Nobody Expects the Spanish Inquisition!

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Good Afternoon,

Continuing nervousness about...well, everything, initially supported gold, and to a lesser extent, silver, today. Four-month highs were achieved in gold intra-day (near $989) as the dollar touched the 1.60 mark against the euro for the first time and sank to 71.40 on the index. Oil started the day out very firm, at just above $146 per barrel, then retreated quite sharply, dropping nearly $10 on the day -its largest drop in three years - after Mr. Bernanke's live testimony stoked fears of a deepening US recession ( and thus, lower energy demand) on the horizon. Today's Capitol Hill proceedings had all of the trappings of an 'interview' at Gitmo - when it came to grilling Bernanke, Paulson, and Cox. They survived, albeit they may not have been able to convince every lawmaker that their assessments and/or proposals were sound.

The dollar climbed back to 71.75 on the index following the intra-day developments. Gold promptly fell away from the day's highs and was seen trading at nearly $20 lower than the $990 area by 11:30 NY time. At last check, bullion was up $3.60 at $975.70 as nervous trading continued in after-hours electronic dealings. Silver turned its early gains into a 15 cent loss to trade at $18.95 at last check. Platinum and palladium followed gold lower (the former declined $40 to $1961, while the latter dropped $8 to $441) in a sympathy move. GM's restructuring plans did not appear to offset fears of lower car sales. As previously opined, the yellow metal's price fate is still currently tied to that of oil, notwithstanding the recent quest for safe-haven purchases by investors.

Indeed, as we have said before, gold would not/ could not ignore a sizeable drop in crude oil, despite its recent popularity by nervous buyers looking for some protection from the financial fallout and that of geopolitics. The other thing is that the depressing prospects of a deepening US recession on the horizon painted by Mr. Bernanke today pulled the rug out from under oil's hitherto one-way marathon and took other commodity hostages with it. Silver, platinum, palladium lost significant ground following the Fed Chairman's take on the economy, and despite President Bush's markedly more optimistic views on the same.

Whether or not margin requirements being raised may have had something to do with the midday oil freefall, remains to be seen. At the end of the day, fears of lessened demand for 'stuff' have the commodity specs cashing chips in, as fast as they accumulated them on the way up. Witness the $630 million (!) that came out of agricultural commodity futures in the week that ended July 8th. Just how much of that exodus is due to the imminent restrictions on commodity speculation that U.S. lawmakers have proposed, remains to be seen. Our guess is, it is the majority. We reported just a couple of days ago that the third quarter was not shaping up to be the same in terms of fund participation in the hitherto white-hot commodity complex.

President Bush said today that these are times of "financial stress" and that temporary measures the administration has taken to shore up Freddie and Fannie, the lifting of the ban on offshore drilling, and the "basic soundness" of the system (FDIC, etc.) should have people taking a deep breath and pausing before they panic any further. His take on the situation did not manage to overcome the reality of his stimulus package yielding smaller than expected results in recent consumer spending patterns, or that of having to spend $5 per gallon of fuel to drive to the local IndyMac branch in order to stand in line and get whatever is left of your money out of there. As we mentioned this morning, rumour-mongering regarding the state of health of other banks and firms is being closely scrutinized by the SEC. We mentioned the concept of restricting shorting activities. During the day, a proposal for the SEC to...restrict the shorting of Fannie and Freddie shares. More restrictions, along different lines. Still, more of the same.

As for the Fed Chairman, today he opted to heavily tilt his Capitol Hill testimony towards the combat against inflation and in doing so, he disappointed stock buyers to the tune of a 200-point decline in the Dow. Following the drop in oil, the Dow's losses were all but wiped off the price tickers. The FOMC still appears divided between those who see "significant risk to the downside on growth" and those who are concerned that "at the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher."

In so many words, the Fed is worried about everything. At this juncture, we would be inclined to conclude that the rate hikes the central bank had likely planned for the September-forward timetable may well be pushed back until after the elections, or perhaps even to year-end. Odds of a 1/4 point hike have now fallen from 50-50 on Monday to between 17 and 32 percent for September and November, respectively. If we had to project odds of a second economic stimulus package having to be cobbled together within the same timeframe, they would likely be on the north side of 50%.

"The potential for runaway price hikes is the top concern of Federal Reserve policymakers, according to testimony by Fed chairman Ben Bernanke and the accompanying report on the economic outlook of his colleagues on the central bank released Tuesday. FOMC members were more uncomfortable about the inflation outlook in June than they had been at any point in the year, according to the Fed's monetary report to Congress. The Fed is worried that high oil prices, combined with the weak dollar, will increase business costs and prices. At the same time, it could make workers demand higher compensation because of the more expensive cost of living. As a result, most Fed members viewed the possibility that inflation could come in higher than expected in coming months." - Marketwatch

Another wave of buying followed by unexpected selling has gone through the boa's belly today. Unlike the boa however, the markets will not rest following the repast as participants will find fresh reasons to do more of the same as the new day dawns tomorrow. As (financial as well as geopolitical) uncertainty remains the principal shade (dark gray) in the global equation, we do not expect a lot of money to come out of gold for the moment. However, if oil continues along this new tack and the dollar proves for a second time that it is in possession of a base, that situation may change. Speculators better get used to such twists. Another thing to get used to is a further rise in volatility and daily ranges such as we observed today. In whatever order they happen first.