Real-time Monetary Inflation (last 12 months): -2.1%

When PNC Wealth Management released its 2010 Christmas Price Index this month (PNC), the cost of the five golden rings in the traditional "12 Days of Christmas" tune was pegged 30 percent higher than last year (don't ask how much those French hens cost now; you don't wanna know).

Overall, Christmas will cost 9.2 percent more this year, helped in large part by the bullishness in gold prices. Procrastinators—those who haven't yet done their holiday shopping—shouldn't despair, though. There may still be a bargain to be had for the bullion-minded. At least that's what the time-tested Relative Strength Index indicates.

The RSI is a widely followed momentum oscillator that compares the magnitude of a security's or a commodity's recent gains to that of recent losses. The comparison results in index readings ranging from 0 to 100.

Charting the RSI next to a security's price offers clues about the "oomph" behind the price. A divergence between the price and the RSI trends is a very reliable signal of an impending market turning point.

Take a gander at the chart of the SPDR Gold Shares Trust (NYSE Arca: GLD) below. Since October, GLD prices have trended upward, albeit raggedly, while the RSI has been in a downtrend. Such patterns lead technicians to conclude that the recent upspikes in gold (you see the same prefigurement on the cash bullion and COMEX futures charts) have been scored with ever-weakening momentum.



If you watch the COMEX open interest figures, you certainly get a sense of that. Interests in gold futures topped out at better than 651,000 contracts in mid-October and have since withered below 600,000.

That's really no surprise given year-end price dynamics. After all, gold's risen 30 percent this year, according to the PNC elves, so it's only natural that fund managers would book profits before the annual mark-to-market (taxes are due on open futures' gains held through Dec. 31).

Still, the trends' disparity points to a prospective bullion sale soon, maybe before St. Nick starts stuffing stockings.

Whether that'll make for a better deal at the jeweler's will depend, of course, on the retailer's turnover rate. Procrastinators might obtain a little negotiating room when haggling for glittery trinkets, but buyers of the PowerShares DB Gold Double Short ETN (NYSE Arca: DZZ) would certainly derive immediate benefit. The DZZ note—which is designed to deliver twice the daily inverse return of gold futures—has been battered this year but looks to have formed a double bottom at the $8 level.




Late-season jewelry buyers should take comfort if DZZ manages some convincing closes above the $8.91 level (the note last traded at $8.41 Friday), but shouldn't lose hope if the note doesn't rally. There's always a fallback position.

I hear Snuggies and Chia Pets are selling well.

Real-time Monetary Inflation (last 12 months): -2.4%

You draw enough charts and eventually you start pondering about their revelations in the small hours of a morning. This morning, I marveled at the hamstringing of the U.S. Federal Reserve Board when I updated my Fed Operations Indicator chart.

Fed Operation Indicator




The indicator's downward momentum (the red line on the chart above) is worrisome. You can see it's dipped below the band scribed by the yellow dashed lines. That band essentially describes the Fed's usual maneuvering room. Smallish open market operations (buying and selling relatively modest amounts of Treasury and agency securities through primary dealers)—akin to alternatively tapping the economy's brakes and accelerator—are typically all that's needed to keep liquidity on an even keel. That is, keep the indicator between the dashed lines.

Breakouts below the band are usually bearish for equity investors and bullish for commodity buyers. They represent periods when commodity prices—the blue line tracking the TR/J CRB Index—rise faster than bond prices. Bonds are depicted by the chart's green line.

In times like this, the Fed would normally tap the economic brakes by withdrawing liquidity—selling paper to primary dealers to mop up cash. These are anything but normal times, however. For one thing, all that liquidity isn't really circulating in the banking system. It's gone into reserves as gun-shy financial institutions have bolstered their balance sheets but still aren't making loans at their former pace.

The lack of money velocity is reflected in our Monetary Inflation Index. On a year-over-year basis (tracking the last 365 days), the daily indicator is negative (see the subhead above). Monetary inflation measures the dollar's global purchasing power reflected through the gold and foreign exchange markets.

U.S. Monetary Inflation



In large part, it's the lending logjam that's prompted the Fed to implement QE2, to dislodge that bolus of liquidity and get it to pass through the economy. The central bank is trying to prime the pump but, up ‘til now, nobody has really been all that thirsty. The demand for loans hadn't yet been kicked up.

That's the Fed's dilemma. It's got its hand on the supply spigot, but it can't kick-start demand. That's in the hands of the legislative and executive branches. The next few weeks will tell us if these the Congress and the president can work together to get demand off the ground.

I'm not holding my breath.

Real-time Monetary Inflation (last 12 months): -2.2%

Crude oil's rally reversed yesterday despite an industry report forecasting a deeper-than-expected decline in U.S. oil inventories.

