Comex gold extends gains to as high as 1049.7 in European morning. Major reasons driving gold's rally are weak USD, inflation expectations and minimal sales from central banks.

The Fed has reduced the policy rate to 0-0.25% since late 2008, making it one of the countries offering the lowest funding rates. Last month, USD 'took over' Japanese yen as the funding currency for carry trades as the LIBOR rate for USD has dropped below than of yen. The dollar index slumped to 76.047, the lowest level in 13 months, in late September. G-17's non-intervening approach to USD's depreciation and RBA's beginning of the tightening cycle put further pressure on the greenback and the dollar index will likely resume its long-term downtrend soon.

Although global central banks have been emphasizing that inflation outlook is subdued, investors do not seem to hold the same view. In the US, University of Michigan survey showed that consumers anticipated inflation will reach +2.2% in a year, significantly above the current level. In fact, the Fed's rate cut to unprecedentedly low level, together with the massive fiscal stimulus as well as other money-printing measures, has generated much worries about hyperinflation should economic growth resume. In the UK, BOE's inflation attitude survey showed that consumers expected inflation to reach +2.4% in a year.

While IMF's sales of 403 metric tons gold in coming years does remain as an overhang to gold price, we do not believe it will have any material impact to gold price. As we mentioned before, the sales will be carried out in 4-5 years at market price and the IMF will ensure it will not cause fluctuation in the gold market. IMF's gold sales will be compensated by gold buying in central banks. Given the huge budget deficits in the US, global central banks have been diversifying away from USD. By August 19, gold sales under CBGA II were 149 metric tons, compared with 358.3 metric tons in 2007/08 and 475.8 metric tons in 2006/07.

Despite all the drivers above, recent strength in gold price should continue to weigh on physical demand. In India, gold imports plunged for a 5th consecutive month in September to 50 metric tons from 54 metric tons on annual basis. Analysts previously anticipated sales to accelerate as we enter Diwali, a Hindu festival, and typical Indian wedding season in mid-October. However, jewelry sales provably get hit this year as gold price rocketed.

While edging above 71, WTI crude oil trades in a relatively narrow range ahead of EIA's inventory report. Although the bullish API report yesterday signals pleasant surprise in today's reading, we believe crude oil price will remain bounded below 75. Record high stockpile and loose OPEC discipline are still concerns in the near-term.