Good Morning,

After a somewhat slow start gold prices picked up the pace overnight as a softer dollar and mildly higher crude oil values lifted the mood and speculative appetite of players. Although thus far unable to break out of the price channel it has carved out recently, gold looks a bit more buoyant at this juncture and is likely to once again be seen testing the upper end of the range. However, aside from short-term fund plays following various economic or geopolitical news items, the bulk of would-be players remains sidelined ahead of next week's Fed meeting and is content to watch the dollar and oil for the moment as the technical side of the gold equation still points to better buying opportunities down the road.

Gold picked up about 1% on the open as the New York midweek session got underway. Spot prices rose $9.50 to $891.60 an ounce as crude oil gained nearly one dollar and approached $135 and as the greenback orbited around the $1.55 mark against the euro. Silver climbed 34 cents to $17.36 while platinum added $40 to $2093 and palladium gained $8 to $465 per ounce on anticipation of labour action in S. Africa in the coming week. The dollar picked up a few tick on the index this morning, rising to 73.66

FedEx delivered a package full of bad news to the markets today, sliding to a loss in its fiscal year's final quarter and sounding bleak on prospects for better times in the coming year. You already know the usual suspects the delivery giant has pointed to. One of them is the weak economy (albeit UCLA forecasters indicated that they do not expect a recession and see near 1% growth in the US economy instead). The other culprit on everyone's mind will be covered by US President Bush later this morning as he makes a statement on the matter. Wonder if it could have something to do with...offshore drilling?

Oil traders might have a busier day than they thought. Inventory data is also supposed to come into that market during today's session. Morgan Stanley's earnings fell by 57% and although it met analyst expectations, that news along with the one that Fifth Third will raise $2 billion and sell assets while reducing dividends provided a supportive environment for this morning's rise in bullion. Bank stocks have failed to take any comfort from the Fed's 'steady as she goes' interest rate posturing and are still looking at their tattered books while hoping that Dr. B does not decide to hike rates just yet. The Dow may not enjoy a very sunny day as it opens for business today...

Mark Hulbert has been watching the rapidly growing bubble that the oil market has become and has the following observations to offer in a Marketwatch article:

One adviser who has focused on the oil issue is John Dessauer, editor of the Investors World newsletter. In a recent communication to subscribers, he discussed the impact on the price of oil of the Commodity Futures Modernization Act, which Congress passed in December 2000. One consequence of that legislation, according to Dessauer, is that the oil market has been grossly distorted.

By how much? Dessauer estimates that if the government rolled back the regulatory changes made in that legislation, oil's price could fall back all the way to $80 per barrel. That would represent a 40% drop from where crude closed on Tuesday.

Dessauer's analysis should give pause to investors and traders alike. A market that could fall by that much for reasons having nothing to do with underlying fundamentals is not the kind of market that your Economics 101 textbook had in mind.

A possible comeback to Dessauer's analysis has to do with the role that arbitrage should be playing in stabilizing the oil market. After all, if oil's price is even close to being in a bubble, then why wouldn't arbitrageurs load up their portfolios with huge short positions in crude, poised to realize huge profits if and when oil's price dropped? At least in theory, their short selling should have already tempered oil's price rise and made it less vulnerable to the kind of market break Dessauer discusses.

The answer is that arbitrageurs do not play the role in practice that theory says they would. In practice, the arbitrage role is mostly fulfilled by a relatively small number of institutional investors such as hedge funds, which invest other peoples' money and often are highly leveraged. For both reasons, according to researchers who have studied arbitrageurs' behavior, they cannot afford to hold onto a short sale if it takes too long for it turn a profit.

As John Maynard Keynes famously once put it, the market can remain irrational longer than you can remain solvent.

If you have any doubt about the wisdom of Keynes' comment, just remember Long Term Capital Management, which went bankrupt in 1998 with investments that -- if held long enough -- would eventually have been profitable.

What role, then, do arbitrageurs actually play in practice? According to a famous study conducted in the mid 1990s by Harvard economist Andrei Schleifer and University of Chicago professor Robert Vishny, they more often become momentum players rather than hedgers: Rather than betting against an apparently obvious mispricing, they often will bet that a mispricing will continue and become even more extreme. Far from being part of the solution to market mispricing, in other words, they become part of the problem.

Back to oil watch and dissecting the news from the financial sector. As of this posting, the gold price had given up about half of its opening gains. The day's tone feels nervous and gloomy across several markets but no major breaks are expected.

Happy Trading.