Saudis Say: May We (try to) Change Your Oil?

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Good Afternoon,

Friday's New York session had gold modestly on the downside for most of the day, as the trade tallied the results of an extremely choppy week and decided not to participate heavily at all. Amid lackluster trading, the metal bounced around following the dollar and oil, and eked out a $1.00 to $2.00 gain to $870.00 bid at futures closing time as participants geared up for the weekend. As opposed to last Friday, when the keyword for the day was "crude oil," the CPI numbers played the role of the 800 pound gorilla in the room today.

The inflation figure came in at 0.6% which was a .10 higher than expected (largely due to a 5.7% jump in gasoline prices) and although it was not quite pointing to an angry ape, the Fed clearly remains in no position to ignore the beast. However, since the numbers were more or less in line with market expectations, gold was able to regain some of the ground it had lost prior to the market opening and flip over into positive territory for the day. A loss of near 3% on the week will still be chalked up however and the metal has spent a period of only a few hours above $900 thus far in June.

We have now come to a juncture where high inflation and expectations of more of the same are (ironically) driving gold lower when they should be bolstering its oft-cited inflation-proofing qualities. The metal has its own 800 lb. gorilla in the room; the greenback specie(s). The dollar has just recorded its largest gain against the euro in three years. At last check, the currency was trading at 1.537 against the euro and was up .33 at 74.10 on the index. Gold, on the other hand showed losses of as much as 4.9% at one point this week, due to the shift in dollar sentiment and the extremely active official jawboning.

Some mild bargain-hunting is managing to keep the metal off six-week lows, we would expect some evidence of buying in India over the weekend) but the risk of further bouts of long liquidation has not abated. The period between the 17th and the 25th will be laden with economic statistics, however the consensus remains that even if the Fed does not yet execute a rate hike, it surely won't cut this time around, and will stress the urgency of inflation combat.

On the oil front, prices fell about $2 to $134.73 and lost about 2% on the week, amid news that Saudi Arabia plans for a 'sizeable' increase in output and says that its next meeting is intended to bring 'stability' to the world oil price. The kingdom's leaders see current values as threatening to derail the global economy and may have taken the pleas (as well as warnings of demand destruction) from part or all of the Group of Eight into account in making this decision.

Over in Japan, the Finance Minister of that country met with the Treasury's Henry Paulson and following their summit he was quoted as saying that the US and Japan need to 'coordinate actions closely because of the many risk factors.' Translation: The two countries will turn their focus on tackling the fires of inflation (fanned by surging oil, food, and other commodity prices) through joint intervention, if needed. Rising global inflation will also be at the top of the agenda of the meeting of the G-8 this weekend, and market watchers also expect some posturing from the participants as regards the desirability of a stronger US dollar.

A growing number of Fed and other central bank messengers have said that interest rates will have to rise, and now the game turns to guessing when such hikes will commence and whether the Fed will prove to be ahead of the curve this time, unlike where it was late last year with its cuts. According to Marketwatch, "Barclays Capital now expects the Federal Reserve to raise rates twice this year, starting in September. The U.S. central bank will increase borrowing costs a quarter-of-a-point to 2.25% when it meets in September and again in October, economists said in a research note Friday. The fed funds rate will increase to 3.5% by the end of 2009, they said."

However, this expected rise in rates translates into potential problems for other assets. Bloomberg reports that : "The specter of higher interest rates is negative'' for gold, said William O'Neill, a partner at Logic Advisors in Upper Saddle River, New Jersey. ``The dollar is the key to the recent slide, with oil taking on a secondary role. I see gold falling below $850 next week.''

On the other hand, there is some way to go before rates return to a level where they become so compelling that they leave no room for bullion in a portfolio: