By Pham-Duy Nguyen and Nicholas Larkin

Jan. 30 (Bloomberg) -- The same unprecedented steps thatcentral bankersare taking to rescue the banking system aredriving investors to gold,the commodity investors buy when theylose confidence in financialassets.

David Einhorn, manager of the $5.1 billion GreenlightCapital Inc. hedge fund, bought gold for the first time. StevenLehman, the Federated Investors Inc. fund manager who beat 99percent of his peers last year, is betting on bullion withToronto-based Yamana Gold Inc. and Goldcorp Inc.

Thecombination of central banks spending trillions ofdollars to prop upthe banking system in the worst financialcrisis since the GreatDepression will cause gold to appreciateat least 17 percent this yearfrom $882.05 an ounce on Dec. 31,surpassing the record of $1,032.70 inLondon, according to 16 of24 analysts surveyed by the London Bullion Market Association.The metal traded at $909.10 yesterday.

“The government can print endless money, but they cannotincrease the supply of gold,” said Michael Pento,chiefeconomist at Delta Global Advisors Inc. in HuntingtonBeach,California, who is doubling holdings of the precious metal to8percent of his $1.5 billion in assets. “Anything the governmentcannotreplicate by decree, I want to own.”

Investors typically buygold during times of financialturmoil as a store of value. Thecommodity has gained in five ofthe past six U.S. recessions.

Printing Money

To rescue the U.S. economy, the Federal Reserve reduced itstarget interest ratefor overnight loans between banks to as lowas zero percent, more thandoubled its total assets during thepast year and agreed to buylong-term Treasuries. The governmentpledged $8.5 trillion on behalf ofAmerican taxpayers and spent$350 billion so far under the TroubledAsset Relief Program tobail out banks.

TheU.S. House passed an $819 billion economic stimuluspackage this week,Germany pledged 80.3 billion euros ($104million) over two years andChina is spending 4 trillion yuan($585 billion) on infrastructureprojects.

George Soros,the billionaire hedge-fund owner, said theeconomy “will deteriorate”and the International Monetary Fundsaid growth this year will slowclose to zero. Analysts predictthat the U.S. contracted 5.5 percent in the fourth quarter, thefastest pace since the start of 1982.

Only20 percent of 1,124 chief executive officers surveyedbyPricewaterhouseCoopers LLP expect revenue to increase thisyear,according to a report released as leaders met at the WorldEconomicForum in Davos, Switzerland, this week.

American Buffalo

TheU.S. Mint suspended sales of American Buffalo 1-ouncegold coins inSeptember after supplies ran out. The Perth Mint,producer of so-calledKangaroo and Nugget coins in Australia,said in October that it doubledoutput in six months. MuenzeOesterreich AG, the Austrian mint, almostquadrupled productionof its Philharmonic coin in the first nine monthsof 2008.

Holdings in the SPDR Gold Trust,the largest exchange-tradedfund backed by bullion, exceed the goldreserves of all but fivecentral banks and the IMF. Switzerland’sZuercher Kantonalbank inOctober said its gold vault was full.

Investmentdemand for gold bars may climb 49 percent to 201metric tons in thefirst half of 2009, according to London-basedresearcher GFMS Ltd. Frederic Panizzutti,senior vice presidentat Geneva bullion refiner MKS Finance SA and themost accurateforecaster in the 2008 London Bullion Market survey, said thepeak will be breached before July.

Greenlight Capital

Greenlight’sEinhorn, in a Jan. 20 letter to clients, saidhe was buying bullion andshares of the Market Vectors GoldMiners exchange-traded fund inresponse to the Federal Reserve’s“exploding” balance sheet. StevenLehman’s $1.3 billionFederated Market Opportunity Fund beat theStandard and Poor’s500 Index by 30 percentage points last year.

TheFed’s assets grew by $1 trillion over the past yearafter the centralbank provided $416 billion in term loans tobanks and purchased $350billion of commercial paper issued byU.S. corporations.

Bullion is already up 16 percent since December 2007, thedate that the Cambridge, Massachusetts-based National Bureau ofEconomic Research says was the start of the current recession.The biggest gain came in the 1973-1975 slowdown, when goldadvanced 88 percent.

