Good Afternoon,

Monday started off with a robust rally in commodities, pretty much across the board. Stimulated by the string of better-than-expected corporate earnings, investor's risk appetite appeared more like a major case of hunger (for speculation and profits). As a result, out they went overnight as well as this morning, and they bought up most everything in sight. Everything, that is, but the US dollar.

Currency speculators left the US currency in a ditch by the side of the road this morning, and it promptly lost 0.50 points on the trade-weighted index - sinking to the 78.87 mark. That is still where the dollar found itself this afternoon. The greenback is now trading at a one month-and-a-half low against the euro. At least one RBS analyst surveyed by Reuters sees the dollar/euro move capped at 1.46 and envisions a lifespan for this euro rally only as short as this week.

The hit parade of rising commodities in the wake of the aforementioned background, appeared pretty complete as of this morning: Iron inched past $90 for the first time this year, copper climbed to a nine-month peak, black gold blasted higher by almost 2% (reaching $64.75 per barrel), and nickel, aluminium, zinc, and lead were all showing gains of between 1.5 and 3.25 percent on the day in early going. The precious metals complex, therefore, was no exception.

Gold prices rose 1.50% in early trade. Then, having reached five-week highs of $956.30 per ounce, the yellow metal was once again seen bumping up against resistance at the upper reaches of its recent range, and it retreated to the $949.00 area by the afternoon hours. Gold market news on the fundamentals side was pretty much more of the same; namely that even though Indian gold sellers are apparently stockpiling gold ahead of Q4's festival season, the stockpiling is hardly from new imports. The country took in barely 12 tonnes of bullion in June - about 50% less than the same month last year.

New York spot dealings opened at $952.70 per ounce for gold, and were last trading at $949.70 per ounce. Participants remained divided as to whether bullion can make a successful upside break and try to test towards $975 or higher this time around, but there is something to be said for the summer spring in gold's step - and the swiftness with which it bounced off of the $905 area in just one week's time.

Players remain focused on the dollar/oil gyrations and were further emboldened in going long gold and other commodities by the overnight private sector rescue of lender CIT. News such as Germany's producer prices falling by the largest amount in 40 years did little to dampen the spirit of speculation that appears to have taken hold of investors since last week. If anything tempered price advances later in the day, it was oil giving up earlier gains to replace them with more modest ones, on the order of half-a-dollar by the afternoon. Still, at $64.16, the commodity presented sufficient gravitational pull to keep gold aloft near the $950 mark.

Silver gained 25 cents on the open, quoted at $13.66 per ounce, and then it fell back to $13.62 after a day of rather lackluster trading. Platinum rose by $11 to $1183 and palladium added $6 to reach $253 per ounce. Swiss bank UBS increased its platinum price outlook for the coming month to $1225 per ounce - a $50 allowance from previous forecasts. Palladium was seen at $240 for the upcoming period. General Resurrected Motors received three final bids for its Opel division, and Porsche appeared to finally be resigning to a VW takeover.

In our view, the euphoria and related summer munchies for commodities (and possibly equities too) might prove to be transitory, as speculators find themselves bidding some prices up beyond the tolerance limits of particular value envelopes. However, emboldened speculators were also seen in the equity market last week, and they appear to have made a comeback in the new one as well. The S&P took a 7% leap last week, completing a 40% comeback from the pits it reached only on March 9. Wherever you look, investors appear return-starved and are ready to pile money into various niches at the drop of a positive news item hat. However...

As we have learned several times during these past two years, bad economic news is but a couple of strata down below the currently glowing daily economic headline flows. In other words, it does not take much for sentiment to turn on a dime and risk aversion to rise yet again. The focus for the week, after earnings have been paraded in the markets, will be Ben Bernanke.

The Fed head has been urged to spell out how (if not when) he will perform a feat to outdo Penn & Teller - when it comes to taking out giant mop in order to dry the decks of the money-flooded economy. At the same time, Mr. B.B. cannot make the liquidity rabbit head for the hat and disappear too quickly. Indeed, an act that requires much talent and timing skills. Nevertheless, we do expect at least a portion of the currently bubbly inflationary expectations to be doused with cautionary words by this central banker. Please take your seats. Bloomberg's Rich Miller reports that:

To keep interest rates at a record low, Ben S. Bernanke may have to show Congress and investors he can be as creative about soaking up cash from the financial system as he was when pouring it in.

The Federal Reserve chairman will probably outline his strategy for exiting the biggest monetary expansion in history when he delivers his semiannual economic report to Congress tomorrow.

Among the options: establishing term deposits at the Fed designed to induce banks to keep money there rather than lending it out, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Bernanke needs to explain that the Fed has the tools to do the job and that it intends to use them forcefully when it has to, said Lyle Gramley, senior economic adviser with New York-based Soleil Securities Corp. and a former central bank governor. That would help hold down inflation expectations and give the Fed the opportunity to stay easier for longer.

House Financial Services Committee Chairman Barney Frank said he expects Bernanke to spell out how the Fed will end its unprecedented expansion of credit when he testifies before the Massachusetts Democrat's panel tomorrow.

'Prepared to Unwind'

I've urged him to be ready to tell people how he's prepared to unwind some of those facilities when it's prudent to do so, Frank said.
Bernanke is very conscious of worries that the Fed may end up rekindling inflation, the lawmaker said. Already, some investors are betting such concerns will force Bernanke's hand.

Trading in federal-funds futures suggests a better-than-even chance the central bank will raise its short- term interest-rate target by January from the current range of zero to 0.25 percent.

