Good Afternoon,

Although as yet unable to break out of the price channel it has carved out recently, gold looked quite a bit more buoyant today and was once again seen testing the upper end of its range. However, aside from short-term fund plays following various economic or geopolitical news items, the bulk of would-be players remained sidelined ahead of next week's Fed meeting and was effectively watching the dollar and crude oil for the Wednesday session. The technical side of the gold equation still points to possible better buying opportunities down the road. A breach of levels above $930 to $945 is required to get the bull back on the main track and right now the metal is still battling to get back to $900. Yesterday's rumor that Iran pulled $75 billion out of Europe and presumably bought 'some' gold with the money failed to move gold the slightest bit.

Gold picked up about 1% on the day and apart from a mid-morning dip, the metal retained the premium as the financial markets were rattled by more ominous forecasts. Spot prices rose $8.50 to $890.60 an ounce as the greenback orbited around the $1.55 mark against the euro. Silver climbed 30 cents to $17.32 while platinum added $31 to $2084 and palladium gained $7 to $464 per ounce on anticipation of labour action in S. Africa in the coming week. The dollar was basically hovering near 73.50 on the index this morning at last check.

The stock market had a migraine for most of the day, preoccupied with FedEx, Morgan Stanley, and Fifth Third. Background soothsaying by RBS calling for a major late summer stock implosion roiled market a bit today as did estimates that the aggregate cost of the credit black hole could reach $1.3 trillion. The interest rate hike camp promptly scaled back expectations to 50/50 and pushed timeframes back a couple of months on the news. See below why it may not be wise to start betting in either direction just yet.

FedEx delivered a package full of bad news to the markets today, sliding to a loss in its fiscal year's final quarter and sounding bleak on prospects for better times in the coming year. You already know the usual suspects the delivery giant has pointed to. One of them is the weak economy (albeit UCLA forecasters indicated that they do not expect a recession and see near 1% growth in the US economy instead). The other culprit on everyone's mind was covered by US President Bush later this morning as he made a statement on the matter. As expected, he called for a lift on the ban on offshore oil drilling as he pedals hard to appear as if he is doing something about the anger and frustration visible at gas stations across the US.

Oil traders had a busier day than they thought they might. While inventory data was supportive of initial gains, the Bush statement took some wind out of the speculative sails as it alludes to the beneficial effects on prices that such output might engender. The barrel of black gold slid to near $133 later in the morning. Morgan Stanley's earnings fell by 57% and although it met analyst expectations, that news along with the one that Fifth Third will raise $2 billion and sell assets while reducing dividends provided a supportive environment for this morning's rise in bullion. Bank stocks have failed to take any comfort from the Fed's 'steady as she goes' interest rate posturing and are still looking at their tattered books while hoping that Dr. B does not decide to hike rates just yet. The subject of who might raise rates first (or not) has many an analyst preoccupied these days. The UK's Telegraph reports on the subject and relays some ominous signs:

The clash between the European Central Bank and the US Federal Reserve over monetary strategy is causing serious strains in the global financial system and could lead to a replay of Europe's exchange rate crisis in the 1990s, a team of bankers has warned.

We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe, said a report by Morgan Stanley's European experts.

Just as then, Washington has slashed rates to bail out the banks and prevent an economic hard-landing, while Frankfurt has stuck to its hawkish line - ignoring angry protests from politicians and squeals of pain from Europe's export industry.

Indeed, the ECB has let the de facto interest rate - Euribor - rise by over 100 basis points since the credit crisis began.

Just as then, the dollar has plummeted far enough to cause worldwide alarm. In August 1992 it fell to 1.35 against the Deutsche Mark: this time it has fallen even further to the equivalent of 1.25. It is potentially worse for Europe this time because the yen and yuan have also fallen to near record lows. So has sterling.

Morgan Stanley doubts that Europe's monetary union will break up under pressure, but it warns that corked pressures will have to find release one way or another.

This will most likely occur through property slumps and banking purges in the vulnerable countries of the Club Med region and the euro-satellite states of Eastern Europe.

The tensions will not disappear into thin air. They will find fault lines on the periphery of Europe. Painful macro adjustments are likely to take place. Pegs to the euro could be questioned, said the report, written by Eric Chaney, Carlos Caceres, and Pasquale Diana.

The point of maximum stress could occur in coming months if the ECB carries out the threat this month by Jean-Claude Trichet to raise rates. It will be worse yet - for Europe - if the Fed backs away from expected tightening. This could trigger another 'catastrophic' event, warned Morgan Stanley.

The markets have priced in two US rates rises later this year following a series of hawkish comments by Fed chief Ben Bernanke and other US officials, but this may have been a misjudgment.

An article in the Washington Post by veteran columnist Robert Novak suggested that Mr Bernanke is concerned that runaway oil costs will cause a slump in growth, viewing inflation as the lesser threat. He is irked by the ECB's talk of further monetary tightening at such a dangerous juncture.

The contrasting approaches in Washington and Frankfurt make some sense. America's flexible structure allows it to adjust quickly to shocks. Europe's more rigid system leaves it with sticky prices that take longer to fall back as growth slows.

Morgan Stanley says the current account deficits of Spain (10.5pc of GDP), Portugal (10.5pc), and Greece (14pc) would never have been able to reach such extreme levels before the launch of the euro.

EMU has shielded them from punishment by the markets, but this has allowed them to store up serious trouble. By contrast, Germany now has a huge surplus of 7.7pc of GDP.

The imbalances appear to be getting worse. The latest food and oil spike has pushed eurozone inflation to a record 3.7pc, with big variations by country. Spanish inflation is rising at 4.7pc even though the country is now in the grip of a full-blown property crash. It is still falling further behind Germany. The squeeze required to claw back lost competitiveness will be politically unpalatable.

Morgan Stanley said the biggest risk lies in the arc of countries from the Baltics to the Black Sea where credit growth has been roaring at 40pc to 50pc a year. Current account deficits have reached 23pc of GDP in Latvia, and 22pc in Bulgaria. In Hungary and Romania, over 55pc of household debt is in euros or Swiss francs. Swedish, Austrian, Greek and Italian banks have provided much of the funding for the credit booms. A crunch is looming in 2009 when a wave of maturities fall due. Could the funding dry up? We think it could, said the bank.

Such a scenario could end up to the dollar's benefit as holders of euros could lighten up under those conditions and seek to court the greenback once again. Or, perhaps another, more attractive currency.

Markets remain nervous and are seeking direction as the amount of jawboning has declined dramatically from last week's levels and as the tone of the little that is being said sounds just a bit more...accommodative. This still leaves room for tests of higher resistance areas ahead of the tipping point that Tuesday's Fed meeting and Wednesday's decision might bring. Tread carefully.

Happy Trading.