Thisyear, the world economy will expand 0.5 percent, theIMF said Jan. 28,predicting that more than $2 trillion of badassets from the U.S. willsink economies from Russia to the U.K.The majority of American banksare insolvent, Nouriel Roubini,the New York University professor who predicted the financialcrisis, said in an interview in Davos.

Stimulus Package

Whileeconomists expect the U.S. to return to growth in thesecond half ofthis year, they also predict the return ofinflation as soon as thefourth quarter. Consumer prices willrise 1.25 percent in the U.S.,according to a Bloomberg survey.

The difference between rateson 10-year notes and TreasuryInflation Protected Securities, whichreflects the outlook amongtraders for consumer prices, widened as theHouse passed the $819billion economic stimulus.

The spreadincreased to 98 basis points from nine basispoints at the end of lastyear. The U.S. recession brought thefigure down from 2.34 percentagepoints six months ago.

Treasuries, which typically decline wheninflationaccelerates and diminishes the value of their fixedpayments,fell 2.3 percent in January, according to Merrill Lynch &Co.’sU.S. Treasury Master index. The Standard and Poor’s 500Indexdropped 6.4 percent, following its worst year since 1937.

Ultimate Hedge

“Gold is the ultimate currency hedge,” said Michael Darda,chiefeconomist at research company MKM Partners LP in Greenwich,Connecticut,who expects gold to surpass $1,000 this year. “Ifcentral banks aregoing to shovel massive amounts of paper outthere, gold will ultimatelyrespond to that.”

Gold rose 5.8 percent last year as theReuters/Jefferies CRBIndex of 19 raw materials fell 36 percent, theworst year in ahalf-century. The metal was one of four commodities togain,along with cocoa, sugar and lean hogs, and the only one toextendits winning streak to eight years. Oil and copper fell 54percent.

The risk for investors is that government efforts torevivegrowth take hold. Seventeen months after seizing up at theonsetof the credit crisis, the $1.69 trillion commercial papermarketmay be the first to cut its reliance on federal bailout programs.

About $245 billion of 90-day commercial paper that companiessoldto the Federal Reserve will mature this week and next,central bank datashow. As much as $50 billion to $70 billion ofthe debt may be rolledover and bought by investors, according toBarclays Capital in New York.

TED Spread

The difference between what banks charge each other forthree-month loans and the rate the Treasury pays, the so-calledTED spread, narrowed to 0.95 percentage point yesterday, downfrom 4.64 points on Oct. 10.

TheChicago Board Options Exchange Volatility Index, ameasure of investorconcern about stock market declines, lost 47percent from its recordclose in November, according to datacompiled by Bloomberg. That was thesteepest 10-week retreatsince the gauge began in 1990.

Gold hasdisappointed investors before. While the metalreached a record in 1980,the closing price in 2005 was littlechanged from that in 1979. On an inflation-adjusted basis, goldcosts about the same as in 1981.

Fed officials warned this week of a prolonged globaleconomic slowdown that may push the U.S. to the brink ofdeflation.

‘Era of Deflation’

“Maybe this excessive easing will one day becomeinflationary, but we don’t see inflation this year,” said JamesSteel,an analyst at HSBC Securities in New York. “The climateis deflationary.Gold has never had a sustained rally in an eraof deflation.”

Steel expects gold to average $825 this year. The metalaveraged $872.25 last year in London and $873.98 in New York.

Bullionrose 11 percent in euros last year and 44 percent inBritish pounds,protecting holders of those currencies as thedollar strengthened. Goldreached a record in pounds on Jan. 23.

The gain in gold denominated in euros and pounds“represents a mistrust of global economies,” said GerrySchubert, a director at Fortis in London.

Fed Chairman Ben S. Bernanke, who has said he prefers theinflation rate between 1 percent and 2 percent, will miss histarget as the economy recovers, said John Brynjolfsson, amanaging director and the chief investment officer at hedge fundArmored Wolf LLC in Aliso Viejo, California.

“Itwould be absurd to think that Bernanke would be able tonail a 1 to 2percent Goldilocks inflation rate coming out ofthis,” Brynjolfssonsaid. “What you have is competitivedevaluation of all currencies aroundthe world. Precious metalsare the only hedge in this kind ofenvironment. The trend of goldover the next five years is a straightline toward $1,700.”

To contact the reporters on this story:Pham-Duy Nguyen in Seattle atpnguyen@bloomberg.net;Nicholas Larkin in London atnlarkin1@bloomberg.net