The American Petroleum Institute estimated that U.S. crude inventories fell by 7.3 million barrels last week, but definitive numbers released by the Energy Department this morning showed the drawdown was actually 3.8 million barrels. Analysts had expected a 1.3-million- to 1.4-million-barrel decline.

The API was closer to the mark with its gasoline estimate. The industry group saw motor fuel stocks rising by 4.8 million barrels, a more aggressive build than the 300,000- to 500,000-barrel increase expected by the Street. Inventories actually rose by 3.8 million barrels, according to the government.

Closer still was the API's reckoning of distillate fuels. Government data shows inventories were built up by 2.2 million barrels last week. The API had eyed a 1.7-million-barrel increase, in stark contrast to brokers' average forecast of a 500,000- to 900,000-barrel decline.

Refinery usage, which was expected to rise by 0.9 percentage points to 83.5 percent, instead rose to 87.5 percent. Gasoline production increased to a daily average of 9.4 million barrels, while distillate fuel output—including diesel and heating oil—increased to 4.5 million barrels.

Gasoline demand now averages 9.0 million barrels per day, down 0.7 percent from this time last year. Mean distillate fuel consumption is 3.7 million barrels daily, a 5.3 percent increase from year-ago levels.

Trading Week

Refining margins were lifted this week as product price increases outpaced crude's upward trend. For the week ending Tuesday, nearby West Texas Intermediate crude gained 5.5 percent, while gasoline ran up 6.4 percent and heating oil was boosted 6.6 percent. Gasoline-rich refining runs earned a 12.6 percent margin, a 1 percentage point gain over last week. Distillate-heavy operations grossed 13.9 percent for a 1.1 percentage point increase.

Crude oil volatility, measured by the CBOE Oil Volatility Index (CBOE: OVX), ticked up 0.3 points to 32.2 percent as the cost of protective puts rose 45.7 percent.

Average daily volume for NYMEX WTI shot up 49.7 percent to 697,121 contracts. Open interest jumped by 31,734 contracts to 1.37 million.

Alongside a dramatic squeeze in WTI's contango, the U.S. benchmark's discount to Brent crude ballooned to $1.81 from last week's $1.22. A three-month roll in NYMEX WTI, which cost $1.40 a barrel last week, now runs 99 cents.

The heating oil/gasoline spread widened by 1.06 cents a gallon this week. Over the same period, the corn/ethanol crush lost 16.7 cents a bushel, the result of a 15.75 cent spike in corn prices. Ethanol's 21-day correlation to corn prices has now tightened to 95.3 percent. Gasoline's premium over ethanol shrank a bit to 25.9 cents a gallon for January delivery.

Technical Picture

Yesterday's spike, if sustained, would have marked a 50 percent retracement of crude's 2008 decline. With the reversal, nearby support will likely be found for the January contract at the area of the Nov. 30 high—$85.90—which also corresponds to the delivery's 10-day moving average.

Two areas of intermediate support—at $87.57 and at $86.44—could be waylay stations.

On the upside, the $90.54 level remains a hurdle for closing prices, while interim resistance at $90.29 ought to be anticipated.

Nearby NYMEX WTI Crude Oil

Real-time Monetary Inflation (last 12 months): -2.0%

Domestic inflation, measured by the core Consumer Price Index, fell to a record low in October, according to the latest data released by the U.S. Bureau of Labor Statistics. Year-over-year, the inflation metric, which represents changes in the value of a basket of goods and services, but excludes volatile food and energy prices, rose by 0.6 percent last month. A year before, core inflation was running at 1.7 percent.

Amid great volatility, gold prices tumbled for the week ending Thursday. When priced in the world's reserve currencies, bullion's biggest loss—outlined below—was registered in U.S. dollars. The yellow metal dipped 3.5 percent in pound sterling, 2.8 percent in yen, 2.5 percent vs. the euro and 2.0 percent against the Swiss franc.

The greenback marked several market milestones this week.

In London, morning gold fixes ended 4.0 percent lower on the week at $1,357; fixes averaged $1,362, $10 higher than the week's mean COMEX spot settlement; COMEX gold ended Thursday at $1,352, off 3.6 percent; average daily volume fell 6.7 percent to 272,230 contracts; open interest also eased, lopping off 9,727 contracts to 633,224; warehouse stocks of bullion continued to build, increasing by another 70,936 ounces (2.2 tonnes) to 11.38 million; inventories now cover 17.7 percent of open interest; the maximum immediate demand for bullion delivery through futures is 2,000 ounces, while 2.65 million ounces are in a deliverable position.

London gold lease rates continued to fall this week; one-year contracts netted 15 basis points (0.15 percent), 6 bps less than last week.

SPDR Gold Shares Trust (NYSE Arca: GLD) bullion holdings dipped 4.6 tonnes (146,479 ounces) to 1,286.249.

