Good Day,

Yesterday's non-surprise by the Fed was good enough for gold prices to come to within $1 of the $1100 spot offer mark during the early afternoon. The language used by the Fed was mostly similar to that which it used in previous recent statements. In so many words: the carry trade can live on for a bit longer, and spec funds can try to keep pushing various asset prices higher, regardless of fundamentals or possible consequences down the road. Fed fund futures were indicating smugness levels among speculators that stretch out into mid-2010.

Early on Thursday, gold prices fell for the first time in four, as a very small dollar recovery dented oil prices and elicited light profit-taking among metals specs. An overnight dip of 126 points in the Nikkei also contributed to uncertaitinies as the week's focus started to shift towards tomorrow's all-important US employment data. At last check, gold was seen at $1088.60 an ounce (off by $3.30) while silver dropped 7 cents to $17.37 and platinum lost $12 to $1353 per ounce. Palladium fell $8 to reach $320 an ounce. Once again, due to  (too much) travel we have to offer up outside quotes in a bit higher proportion than the norm, and post the comment prior to market opening.

Analysis from Belgium's GoldEssential tracks the on-going gold saga as follows:

A slightly higher dollar sparked some profit taking as charts have entered a short-term overbought condition and as resistance ahead of $1,100 is significant, said Matthias Detremmerie at Goldessential.com, who added traders were hesitating to add to the already lofty gains ahead of rate decisions by the BoE and ECB, and with U.S. non-farm payrolls
coming up on Friday.

A Reuters report quoting an ex-adviser and saying that the PBOC (Peoples Bank of China) would not be interested in buying a part of the IMF gold as Chinese gold was much cheaper, had little impact on the market thus far. Resistance at the $1,100 an ounce mark is however expected to be strong said Carl Johansson, Sr Precious Metals analyst at Goldessential, referring to the large open interest of call options for the December COMEX contract, with strike price at the level. Some 12,222 calls - the equivalent of around 38 metric tonnes - are currently situated at the $1,100 an ounce mark, Johansson said, adding that the writers of these call options would very much want the price to remain below this level, and may put up a fight.

A peculiar thing is that the open interest in the COMEX $1,100 December call option (EGCZC1100) moved up around 40 pct from some 9,000 to above 12,000 lots on October 15, the day the contract backed away from its previous record high of $1,072 an ounce, Johansson said, adding that most likely, someone or some may have thought that things had topped out and that it could prove lucrative to  write out these call options. Johansson believed that the writers of these calls could have had some sleepless nights recently, and that setting up a fight to safeguard the price from breaking too much above the $1,100 level could be a quite difficult task. Speculators are still hunting for it. There are no guarantees on both sides, although I expect the volatility to increase as the price nears that level.

The midweek analysis from Elliott Wave read as follows yesterday afternoon:

Gold's rise above $1063.40 early yesterday morning immediately shifted the odds toward the potential for the near-term rally to carry toward the $1100 level prior to completing wave B (circle). The rally from $1025.70 (Oct. 29) is a fifth wave, as indicated by the labels on our chart, the final leg of advance in wave (C) of B (circle). Yesterday's strong gain carried the Daily Sentiment Index (trade-futures.com) to 91 percent gold bulls from 83 percent the day before.

The single day 8 point jump in optimism is the largest daily increase since an 11 point jump from 75 to 86 from March 18-19, 2009, one day prior to the March 2o gold high ($967.95), which remained intact for two months. In addition, each of gold's prior short-term highs coincided with optimism pushing above 90 percent, which it now has. Based on the near-term subdivisions, it appears that prices have at least one more down-up sequence before we can count five full waves within wave 5, a necessary requirement to consider the wave structure complete.

Since wave 3 is shorter than wave 1, wave 5 must top below $1,113.10, after which wave 3 would become the shortest wave of waves one, three and five. This would violate one of Elliott's three main rules and requires us to readjust the way we interpret the wave labels. With silver still failing to confirm gold's push and with optimism back in the range of prior highs, odds favor that gold's surge is in its latter stages.

