Gold - Forex Correlations Reaching Record Levels for Commodity Currencies

Crude Oil, Gold to Recover as Soft US Jobs Report Stokes Dovish Fed Bets

Crude oil, gold and silver prices are likely to recover as April’s US jobs report returns the worst outcome in three months, hinting the Fed will be slow to unwind stimulus.

Crude Oil, Gold Decline as Traders Begin to Position for the Expiry of QE2

Crude oil, gold and silver prices pushed lower as traders seemingly began to reposition for a world without QE2, weighing on inflation bets and sapping risk appetite.

Guest Commentary: Gold & Silver Outlook 05.05.2011

Gold and silver continue to fall for the third straight day; let's examine the precious metal market for today, May 5th.

Gold Pushing Daily Record Highs

U.S. Dollar Trading (USD) the USD hit fresh year lows against most currencies in Europe overnight but pared back those losses in the US session on profit taking. Weekly Jobless claims jumped to 429k vs. 392k expected. Q1 GDP also missed at 1.8% vs. 2.0% forecast Q/Q. In US stocks,

Radiation Levels Rise in Asia - Oil, Gold, Stocks and the USD Fall

The main focus of the markets remains being the Japanese nuclear issue in Asia, and the Portuguese debt problem and the Libya War in the West. Portugal`s yields are already at unsustainable levels, and there is talk of the President forming a caretaker government to pass a new budget, with the purpose of implementing austerity rules and reinforcing confidence to allow a refinancing of the June redemptions. We doubt that the President will choose this path, since the budget is a major point of contention in the political field, and an aggressive stance may well lead to a backlash from the new parliament, which could potentially complicate an already difficult situation.

Meanwhile, representatives of 40 nations from the E.U., the Arab League and NATO will be meeting in London today to discuss the future of the operations against the Libyan regime. Today news reports speak of the Colonel`s forces defeating and pushing back the rebel army from some of the coastal cities that they had gained on Sunday, but there is no sign of the initiative changing hands as the bombing campaign goes on. Statements from the U.S. side have detailed plans to use low-flying attack planes in ground attacks against the Libyan Army, and it is clear that pressure will be kept up. On the domestic front, a recent poll has shown that support for the Libyan campaign among U.S. Citizens does not exceed 48%, which is the lowest level of support for a military operation at its inception so far, and does not bode well for the president`s popularity if results are not obtained soon. If the campaign ends prematurely, oil prices could naturally see a significant correction.

In Asia, reports of higher-than-natural radiation levels have been emerging across a wide region. USA, Vietnam, Korea, and China have discovered radioactive particles in the air, but the authorities insist that the level of detection remains very low, posing no significant hazard to public health for now. The death toll in Japan has reached over 10,000 as 17,000 people remain missing, while cooling efforts at the reactors continue in spite of very high radiation readings. The latest reported leak of plutonium has compelled the government to publicly discuss plans to temporarily nationalize TEPCO, on the back of complaints that the company has not been responsible and effective enough in battling the crisis. The PM Naoto Kan has described the situation in Fukushima as "unpredictable", while Yukio Edano has characterized the same as being "very grave". 

Interestingly enough, the FX market is somewhat more optimistic today than the stock market, which is performing rather poorly on a global scale. The USD is lower against most peers, but up with respect to USD JPY, which is usually a sign of improved optimism. On the other hand, gold and oil are both lower, but the downtrend does not show a lot of signs of conviction, and could reverse rapidly and easily if the factors that dampen global sentiment once again dominate news reports.

Libyan FM Defects as Gold, Stocks and Oil Rise

Markets have been exceedingly resilient against the disappointing releases and difficult events of the past weeks, and as such releases become rarer, traders are displaying a great deal of enthusiasm about purchasing risk. Today is a bullish day although there is nothing particularly bright in the  political or financial news flow.

