Operation Twist is a program where the Federal Reserve sells shorter-dated securities and buys longer-dated ones in a bid to push down longer-term yields. This does not actually increase the central bank’s balance sheet, as would quantitative easing, which is the outright buying of Treasury securities in an effort to push down long-term yields.

“There is a risk of a mini-Twist, but we see the Fed standing pat at this meeting and/or starting to move to QE3 if it deems more easing is needed in the future,” said Nomura Global Economics. However, economists said, a “token gesture” could come from the Fed in the form of a statement that it is considering adding more U.S. Treasurys or mortgage-backed securities, if the economy needs it, by balance-sheet expansion.

BNP Paribas looks for easing in the form of either Operation Twist or third round of quantitative easing. “Extending Twist may be an attractive option at this time and the FOMC might choose to use aggressive language in its statement that hints at balance-sheet expansion in the near future, should the dismal outlook persist,” BNP said.

Barclays Capital called Operation Twist “the most likely outcome,” saying it would give the Fed more time to sort out whether recent softness in data is mainly “payback” for hiring during a warm winter or a more prolonged slowdown. “If the latter is the case, then more outright asset purchases that expand the balance sheet (QE3) would become likely,” Barclays said.

Wright figures the Fed will do something since economic data lately has been more sluggish but inflation metrics appear--such as the consumer price index and the price of commodities themselves— in check. However, he looks for the Fed to either signal or actually extend Operation Twist, with potential for the Fed to extend the strategy to other asset classes, such as also buying mortgage-backed securities.

Wright said there appears to be some uncertainty on the part of the Fed itself as what to do. This probably limits the likelihood of QE3 just yet, since some members may fear acting too aggressively and allowing price inflation to gain a foothold.

“Once you let the genie out of the bottle, to get inflation back in is very, very difficult,” Wright said. “The only way do that is to take liquidity out of the market. They would have to drastically raise interest rates, which…would very rapidly curtail economic expansion.”

Further, he said, policy-setters have shown a reluctance to make more profound moves such as QE unless there is an outright crisis.

Shawn Hackett, president of Hackett Financial Advisors, does not expect the Fed to do undertake any kind of action this week.

“There’s no reason to do anything yet,” he said. “Every time (economic data) starts to get bad enough, (the data) moderates. If the EU falls apart, then that’s something different.

But I think the Fed is going to start to take a U.S.-centric view, saying that ‘we will do what we need to, to keep us inoculated from Europe.’”

He questioned how much good would come from further Operation Twist. “They have to do something that will make the markets take a different view,” he said.

Gold Reaction Would Be More Muted To Operation Twist Than QE3

Analysts were mixed on how gold might react to some extension or variation of Operation Twist, although most did not appear to expect a massive move, as might be the case with no Fed action at all or a QE3.

Filip Petersson, commodity strategist with SEB Commodity Research, suggested Operation Twist might be neutral to slightly bearish. However, he tends to lean toward another liquidity injection such as QE3, which coupled with the European risk means more potential for upside in gold.

Wright, meanwhile, said gold could draw a slight bid from some form of extended Operation Twist. He would expect limited gains, perhaps to the $1,650 area, however, since the market has already been factoring in some sort of Fed action.

Sterling Smith, commodity analyst with Citi Institutional Client Group, said QE3 would be bullish, but with nothing more than further Operation Twist, gold could continue to clank against the upper area of a band of resistance around $1,650.

“To get gold really moving, you need a definite QE3,” he said. Smith later added: “Operation Twist is not nearly the food for a gold bull that outright QE is.”

By Allen Sykora and Debbie Carlson of Kitco News; asykora@kitco.com and dcarlson@kitco.com

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