Good Day,

Dollar weakness was manifest once gain as the new trading week got underway, with the US currency recording a fresh 14-month low against the euro overnight. The greenback also slipped on the trade-weighted index, losing 0.13 to 75.31 at last check. This morning's macroeconomic news reveals a mixed bag of confidence, one that is dependent on geography.

German consumer sentiment slipped for the first time in more than a year, as locals worry about continuing job losses. Over in the UK, in the midst of a rather nasty economic picture, business confidence levels rose to an 18-month high based on the latest survey.

New York spot bullion trading got off to a start slightly in the negative column for gold. The yellow metal fell $1.40 at the start of the session, quoted at $1053.40 an ounce, as against the aforementioned drop in the dollar index, and its small decline consisted of  about an 80-cent gain on dollar weakness-induced gain versus about $2.20 worth of declines on market-based selling. Thus, the net starting price outcome on the day.

Russia, which had increased its gold holdings by 74 tonnes in the year-to-date, now appears to be in need of selling about two-thirds of that accumulated pile before the calendar runs out on 2009. Silver was down 6 cents at $ 17.60 while the noble metals showed lackluster price conditions as Monday's action got underway. Platinum was off $2 at $1357 and showed signs of fatigue in trying for the $1400 area. Palladium appeared stalled in the $330s, falling $1 to the triple-three mark again, with little in the way of fresh, market-moving automotive world news.

Indian buyers made scattered purchases over the weekend, as Friday's mild drop in values attracted a few of them. We still cannot dismiss attempts by the funds to try to take prices to fresh records, but a the opportunities handed to them by a uni-directional dollar are becoming less abundant. In addition, a final push to 1080-1100-1130 could make the eventual readjustment more painful. 

In the interim, the disconnect in the views on potential inflation continues to be manifest as one examines gold and bond investors. SmartMoney finds as divergent a picture as can be had:

In theory, the direction of both gold prices and Treasury yields reflects what investors think about inflation and the health of the U.S. economy. But these days it appears the two are looking at decidedly different facts. While gold prices have soared to around $1,059 per ounce, the yield on the 10-year Treasury is only 3.4 percent, lower than early in the summer and lower than even a year ago.

Gold's steep price indicates that many buyers are sure the U.S. government's trillion-dollar deficit will lead to rampant inflation and a potential collapse of the U.S. dollar. Since gold holds its worth if the dollar loses value, it has been a haven for fearful investors for decades. But bond investors don't seem to be sweating at all. If they were really worried about inflation, analysts say, bondholders would demand much higher interest rates on Treasurys. In one market they're ignoring inflation's impact, and in the other they're banking on it, says Jeffrey Kleintop, chief market strategist at LPL Financial.

To which, we say, consider who is doing the 'ignoring' as well as the 'banking' - funds whose dismal 2008 experience is making for a 'shoot anything that moves' mind-set this year. The larger picture in the dollar and gold (still a case of inverted Siamese twins) remained mostly unchanged, as challenges of the 75 level on the index for the former are heeding the increasingly aggressive interventionist-flavoured central bank rhetoric.

The same background market fabric is applicable to gold, as fresh attempts to overcome the $1070 area have now become scarcer, and as short positions are starting to close the yawning gap that had previously pushed the ratio of longs vis-a-vis them to about 9:1 and had threatened to expand further. Analysis from GoldEssential.com received this morning paints the speculative positions picture as follows:

Our conclusion remains identical to previous versions in the sense that an unwinding of heavily piled up speculative long positions remains a tangible risk and a significant burden to carry for those anticipating on unidirectional upside potential.

The percentage increase in fresh speculative shorts has now been positive for three consecutive weeks, with them having increased 7.29 pct in the week to October 20th. Speculative short positions have risen 70 pct since having hit a low of 21,608 lots in the week ending September 29th, 2009.

Although the absolute increase of fresh speculative shorts has been less influential at 14,149 lots (around 47 tonnes), it could unfold into a bit of re-balancing, something where this skewed market has been long waiting for. Speculative long positions have decreased for the first time in three weeks (-0.47 pct), but remain around the 6.8-fold of existing speculative shorts.

Our conclusion becomes slightly altered in the sense that any short-term rebalancing of the disparity between speculative long and short positions may be less violent than anticipated on the short term, although the absolute level of speculative long positions remains worrisome and continues posing a very real opening of the floodgates type of liquidation risk should prices see a medium-term reversal or extended drop at one point, a scenario that is ultimately unavoidable.

So, how do things look -price wise/historically/based on mathematical counts- as concerns gold's recent achievements? Fresh analysis from BNP Paribas dissects the bug and finds the following structure and developing conditions (not far off our own mark, and still pointing to a spec fund and dollar-driven situation, exclusively):

Gold reached hit a new all-time high in October on 6th, 7th, 8th, 9th, 12th October, and then again on 20th October when it fixed at $1,061.75/oz. Looking back at the history of the gold price since 2003, over 1,714 trading days gold hit a new high (post-2003 . the 1980 high of $850/oz would remain so until 3rd January 2008) on 178 of those days (mostly from 2002 onwards), testament to the strength of its bull run. But many of those highs lasted just one or a few days.

There were five occasions it hit a new high which would not be seen again for months . on 5th February 2003 (when it took 149 days for the high to be beaten); 1st April 2004 (141 days); 2nd December 2004 (195 days); 12th May 2006 (341 days); and 17th March 2008 (382 days). After those highs had been reached, gold fell back, at its worst by 16%, 12%, 9%, 23% and 30% respectively.

This is the kind of correction of which many analysts . including ourselves . are fearful. If this was to occur, then from the current high of $1,061.75/oz, gold would fall back to a price of between $746/oz and $966/oz.

The time span for this to happen hitherto has been 44, 25, 44, 104, and 157 trading days after the peak, giving us a time somewhere between mid-December 2009 and May 2010. There are important internal dynamics . such as weak Indian imports and even weaker central bank sales . but all the action right now is investor-led [read: spec funds] and based on larger financial flows, most importantly the suggestion that the dollar is losing its global currency status. It is premature to put much faith in that however; if the dollar regains esteem, gold could get savaged, but perhaps not yet.

Another little thing to consider as regards funds and their recent 'activities' in the commodities sector, is the trend toward heavier regulation, more frequent and detailed reporting, and an augmented degree of visibility. Not exactly what they were looking for, but, hey, this is the post-crash era, no? Then again, one cannot say that some of this was not self-inflicted (see $150 oil)... BNP sums it up with a tidbit from the world of natgas - however, feel free to substitute that word with any softs, or metals, at will:

The announcement by the United States Natural Gas Fund (USNGF) that it will preemptively rebalance its portfolio of natural gas investments in anticipation of a CFTC clamp-down on position sizes, by reducing positions in listed natural gas futures in favor of increasing holdings of over-the counter natural gas swaps, is a sign of things to come.

Regulatory zeal has just become one more thing to hedge against. Inevitably, some will do it more successfully than others. The USNGF managed to re-jig its portfolio to include such a so-called regulators' hedge, while retaining a majority of its holdings in listed natural gas futures; smaller funds might find this sort of move more difficult to pull off. But tighter regulation will simply spur hedge funds to more...sophisticated ways of handling business.

For funds, it has been: Games without frontiers, thus far. But, it may not be war without tears, going forward. With apologies to Peter Gabriel.

Jon Nadler
Senior Analyst