Good Morning,

A break to higher levels for the greenback against the yen was just one of the manifestation of a possible turn in sentiment among speculators early on Monday. Overnight trading (albeit without Japanese participation -as locals were out on holiday) saw a marked rise in the 'jitter factor' related to just how overbought commodities and oversold the dollar have become ahead of what might prove to be an important week, and not only in terms of jawboning by officials.

Gold opened the new week with a $9.50 per ounce decline, quoted at $997.00 as player selling brought the metal close to the $1K mark during the overnight hours and the tilt pointed lower as the bell rang at 8:20 this Monday. On the trade-weighted index, the greenback was last seen at 77.01 (up 0.56) and at $1.463 against the euro, while crude oil fell $1.86 to $70.18 per barrel, a victim of dollar strength. Options to protect against a more sizeable decline in black gold would cost one dearly today...In any case, watch the 77 index mark, the 1.46 euro level, and 70 oil. They have all played into the four-digit mark achievement for gold.

Silver fell 34 cents at the start of Monday's session, trading at $16.64 per ounce, while platinum sank $15 to $1313 and palladium dropped in sympathy, opening at $296.00 the troy ounce. The longs could still be seen trying to keep things aloft in this market, but the dollar will call the shots at the end of the day. And coming days, as well. Dissecting the market up to the 15th of the month, our friends at GoldEssential.com find the COT situation to offer...more of the same as seen in the preceding several weeks. Namely, that NSL to OI (net speculative length to open interest ratio) has hit a fresh record high, with absolute net speculative length now also in record-high territory.

Given price action is still seen hovering around the $1,000 an ounce area without making fresh record highs (yet), we believe that the over-extended long positioning poses a very real risk for prices to make a U-turn and head back to significantly lower levels. We reiterate that there - apart from the dollar decline - are little fundamental reasons to believe that gold should trade at or above current levels from a sustainability-point of view.

This is borne out of some of our own internal studies, as well. The nearly decade-long surge in gold prices is twice as large a story if you apply the dollar lens to the telescope (210%) as opposed to the lens that amalgamates other major currencies (112%). Where would we be today, when that bias is removed from the price equation? Nearer $771 to be exact. More on this, later.

As regards dollar decline and dollar recovery, in short order, the FOMC meeting, scheduled for mid-week, has dollar sellers worried that the signals coming from the central bank will contain not only the seeds for removing the hitherto ample stimulus, but a timetable and/or outline of 'how to' steps that will be part of the discussion. This, despite conditions in the US that reveal a shrinkage in  credit for the past half a year. In addition, fears of similar course-change actions being mentioned in the upcoming G-20 meeting, as well as the fact that the summit could yield tighter capital market regulation and divert players from overbought risk-laden assets had the trade on the defensive this morning.

Finally, on Friday, the Executive Board of the International Monetary Fund announced that it had approved the long-talked-about sale of 1/8th of its holdings, in a volume strictly limited to 403.3 metric tons, with these sales to be conducted under modalities that safeguard against disruption of the gold market. Reports (see Mineweb) indicate that such sales could commence by September's end.

Perma-bulls jumped all over the news and in an effort to keep the gold rally aloft for a while longer, declared China to be the undisputed taker of the institution's gold, despite China's indications that if such purchases were to take place, they need to be 'significantly under the market.' Therein lies the rub. The IMF's own parametres clearly indicate that the selling is to be done 'at market prices.' So, here we have the case of the seller coming to market at nearly a record level, whilst a buyer (and not just the Chinese) are facing a value proposition that leaves them wondering, to say the least.

Mind you, even if Beijing were to give the nod to such an acquisition, it would barely bring its gold holdings in line with the target of 2% of reserves it has set for itself. In that sense, with current holdings at barely 1.6% of  that total, the purchase should go a long ways towards achieving the mission. It's about price, at the end of the day however.

The question also is, if it took the central bank several years of semi-clandestine or virtually unnoticed forays into the gold market to acquire the last 400+ tonnes in its coffers, then why -suddenly-rush out and offer the plate in a public fashion? For the moment, discussion/speculation about the entire matter remains in the hands/mouths of the usual suspects: unnamed sources in China (academicians et alii) and starry-eyed newsletter scribes. We will leave it to post-G20 saysay (as opposed to hearsay) to learn any such facts and bring them to you as they occur, and if so. Thus, let's postpone the guessing and second-guessing until then.