In Japan, "radioactive iodine-131 at a concentration of 4,385 times the maximum level permitted under law has been detected in seawater" near the Fukushima Daiichi nuclear plant today, according to the Kyodo news agency. The government is continuing to deny that the leaks constitute an immediate health hazard, but fears about the so-called recriticality are being voiced both in and outside Japan as the crisis drags on. 

Elevated radiation levels have been detected as far away as Britan and Switzerland, and some radioactivity has been detected in milk in the U.S. as well, although these levels are extremely low so far and do not pose any risk to people, according to official reports. Markets appear to have shrugged off the risk of wider contamination and seem to have settled for the viewpoint that the greatest economic and political impact of the leaks will be felt in Japan itself, with negligible results for global growth.

In Libya, Colonel Gaddafi`s foreign minister, and former intelligence chief, Moussa Koussa has defected to the U.K. after taking a flight through the neighboring Tunisia. There are signs that the Libyan leader`s regime is cracking from the inside, but the military situation remains inconclusive, so markets did not react strongly to the news. 

In the U.S., some focus is on the release of the list of banks that borrowed from the discount window during 2008-2009 - the most difficult days of the global financial crisis. The Fed will be releasing the identities of future borrowers after the passage of two years, in line with the Dodd-Franks Bill on banking regulation passed last year. If anything, this should make Fed officials a bit more cautious while bailing out financial firms, since from now on they may be accused of corruption and collusion of interest once the details of their past actions are made public. However, we are skeptical that the impact will be as strong as many would like.

Markets outside of the U.K. and the Eurozone were optimistic today, in anticipation of a favorable unemployment report. Most Asian markets were higher, as were gold and oil, and EUR USD appreciated while USD JPY fell. In Europe, focus remains on the uncertainties surrounding the Eurozone sovereign debt issues, the resolution of which is likely to stretch years into the future. Some concern is caused also by the ambigous position of the Irish government vis-a-vis their creditors. How much private lenders of the government will have to swallow in losses is an issue that is still haunting the Eurozone, suppressing the Euro currency even as the rest of the world retains a rather strong sentiment towards risk.

Gold Fell Sharply, Dollar Rallied on FOMC, But Trade Volume Is Weak

Trade volumes in FX was reported to be weak on the second trading day of the year, and while gold and commodities have seen sharp movements, it is not clear that this is the beginning of a multi-week correction trend. Gold, in particular, has lost more than $45 per ounce in another of its typical sharp swings, in anticipation of a stronger dollar, and some concern about the Chinese interest rates. FOMC minutes released Tuesday further boosted the USD-positive sentiment, since the committee appears to note some economic improvement, and refrains from making any kind of commitment to another round of QE. Core inflation, according to the minutes, has bottomed out, and while 2011 may see some upside momentum in prices, 2012 will bring price stability back. In short, we`re told, this is as far as the FOMC is prepared to go for now on QE, with no clarity provided on when on how the program will be ended.

We have seen such statements before. Even in October 2007, the FMOC member Randall Krozner was speaking about the importance of keeping rates at a reasonable level, about his concern about inflation expectations, and issuing forth stock statements in an air of seriousness, yet the same FOMC later brought rates to zero, as we all know, and there they have stayed till now. We don`t suggest that the Fed doesn`t know what it is doing, because that is the subject for a different debate, but we do mean that their statements on the outlook are no more important than any analyst report that would be issued with respect to their future actions. In other words, we don`t think that the Fed knows what it will do any better than the typical analyst, and the minutes are more valuable then analyst reports only because people short-term trade the markets with them.

The release emphasizes that the risks to the growth outlook are significant, focusing on the house price, and Eurozone debt crises. If these progress in a manner that weakens sentiment in the markets considerably, driving interest rates on mortgage, and consumer loans higher than where the Federal Reserve wants them to be, Ben Bernanke`s statements up to date ensure that the Fed will act.