Junior gold miners lost marginally more than larger-cap producers this week; the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ) slipped 4.7 percent as the Market Vectors Gold Miners ETF (NYSE Arca: GDX) pulled back 4.5 percent; the average reading of the Gold Miners Ratio—GDX over GDXJ—rose from 1.50x to 1.54x.

The broad equities stock market proxied by the S&P 500 Composite fell 1.4 percent this week, nudging up the benchmark's correlation to gold and gold stocks; the blue chip stock index's correlation to bullion climbed 9 points to 66 percent, while its coefficient vs. gold producers ticked up 3 points to 80 percent.

WTI crude oil prices slumped 6.8 percent to $81.85; the gold/oil ratio slipped from 16.2x to 16.1x.

One-year TED spreads inched down 4 bps to 0.49 percent on a softening in Treasury rates; the spread reflects the rate premium demanded by financial institutions on interbank loans.

The discount to one-year Treasurys in the COMEX gold futures term structure widened 9 bps this week; the one-year gold contango narrowed 11.5 percent to $12.30 an ounce.

Long bond yields vaulted 10 bps to 4.30 percent, making the Treasury yield curve more acute; the spread between three-month bills and 30-year bonds is now 417 bps.

The U.S. dollar continued to rise against the world's second reserve currency; the euro shed 1.9 percent of its value relative to the greenback, averaging a cross rate of $1.3634 and ending Thursday at $1.3506.

Daily reads of the one-year monetary inflation rate fell from -0.2 percent last week to -1.4 percent; monetary inflation, rather than measuring changes in the cost of a basket of domestic goods and services, tracks the U.S. dollar's gold purchasing power versus that of the euro; at today's rate, the real return, i.e., adjusted for monetary inflation, on three-month Treasury bills is 114 bps.

Year-Over-Year Inflation Metrics

Real-time Monetary Inflation (last 12 months): -1.4%

Last week, the American Petroleum Institute, the oil industry's trade and research arm, estimated that domestic crude oil inventories fell by 7.4 million barrels. Definitive data from the U.S. Energy Department, however, showed a drawdown of only 3.3 million barrels.

This week, the API trotted out another call for a 7-million-barrel decrease and got it right. Late Tuesday, the institute's survey indicated that crude stocks tumbled by 7.7 million barrels. Energy Department data released this morning documented an actual decline of 7.3 million barrels.

U.S. commercial crude oil inventories now stand at 357.6 million barrels.

Analysts' expectations contrasted sharply with API's this week, with some on the Street eyeing a 300,000-barrel drawdown, and others, at the other extreme, looking for a 1.2-million-barrel build.

The contrast between the industry group's and analysts' guesstimates of gasoline inventories wasn't as dramatic. The API said that motor fuel stocks fell by 1.7 million barrels, while analysts called for a decline between 400,000 and 800,000 barrels. Government data showed the actual drawdown, at 2.7 million barrels, was more bullish.

The Energy Department also reported that distillate fuel inventories, including diesel and heating oil, decreased by 1.1 million barrels. The API estimated a 222,000-barrel build, compared with Oil Patch expectations of a 2.1-million- to 2.2-million-barrel drop.

Refinery usage was forecast to rise from 82.4 percent to 82.9 percent, but actually jumped to 84.0 percent. Gasoline production fell to a daily average of 8.9 million barrels, while distillate fuel output increased to 4.3 million barrels.

Demand for motor fuel averaged 9.1 million barrels per day, up 1.8 percent from the same period last year, while the daily consumption of distillate fuels averaged 4.1 million barrels, a 13.9 percent increase from year-ago levels.

Trading Week

Oil price volatility spiked 2.5 points higher this week to an annualized rate of 33.4 percent.

For the week, West Texas Intermediate tumbled 5.1 percent, while gasoline slipped 3.3 percent and heating oil declined 4.1 percent. Refiners' margins, as a result, improved. Operators cranking out gasoline-heavy product mixes saw their margins tick up 1.7 points to 11.5 percent. Distillate-rich runs brought in 13.3 percent, a 1.6-point improvement.

The heating oil/gasoline spread contracted by 2.6 cents a gallon this week.

Meanwhile, the ethanol crush improved from $1.46 a bushel to $1.52 as prices for the alcohol fuel fell by 10.2 cents a gallon. In was the 35-cents-a-bushel decline in corn prices that boosted the crush margin. Corn's correlation to ethanol spiked to 93 percent this week.

Average daily volume for WTI futures jumped 25.7 percent to 761,746 contracts, while open interest slumped by 37,906 contracts, ending at 1.455 million on Tuesday.

Commercial traders amassed a record-high net short position in WTI futures as the oil market's contango narrowed. A three-month roll, costing $1.62 last week, is now $1.38. Meanwhile, Brent crude's premium to the U.S. benchmark expanded to $1.04 a barrel from 48 cents last week.

Technical Picture

Crude oil's upward momentum was broken this week. Front-month December is now aiming southward toward a consolidation area around the $81.80 level. Underneath is a critical retracement level of oil's September-November ascent at $79.70.