Anecdotally, the depth of belief in gold's unlimited upside potential remains strong, as our office is still receiving emails claiming that the U.S. Dollar is on the verge of being devalued, thereby resulting in an immediate doubling of gold's price to $2000. The U.S. dollar cannot be devalued because it's not linked, backed or convertible into anything, which would allow it to be devalued. Such was not the case back in the 1930s, when President Roosevelt devalued the dollar by raising the price of gold from $20.67 to $35.00. But back in 1934, one could, by law, convert their dollars into a set amount of gold. No such linkage exists today, making devaluation impossible. One could certainly argue, as the hyper-inflationists do, that the Fed and the U.S. government will monetize all debt, which would thereby drive down the value of the dollar. But these actions are different and separate from the strict meaning of devaluation. These facts do not preclude a further gold rally, but if gold does push higher, it will not be because the U.S. dollar is on the verge of being devalued.

Meanwhile, a veritable cage fight erupted in the media yesterday, following Nouriel Roubini's presentation a the Inside Commodities conference this writer attended yesterday. No sooner had the echoes of Dr. Roubini's words died down in he halls of the NYSE, that Jim Rogers launched a counter-attack of bullish words, which was then followed by an equally explosive retort by the NYU professor.

In short order, Mr. Roubini opined that the carry trade based on the practically zero-cost dollar is creating asset bubbles that are looking 'maternal' in character. Such bubbles- he said- will pop with devastating effects, making the crisis of 2008 look like a picnic by comparison.

Mr. Rogers, speaking from his Singapore neighborhood presumably, retorted that:

Mr. Roubini is wrong about the threat of bubbles in gold and emerging-market stocks. Many commodities are still down from record highs and equity markets aren't on the brink of collapse, Rogers, chairman of Singapore-based Rogers Holdings, said in an interview on Bloomberg Television today. The price of gold will double to at least $2,000 an ounce in the next decade, he said. 

He then went on to accuse the professor of 'not doing his homework -again. (Wait: wasn't it professors who normally hand homework out for others to do?). Anyway, the academic-versus-the-guy-with-a-commodities-book brawl went on for the afternoon:

Mr. Roubini, the economist who predicted the global economic crisis, said a forecast by investor Jim Rogers that gold will double to at least $2,000 an ounce is utter nonsense. There is no inflation or near-depression to drive gold prices that high, Roubini said today at the Inside Commodities Conference in New York. If a severe depression came to pass, with investors buying canned goods and hiding out in log cabins, maybe you want some gold in that scenario, Roubini said.

Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense, Roubini said. Gold rose to a record $1,096.20 today on the New York Mercantile Exchange's Comex division on speculation that central banks and investors will purchase the metal to hedge against a declining dollar. Rogers, who predicted the start of the commodities rally in 1999, said in an interview on Bloomberg Television today that Roubini is wrong about the threat of bubbles in gold and emerging-markets stocks. The price of gold will double in the next decade, he said.

In his New York speech, Roubini repeated his assertion that asset prices have risen too much, too soon, too fast. He's a New York University professor and chairman of New York research and advisory firm Roubini Global Economics.  It is very hard to justify oil going from $30 to above $80 based only on the fundamentals of supply and demand, Roubini said. Prices are in part a bubble, he said.

Position limits on oil trading, if they helped reduce volatility, may be beneficial because the swings in oil prices have been destructive to the global economy, Roubini said. Roubini predicted in 2006 the financial crisis that spurred more than $1.6 trillion of credit losses and asset writedowns at global financial companies. - so went the story on Bloomberg.

Finally, Seeking Alpha contributor Scott Grannis meanwhile posted the following blog entry last night, and parts of it arrive to the same conclusions as those of the professor's (at least in terms of the genesis of these bubbles):

Gold was in the news Tuesday, setting a new all-time high of $1085/oz. as of this writing. The first chart here shows nominal prices, while the second shows gold in constant dollar (real) prices. Either way you look at it, gold has enjoyed a pretty spectacular run since early 2001. At the risk of slighting the obvious geopolitical risks that motivate gold buyers these days, gold has for the most part benefited from years of accommodative monetary policy from almost all of the world's central banks.

