Oil has approached the $120 level after BP shut down a crucial North Sea pipeline over the weekend following failed efforts to avert a refinery strike in Scotland. The Forties Pipeline system carries approximately 700,000 brl of oil per day, about 40% of UK production.

The two-day strike at Grangemouth refinery will come to an end on Tuesday. Grangemouth provides power for the pipeline's offshore processing center. While BP reports that the pipeline will be back up within 24-hours, it may take as long as a week before the plant is able to return to production.

In Nigeria, Exxon is experiencing its own labor problems, and has shut down nearly all of their production. Nigeria is the eighth-largest global producer of oil and Exxon accounts for about 40% of that production. Nigerian oil, like North Sea oil, is highly desired for its low sulfur content and ease of refining.

Reports are circulating today that rebels had staged an attack near Nigeria's largest oil export terminal at Bonny Island. Attacks on pipelines have increased supply concerns in recent weeks, but were only a minor worry. With output now curtailed by as much as 40% due to the Exxon strike, there is additional upside potential in oil.

Strong fundamentals, along with the supply disruptions and investor flows should keep oil tracking higher. Robust demand from China, India and the Middle East seems to be offsetting slackening of US demand resulting from the high prices and the worsening economic conditions. Gains in oil contribute significantly to the global inflationary spiral and increase the hedging appeal of the yellow metal.

The Fed's FOMC meets Tuesday and Wednesday this week. Chances of a 25bp rate cut are running about 84% and such a move is widely anticipated. A larger 50bp cut has been completely priced out. Additionally, there is a growing consensus that the Fed will signal a pause in the easing cycle.

The anticipation of a pause has been supportive to the dollar, although the greenback remains mostly confined to the ranges that were established last month. We're watching the dollar index in particular to see if recent upticks have any follow-through. So far, that has not been the case and resistance at 72.84/73.16 remains well protected.

While significant risks to growth remain, it's going to be difficult for the Fed to ignore the price risks this time around. If the policy statement does indeed suggest a pause, the pretense is likely to be the desire to see how recent policy actions are working.

Despite the increasing price risks, the Fed is likely to react decisively, if the economy continues to flounder. Further rate cuts in advance of the next FOMC meeting on 25-Jun would be likely if the stock market resumes its slide.

Investors moved out of mutual funds in droves during the first quarter, the worst start to a new year in more than a decade. Substantial outflows are the result of poor performance, and presumably an expectation that the funds are destined to under-perform for some time. The FT is reporting today that retail and institutional investors pulled $100 bln from equity funds in Q1.

Gold provides an excellent store of wealth for investors coming out of the stock market. Gold is likely to remain underpinned as a result of such flows. The DJIA should have some difficulty sustaining any short-term gains back above 13,000. Signs of renewed weakness are likely to result in further equity outflows that will benefit gold.

We expect the Fed to continue with its various facilities that have injected massive amounts of liquidity in recent months. Certainly any new shocks to the banking system, and there are indeed still substantial systemic risks, are likely to be met with a fresh flood of liquidity. These programs have a considerable debasing effect on the dollar, offering further evidence that the bounce in the dollar is just a brief reprieve in the long-term downtrend.

A declining dollar makes hard assets, such as gold, increasingly appealing as alternative assets. Gold and the dollar are also negatively correlated to an indication that the dominant downtrend in the dollar is re-exerting itself should send gold back toward the midpoint of the recent range around $950.

Gold Market Movers:

German State CPI for Apr notably soft.

German GfK consumer confidence for Apr jumped to 5.9, versus revised 4.8 in Mar. This was significantly greater than the market was expecting and marks a 7-month high.

UK Hometrack house prices for Apr -0.9% y/y.

Oil nears $120 following labor and military strikes

Investors pull out of mutual funds

Gold rises as record crude raises inflation concerns