Good Afternoon,

In a complete reversal (and then some) of Friday's powerful but mainly oil-driven rise, gold prices fell victim to selling pressure that (at least today) was mostly dollar-driven. While oil spent a good part of the morning on the plus side, gold's fall only accelerated once black gold started to come off in the wake of the greenback's rise. Dollar-supportive rhetoric rose several decibels overnight as US officials once again signaled that a floor needs to be put in place for the beleaguered currency and that they have laid out an arsenal of tools designed not only to achieve that goal, but also to get the dollar to strengthen from current levels. That message is now being hammered home pretty strongly, despite hecklers on the sidelines yelling: Too late!

Markets heard from President Bush who -without being prompted by reporters- indicated that his administration 'wants a stronger dollar' as well as from Chairman Bernanke who said that his institution would 'strongly resist rising inflation expectations' and finally from the Treasury's Mr. Paulson who said that he 'would never take intervention off the table or any policy tool off the table.' Recall that it would be the Treasury that would act to intervene, and not the Fed. The threat of a combined rate hike and currency intervention has put dollar sellers on notice that their nine month-old bear jamboree party is now taking place in a hall which the musicians have already left, and where the lights are out. Fedspeak continues in full swing this week, following a fairly major slap in the face by last Friday's oil market action. Its messengers are taking the red pen to formerly used euphemisms and replacing them with unequivocal action words.

Following several such influential endorsements, the greenback once again took off for higher ground and rose to 73.70 on the index, to a three-month high against the yen, and to 1.545 against to euro. Gold prices swooned by about $30 per ounce, to well under $870 following the show of force by the US administration, and after having touched lows near $863 during the session, tried to stabilize in the afternoon. Spot was indicated at $867.30 down $25.30 at last check. Today's readings of the pulse of the US economy showed a better than expected level of growth as seen in the largest export numbers in some four years. Unfortunately, the number was overshadowed by a more than $60 billion trade deficit in April, largely on account of oil prices. In any case, it appears more clear today that Friday's reaction to the jobless figures was not only exaggerated, but probably a misread of the overall status of conditions.

Crude oil took off in a significant way this morning (rising more than $3), after analyses of falling demand were seeing a supply side that remains unable to match them still. The day's session turned against it as well however, and the high-flying commodity found itself down by the same $3 at $131.07 as of the last check. Silver lost half a dollar to fall to $16.59 while platinum fell $47 to $1996 and palladium was quoted at $423 per ounce. Rhodium, which recently flirted with the 10K mark was off $225 at $9435 per ounce.

Developments on the oil front: The IEA lowered its forecasts for the average global oil product demand by about 80,000 barrels per day for the current year. Saudi Arabia called for an emergency OPEC meeting to discuss the 'unjustifiable' price of crude, while OPEC's Secretary General echoed 'great concerns about this increasing role of speculation' as a major component of the recent explosion in the value of dinosaur juice. Europe's truckers brought Spain's transport to a halt and are jamming highways from France to Portugal and to Scotland as the unrest among 18-wheelers threatens to spread while various governments try (thus far, unsuccessfully) to mitigate soaring fuel prices.

An interesting and (likely) controversial commentary appeared in the Asia Times overnight. It was written by Thomas Palley, the founder of the Economics for Democratic and Open Societies Project. We bring you the text in full - it will raise objections to be sure, but it is an important read at this juncture.

US Federal Reserve Board chairman Ben Bernanke has recently been on the receiving end of significant criticism for his monetary policy. One approach can be labeled the American conservative critique, and is associated with the Wall Street Journal. The other can be termed the European critique, and is associated with prominent European economist and Financial Times contributor, Willem Buiter.

Both argue that the Fed has engaged in excessive monetary easing, cutting interest rates too much and ignoring the perils of inflation. Their criticisms raise core questions about the conduct of policy that warrant a response.

Brought up on the intellectual ideas of Milton Friedman, American conservatives view inflation as the greatest economic threat and believe control of inflation should be the Fed's primary job. In their eyes, the Bernanke Fed has dangerously ignored emerging inflation dangers and that policy failure risks a return to the disruptive stagflation of the 1970s.

Rather than supporting cutting interest rates as steeply as the Fed has, American conservatives maintain the proper way to address the financial crisis triggered by the deflating house-price bubble is to re-capitalize the financial system. This explains the efforts of Treasury Secretary Henry Paulson to reach out to foreign investors in places like Abu Dhabi. The logic is that foreign investors are sitting on mountains of liquidity and can therefore re-capitalize the system without the US taking recourse to lower interest rates that supposedly risk a return of '70s-style inflation.

The European critique of the Fed is slightly different and is that the Fed has gone about responding to the financial crisis in the wrong way. The crisis, in the European view, constitutes a massive liquidity problem, and as such the Fed should have responded by making liquidity available without lowering rates. That is the course the European Central Bank has taken, holding the line on its policy interest rate but making large quantities of liquidity available to euro-zone banks.

According to the European critique, the Fed should have done the same. Thus, the Fed's new Term Securities Lending Facility, which makes liquidity available to investment banks, was the right move. However, there was no need for the accompanying sharp interest rate reductions given the inflation outlook. By lowering rates, the European view asserts, the Fed has raised the risks of a return of significantly higher persistent inflation. Additionally, lowering rates in the current setting has damaged the Fed's anti-inflation credibility and aggravated moral hazard in investing practices.

The problem with the American conservative critique is that inflation today is not what it used to be. Inflation in the 1970s was rooted in a price-wage spiral, in which price increases were matched by nominal wage increases. That spiral mechanism no longer exists because workers lack the power to protect themselves. The combination of globalization, the erosion of job security, and the evisceration of unions means that workers are unable to force matching wage increases.

The problem with the European critique is it overlooks the scale of the demand shock the US economy has received. Moreover, that demand shock is continuing. Falling house prices and the souring of hundreds of billions of dollars of mortgages have caused the financial crisis. However, in addition, falling house prices have wiped out hundreds of billions of dollars of household wealth. That in turn is weakening demand as consumer spending slows in response to lower household wealth.

Countering this negative demand shock is the principal rationale for the Fed's decision to lower interest rates. Whereas Europe has been impacted by the financial crisis, it has not experienced an equivalent demand shock. That explains the difference in policy responses between the Fed and the European Central Bank, and it explains why the European critique is off the mark.

The bottom line is that current criticism of the Bernanke Fed is unjustified. Whereas the Fed was slow to respond to the crisis as it began unfolding in the summer of 2007, it has now caught up and the policy stance seems right. Liquidity has been made available to the financial system. Low interest rates are countering the demand shock. And the Fed has signaled its awareness of inflationary dangers by speaking to the problem of exchange rates and indicating it may hold off from further rate cuts.

Keep alert for more dollar talk and look for the possibility of slipping back towards the $850/$845 area. We were justified in our skepticism of last week's rise, as it was essentially oil-driven. Should gold reach and/or breach the $845/850 area, the path would be open for a drop of anywhere from $800 to $825 as a first possibility. We will soon bring you some surprise news and analysis, from the International Precious Metals Institute meeting in Phoenix, Arizona. A Clue: It will contain keywords such as: silver...manipulation...shortages...shorts...and...naked! Film at eleven. Or, film on the 11th, to be more precise.

Happy Trading.