On Eurozone issues, we note the impact of an article at PIMCO`s website. They seem to be getting out of Eurozone peripheral debt, which has had a rather strong impact on bunds and Treasury bonds according to reports.  German unemployment was released unchanged at 7.5%, while Eurozone CPI rose above the ECB`s two percent target at 2.2%, and is not giving any sign of easing unless the Euro finds some respite from the constant talk about its demise. While the ECB`s actions are often hard to predict, we don`t expect any rate increases unless the Euro goes into a stall.

Korea, Chile Intervene, Brazil  "Ready to Take Strong Measures"

The focus has been on other issues recently, but the wave of competitive devaluations is still with us, with two central banks intervening today in local markets in order to rein in speculative inflows yet again, and Brazil threatening to alter commerce and FX regulations, as well as reduce government spending in order to control the real`s strength, and facilitate lower interest rates. Of these announcements, we think that the Brazilian one is the most interesting, because it goes beyond the usually futile intervention threats in order to discuss the implementation of controls on capital movements which echoes of times before the 2000-2010 period.

Just to the west of Brazil, we have Chile intervening by purchasing an enormous $12 billion dollars in the market, building up its reserves, and pulling the rug from under the feet of peso buyers, at least in the short term. Short-term traders were naturally gutted in the course of this heavy-handed intervention, but others note that, unless copper prices recede from their high levels, the Chilean central bank will have to keep pumping pesos into the market, as the country is producing about 35% of the global copper output. Anything less than that, and the peso will find solid demand.

Bank of Korea was also seen actively selling the won against the dollar in Asian trading, but that kind of action is fairly regular nowadays.

USDCNY Still dormant, But Appreciation Will Resume as Hu Jintao Meets Barack Obama on January 19th

Hu Jintao and President Obama will have a face-to-face meeting in two weeks or so, and many people expect the Chinese to time the next leg of yuan appreciation to coincide with the visit. Yang Jiechi, the ill-tempered Chinese foreign minister, and Treasury Secretary Geithner, the main engineer of the Bush era bailouts, will meet on Tuesday to prepare the groundwork for the visit, in a process that will keep building up momentum. Just before President Hu Jintao visits the U.S., Robert Gates, the Defense Secretary will be in China to discuss some Taiwan-related arms sales issues that are understood to have angered the Chinese. So the hectic pace of U.S. - China dialogue will be maintained into 2011.

USDCNY was fixed at 6.6215 vs.  6.6227 of Friday.

We conclude by mentioning the troubles faced by DPJ`s veteran backroom dealer, career politician Ichiro Ozawa, who is facing pressure to resign after corruption and bribery investigations have been initiated against him.  He has told the PM, who has been calling for his resignation, that he alone and the Japanese people will determine whether he will quit his seat at the Diet. If Mr. Ozawa quits, it will at least give the PM some calm as he makes his final attempts to salvage his disgraced government in the eyes of the voters.

 

Gold Fell Sharply, Dollar Rallied on FOMC, But Trade Volume Is Weak

Trade volumes in FX was reported to be weak on the second trading day of the year, and while gold and commodities have seen sharp movements, it is not clear that this is the beginning of a multi-week correction trend. Gold, in particular, has lost more than $45 per ounce in another of its typical sharp swings, in anticipation of a stronger dollar, and some concern about the Chinese interest rates. FOMC minutes released Tuesday further boosted the USD-positive sentiment, since the committee appears to note some economic improvement, and refrains from making any kind of commitment to another round of QE. Core inflation, according to the minutes, has bottomed out, and while 2011 may see some upside momentum in prices, 2012 will bring price stability back. In short, we`re told, this is as far as the FOMC is prepared to go for now on QE, with no clarity provided on when on how the program will be ended.