Easy money helped inflate the housing bubble several years ago by keeping rates artificially low. Easy money works by effectively lowering the hurdle rate for purchasing hard assets. People must always ask themselves this key question before buying gold, commodities, or real estate: Will gold (or oil, or copper, etc.) prices in the future rise by more than the interest rate on safe assets? The lower the interest rate, the easier it is to answer in the affirmative.

Easy money thus erodes the demand for money and boosts the demand for hard assets, resulting in rising tangible asset prices. Money loses its value relative to things, and that's what inflation is all about. Rising gold prices are thus a signal that interest rates are too low and monetary policy too easy. There is more money in the system than the system wants, and that is the fundamental monetarist equation for inflation. That we haven't seen inflation show up in the CPI (well, at least not very much so far) is simply a reflection of the long and variable lags between monetary policy and the real world.

I've always thought that the primary objective of a central bank that chose to adopt interest rate targeting as its method for implementing monetary policy (as all major central banks have done) should be to pick the interest rate that leaves the market indifferent between buying government bonds and tangible assets such as gold and real estate. In practice, this could be described as a type of gold standard: the central bank should simply raise or lower interest rates (by selling or buying government bonds) in order to keep the price of gold within some specified range.

Shrinking or expanding the money supply in this fashion would automatically keep the market indifferent between buying financial assets and tangible assets, because it would avoid monetary excesses or deficiencies, and thus deliver an essentially zero rate of inflation. Such a policy would inevitably lead to a very low and stable interest rate environment. And that, according to supply-side tenets, would be the best way for monetary policy to stimulate the economy.

If the Fed were to do this today, what should its target price for gold be? That is a question that has no definitive answer, but I'm going to guess that it should be somewhere in the $400-500/oz. range. As it happens, the real price of gold over the past 100 years has averaged about $450. If $450 is the price of gold that corresponds to neutral or zero-inflation monetary policy, then gold today is trading for a premium of over 100%; buying protection against inflation in the gold market is very expensive. Put another way, the Fed is going to have to continue to stand pat, and/or inflation is really going to have to accelerate just to keep gold from falling. If the Fed were to tighten policy sooner than expected, and with vigor, gold prices could tumble dramatically.

I'm not arguing against an investment in gold today, since rising gold prices seem to be the path of least resistance for now, considering that with one single exception (the Australian central bank), the world's major central banks have given every indication that a tightening of monetary policy is unlikely in the near future. My point is that buying gold is a very risky proposition now that it is trading at these lofty levels. In a best-case scenario for gold, we might see it revisiting its 1980 high in today's dollars (about $1800), but in a worst-case scenario it might fall back to $400. That's a very lopsided risk/reward proposition (aka an extremely speculative investment).

What could drive the worst-case scenario? Gold prices are extremely vulnerable to the mere suggestion that the Fed might begin reversing its liquidity injections. Gold prices are also very vulnerable to signs of stronger-than-expected growth, since the market can easily put two and two together and realize that a stronger economy means an earlier and more aggressive monetary tightening.

And while on the subject of vulnerable gold prices, these same arguments hold for T-bond prices. Yields on Treasuries are very low, mainly because the Fed is expected to be very easy for a very long time. Even the slightest change in those expectations could result in a sharp rise in Treasury yields, and a significant decline in T-bond prices.

Yes, indeed, $400 (!) sounds as outlandish today as the $2000 (!!) target offered by Mr. Rogers. Or, the $8000 (!!!) an ounce prediction that was also floated at yesterday's gathering in New York. However, one recent Elliott Wave argument for perhaps $550-600 gold was also floated. It referred to the oft-cited gold perma-bull loss of purchasing power of the dollar since 1913 (the Fed's creation). That 96% loss is a 25x multiple. In order to offset such a decline, gold would have had to move be the same 25x factor, meaning, to about $500+  given its roughly $20 starting point at the time of the birth of the Fed.

Well, gold is more like 50x -plus from that same $20 an ounce. In so many words, according to that metric, overvalued by about $500 or $600. We will stick with the Kitco Gold Index fair value for now, a figure nearer $800, but cannot dismiss an eventual reversion to the mean - in a range of from $680 to $880 - if and when the Fed pulls the plug on the bathtub full of easy money with which spec funds are now playing in his niche.

Let the cage fight roll on. You just know it will.