Oil is consolidating after setting another new all-time high on Monday. The latest record above $127 comes despite a commitment by the Saudis to increase output by 300k brl/day and news that President Bush signed the bill that temporarily suspends accumulation of oil for the strategic oil reserve.

Meanwhile, OPEC's president Chakib Khelil reiterated that there is no shortage of oil, that high prices are the result of speculation and a weak dollar. Speculation is being driven by expectations of higher prices in the wake of recent projections that suggest prices could go as high as $200 brl.

As evidence of the increasing impact of speculation: In just the past 5 years, the number of oil futures contracts exchanged on the NYMEX has more then doubled.

The persistent rise in crude prices is stoking fears of global inflation. I don't think we've even begun to see the broader impact of $120 oil and here we are nearly at $130.

German PPI for Apr came in much higher than expected today at 5.2% y/y, driven primarily by higher energy costs. Meanwhile, US core PPI for Apr surged 0.4%. While the headline number was a more constrained +0.2%, the implications are clear, global price risks are mounting.

Gold is a particularly effective hedge against energy-based inflation. Therefore, as crude prices rise, gold should track higher as well.

Despite an unexpected drop today in German investor confidence, there are growing expectations that the ECB may raise rates in the short-term in an attempt to get a handle on inflation. The euro is trading higher against most currencies as a result.

Despite the rapid pace of inflation, the Fed is unlikely to raise rates before Dec. To begin reversing out recent rate cuts sooner than that would create an unstable environment for business, making long-term business planning difficult and thereby undermine the credibility of the Fed.

The Fed is likely to remain focused on risks to growth and committed to its easier monetary policy for at least the next 6 months. At the same time, the ECB's primary mandate is price stability. With prices increasing at a pace well above the ECB's comfort zone, the central bank is compelled to act. It is this expectation of widening interest rate differentials that is likely to weigh on the dollar.

The EUR-USD rate has now retraced more than 50% of the decline from 1.6020 to 1.5280. A push above 1.5694/1.5700 would clear the way for a test of the 61.8% retracement level of the aforementioned downmove at 1.5737. Penetration of the latter would return considerable credence to the long-term downtrend in the dollar.

The dollar index continues its retreat toward the pivotal 72.00 level. A convincing push back below this level would signal that the all-time low in the dollar at 70.70 is back in play.

In recent weeks we maintained that all of the recent talk about the dollar bottoming was premature. Gold is also the classic hedge against a declining dollar. If the dollar's downtrend is reestablished, look for the dominant uptrend in gold to resume as well.

Short-term sights in the yellow metal are set on the 936.60/952.80 zone. Further out, scope is seen for renewed tests above the $1,000 level.

With many of the market forces that pushed gold above $1,000 earlier in the year starting to re-exert themselves, it is also worth noting that a cyclical gold buying opportunity is at hand as well.

In the recently posted research piece Bargain-Hunting for Gold: Seasonal Price Trends Look Favorably on Summer Purchases, it is noted that, "any random assortment of purchases made throughout May, June or July on average proves to be a fruitful maneuver by year-end."

Gold Market Movers:

US PPI for Apr +0.2%, but core surge of 0.4% overshadows the headline figure.

ZEW's Franz expects ECB to raise rates in "near future"

German ZEW investor confidence index for May tumbled to -41.4, from -40.7 in Apr. The market was expecting a rebound.

German PPI for Apr 5.2% y/y, well above market expectations.

BOJ leaves rates unchanged at 0.50%

Gold/oil ratio outlook mixed after some 'disconnect'

Gold ETF demand doubles in the first quarter

Fears of prolonged credit crisis set to hit Wall St.

ECB head: Credit crunch 'ongoing'

New era of tough times ahead

Sino gold raising A$204 million, to close hedges