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Stuck in the Middle
By Jon Nadler

This morning's encouraging gains in gold all but dissipated by the time the afternoon got underway, and in fact the active December contract did end on the negative side, losing over $3 today. Intense pressure from further declines in crude oil (following a surprise rise in inventories in the US) and an additional gain in the US dollar (to near 74.25 on the index) prevented the precious metal from regaining its composure following three sessions of significant losses. We can now add a fourth one to that string.

The markets in general (stocks aside) greeted yesterday's unsurprising Fed decision with little more than minor moves after it became evident that the central bank is now dividing its attention between growth (not happening just yet) and inflation (happening allright, and on the public enemy list at pole position). Then again, it could also be argued that the Fed's steady stance and the Dow's rally were likely (and in good part) the results of an oil price that has finally cracked (how does a 20% + 'crack' sound?), and of the most sizeable slump in commodities since 1980. Looks like the commodity markets may be doing the Fed's job on its behalf, at least as regards bringing down inflation. It's the growth part that has the sellers of commodities crowding the market exit doors.

New York's midweek session commenced on a firm footing, but ended up on the feeble side, showing gains of between $1.50 to $3.50 in spot prices as after-hours trading got underway. The combination of stern US words directed at Iran (it is continuing to stall on the offer from the West) and a second-quarter $821 million loss at already troubled Freddie Mac supported gold early today, but it was insufficient to stem the selling spillover effects from the oil pits. Based on NYMEX data, bets (puts) that oil will fall below $110 by December outnumbered calls by over 3-to-1. Yesterday's breach of the 200-day moving-average presents sizeable immediate problems for bullion and the continuing shrinkage in open interest, as well as the mounting losses in ETF ounces under management might be building a negative feedback loop at this juncture. Getting back to $900 remains the first order of business, but remaining gold players are much more apprehensive after the commodities complex recently gave a technical bear signal that remains difficult to ignore.

Even the euro which looked set to gain against the greenback on anti-inflation perceptions as regards the ECB, was not able to capitalize on those stories and was last seen at x1.542 against the greenback. The dollar is increasingly looking more attractive as it draws trend-followers and as the ECB stance is seen as a poker face trick in view of the region slowing, and as the yen suffers from what is apparently the end of Japan's longest postwar economic expansion. Whatever the dollar's problems (and they are not lacking) the alternatives are starting to look a bit suspect to players. About the only non-event in the markets today was the Dow's (thus far) "Ferris Bueller" kind of day.

Analysts at Danske Bank believe that with "gold prices crashing down below $900 per ounce in recent sessions the longer-term bull trend remains intact despite the weakness." Their indicators point to a possible correction of possibly no more than " 38.2% of the last bullish move and that such a Fibonacci retracement could bring gold prices as low as $740 before the bull trend reasserts itself." Other technical observer sources report/warn that a fall-off to $680 also cannot be ruled out, should gold fall out of its consolidation triangle along the lines of what platinum just did. Mind you, some chart strategies such as Elliott Wave have simply had to back to the drawing board as interpretations of hitherto imminent upswings were misinterpreted and the correction that was previously believed to have concluded, has done anything but. Silver rose 9 cents to $16.51 and it also gave up most of its early Wednesday gains.

Platinum added $37 and palladium $4 to reach $1592 and $351 respectively. A $10 billion hostile takeover bid for S. Africa's third largest platinum miner Lonmin supported the rise in the PGM complex abut also in gold, as analysts see the takeover play as a part of a consolidation trend for that country's mining sector that could hamper supplies to a degree. At least as far as gold is concerned, that may not turn out to be the case, as Russia's output is seeing double-digit gains this year and as China's production levels all but guarantee a second year of topping the list of global producers in tonnage terms.

While the news that perchlorate (a salt) was discovered on the Martian surface got a bit more attention in the news than the Fed's non-decision on rates, there are those who feel that, given the circumstances, the US central bank actually did the correct thing. Dissent continues to be part of the Fed's internal landscape. However, Bloomberg columnist John Berry has the following observations to tender:

"Federal Reserve officials, stuck between their conflicting goals of maximum employment and stable prices, chose yesterday not to favor either one. It was a wise choice.