We have seen such statements before. Even in October 2007, the FMOC member Randall Krozner was speaking about the importance of keeping rates at a reasonable level, about his concern about inflation expectations, and issuing forth stock statements in an air of seriousness, yet the same FOMC later brought rates to zero, as we all know, and there they have stayed till now. We don`t suggest that the Fed doesn`t know what it is doing, because that is the subject for a different debate, but we do mean that their statements on the outlook are no more important than any analyst report that would be issued with respect to their future actions. In other words, we don`t think that the Fed knows what it will do any better than the typical analyst, and the minutes are more valuable then analyst reports only because people short-term trade the markets with them.

The release emphasizes that the risks to the growth outlook are significant, focusing on the house price, and Eurozone debt crises. If these progress in a manner that weakens sentiment in the markets considerably, driving interest rates on mortgage, and consumer loans higher than where the Federal Reserve wants them to be, Ben Bernanke`s statements up to date ensure that the Fed will act.

On Eurozone issues, we note the impact of an article at PIMCO`s website. They seem to be getting out of Eurozone peripheral debt, which has had a rather strong impact on bunds and Treasury bonds according to reports.  German unemployment was released unchanged at 7.5%, while Eurozone CPI rose above the ECB`s two percent target at 2.2%, and is not giving any sign of easing unless the Euro finds some respite from the constant talk about its demise. While the ECB`s actions are often hard to predict, we don`t expect any rate increases unless the Euro goes into a stall.

Korea, Chile Intervene, Brazil  "Ready to Take Strong Measures"

The focus has been on other issues recently, but the wave of competitive devaluations is still with us, with two central banks intervening today in local markets in order to rein in speculative inflows yet again, and Brazil threatening to alter commerce and FX regulations, as well as reduce government spending in order to control the real`s strength, and facilitate lower interest rates. Of these announcements, we think that the Brazilian one is the most interesting, because it goes beyond the usually futile intervention threats in order to discuss the implementation of controls on capital movements which echoes of times before the 2000-2010 period.

Just to the west of Brazil, we have Chile intervening by purchasing an enormous $12 billion dollars in the market, building up its reserves, and pulling the rug from under the feet of peso buyers, at least in the short term. Short-term traders were naturally gutted in the course of this heavy-handed intervention, but others note that, unless copper prices recede from their high levels, the Chilean central bank will have to keep pumping pesos into the market, as the country is producing about 35% of the global copper output. Anything less than that, and the peso will find solid demand.

Bank of Korea was also seen actively selling the won against the dollar in Asian trading, but that kind of action is fairly regular nowadays.

USDCNY Still dormant, But Appreciation Will Resume as Hu Jintao Meets Barack Obama on January 19th

Hu Jintao and President Obama will have a face-to-face meeting in two weeks or so, and many people expect the Chinese to time the next leg of yuan appreciation to coincide with the visit. Yang Jiechi, the ill-tempered Chinese foreign minister, and Treasury Secretary Geithner, the main engineer of the Bush era bailouts, will meet on Tuesday to prepare the groundwork for the visit, in a process that will keep building up momentum. Just before President Hu Jintao visits the U.S., Robert Gates, the Defense Secretary will be in China to discuss some Taiwan-related arms sales issues that are understood to have angered the Chinese. So the hectic pace of U.S. - China dialogue will be maintained into 2011.

USDCNY was fixed at 6.6215 vs.  6.6227 of Friday.

We conclude by mentioning the troubles faced by DPJ`s veteran backroom dealer, career politician Ichiro Ozawa, who is facing pressure to resign after corruption and bribery investigations have been initiated against him.  He has told the PM, who has been calling for his resignation, that he alone and the Japanese people will determine whether he will quit his seat at the Diet. If Mr. Ozawa quits, it will at least give the PM some calm as he makes his final attempts to salvage his disgraced government in the eyes of the voters.

 

Crude Oil Falls Most Since November, Gold Plunges after FOMC Minutes

Commodities fell across the board as traders locked in profits and concerns about valuations emerged. Up on deck is the government report on U.S. petroleum inventories.

