Oil prices are up more than $10 bbl over the past two sessions as Iranian missile tests took the saber rattling to the next level. The missile tests -- some with the capability to reach Israel and US bases in the region -- were seen as a response to Israeli military exercises last month that were viewed as a test run for a strike on Iranian nuclear facilities.

Israel has adamantly stated that a nuclear-armed Iran is unacceptable. Iran claims that their nuclear program is purely for energy generation and has defiantly refused to halt uranium enrichment.

The US was quick to warn Teheran in no uncertain terms that they would defend American interests in the region and would not hesitate to defend Israel. Meanwhile, the Israeli defense minister hinted once again that a preemptive strike against Iran might be in the offing.

The Jerusalem post reported today that IAF warplanes were active over Iraq. Sources cited in the article said that American bases in Iraq might be used to launch a raid against Iranian nuclear sites.

The significant escalation in tensions has sparked aggressive forward buying as end users seek to secure supply ahead of a potential military conflict. Of course the pure speculators are jumping on board for the ride as well, driving oil back within striking distance of the record highs.

OPEC has warned that if Iran -- its second largest producer of oil -- is attacked, there is no way they will be able to make up for the lost production. OPEC's secretary general said that price gains would be "unlimited" in the eventuality of a military conflict. A strike in Brazil and renewed militant activity in Nigeria are adding additional upside pressure to crude.

Iran's economy is struggling as a result of economic sanctions. President Ahmadinejad is facing mounting criticism within the country and is up for reelection next year. Meanwhile, the Bush administration is counting down its final months in the White House and a corruption scandal in Israel threatens to bring down the government of Ehud Omert before the end of the year.

Of the three major players in this drama, all three of them have weak governments. As pointed out in a BBC article we highlighted yesterday, "That is never a good formula for rational policy-making."

Gold is the classic hedge against energy-based inflation. Look for the yellow metal to be supported by higher oil prices. Higher crude is also going to continue to weigh on the US economy and could push us over the brink into recession. Gold is also a great hedge for general economic uncertainty and provides excellent diversification with the stock market looking rather bearish.

Of course the latest turmoil associated with potential insolvency at Fannie Mae and Freddie Mac keeps the credit/liquidity crisis highlighted as well. The government sponsored lenders own or guarantee approximately $5 trillion in debt.

If the GSEs ultimately require a bailout, that money is likely to come fresh off the printing presses and will put additional downside pressure on the already weak greenback. Systemic risks and a falling dollar also favor gold purchases.

With the Bear Stearns 'rescue' -- and I use that term very loosely -- still fresh in the markets memory, a potential bailout of Fannie and Freddie once again begs the question: Where do the bailouts end? Is the government essentially sending the message that no major financial institution will fail as long as they have the ability to print money? If so, the implications for the dollar are extremely dire indeed. Best get you some gold.

Gold Market Movers:

Michigan preliminary sentiment index for Jul at 10:00 ET. Market is looking for further erosion.

US trade deficit for May narrowed to $59.8 bln.

US imports for June +2.6%, above market expectations.

Canada trade surplus for May rose to $5.5 bln.

Canada employment for June -5k. Jobless rate at 6.2%.

Gold can help to keep bankers (somewhat) honest

Gold secular bull market still intact and remonetisation has begun

SAfrica gold output down 11.6 pct yr/yr in May

Freddie and Fannie in turmoil

US weighs takeover of two mortgage giants

OPEC warns against military conflict with Iran

Israeli warplanes practice in Iraq