Good Afternoon,

Wednesday's gains in gold were easily undone overnight, and prices fell sharply for most of Thursday's session as the market's roller-coaster pattern continued amid the high-noon standoff developing between the Fed and the US dollar's morticians. Depressed by a surging (up .64 to 73.87 on the index) US dollar and an initial $3-$4 slide in crude oil the precious metal gave back all of yesterday's gains and fell to a low of $856.50 in active trading this morning.

Strong anti-inflation rhetoric from the Fed's Mr. Plosser (he said interest rates will have to rise) augmented expectations of US interest rate hikes and pushed their possible date of enactment closer to the present. Adding to the dollar's rise were reports expecting retail sales in the US to show a decent gain in the wake of stimulus cheques which were mailed to US taxpayers finding their way into store cash registers in lieu of bank savings accounts, as some had expected.

New York spot trading was last quoted at $870 bid per ounce, as players took cues from a recovering crude oil price in the hour after lunch. The futures session ended with a near $11 loss on the day. The gain in retail sales (up 1% to the strongest level in six months) adds to the case being made for a hike in interest rates. Initial jobless claims moved higher, adding 25,000 individuals to those filing for benefits and import prices rose 2.3% due largely to oil values. Two heads rolled at Lehman today, but the news barely moved the tilt meter in the markets (ex. Lehman shares which continued under pressure after a brief rise).

The US dollar broke through the 74 level shortly after the retail numbers hit the wires, but spent the rest of the session near 73.90 on the index. Silver was off 34 cents to $16.50 while platinum lost $17 to $2026 and palladium rose $11 to $436 per ounce. Bond and treasury markets are now pricing in a 125 basis point rate hike by this time next year, and a 50 basis point increase by Q3/Q4.

We had cautioned that this was going to be an especially intensive Fedspeak week, and it appears as though its spokesmen have hit every mike at every podium with an Is this on? test before talking very emphatically about inflation combat. Such jawboning has been the subject of several tests by now (such as we saw last Friday and yesterday) but looks like it is gaining traction with investors, at least as evidenced by the latest price metrics in commodities and currencies.

Speaking of jawboning, we bring you relevant statements from and address by Federal Reserve Bank of St. Louis President James Bullard (as quoted on Bloomberg):

Policy makers should act later this year to prevent a jump in the inflation rate anticipated by the public that would threaten the central bank's credibility.

The Fed's current low target interest rate ``might generate inflationary problems,''

``If we don't take action and stay on top of the situation,'' the rise in prices will probably accelerate.

``After a 10-month period in which the dominant policy concern has rightly been the state of financial markets, policy can begin to address pressing inflationary concerns during the remainder of the year.''

Reducing the fed funds rate to 2 percent was a ``preemptive'' move aimed at calming financial markets and may not be appropriate as markets stabilize.

The rise in inflation ``since 2004 has been due, in large part, to the rapid increase in energy and other commodity prices.''

Keep an eye out for the dollar at or near 74 on the index, watch for further profit-taking in crude oil and most importantly, remain on alert for a gauge of how substantive the support above 850 proves to be, and whether any robust bargain hunting emerges at current levels. India's physical offtake could show signs of life near these levels, albeit Western investment demand is remains lackluster as speculators are either mesmerized by oil or fearful of the course the dollar has embarked upon. Market observers remain apprehensive about the paltry additions to the gold ETFs that have been recorded since the massive 85tonne (about 10% of balances) outflow in April. The gold outlook report from HSBC characterizes the situation as follows:

While no published data are available, we believe hedge funds have been especially active in the ETF space for several months. That would explain the rapid increase in ETF redemptions recently. The combined WGC-sponsored ETFs plus Barclays iShares, which comprise the bulk of ETF gold holdings globally, reached a peak of combined offtake of circa 890 tonnes of gold bullion on 13 March of this year. In just six weeks, the figure dropped to 805 tonnes as of 30 April.

Such redemptions in the heretofore firm ETFs, if they signal a qualitative change in investor sentiment, might imply further price weakness. Put into perspective, the level of redemptions in the ETF for that period, is the equivalent of nearly 40% of annual South African output. If redemptions of that magnitude continue, not only could they call into question the notion that ETFs represent near-permanent bullion offtake, but further liquidation could weigh heavily on prices. That said, it is still our view that the bulk of gold ETF investors are likely to hold gold over the long term.

Happy Trading.