Gold Facing Formidable Headwinds After Ten-Year Rally

Crude Oil Grinds Higher on Outlook, Gold Edges Lower After 30% Gain in 2010

Loose monetary conditions provided the fuel that enabled commodities across the board to rally strongly in 2010. Those same ingredients remain in place at the start of 2011, but much has already been priced in.

Markets Take a Deep Breath Before the Irish Vote, Gold Rises

Gold was close to its nominal all-time high today, reaching as high as $1419 per ounce, as the Euro fell, and bourses oscillated during the day. The focus is on the Irish budget vote tomorrow, with markets remaining reasonably quiet in the lead-up period.

Bernanke says cheap yuan is bad for both China and U.S. More QE possible if the economy continues to underperform.

The limited bullishness in trading was a result of the focus on Ben Bernanke's comments today during interview for the CBS program "60 minutes", in which the chairman made it clear that he and his team are prepared to go further beyond the $600 billion in bond purchases and similar operations if the sluggishness of the economy persists.

On the USDCNY issue, he stated that the Chinese must allow greater flexibility for the yuan so that they do not have to adopt the same monetary stance as the Fed, and can combat inflation by pursuing their own independent stance based on domestic factors. He maintained the line adopted by Treasury Secretary Geithner that the Chinese position is untenable and harmful to the U.S., China, and their trading partners. On the whole, the currency issue appears to have been left almost entirely to the management of the Treasury Department, and Mr. Bernanke's comments do not signal any change.

The chairman was asked some questions about the external debt of the U.S., to which he replied in an optimistic but cautious tone, saying that while the U.S. does not face a confidence or solvency crisis at the moment, Americans should not "wait however many years it takes until we are at that point". He maintained his cautious tone in response to questions about budget cuts, stating that the U.S. must avoid hasty budget cuts, although something needs to be done to manage the rising debt burden.

Although in this particular case, Bernanke did much to say nothing while talking a lot, in general it is hard to fault the Fed Chairman for indecisiveness, or lack of clarity. The ECB for instance, finds it difficult to find a common stance nowadays, and is a hotbed of dissession of conflicting opinions. Rapid reversals of course are common. The Fed, on the other hand, presses on with its conclusive main theme of printing as much money as it can in order to keep the economy afloat and preventing a recession, and while the merits of its choices are always open to heated discussion, that it has been communicating its plans sufficiently clearly over the past quarters is not a major point of contention. Whether this will benefit the U.S. economy over the long term is a different matter, however.

Merkel threatens to leave the Euro, refuses to commit to an enlargement of the EFSF, CDS rally

The Guardian newspaper has published an article where it is reported that PM Angela Merkel threatened, somewhat lightly, that Germany may quit the Eurozone if her concerns are not heeded. Bloomberg, too, reports that the Germans are unwilling to join the Eurobond idea currently being discussed, and that they don't want to sponsor the proposed increase in the size of the EFSF. At the same time, the same Germans are saying that the Euro is safe, that the Eurozone will not break up, and that they will do their utmost to prevent the risks from threatening the demise of the common market. One must wonder what exactly they have in mind if they are not prepared to pay when the bill comes due, since the cost of the survival of the single currency is not small.

There seems to a degree of consensus among a majority of analysts and commentators that the Germans will eventually have to give in to market demands, if only because the alternative is impractically dangerous and destructive. No one knows how deep the impact of the chain reaction following the implosion of the Euro would be. We quote in this context briefly from report in Bloomberg that reads:

Europe has "no credibility" in ruling out debt restructurings, Kenneth Rogoff a Harvard University professor and former International Monetary Fund chief economist, said in a Bloomberg Television interview broadcast today. "Greece will be very lucky to avoid restructuring, Ireland, Portugal -- they're just in denial, saying it can't happen. They really haven't drawn clear lines, they haven't really said what they wanted to do, they haven't really made choices."

Nor can the nations of the core afford to let them collapse with totally unpredictable consequences for the whole world. So some series of bailouts will follow until Spain reaches the door with open hand.

