Good Afternoon,

Gold experienced a day full of price jitters, fits, and starts in New York today, as players digested the near-term market fallout from the ECB rate cut and the state of the US economy. The US dollar, crude oil, and commodities had an active yet quite schizophrenic kind of trading session on this mid-month day. The metal came within a 90-cent thin hair of sliding under the $800 psychological support number, and traded up, down, and sideways with quick changes in direction most of the day. At last check, bullion was maintaining a $6 gain, hovering near $816.

Gold futures ended on the losing side for a fourth day and closed at a low not seen since December 9. Although it appears that for the time being at least - gold avoided the sub $800 zone, silver the sub $10.50 area, and the Dow the under 8000 level, the jury remains sequestered as to near-term prospects in these markets. Deflationary pressures and related psychology are taking hold further each day, and following each set of new economic data.

Commodities guru Ira Epstein from his namesake firm's offices in Chicago: A rising dollar coupled with falling energy prices is not inflationary. There is no inflation yet for gold to hang its hat on. Until inflation shows signs of surfacing, gold has a better chance of holding value off of shocks to world economic woes than inflation. That will change if the stimulus package and other moves world governments are initiating take hold. Inflation will return in a serious way but that time is not now. Deflation at anytime is something that can overwhelm Gold. It is Gold’s enemy.

Evidently, more economists are boarding the deflation train - one that appears to have already left the station and is picking up steam. Marketwatch's Deborah Levine has been gazing into the TIPS market and finds that:

Deflation has probably hit the U.S., the December consumer price index is expected to show Friday, and one gauge widely watched by the bond market indicates it may stick around for years to come. Economists anticipate consumer prices fell in December by 0.8% from November, according to a MarketWatch survey. This monthly decline would mean prices fell 0.2% from the prior year, the first year-over-year decline since 1955. Prices have already been tumbling at the wholesale level.

While much of December consumer price drop can be chalked up to plunging energy prices at year-end, deflation may not end there. The $530 billion market for Treasury Inflation Protected Securities shows prices are expected to continue dropping for several years as a shrinking economy curtails demand.

The market is forecasting a deflation scenario for years, said Tim Wilhide, co-manager of the $831-million Hartford Inflation Plus Fund. Nothing on the horizon says right now that the economy is turning around.

The gap between yields on regular five-year notes and five-year TIPS is negative 0.33 percentage point, suggesting consumer prices will decline 0.33% on average over the next five years. That difference is known as the break-even rate and is considered a signal for what investors expect inflation to be over the life of the debt. TIPS pay investors a coupon rate plus inflation as measured by the consumer price index.

Shorter-term TIPS are pointing to even more deflation, pricing in a drop of nearly 2% over the next year, Wilhilde said.

That's quite a switch from last July, when the break-even rate topped two percentage points as oil prices hit their record highs. The sharp drop-off in commodities prices since oil hit its $147-a-barrel record in July is one reason TIPS are now suggesting deflation over the coming years. Oil prices have dropped from around $92 a barrel a year ago.

Propelled largely by falling energy prices, a report Thursday showed producer prices fell 0.9% in 2008, the biggest since October 2006. We expect that the theme of global deflation is still set to dominate in the coming months, said Alan James, head of global inflation-linked strategy for Barclays Capital. But a particular dynamic in the bond market has also sent that break-even rate lower: As investors rushed to hide their money in the safest, most liquid assets -- conventional U.S. Treasurys -- demand for inflation-protected Treasurys has dwindled rapidly.

Distaste for TIPS has squeezed the break-even rate to levels some investors say belies the true inflation story.

The break-even is completely unrealistic, said Ellen Safir, chief executive and founder of New Century Advisors. Nobody is forecasting deflation out for five years when we think of what the government is geared to do to re-inflate the economy. She thinks return to eventual growth means TIPS are undervalued, because they aren't being discounted to account for any inflation that is sure to come back at some point.

Some economists do see deflation lasting through much of this year, however, and lingering longer if economic growth doesn't turn around. The big risk is that we don't see the economy pick up towards the end of 2009, CIBC Global Markets senior economist Meny Grauman said. If energy markets continue to slide lower, or even don't do much at all, that will make it harder to break out of the slide in the CPI.

The bank anticipates high prices from last year will propel more negative CPI readings, starting with December's figure. It then forecasts economic growth to resume by the very end of 2009, and with it, energy prices and inflation.

Silver was up 2 cents in the afternoon, quoted at $10.57, while platinum continued to give back portions of its previous gains, losing $10 to $919 and palladium was off by $3 to $178 per ounce. Support near $800-$805 really needs to hold at this time, lest the metal heads for a repeat visit of the $775 value zone.

The ECB signed on to the global rate-slashing campaign this morning by offering a half-percent chop of its own. The cut was in line with analyst expectations, but it also revealed internal discord at the central bank, much like the brewing battle of the hawks and doves at the Fed we reported yesterday. Facts are facts however, and the eurozone industrial output has swiftly gone from a -0.4% figure last June, to a -7.7% showing as of November.

Thus, the ECB took a big step in December by wielding a big knife and cutting 75 bp off its key lending rate. The euro already traded at a five-week low ahead of the rate cut announcement, but the dollar picked up steam against the common currency following the news. At last check, the greenback was at 84.43 on the index, and at 1.3086 against the euro. Oil prices fell apart today, and slid to the $33.20 level following OPEC statements that demand for black gold will drop again this year. So much for inflationary pressures coming from the oil pipeline. More and more firms (Morgan Stanley, Citi, Royal Dutch Shell) are sitting on black gold in storage on supertankers.

Judging by today's shave and a haircut, economic conditions have not yet made it into the comfort zone over in the Old World. As things stand after the adjustment, the ECB still has the highest lending rate among the big central banks. Room remains for further tweaks this year, as hardly anyone expects a quick u-turn in the regional economy in 2009. The general picture is agonizingly weak, with new car sales slumping, inflation rates slowing to a two-year low, and an implosion of epic proportions in Spain's formerly red-hot real estate market.

But, hey, who is to say that the landscape is much better over in the US? Not the headlines that show JP Morgan Chase's profits falling 75% to a puny (for it) $700 million net in Q4, or the ones that reveal opaque treatment of shareholders by Apple in the wake of its founder's health condition. Or, for that matter the news that B of A could use more billions on top of the 25 it already has received to help digest its Merrill purchase. Quite a costly Tums tablet, eh? You just know things are bad all over when Google (!) announces job cuts.

Today's cherry on top of the US economic and financial news sundae comes from exactly where you would expect it: real estate. US foreclosures rose 81% last year, to a number exceeding 2.3 million. Nevada and Florida lead the funeral march of overinflated properties falling into default. Built on easy (and that's an understatement) credit, the US real estate house of cards could yield another 5 to 8 million foreclosures over the next 46 months in the opinion of real estate experts.

US PPI numbers fell 1.9% last month, for a fifth straight month, while initial jobless claims were up by 54,000 last week amid continuing claims of 4.5 million. These stats, along with the factored-in ECB rate cuts could give the dollar some difficulty in making immediate further progress and therefore gold could benefit from a bit of a boost in the session, but the going will not be very easy. Resistance now looms where previous supports were taken out.

Tread very carefully,