Interest on reserves is an important part of the exit strategy, Fed Vice Chairman Donald Kohn said at a conference at Princeton University May 23. The Fed's William Poole said it may not be so easy for the Fed to choke off credit expansion by raising the rate paid on reserves once banks start lending in earnest.

Historically, banks have had to fund new loans by adding to their liabilities, by issuing certificates of deposit or commercial paper, said Poole, a senior economic adviser to Palo Alto, California-based Merck Investments LLC. This time, they will be able to finance increased lending just by drawing on an asset they already are sitting on, which is the reserves at the Fed.

A possible way to counteract that would be by establishing term deposits at the central bank, where excess reserves could be parked for extended periods, rather than just overnight, Crandall said. The Fed might hold periodic auctions to encourage banks to leave the funds with it, he added.

U.S. central bankers have also mentioned using reverse repurchase agreements to help drain money from the financial system. In such a transaction, the Fed would sell bonds to Wall Street dealers with an agreement to buy them back later. Fed staff briefed policy makers on ways to exert greater control over the supply of reserves at their meeting on June 23- 24, according to the minutes.

Meeting participants agreed that the Federal Reserve either had or could develop tools to remove policy accommodation when appropriate, the minutes said.  

Investor expectations for inflation for 2015 to 2019 -- the so-called five-year, five-year forward rate calculated by the Fed -- increased to 2.79 percent last week from 2.1 percent at the start of the year. The rate, which is based on trading in Treasury Inflation Protected Securities, has averaged 2.66 percent since 2005.

What's got investors concerned is the combination of the Fed's expanded balance sheet, a record $1.8 trillion budget deficit and the building congressional pressure on the politically independent central bank, said Peter Hooper, chief economist for Deutsche Bank Securities in New York.

That raises the stakes and the potential for an inflationary misstep, said Hooper, a former Fed official. It's in the Fed's interest to reassure investors that won't happen.

Okay, in a few days' time we will know where the Fed chief stands on these matters. No cloak of silence over his testimony. Pssst....wanna know a possible secret? How 'bout a tacit, behind-the-scenes Sino-American monetary pact? Intrigue! Mystery!

As only Marketwatch's David Marsh can bring to the table:

Is there a clandestine understanding between the world's two most powerful central banks, the Federal Reserve and the People's Bank of China? Naturally, no one can talk about it, let alone confirm or deny anything. But it's not too difficult to make out the broad outlines of how Chinese-American monetary cooperation may be working.

People's Bank governor Zhou Xiaochuan and other figures in the Chinese leadership seem to use every opportunity to broadcast finely calibrated skepticism over the dollar's future. Such Jeremiahs feed on and -- in turn -- feed doubts about potential American inflation caused by the Fed's quantitative easing and exploding budget deficits. But both Washington and Beijing appear to recognize -- whatever the saber-rattling -- that large-scale shifts in the currency composition of Chinese currency reserves are more or less impossible. Roughly two-thirds of Chinese reserves of more than $2 trillion are thought to be held in the greenback.

Heavy Chinese sales, or even a deliberate policy of diverting export proceeds into Euro or yen by re-dominating sales contracts, would depress the U.S. currency and lower the value of Chinese reserves. It's the well-known Beijing dollar trap. And it has to be said: the Chinese have maneuvered themselves into it of their own volition, and in full knowledge of the potential problem.

So Governor Zhou's strictures are, to a certain extent, shadow boxing. However, in return for a tacit standstill agreement on the currency composition of reserves, the Americans have to acknowledge that the renminbi's value will rise only moderately. If the Chinese continue taking in dollars, logic tells us the Chinese currency can hardly revalue strongly. A signal of the U.S. authorities' acceptance of this state of affairs is that the word manipulation for Chinese currency management now clearly is banned.

There is another, still more intriguing, side to Chinese currency pronouncements. The doubts voiced from Beijing on the dollar's stability, far from unsettling the U.S. monetary authorities, are actually manna from heaven for the Federal Reserve. The Obama administration hardly can go in for years of reckless deficit spending when the country's largest creditor is emitting so many warning signals.

More importantly, the Fed is getting a certain amount of cover from Beijing for its eventual exit strategy -- a reversal of quantitative easing and a rise in interest rates as soon as economic recovery gets under way. The Chinese even are giving a strong tailwind to Fed Chairman Ben Bernanke's bid for re-nomination after his initial four-year term ends in January. The reason? With the Chinese appearing to turn the knife through gloom-laden dollar prognostications, President Obama knows that appointing a heavily political successor to Bernanke would be fraught with great risks.

Any Fed chairman who looks less than squeaky-clean on currency stability is likely to send dollar holders heading for the exits -- and could spark the full-scale currency collapse that Wall Street bears have been growling about for months.

So, if Obama wishes to replace Bernanke, he can do so only by bringing in a full-scale monetary hawk -- a step that he must rule out on domestic political grounds. The conclusion is that the Chinese maneuverings leave Obama with no choice but to re-appoint Bernanke, whatever the doubts about his stewardship that have arisen in recent months.

When Bernanke a little later this year eventually is confirmed in a second term of office, what's the betting that a laconic red-rimmed telegram from Governor Zhou will turn up in his in-tray? The missive and its contents, of course, will remain secret. We can only guess at the possibility that the two men, just for a moment, will share the opportunity for a modicum of discreet self-congratulation.

Two men. A cone of silence. All is well with the world.

A Good Evening to All.