---

Meanwhile, ECB's Christian Noyer, the Governor of Bank of France, has remarked today that the present measures of liquidity are to be maintained at least until the first quarter of 2011.Many suspect that they may be extended quite a bit further unless the periphery stages a rather unlikely recovery by then.

Although Moody's cut Hungary's sovereign rating by two notches to Baa3, the debt markets were generally stable, after the exhausting widening of the past weeks. The market remains weak, but is not willing to stage any strong move to either side at the moment. This is, after all, a Monday. Our eyes will be on Ireland's vote this week on the 2011 austerity budget, as the government tries to survive with its paper-thin majority. The possibility of failure, and an ensuing general election is preventing the markets from staging a meaningful movement before the result of the Tuesday vote becomes clear.

With respect to the interbank market, the improvement in CDS and peripheral spreads has not been mirrored in the Euribor rates, with the 3-month benchmark moving to 1.028% vs. Friday's 1.027%. Euribor rates have retreated from the 1.050% level reached earlier, but we conjecture that they will reach beyond those levels at some point next year as the usual concerns become transferred to the banks due to exposure concerns. That tensions remain significant in this segment is made evident by the deposit facility usage statistics of the ECB, which show that Eurozone banks placed some Eur84.85 billion in the bank's coffers for interest income versus the previous week's Eur26.93 billion, implying a lack of counterparty trust in the region as uncertainty dominates. These numbers are tempered by the lack of a need, apparently, to resort to the marginal lending facility, which we take to mean that the banking sector remains isolated for now from the issues for as long as the authorities can avoid a breakdown. As Merkel's comments show, however, it is far from clear that this will be the case.

Monday is a quiet day, with few news providing guidance on how the rest of the week may progress. At the same time, we suspect that the Irish vote tomorrow has the potential to wreak havoc on the markets if the result leaves the country without a government during this most difficult period.

More Setbacks for Barack Obama, Gold Rises

Gold has rallied today on the back of positive sentiment in equities which we will be attributing to the year-end effect from now on, unless convincing data on the health of the global economy becomes available over the coming period. In particular, that China`s communicated intention to tighten is not dampening risk sentiment is a sign of over-optimism, unless we assume that market consensus regards the cautious nature of China`s rulers as a sign that the proclaimed tightening phase will be mild and brief. We believe that the outcome in this respect is related to the fate of the USD over the coming months as much as it depends on the domestic Chinese situation, and is a lot more uncertain than it is being factored in by the markets for now.

In any case, the Chinese are out of options, if our analysis of the situation is correct, and although we admit that they are by nature cautious about their decisions, our  emphasis is that the nature of the Chinese economy and the political situation at home and abroad does not facilitate the undertaking of radical solutions.

Every one seems to know that China is facing a serious inflation problem at home. Two interrelated causes, among others, cause for this problem, that of hot money inflows, and that of wage pressures as the labor market in the Eastern, coastal regions becomes very tight after years of preferential treatment of the area. It has been reported to be tight for a while, but because Chinese labor has a hard time making its claims heard, serious changes occur slowly. Against this background, the consensus is that the PBOC must raise interest rates to combat inflation, since the yuan is pegged to the USD, but raising rates is ineffective since liquidity extracted by the central bank is more than compensated by foreign inflows that seek to benefit from interest rate differentials.    At the same time, if the PBOC does allow the yuan to appreciate significantly against the yuan, the extremely imbalanced, inefficient, government-subsidized, and export-biased nature of the Chinese economy poses a risk of collapse which the authorities are determined to avoid at all costs.

Against this argument it is often proposed that the growth of the Chinese economy is fuelled much more by consumption that it is generally assumed, and that the observed overheating is caused not to a small extent by much needed infrastructure investment in a country that is still a third world economy in many ways. While a higher target of inflation is acceptable for any developing economy, and infrastructure investment makes sense in a long-term point of view, experience shows that bubbles are likely to develop where there are the most convincing arguments to support them. Rationalizations on the basis of size and capacity do not negate the evidence supplied by the parabolae on many of China`s economic indicators.

