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Mushroom Clouds and Friday Night Fights

By Jon Nadler       Printer Friendly Version
Jun 6 2008 3:20PM

Good Afternoon,

A staggering 8.5+ % upward move in oil (to a new record near 139) followed yesterday's already historic gains in the commodity and it promptly translated into a 2% gain in gold, a 2.6% fall in the Dow, and a near .80% drop in the dollar index. Pundits will spend the weekend sorting out whether the Friday spectacle in the pits was caused by the jobless numbers or hyper-greedy and/or fearful oil speculators. Essentially, gold today still looked like it was simply going along for the ride, no matter the magnitude of its gains. For that matter, so did everything else that was caught in the massive wake of the oil tsunami. If in fact the unemployment number triggered the chain reaction, then it once again became apparent that oil remains the primary beneficiary of most of the flight by funds from the dollar.

Oil traders (at least) also appear to be calling Mr. Bernanke's bluff as far as his resolve to curb inflation by raising rates. The talk of the day (once again) is focusing on how soon $150 oil will be achieved. Some say that before the July 4th holiday rolls around, we will already see this ominous number in oil. Others ponder whether the spike is a premonitory move based on rising apprehensions that someone (the US or Israel) will take pre-emptive action against Iran in the not too distant future. Whatever the reason, the amount of 'buy' tickets floating around today was impressive enough to bury whatever shorts were still alive in the oil pits at the start of the day. If there was ever an example of a massive blow-off top in a commodity, the past two days in oil will probably end up in textbooks some day. So will the gamblers who will lose their fortunes during this colossal event.

Some analysts feel that the Middle East situation partially contributed to today's spike, but that it is only a temporary boost. While Shaul Mofaz, Israel's transportation minister and a contender for the post of prime minister, did tell the Yediot Ahronot daily newspaper that "Israel will have to attack Iran if it doesn't abandon its nuclear-development program" Antoine Halff, head of energy research at Newedge USA LLC in New York, said that: "The Iranian risk premium which had left the market for some time is likely to return and hover over the market in the next few weeks," However, Mr. Halff also said that: "The knee-jerk reaction to the comments by Mofaz will wear off quickly because Israel would not broadcast its intention in this fashion." Our take is that Israel would prefer to contract the job out to the US in any case. Let's hope no one does anything, otherwise the summer could turn out to be a lot hotter than normal...

New York spot prices opened the day with a near 1% gain, and we wrote this morning that it looked set to rally back to $900 in the wake of the poor jobs report for May. Shortly after the loss of 49,000 jobs on the month was reported (albeit less than the 60,000 expected loss) the greenback caved to well under 73 on the index (73.45 at last check) and gold took off to a high of $900.40 in a classic knee-jerk reaction. The unemployment rate rose to 5.5% a .5% increase that represents the largest such spike in 33 years. Let's see how oil prices fare going forward as the 8.5 million jobless may not make it their first priority to fill up on a nice tankful or premium, or buy a brand-new gas hog either. If in fact the statistics are a harbinger of a deeper than expected slowdown, then oil has no business spiking in this manner and stoking inflation.

Gold spot was trading at $896 at last check, while silver rose a more modest 25 cents to $17.42 and platinum rallied $69 to $2075 per ounce. Palladium gained $6 on the day, quoted at $431 per ounce. Crude oil was ahead by nearly $10.00 at $138.00 per barrel. This week's losses were clearly erased for gold, but the structural shift in the focus of central banks away from growth stimulation to inflation combat means downside risk remains in the picture, short-term rallies notwithstanding. This is a sea-change, not some passing fad for jawboning about 'concern.' Toda's oil spike does nothing but further sharpen such focus and prepare them for direct action. Former St. Louis Fed President William Poole said today that -were he still at the Fed- he would be preparing the markets for imminent rate hikes. "Better to take your medicine now, than a bigger dose of your medicine later."

In the interim, news tickers flashed headlines of a second month of declining industrial production in Germany (the EU's largest economy) for April. Signs of cooling do not appear to play a role in the current mindset of the ECB however. In fact, the rate increase rhetoric was ratcheted up a further notch this morning in Euroland. This may not go over without a bruising internal fight at the ECB however. London's Telegraph reports that:

" Less than a year after the credit crisis erupted, the European Central Bank has shocked financial markets by making it clear it is prepared to risk a potential recession in Europe as it steps up the fight against inflation.

There could be a bloody fight at the ECB over rates

ECB President Jean-Claude Trichet spelt out to markets that it was in a "state of heightened alert" as the global spike in oil and food prices threatened to trigger a wider inflation spiral across Europe. The comments, made yesterday as the ECB kept interest rates at 4pc, sent European bond prices tumbling and the euro soaring.

Prices for European government bonds continued to fall today as traders rapidly unwound the earlier consensus that the ECB would eventually be forced to cut rates as the Eurozone slowed.

Charles Diebel, European bond strategist at Nomura, said: "They're sending a message that they will throw the economy into a brick wall and risk renewed credit turmoil if it means controlling inflation."

The ECB steadfastly refused to cut interest rates as the credit crisis flared, and its signal yesterday comes as the world's top central banks turn their collective attention to rising prices.

Federal Reserve chairman Ben Bernanke, who has slashed US interest rates by more than 300 basis points since September, this week left little doubt that battling inflation, rather than further easing in monetary policy, was now at the top of his agenda.

In the UK, Bank of England Governor Mervyn King has warned against the dangers of an inflation spiral and signalled rates are unlikely to be cut from 5pc anytime soon. Inflation is rising in all three economies - with it hitting 3.6pc in the Eurozone in May - and economists reckon that the central banks are mindful of the mistakes made in the 1970s when inflation was rampant.

Jim O'Neill, chief economist at Goldman Sachs, said: "The comparison with the 1970s has aspects of reality. That is at the forefront of central banks' thinking."

However, it's unlikely that the ECB will be able to raise rates this year without an internal battle on its ruling council that pits the faster-growing economy of Germany against Spain and Italy, where growth is anemic, according to Mr. Diebel.

"It's going to be bare-knuckle fight."

The latest economic data out of the Eurozone suggests that even the German economy - the region's standout performer this year - is now buckling under the weight of the rising oil price. Industrial production fell 0.8pc in April, figures showed today."

Mr. Bernanke may have an internal fight on his hands as well, should he proceed with his stated attack plan. However, he would ultimately be regarded in a much better light if he chooses to stick to his guns and not let the inflation hydra go on a rampage. Several Fed members have already warned that the non-stop rate slashing campaign should have been halted a while back, so in that sense the Fed fight might not be as animated as the one over at the ECB. There are those however, (politicians mostly) who keep preaching for any accommodation that is possible, to be given to the almighty consumer and to the institutions that have made some bad calls in their investments. For them, rates at zero are not good enough. Thus far, Mr. BB has emulated Mr. Trichet only verbally. Rate action from either side of the Pond may now be a matter of weeks. It could even turn into a contest as to which side hikes first 9

Stocks will not like today's data very much at all. But the street is getting used to the idea that such news is no longer a catalyst for a surprise Friday afternoon discount rate cut. That era has come and gone.

Watch for closing levels at or above $900 at 5:15 NY time, and (more importantly) for any words from any central bank on inflation, oil, interest rates. Perhaps even over the weekend. The oil market thumbed its nose at policymakers today. Don the wrestling gear.

Happy Trading,

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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