With crude now below its 10-day moving average, overhead resistance is at $85.92 today. Intermediate resistance should be expected at $82.51 and $83.33, basis the December contract.

Near-term support rests at $81.02 and $80.35.

Front-Month WTI Crude Oil

Real-time Monetary Inflation (last 12 months) 0.2%

Gold targeted the US dollar for a shellacking this week while allowing other reserve currencies to build on the previous week’s gains. At Thursday’s close, gold was off 0.9 percent vs. the euro and sterling. Bullion lost 0.2 percent against the Swiss franc and the yen.

* Morning gold fixes in London averaged $1,355 this week, but finished 2.6 percent higher at $1,361; Thursday’s COMEX $1,383 spot settlement reflected a 3.0 percent weekly gain for bullion; average daily volume for gold futures jumped 21.5 percent to 209,720 contracts; open interest increased by 44,298 contracts to 647,341; COMEX bullion stocks fell by 85,879 ounces (2.7 tonnes), leaving 11.204 million ounces to cover 17.8 percent of open interest; demand for current delivery doesn’t exceed 7,100 ounces, while 2.7 million ounces are in a deliverable position.

* One-year London gold lease rates remained stalled at an average 27 basis points (0.27 percent) this week.

* SPDR Gold Shares Trust (NYSE Arca: GLD) bullion assets fell again, dipping 0.9 tonnes (29,321 ounces) to 1,292.2.

* Gauged by a decline in the Gold Miners Ratio, investors stepped up their risk-seeking this week. Shares of the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ) were bid up 12.3 percent while the Market Vectors Gold Miners ETF (NYSE Arca: GDX), a fund comprised of larger-cap producers, appreciated 6.1 percent; the average Gold Miners Ratio—GDX over GDXJ—fell from 1.59x to 1.56x.

* The broader market rose along with gold stock prices; the S&P 500 Composite rose 3.2 percent on the week, cranking up its correlation to gold-based assets; the blue-chip index’s coefficient for bullion leapt 24 points to 67 percent; a similar correlation to senior gold producers represented an 8-point jump.

* WTI crude oil prices climbed 5.2 percent to $86.49, but the rise in gold prices kept the gold/oil multiple at 16.2x.

* One-year TED spreads were steady at 54 basis points; short-term Treasury yields and Libor were static this week.

* COMEX gold futures finance rates narrowed to an 18-basis-point discount to one-year Treasurys; a diminishing spread indicates a market anticipation of steady-to-firmer rates; the one-year gold contango rose 1.0 percent on the week to an average $10.40.

* Long bond yields inched up a basis point to an average 4.01 percent; the Treasury yield curve steepened by 2 ticks to 390 basis points.

* The US dollar slide vs. the euro deepened by another 1.8 percent; cross rates averaged $1.3956 this week and finished Thursday at $1.4038.

* Daily reads of the one-year monetary inflation rate rose to 0.1 percent; at today’s rate, the real return on three-month Treasury bills is -6 basis points.

Real (Adjusted for Monetary Inflation) 3-Month T-Bill Yields

Real-time Monetary Inflation (last 12 months): -0.1%

Back in 1984, Mr. Miyagi famously intoned "Wax on. Wax off," to his Karate Kid pupil. The training mantra for the hero of the eponymous flick could well be adapted to the 2010 market as "Risk on. Risk off."

Judging from the Gold Miners Ratio—the price multiple of the Market Vectors Gold Miners ETF (NYSE Arca: ) over the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ )—investors flipped the risk switch to the "On" position in July and have kept the light burning ever since.

The price of the larger-cap producers' funds was once twice that of the junior portfolio, but that premium's been chipped away as buyers bid up GDXJ. The ratio's chalking up a new low at 1.58, signaling a new high in mining aficionados' risk appetite. Think of an investment in GDX as an analog to a blue-chip stock purchase, while GDXJ is akin to a venture capital play.

Since the beginning of the year, the GDXJ portfolio's gained 41 percent, while the GDX fund's appreciation has paced that of gold at 24 percent.

That's an important distinction. GDXJ's relative strength to gold shot up this summer after being whittled away by the senior stocks in the spring.

Relative Strength Advantage: GDXJ Vs. GDX

The present advantage enjoyed by GDXJ, however, is due more to a weakening in GDX's strength rather than increased vigor in junior issues. GDXJ's raw relative strength has actually been stalled over the past month.

GDXJ is now trying to regain the high ground reached at $36.77 in mid-October. Last week's price action was constructive after a rebound from the $34 level. Shares were worth $36.18 as Friday's trading wound up.

There was a bullish crossover in the fund's RSI indicator last week, but its momentum oscillator weakened along with Friday's 1.8 percent gain. The wobble in market momentum has got some traders worried, especially in light of the capital outflows seen in September. The fund's Money Flow Index fell precipitously then as prices reached their present plateau.