It is difficult, also, to justify the belief that China needs so many factories of low added-value products, because  the country has moved out of the class of nations where such products offer the greatest returns long ago, and remains a profitable destination for their producers only because of the government`s policies that artificially maintain consumer incomes at a low level by investing proceeds in U.S. Treasuries, and other external assets. Indeed, that the government is trying to force domestic firms to invest the country`s wealth oversees, instead of diverting these resources to establish a social security system at home is a sign that the Chinese are beyond their limits in benefiting from savings and investment . Finally, there is the limit posed by physical and natural contraints. The northern regions present such a picture of despair in terms of the quality of the environment that even in the highly unlikely case that the Chinese model, and the people`s tolerance for low wages were not exhausted, it appears that the country itself is very close to its limits.

We must wonder, after all, how much it is the wish of the Chinese to see the income level of the population rise rapidly. It is the explicit desire of the CCP that it will hold on to power for many more years to come (official comments place the lifespan of party autocracy between 25 and 100 years.). Assuming that China is no less  susceptible to centrifugal pressures and the desire for freedom than any other country of its size, it is possible that the Chinese government is intentionally pursuing a path that will prevent the income of society from rising too fast in order to prevent the breakdown of social structures that are  sustaining the party`s grip on power. After all, one plausible way of managing the excess liquidity in the country`s system without raising wages or interest rates is to impose and increase labor taxes on profitable companies in order to improve the confidence of the general populace. But the Chinese are not choosing this path either because they are worried about competitiveness, or because they don`t want to see the population becoming too complacent about the future, and thinking about here and now, with predictable unpredictability for the domination of the CCP.

What happens in this country will determine the trajectory of the globe for many years to come, and since the U.S. and the rest of the developed world are sidelined to a large extent due to the implosion of the past years, we believe that the future of China is almost identical to the future of the world economy.  It is arguable, from a purely analytical point of view, with no thought of the human cost, that a quick disintegration of the Communist Party would bring the easiest transition for everyone. But the CCP is not the Communist Party of the Soviet Union, and in spite of endemic corruption and incompetency, it does enjoy the support and enthusiam of a large section of the population, and can show the rising prestige and wealth of the country, even if it doesn`t imply prosperity, as its accomplishments in defense of its legitimacy. In any case, The Chinese probably do not think much about how much better their fortunes would be if they were ruled by a democratic, more competent and responsible government, since the CCP is all that they have.

In news events, the yields of Chinese CDS have risen last week,on the back of speculation that the country will face difficulties as it tries to bring inflation under control. U.S. sentiment was not impacted by the court decision that struck down a key component of the administration`s health care reform plan, but the development does have long-term significance for the markets in terms of the reelectability of the president. Equities, currencies, gold and oil are rallying, and cautious optimism is the theme of the day for today.

Gold and Oil Rise, As Rating Rumors Abound

Gold, and oil are higher today, while the Euro is weakened against the dollar, and the yen holds its ground the against the American unit. Bourses are mixed, with European equities generally doing better than the rest, as American markets demonstrate a very indifferent performance.

Today is mostly a quiet day, but there is some talk about some major European nations, including France, losing their triple A ratings unless strong measures are taken to address the Eurozones problems. The nations on the watch list nowadays are Ireland, Greece, Spain, Portugal, Belgium, Italy. But oddly enough, even France is having a fair share of speculation and gossip depressing its CDS and bonds as bondholders look anxiously at the future, and the few remaining speculators sell to benefit from sentiment. Nonetheless, action is weak as we approach the end of the year, and it looks like this trend will stretch out until the cold days of December are over.

