Good Morning,

Gold prices regained 1% of the 3% they lost in yesterday's rout overnight, as scattered physical buying emerged in Asia. Reports from India show that demand dried up shortly after prices started to recover and buyers are still largely sidelined. Somewhat toned-down euro rate hike talk emerged from the ECB early today and was seen at odds with concurrent statements made by other officials about the same issue. To wit:

Reuters reports that the euro momentarily hit a session low against the dollar after European Central Bank board member Jeurgen Stark was reported as saying the central bank is not considering a series of rate rises, even as investors expect a hike in July. A matter of nuance, this. That the coming rate hike(s) are not intended to constitute a string is one thing. The fact that they are coming, is another. Reuters also reports that: European Central Bank (ECB) chief Jean-Claude Trichet, who shocked markets last week by saying ECB rates could rise next month, reiterated his comments on Monday.

Other European central bankers weighed in yesterday, with Erkki Liikaken, a Finnish member of the ECB’s rate-setting Governing Council, saying the bank was in a state of heightened alertness. Politicians joined the fray ahead of a meeting in Japan where food and fuel price inflation was expected to dominate talks among finance ministers of the Group of Eight (G-8) rich industrialised states. I think we need to take very seriously the concerns that have been expressed by the central bank, German Deputy Finance Minister Thomas Mirow said ahead of the G-8 meeting.

The US dollar headed lower this morning, losing about .25 on the index at 73.43 whilst crude oil gained $2.40 at $133.72 and that combination gave bullion additional energy to attempt to repair the fresh damage sustained on Tuesday. A few Asian central banks were seen trying to halt the greenback's rally by selling it to support their currencies (Thailand, S.Korea) but such action elicited ominous comments among currency strategists.

Bloomberg quotes Morgan Stanley's Stephen Jen as remaking that: U.S. policy makers have set the stage for ``outright intervention'' to sever a vicious circle between a weak dollar and high oil prices. The U.S. campaign for a stronger currency, aimed at containing oil prices, ``will work.'' Thus, risks of further declines remain in place for gold (see below) as the new anti-inflation/anti oil attitude among central banks is spreading and as the level of bargain hunting at recent lows was rather anemic. The $850 area continues to present a potential tipping point for the precious metal.

New York spot prices opened with a $9.40 gain at $876 per ounce. Silver was up 4 cents at $16.60 while platinum gained $27 to $2019 and palladium added $5 to $427 per ounce respectively. Today's economic calendar offers consumer comfort index figures and non-manufacturing activity level among other statistics. The focus among players remains on interest rate and inflation combat talk, although crude oil prices and anti-Iran rhetoric by Mr. Bush continue to be attentively followed as well. Thursday and Friday will offer more information about the state of the US labour market as well as more opportunity to move these markets more decisively.

Will the ECB celebrate its 20th birthday, or will 2018 see economic historians writing about the noble but ultimately flawed experiment that some see the single currency to be? We bring you excerpts from an article in The Guardian and let you make up your own mind:

The European Central Bank celebrated its 10th birthday last week with a giant cake and, four days later, out of the remains sprung an ugly rabbit: the central bank could raise interest rates next month to contain soaring inflation that is now running at almost twice its close to but below 2% target.

The brutally frank response by ECB president, Jean-Claude Trichet, to the first question at his monthly press conference not only broke with his typically arcane replies. It smashed the consensus among economists - and anxious political leaders - that a deteriorating eurozone economy would force the bank to cut borrowing costs later this year - or early in 2009 at the latest.

The ECB, initially, also appeared to have bucked the trend among central banks for cutting rates but, in fact, it really seems to be resetting the trend. In the US Ben Bernanke, Fed chairman, in a speech this week echoing Trichet's language about anchoring inflationary expectations, dropped a broad hint that America's central bank will raise borrowing costs later this year after shredding them to 1%.

In Britain even the Bank of England, caught between the devil (housing/consumer slump) and the deep blue sea (rising inflation), is starting to mutter the same language. It's been enough for money markets to price in rate rises in the second half of this year.