GDXJ Price Vs. Money Flow Index

This indicates that, while the risk trade is on, investors have their hands on the switch plate while they await the week's election results and the outcome of the upcoming Fed meeting.

Wednesday ought to be fun.

Real-time Monetary Inflation (last 12 months): -0.5%

For the week ending Thursday, gold lost ground to all the reserve currencies, save the Swiss franc. Setting aside the US dollar, bullion strength waned most against sterling, which rose 2.2 percent. The euro set gold back 1.5 percent as the yen climbed 1.4 percent. The Swiss currency inched 0.5 percent lower.

Now, for the dollar …

* London morning gold fixes finished the week 1.4 percent lower at $1,337 after averaging $1,331; COMEX spot settlements averaged $1,333 to wrap up an off week 1.3 percent lower at $1,342; COMEX average daily volume slumped 4.8 percent to 186,033 contracts; open interest fell 21,039 contracts further to 603,411; total COMEX inventories climbed 55,922 ounces (1.7 tonnes) to 11.118 million, mostly by shifts of bullion to “eligible” status; warehouse stocks now cover 18.4 percent of open interest.

* Once again, one-year London gold lease rates held steady at an average 27 basis points (0.27 percent).

* Vault assets of the SPDR Gold Shares Trust (NYSE Arca: GLD) decreased by another 5.2 tonnes (166,059 ounces) to 1,293.1.

* The risk trade was apparently switched on for gold mining stock aficionados this week; the Gold Miners Ratio fell to 1.58 from 1.64 as exploration and development companies outpaced established producers; the share price of the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ) shot up 6.3 percent compared to a 4.2 percent gain for the larger-cap Market Vectors Gold Miners ETF (NYSE Arca: GDX); the S&P 500 Composite ticked up 0.3 percent while its correlation to gold producers ratcheted up another 6 points to 58 percent; the index’s correlation to bullion also rose 6 points to 44 percent.

* WTI crude oil prices rose 2.0 percent to $82.18; the gold/oil multiple fell back to 16.2x from 16.6x.

* One-year TED spreads were firm at 54 basis points as Treasury yields and Libor held steady.

* Implied finance rates in COMEX futures were at a 21 basis-point discount to one-year Treasurys, though the narrowing trend indicates market anticipation of a firmer rate environment; the one-year gold contango rose 4.1 percent on the week to $10.20.

* A 7-basis point rise in average long bond yields, coupled with a basis-point decline in three-month bills, steepened the Treasury yield curve to 388 points.

* The euro gained a basis point on the US dollar, averaging a $1.3947 cross rate.

* Daily reads of the one-year monetary inflation rate fell to -0.4 percent from -0.2 percent; at today’s rate, the real return on three-month Treasury bills is 58 basis points.

Real-Time Monetary Inflation

Real-time Monetary Inflation (last 12 months): -0.5%

Traders and investors have been on tenterhooks this week trying to divine the extent of the Fed's next round of quantitative easing. Fed-watching is nothing new, but it's not just the usual cadre of traders and dealers eyeballing the central bank's moves anymore. John and Jane Public have piled into commodity-based investments, among other things, in anticipation of a big slug of Treasury purchases.

When the Fed buys bills, notes and bonds, cash is injected into the banking system, potentially fanning the embers of inflation. Ergo the interest in commodities—the ultimate barometer of inflation.

That's, in fact, one of the inputs employed in calculating our Fed Operation Indicator (see it illustrated in "The Dollar Is A Third-Rate Currency")—a predictor of Fed open market operations.

The Fed Operation Indicator is another in-house metric, like the Gold Insurance Cost Index (highlighted in "Gold's Insurance Cost Index Explained").

A reader's asked for a description of the gizmos and wheels driving the Fed Operation Indicator, so here goes ...

The indicator relies upon two inputs: the Thomson Reuters/Jefferies CRB Index—a benchmark tracking 19 diversified commodity futures contracts—and a maturity-weighted Treasury securities index. The Treasury index is proprietary, but you can create your own with an amalgam of iShares Barclays Treasury Bond ETFs: SHY for the 1-3 year bucket (61 percent); IEI for 3-7 years (21 percent); the 7-10 year span's covered by IEF (7 percent); TLH for 10-20 years (7 percent); and long bonds represented by TLT (4 percent). The weightings approximate the maturity distribution of outstanding Federal debt.

The indicator's current value is the dividend of the Treasury/CRB index ratio and its 40-week moving average.

When the indicator is above 1.05, bond prices are rising (and yields falling) at a faster pace than inflation, metered by commodity prices. Normally, this would incent the Fed to accommodate. By injecting cash through open market purchases—among other techniques—interest rates would be lowered.

A reading of 0.95 or lower indicates inflation running ahead and signals the need for Fed intervention to hike interest rates.