Something else that appears to have been placed on possibly terminal hold, is TEOTWAWKI. None other that Nobel laureate Paul Krugman opines so. However, stepping back from the abyss still leaves the economic world on some jagged, threatening cliffs which will require the most careful of steps if the trek is to get back to solid ground.

Mr. Krugman specifically mentions and confirms at least two items of interest which have been heavily on our minds, as noted in several previous commentaries: China's inability to single-handedly throw the rescue rope out, and the utter collapse of world trade. Bloomberg fills us in on the professor's take:

The end of the world appears to have been postponed, Krugman, a professor at Princeton University, said at a seminar in Helsinki today. The world economy does not appear to be falling into an abyss but is still in trouble. The outlook is very fuzzy' and a W-shaped recovery may become U-shaped.

Germany, France and Japan emerged from recession last quarter, adding to evidence some of the world's biggest economies are over the worst. The U.S. recession probably ended in late July or August, Krugman said, after gross domestic product fell 1 percent in the second quarter from the prior three months.

The Nobel Laureate said the truly extraordinary thing has been the collapse of world trade, the subject for which he was awarded the prize last year, and he cast doubt on the potential for exports to lead the global recovery. He also said China's economy isn't big enough to serve as a growth engine. The problem is that this is a global financial crisis, he said. How can we have an export-led recovery unless we find another planet to export to? Krugman questioned whether China's economy is large enough to be a locomotive of recovery.

One of the reasons it's so difficult to tell a story about a fast recovery is the large surpluses in Asia, he said. If they can find a serious increase in consumer demand, that would help. We don't really understand why the Chinese savings rate is so high, but it's probably due to large precautionary savings. He warned that any decision by China to diversify its currency reserves away from the dollar would hurt Europe and Japan the most.

While budget deficits saved the world in the short term, for most people things are going to get worse, he said. Governments can help us cope with the crisis, but they have levels of debt that are sufficiently high to be a source of concern.

Even so, the recovery remains too frail to warrant scaling back support measures, he said. Exit from stimulus should certainly wait until we have clear signs that we're closing the output gap. This is no time to start exiting stimulus. Economies can suffer more than necessary if governments introduce austerity measures prematurely, Krugman said.

Obviously deficits are building up, but to respond with severe cuts increases the human and the economic cost right away. You do not want to inflict upon yourself the equivalent of an IMF program. You want to avoid doing that if you can. You have to keep an eye on the debt numbers but not panic over them if you can avoid it.

While, last quarter's drop in U.S. GDP was the fourth in a row, the longest contraction since quarterly records began in 1947, Krugman said the U.S. has $1.1 trillion in annual capacity staying idle. The U.S. consumer that's been such an important driver of the global economy, is exhausted, he said, forecasting U.S. unemployment may rise until early 2011.

Leading the recovery will be business investment, he said, but what's going to drive business investment? It would be very helpful if someone could make a discovery that would lead us out of this recession. If we can introduce effective climate change policies, particularly the cost of carbon emissions, that would be a reason to invest.

A good agreement at the forthcoming international climate change summit in Denmark wouldn't just be good for the planet, it would be good for the recovery, Krugman said. The crisis has hurt the euro in its 'competition' with the dollar, he said. The international role of the euro is that it has suffered a setback. The crisis has not been good for the euro and its competition with the dollar as the international reserve currency.

Krugan said he was concerned global efforts to emerge from the crisis could just drag on and on for a long, long time. The consequences of that are that you start to have problems with financing the debt and you start to have social and political problems, he said. My great concern is that this just drags on and on with severe consequences for political and social stability.

History is no guide to a path to recovery, he said. The trouble is, we really have no road maps. The only model is the Great Depression itself. That was ended by a very large spending program known as World War II and we don't really want to repeat that.

Until later, -and it looks like there will be a 'later' - happy Monday to all.

Jon Nadler
Senior Analyst
 
Kitco Metals Inc.
North America