Cutting the Federal Open Market Committee's 2 percent overnight lending rate target might have stimulated weak economic growth, at the risk of making inflation worse. Increasing the target in an effort to bring down inflation might have made the credit conditions plaguing the economy even tighter, undermining what growth there is. So the FOMC did neither, deciding instead to leave the target unchanged for the second meeting in a row while waiting to see how economic events unfold.

Actually, recent economic news hasn't been as bad as some gloomy analysts portray. The economy continues to grow, the number of payroll jobs is falling relatively slowly, and it just may be that the break in commodity prices that Fed officials have long expected is at hand. Crude-oil prices have dropped almost 20 percent over the past month, to $118.60 a barrel from a peak of $147.27. Corn prices have plummeted more than 30 percent, to $5.45 a bushel, over the same period.

Higher food and energy prices have been major contributors to the 5 percent increase in consumer prices over the past year. If the run-up slows -- or in the case of gasoline, reverses -- that would not only ease inflation pressures, it would ease some of the squeeze on consumers' pocketbooks and encourage more spending on other goods and services. Even in the face of soaring consumer costs, the gross domestic product increased at a 1.9 percent annual rate in the second quarter, with consumer spending bolstered by the tax- rebate checks many households received. Meanwhile, there are growing signs of stabilization in the hard-hit housing sector. New-home sales were higher this spring than originally reported, and sales of existing homes fell only 1 percent from December to June. And the backlog of unsold new homes dropped sharply in June. The slowing decline in housing was evident in the second quarter, when cutbacks in home construction knocked only 0.6 percentage point off the increase in the gross domestic product. That's an improvement over the fourth quarter of 2007, when the drag from housing reduced the GDP growth rate by 1.3 percentage points, and the first quarter, when it was 1.1 percentage points.

The second-quarter GDP number would have been considerably larger, except that a sizeable portion of the goods sold this spring came out of business inventories rather than new production. In fact, except for the big change in inventories, growth would have been at a 3.8 percent rate in the quarter rather than 1.9 percent. A significant improvement in the nation's trade balance also provided a large boost to growth. Chances are, growth in the second half of the year isn't going to match the second-quarter pace. Nevertheless, the incessant warnings that the economy faces a deep recession are overdone.

The FOMC correctly said that "downside risks to growth remain," including problems in financial markets. Those risks are diminishing, partly because of the Fed's active efforts to provide liquidity to the markets by lending cash and Treasury securities to financial institutions and primary dealers. So the Fed can do -- and is doing -- more than adjusting interest rates to support the economy. On the inflation front, there's good news in addition to the possible break in commodity prices.

One concern of some Fed officials has been that the jump in food and energy prices could cause workers to demand larger pay increases. That isn't happening, according to the employment cost index, the Labor Department's broadest measure of employers' labor costs. The ECI, which includes wages and salaries and the cost of benefits, rose 0.7 percent in the three months ended in June and 3.1 percent in the year ended that month, the department reported July 31. Both increases were smaller than those in the previous quarter and year. In other words, there is no hint of a wage-price spiral, with higher headline inflation spilling over in a significant way into core inflation.

While the FOMC said the inflation outlook "remains highly uncertain," it also said it still "expects inflation to moderate later this year and next year." That relative optimism has been based partly on the anticipation that commodity prices would stop rising rapidly and, possibly, come down. Richard W. Fisher, president of the Dallas Federal Reserve Bank, again dissented yesterday in favor of an increase in the lending rate target. At the FOMC's June meeting, Fisher said he wanted a rate increase because the risk that inflation would not moderate as expected "had increased substantially."

His counterparts in Philadelphia, Charles I. Plosser, and in Minneapolis, Gary Stern, who had indicated in recent weeks that they would like the target raised, didn't join Fisher in dissent. If the growth and inflation pictures aren't any clearer six weeks from now at the FOMC's Sept. 16 session, standing pat may again be the best policy choice."

Although we diverge in expectations as to how that September 16 meeting will eventually turn out, for the time being, this is the background situation, and it can be said that most of the available gauges and barometers are reflecting it fairly. Including gold.

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