Readings between 1.05 and 0.95 are neutral.

Fed Operation Indicator



As you can see from the chart, the Fed indicator has wobbled in the neutral zone in 2010. Even more interesting is the indicator's current reading—0.94—which implies a Fed course of tightening, not accommodation.

Now, there are two things you ought to know about the Fed. First, the vagaries of a red line on a chart do not compel the bank to intervene. What the Fed ought to do is a vastly different scenario than what the Fed actually does. Second, the Fed has a number of tools it can use to tinker with the economy. The one most frequently employed is "moral suasion," a fancy phrase for "jawboning." Words are a lot cheaper than Treasury purchases, so if the Fed can "talk" the market into readjusting its expectations, it saves capital—of both the monetary and political sorts.

Over the past couple of days, the doubts that have swirled in the markets about the size of QE2 bear the earmark of such jawboning.

We'll soon find out just how much those words are worth.

Real-time Monetary Inflation (last 12 months) -0.5%


We've expounded on the option market insurance model in this column before. In their most basic utility, options offer investors protection from catastrophic changes in asset values, just like homeowners, automobile and—gulp!—life insurance contracts.

And just like other insurance markets, option prices are determined in part by the issuers' perception of risk. When the odds of a payout increase—because of increased fire hazards, a poor driving record, disease or wobbly asset values—the cost of protection rises.

For years now, professional traders have gauged risk in the investment market by metering the volatility assumptions embedded in option prices. The Volatility Index (VIX) measures the expected variance in the stock market over the ensuing 30 days by extracting the implied volatility of near-term options on the SPDR Depository Receipts (NYSE Arca: SPY).

More recently, the VIX concept has been translated to the oil and gold market. The CBOE Gold Volatility Index (CBOE: GVZ) has been tracking risk expectations in the gold market by distilling the "IV" ("implied volatility") SPDR Gold Shares Trust (NYSE Arca: GLD) options for the past couple of years.

Presently, GVZ pegs the annualized volatility of the gold market at 20 percent. Is that high or low? Well, it's certainly higher than it was. Last month, anyway. Back in September, when gold was reaching new nominal highs, GLD volatility dipped as low as 16.7 percent.

The implication? Back then, option traders were pricing contracts with the expectation that gold prices proxied by GLD would likely vary—up or down—1.4 percent (16.7 percent divided by 12 months) over a 30-day period.

When GVZ—aka volatility—is high, writing (selling) naked options and credit spreads are more likely to make money. When GVZ is low, debit spreads and naked option purchases are favored.

Relatively speaking, buying GLD options would have been the play in mid-September. If you were exceptionally prescient, you would have bought calls for a month-long, $130-an-ounce ride up Bullion Mountain.

GVZ peaked at 22.6 percent—along with gold prices—on Oct. 14. GVZ then signaled a heightened risk of change in gold's price trend. Now GVZ's falling along with gold prices, indicating a certain market complacency with the trend.

The Gold Insurance Cost Index measures the risk of price trend changes as well and, as you can see from the chart below, pretty much tracks alongside GVZ. The insurance index is derived by comparing GLD option premiums to SPY contract costs. Each day, puts with at least eight weeks ‘til expiration and each 10 percent out of the money are ratioed: the GLD put premium in the numerator and the SPY premium down below. The daily change in the resulting percentage is then indexed to a base level. In the chart below, the starting date is arbitrarily set as July 23.

Gold Volatility Index (GVZ) Vs. Gold Insurance Cost Index

Real-time Monetary Inflation (last 12 months): -0.2%

Silver's slipping away. Check that. Silver's momentum has slipped.

Prices for the white metal put in a near-term top along with gold (see "Gold Signals: A Sell-Off Is Due") as the December COMEX contract reached for the $25 level. When failure set in, skid marks were left at $24.95.

By last week, the $23 level was probed by sellers. On Tuesday, prices tumbled through the contract's 10-day moving average at $23.63 and, on Friday, prices bounced off the momentum-defining 21-day average at $22.95.

Along with a fall-off from the overbought levels indicated by the Relative Strength Index, a bearish crossover in the MACD indicator also printed last week.

So, get out your pencils and rulers. This week's price action will be critical in establishing objectives for bears and would-be bulls alike.

A close under the 21-day average would likely set up a test of the $21.24-$21.37 area, if intermediate support at the Oct. 8 reaction low of $22.35 is taken out. The $21-level objective is defined by the price target of December silver's July 28 pivot point low and a 50 percent retracement of the contract's August-October rally. Yesterday's resistance has now become today's support.

December COMEX Silver

For those looking at bearish possibilities underneath the $21 level, keep an eye on December's 50-day moving average, now at $20.88, and more significantly, the $21.50 level, representing a 62 percent retracement of silver's late summer-to-fall run-up.

Real-time Monetary Inflation (last 12 months): -0.5%

Gold's breakdown was this week's feature.