Moody`s, of course,  has been slashing ratings and issuing warning about downgrades for quite some time. It is just three days ago on Friday that the agency cut Ireland`s sovereign credit rating by five notches, after warning on Wednesday that it would move against Spain as it sees "substantial funding requirements" weakening the country`s prospects. By contrast, in August Moody`s had stated that France, in addition to U.K. And U.S. would maintain their ratings as they move aggressively to cut deficits, but it seems like the events between then and now have compelled them to change their outlook on anything that is West of Germany.  France`s CDS yields have been rising  on the back of these developments, reaching an all-time high of 105.5 bps which is almost triple the yield at the beginning of this year. It is now costlier to buy protection on France than on Czech Republic or Chile, which are both rated lower by ratings agencies.

So what is the interpretation of all this? We think that the European CDS market is even more illiquid these days as everyone moves to vacation, but beyond this trivial fact, there is also the somewhat scarier fact of rising correlation across the board in Europe, as markets begin to throw all these nations, as long as they are to the West of Germany, in to the same bag, partly due to worries about contagion, partly because of the recent rapid reversals in markets, and of course, because they want to bring down someone before the game is over in Europe. Some analysts and even academics  regard a default in the Eurozone an inevitable event nowadays, and there is a lot of doubt as to whether the Euro itself will survive such a severe test. And once markets begin to question the future of the Euro, there is very little that is immune to suspicion and doubt, which is why we are seeing convergence in the market`s assessment of the regions. It does indeed seem that the market`s general pooling of all these widely disparate economies into a single basket is a little irrational. But at the same time, isn`t it true that there is hardly a signle economy in the world that would be immune to adverse results and crises if creditors and speculators begin to doubt the will and credibility of authorities and governments? This, then, above anything related to markets, CDS, or bonds, is what is driving the rapid convergence that we have been observing in Western Europe these past months. Just like a few years ago it looked like nobody could default, it now looks like just about everyone is on the road to a default. Market sentiment and action is only in part based on rational arguments, but that is something most of us know very well already.

What, then, is in store for sovereign debt in Europe next year? And what about the rest of the world? The rest of the world will probably remain immune to these pressures because traders are focusing on Europe, and there are a lot of target candidates in the area. For at least the six months we`ll keep hearing about potential defaults, austerity, and ever stricter budget plans. At least for the first six months, it seems very unlikely that anyone will default, because most of the nations in dire straights have been funded amply for quite some time into the future. This also coincides with seasonal market patterns, since the first half of the year is generally more bullish than the latter, and as such, we suspect that much of the real action and sweating for the Eurozone will be kept in store for the second half.

Will there be a default in 2011? With Merkel and Sarkozy still in office, we find it hard to believe that any particular nation will be allowed to default. After all, if the E.U. has already spent close to $1 trillion in bailing out nations in order to protect the currency, what is the point of refusing a couple hundred billion more(!) and keeping the edifice intact at least until the next elections? The Euro will of course keep weakening on a year-on-year basis, with its descent being prevented from being a plunge only because of the Fed`s QE2-3-4  series.

In short, then, we don`t expect a default in 2010, and believe that one would only come in consequence of a big public relations disaster or a severe breakup among leaders of the union at a personal and international level. That, of course, is impossible predict accurately, at least as far as we are concerned.

The fireworks, so to speak, will only begin once the current frustration of voters transforms to real wrath at the ballot boxes, as oceans of cash evaporate into thin air even as the promised improvement in growth fails to revive the region`s economies. This is true for not only the periphery, but also for the core, because next year is likely to see weaker growth after this year`s fairly strong performance. In the meantime, all we need to do is to wait and see. It is difficult to purchase the USD with Bernanke standing on our path, and it is nearly impossible to purchase the Euro confidently with all the troubles standing in between. Some would go and gamble into emerging market currencies as a "safe haven" gamble, but we find it difficult to find confidence in anything other than gold as long as the cash channels remain open into world markets.

Crude Oil Rises but Underperforms Equities, Gold Positioning Hints Topping

Most crude oil benchmarks are now approaching the psychologically-significant $100 level, but fundamentals suggest that a sustainable break is not yet in the cards.