Good Day,

Overnight action in the gold markets provided little substantive change from the approximate levels seen last Friday, as the metal dipped to $985 but also covered the upper end of a narrow range near $995. Having reached a two-week low, gold is possibly setting up for a potential push back towards higher ground but failure to elicit robust demand from physical buyers and the apparent yawn with which the metal is greeting the machismo displays out of Iran has traders on the alert for possible tests of support near $975 as well. Monitoring the closing levels will become an important sport for the next several sessions in precious metals. The dollar was trading higher at last check, hovering just under the 77 mark on the index, while crude oil lost about half a dollar and sank to $65.50 per barrel.

Our friends at GoldEssential.com sum up the latest COT reports as follows:

We see that evolutions in speculative open-interest are still skewed to the bullish side, as no net liquidation amongst speculative long positions has been witnessed over the last week five weeks. However, the evolution in fresh speculative short positions has been equally positive over the last three weeks, reflecting increased beliefs
that prices will decline.

Moreover, the momentum of the increase in speculative long positions has markedly slowed down after having peaked three weeks ago (Sep 8; +22 pct, Sep 15; +5 pct, Sep 22; +1 pct). We furthermore note that extended readings on the NSL to OI indicator (net speculative length to open interest ratio), which sits at a record high,
have increased the downside risks in price action from a speculative
positioning point-of-view.

Given price action has not yet convinced above $1,000 an ounce area in our opinion, having so far failed to record fresh record highs, 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. Short-term inflationary
threats still read low risk.  As such, we are convinced that what has recently pushed prices from $950 to above $1,000 has had a speculative origin, which is eventually expected to run out of steam and find itself in a tough environment.

We still feel that medium-term corrective pullbacks towards $850 (3-6M) would result in a healthier market, but acknowledge that the current conditions remain favorable for a (short-term/lived) speculative blow-off
to the topside, although with risks for the latter scenario slightly reduced in comparison to last week's analysis.

Due to travel schedules we will not be able to give you live pricing at this point, but note that -at last check- gold was trading unchanged at $990.70, silver was down 5 cents at $15.99 and platinum was higher by $2 at $1275 per ounce, while palladium dropped by the same amount, easing to $288 per ounce.

While the FOMC meeting and the G20 meeting failed to yield concrete statements about when (not how) the Fed would begin to mop the liquidity-flooded decks, there are writers who keep a vigil on, and dissect the indirect jawboning coming from central bank officialdom. One such piece surfaced just over the weekend. Take note:

Policy wonks in Washington do not publish articles in major periodicals such as The Wall Street Journal in an attempt to develop a byline. Given the impact of commentary provided by high ranking officials within the Federal Reserve, any article would be reviewed multiple times prior to submission. The Fed wants to be sure any commentary is properly nuanced so as to send the desired message, while not unnecessarily upsetting the markets.

I enjoyed reading the tea leaves embedded in just such a commentary, The Fed's Job Is Only Half Over in today's WSJ. The writer, Kevin M. Warsh, is a senior Fed official and a member of the Federal Reserve's Board of Governors since 2006. Mr. Warsh writes in a very professional fashion while laying out the Fed's actions to date. His commentary gets most interesting in looking toward the future. While not negating the Fed's policy statement released the other day, Warsh leaves little doubt as to which way the Fed is leaning:

In this environment, market participants and policy makers alike should steer clear of ironclad policy prescriptions. Nonetheless, I would hazard the view that prudent risk management indicates that policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities.

What is Warsh saying? The Fed is going to need to withdraw liquidity from the system sooner than what economic indicators may indicate or market participants may desire.

Whatever it takes is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If whatever it takes was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Federal Reserve's institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.

What is Warsh saying here? The Federal Reserve can not simply flood the system with liquidity to the benefit of market participants, but without thoughtfully considering the loss of its credibility.

Why is Warsh, on behalf of the Fed, releasing this commentary? In my opinion, I believe the Fed is becoming increasingly concerned that excess liquidity has flooded the system, driven asset levels too high, and the dollar too low. In the process, if liquidity were to continue to flow, the cost could be a dangerously precipitous decline in the value of the greenback.

Add it all up, and although the Fed does not want to spook the markets, this statement is an indication that the Fed is getting ready to take its foot off the accelerator. In the process, our equity markets should give ground.

Off to catch a(nother) plane.

Jon Nadler
Senior Analyst