* In London, morning gold fixes averaged $1,358 and finished the week 2.6 percent lower at $1,345; the mean COMEX spot settlement was $1,349, but wrapped up the week with a 3.8 percent loss—at $1,325—Thursday; average daily volume for COMEX gold futures rose 10.9 percent to 209,827 contracts; open interest fell 2,886 contracts to 624,450; COMEX warehouse stocks increased 84,211 ounces (2.6 tonnes) to 11.17 million to cover 17.9 percent of open interest.

* One-year gold lease rates in London held steady to average 27 basis points (0.27 percent).

* SPDR Gold Shares Trust (NYSE Arca: GLD) bullion assets fell 6.1 tonnes (195,348 ounces) to 1,288.3.

* Gold exploration and development companies were hit hardest this week, evidenced by an 8.0 percent decline in the share price of the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ); the larger-cap Market Vectors Gold Miners ETF (NYSE Arca: GDX), a fund comprising gold producers' stocks, cheapened 6.7 percent; the gold miners (GDX/GDXJ) ratio rose to an average of 1.64-to-1; the S&P 500 Composite inched up 0.6 percent on the week, as its correlation to gold producers rose another 19 points to 52 percent; the index's correlation to bullion jumped 30 points to 38 percent.

* Domestic crude oil prices fell 2.8 percent, with nearby WTI futures settling at $80.56 on Thursday; the gold/oil multiple ticked up to 16.6x from 16.5x.

* One-year TED spreads backed down 1 basis point to 0.54 percent as Treasury yields continued to lag a steady Libor.

* COMEX gold futures' implied finance rates maintained a 22 basis-point discount to one-year Treasurys, indicating an increased likelihood of steady-to-rising rates; the one-year gold contango eased 1.9 percent, to $10.10.


* Long bond yields rose 12 basis points to an average 3.93 percent, while three-month bills nosed up a single basis point to 0.13 percent; as a result, the Treasury yield curve steepened to 380 basis points.


* The euro lost 0.7 percent vs. the greenback, finishing the week at $1.3874; cross rates averaged $1.3940.


* Daily reads of the one-year monetary inflation rate averaged -0.2 percent this week; at today's rate, the real return on three-month Treasury bills is 57 basis points.


Real (Adjusted For Monetary Inflation) Yields: Three-Month T-Bills

Real-time Monetary Inflation (last 12 months): -0.1%

While today's gold sell-off hit bullion hard, mining stocks were thwacked. Heading into the East Coast lunch hour, spot gold prices were off 2.5 percent, while the stocks of gold producers proxied by the Market Vectors Gold Miners ETF (NYSE Arca: GDX) had tumbled 4.1 percent.

Ah, the leverage of mining stocks.

Miners have lost a lot of ground to bullion in the bull market, but have been struggling to regain their strength. We examined the progress miners made this year in our feature, "Are Gold Stocks Better For Your Portfolio?". To better understand the stocks' performance, however, we should regard a longer time frame.

When the GDX portfolio—tracking a global 30-stock index—was launched in 2006, it outperformed bullion, but very soon began to slip. Within a year, GDX's relative strength had fallen into negative territory, finally bottoming in October 2008. Miners were acting very much like other stocks in 2008.

Relative Strength (GDX To Gold)

Gold miners then rebounded until a year ago. In September 2009, mining stock momentum fizzled compared with gold, even though the stocks' price movements are highly correlated (76 percent) to bullion's.

And that's the key to understanding mining stocks' performance over the past four years. They're better—or have been better—than stocks in general, but not as good as gold itself.

The numbers bear testimony to this:

Gold Miners (GDX) Relative Performance

23-May-2006 Through 18-Oct-2010

For their volatility—measured by its beta coefficient—miners haven't yielded enough reward. The stocks' alpha is negative, meaning gold produces better risk-adjusted returns.

The story's completely different, however, when gold miners are put up against the recent performance of blue-chip stocks. Here, miners outshined the broad market, producing alpha—or excess returns—with less volatility.

Keep this in mind as we head deeper into earnings season.

Real-time Monetary Inflation (last 12 months): 0.2%

Sometimes I feel like Cassandra. Gold's flashing "sell-off" signals, but a lot of speculators seem not to care. Allow me to state my case.

First, let's look at the technical picture.

Gold's Relative Strength Index (RSI) has been in overbought territory since Sept. 6—to date, 22 trading days.

RSI measures a market's strength or weakness. A high RSI, e.g., above 70, suggests an overbought bull market. For gold now, here's the kicker: its RSI trend has been diverging from its market price trajectory since Oct. 7. Simply put, metal prices have been moving higher, but the RSI has failed to follow suit. This points to an impending break in the price trend.

The wobble in bullion's strength is confirmed by its price skirting its upper Bollinger band.