The ECB, intellectual child of the Bundesbank, according to the Financial Times, remains reviled among some (leftish) Anglo-Saxons for its hawkish counter-inflationary obsession - to the detriment of jobs and growth. But Trichet's argument is simple: the eurozone's 320 million citizens, soon to be joined by Slovaks, count on it to deliver price stability. In its first 10 years it has created 16m jobs as a result - 2m more than the model US economy.

It's not 1920s-style Weimar inflation he's worried about but that of the 1970s following the first oil price shock and the ensuing spiral via consumer charges and wage increases that cost millions of jobs. The ECB expects inflation this year to remain above 3% (3.4%) and forecasts it to be between 1.8 and 3% next year, proving to be more protracted than anticipated. Growth is expected to slow to around 1.8% in 2008. So economists are now accepting that the bank will raise rates by 25 basis points next month and then - a big maybe - give them one more tweak upwards before cutting again next year.

This may help inflation-wary Germany, the europhobes rail, but what about faltering France, immobile Italy, slumping Spain - and imploding Ireland? The tensions of running a single monetary policy for 15, soon to be 16, nations in contradictory stages of development will, they say or, rather, wish, cause the zone to burst apart at some point over the next decade.

Finally, Mark Hulbert over at Marketwatch keeps looking for gold's wall of worry and has thus far been unable to find it. This situation had him worried recently, and it turns out that the hunch was right. Now, he writes that:

Things were so grim in the gold market at one point on Tuesday morning that gold bullion was sporting a big loss for the day even while crude oil - its erstwhile partner in crime - was up for the day.

Contrarians were not surprised. Nor would they be surprised if we see more of the same in coming sessions.

That's because gold-timing newsletters are exhibiting too much complacency in the face of extraordinary volatility.

Consider the latest readings of the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the average recommended gold exposure among a subset of short-term gold timing newsletters tracked by the Hulbert Financial Digest. As of Tuesday night, the HGNSI stood at 33.9%.

That's right where this sentiment index stood two weeks ago, when I last wrote about gold market sentiment, even though gold bullion over the intervening trading sessions has fallen by about $30 per ounce. See May 29 column

That's not the kind of action that leads contrarians to conclude that a decline is not a serious one. That conclusion would require advisers to throw in the towel and argue that the gold bull market is finally over.

That's not what we're seeing now.

Other comparisons lead to a similarly grim forecast. Consider, for example, where gold sentiment stood one month ago when bullion was trading at more or less the same level as today. The HGNSI then was minus 10.7%, or some 45 percentage points below where it is currently. That 45-point difference is a good indication of just how much the wall of worry has evaporated.

When gold bullion does reach a more sustainable bottom, assuming that sentiment adheres to the historical pattern, pessimism will be so thick you could cut it with a knife. We're not there yet.

One of the reactions I received two weeks ago when I reached a similar conclusion is worth mentioning, since it is a good illustration of the sentiment pattern. The comment was that gold's volatility is of no real concern, since -- at least to this particular reader -- he invested in gold to build up wealth in an alternative currency rather than make a short-term profit.

That is a perfectly valid reason to hold gold. But, what's interesting to note from a contrarian perspective is that comments such as this one get made more often at some phases of gold's cycle than others. When sentiment is too bullish, for example, then investors are likely to react philosophically to any decline, rationalizing why the decline is of no real concern.

At other points in the market cycle, a decline becomes so serious to be of genuine concern, and at that point you will see far few holders of gold philosophically rationalizing why it doesn't matter.

When that happens, it is likely to be a bottom in the gold market of major significance.

Such findings are corroborated by a quick survey in various gold-oriented forums, where the bravado rages on with comments such as 'bring it on! and it does not matter! - aside, of course, from the incessant chatter about how each and every decline is evidence of manipulation. Wonder what last Friday's $25 rise was if that's the case. Probably 'reverse manipulation' of some kind.

Watch oil and keep listening for Fedspeak ahead of the pre-weekend economic data. A day of gains is welcome, but they seem as nervous ones given the current fluid conditions. Volatility will abound, at it will mainly be related to words from officialdom.

Happy Trading.