Bollinger bands connect price points two standard deviations above and below a commodity's moving average. Wider bands bespeak greater market volatility; narrower bands indicate relatively stable markets, but it's the divergence that's the important thing. Gold's new price highs are touching the upper volatility band but the upward thrust isn't being confirmed by an upturn in market strength.

The icing on the indicator cake, if you'd care to characterize it as such, is a downward reversal in gold's momentum oscillator. The "oomph" in gold's upward trajectory is fizzling.

So what of fundamentals? Well, let's put aside monetary policy and longer-term metal dynamics for a moment to concentrate on near-term fundamentals—the demand and supply for gold contracts.

Normally, it's commercial dealers and institutional investors that move gold's price. Over the past two weeks, however, the gold futures market has been moved by speculators. This past week, it was small specs cranking up their net long positions by 9.8 percent while commercials and money managers essentially neutralized each other. The previous week, it was large, noninstitutional specs that ruled with a 20.8 percent jump in net long positions.

Even with this week's goosing, the length of speculative positions in the gold market was shortened by 4,411 future contract equivalents, the first drawdown in the past 10 weeks.

All this points to gold's near-term price vulnerability. Now, we're not talking about a wholesale reversal in gold's fortunes. The prospects of another round of qualitative easing still loom large, but cyclically, the market's ripe for a give-up.

To what degree?

Well, it depends. A close under spot's 10-day moving average at $1,352 today would be a first step to a breakdown, but a dip under last week's lows at the $1,341 level would be a stronger signal.

Assuming a sell-off occurs, the target for shorts (and the potential buy-in for bulls) would be the 50-day moving average—today at $1,273, and, if breached, the 200-day average—now at $1,188.

Moving averages are just that—moving. So, to keep abreast of potential cyclical bottoms, stay tuned to this column.

Real-time Monetary Inflation (last 12 months): 0.0%


Year-over-year, the U.S. Consumer Price Index held steady at 1.1 percent, though the core rate, i.e., excluding the volatile food and energy components, inched down to a 49-year low of 0.8 percent.

Inflation at the wholesale level, reflected in the Producer Price Index for Finished Goods, rose 90 basis points (0.90 percent) to 4.0 percent in September.

The HAI Monetary Inflation Index rose 2.4 percent by September's end to stand at -0.3 percent.

Gold gained ground on the major reserve currencies this week, scoring new highs against the U.S. dollar and sterling. On Thursday, bullion's average asking price was 2.7 percent higher versus the British pound, 1.9 percent higher in Swiss francs and 1.5 percent higher in euros. Gold appreciated 1.4 percent in yen.

Key indicators of U.S. dollar strength for the week ending Thursday:



London morning gold fixes ended 1.6 percent higher at $1,381 after averaging $1,352 for the week; COMEX spot settlements averaged $1,358 and finished 3.2 percent higher at $1,377; average daily volume for COMEX gold futures rose 37.7 percent to 195,669 contracts; open interest climbed 5,395 contracts to 627,336; COMEX bullion inventories jumped 130,479 ounces (4.1 tonnes) to 11.09 million and now cover 17.7 percent of open interest.


One-year gold lease rates in London ticked up a basis point to average 0.27 percent.


Bullion assets held by the SPDR Gold Shares Trust (NYSE Arca: GLD) increased by 15.8 tonnes (507,982 ounces) to 1,304.2.


Investors' risk appetites continued to sharpen, evidenced by a 5.8 percent surge in the share price of the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ); the Market Vectors Gold Miners ETF (NYSE Arca: GDX), a fund comprising larger gold producers' stocks, rose 2.9 percent; the Gold Miners (GDX/GDXJ) ratio, as a consequence, fell from an average 1.65 to 1.61; stocks in general, measured by the S&P 500 Composite, improved 1.4 percent on the week, boosting the benchmark's correlation to gold; S&P's correlation to gold producers shot up 19 points to 33 percent as its bullion coefficient turned positive with a 10-point climb to 7 percent.


Domestic crude oil prices rose 1.5 percent as spot WTI futures settled at $82.89 per barrel; the gold/oil ratio inched up from 16.2x to 16.5x.


One-year TED spreads nosed up 2 basis points to 0.55 percent as Treasury yields softened against a steady Libor.


The embedded discount in COMEX gold futures finance rates narrowed to 22 basis points under one-year Treasurys, indicating an increased likelihood of rising rates; the one-year gold contango rose 60 cents an ounce, or 6.2 percent, to $10.30.


Yields on the long bond averaged 3.81 percent, a 10 basis point jump for the week; continuing softness at the short end steepened the Treasury yield curve 9 basis points to 3.69 percent.


The euro gained 0.6 percent against the greenback, averaging a cross rate of $1.3926.


Daily reads of the one-year monetary inflation rate again averaged 0.0 percent this week; at today's rate, the real return on three-month Treasury bills is 9 basis points.

Twelve-Month Inflation Metrics

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