Oil is maintaining a generally weak tone in the wake of last week's sharp losses. Forecasters are now saying that Tropical Strom Dolly will miss the oil production and refining areas of the Gulf of Mexico. This has put oil under additional pressure.

Gold continues to show excellent resilience in the face of oil losses as the gold/oil ratio edges closer to our target at 8. If the ratio rebounds above 8, we would then see potential back toward 10, which is still well below historic norms. The bullish outlook for the ratio is consistent with our belief that gold will continue to benefit from diversification flows coming out of both oil and stocks.

Keep in mind that most analysts believe that crude is one hurricane away from a sharp recovery. While Dolly doesn't seem to be a threat anymore, the 2008 hurricane season is off to a brisk start and there are more than 4-months left to go.

Any significant escalation in Middle East tensions could cause oil to rebound as well. US Secretary of State Condoleezza Rice has already threatened Iran with further sanctions if they fail to accept the latest six-nation proposal.

Iran has two weeks to respond to that proposal, if they maintain their hard-line, look for tensions and oil to rise. The fact that a high level US diplomat sat in on last weekend's meeting in Geneva has been heralded by some as a major shift in the Bush administrations position on Iran. However, it is very premature to rule out a preemptive strike against Iran by either the US or Israel.

If oil rebounds we would anticipate that it would once again have a bullish impact on gold, although it will be interesting to see how the gold/oil ratio reacts in such an event. Overall, one might expect speculation on the long side of oil to be a little more tentative the next time around. Bets on military action against Iran are likely to be more aggressive than bets on the weather.

US stocks were unable to hold on to early gains on Monday, ending the day modestly lower. Wall Street was initially poised for a lower open today following a series of disappointing earnings results after the bell yesterday. This morning, Wachovia reported a record $8.9 bln Q2 loss, which weighed on equities as well. However, the Dow has gotten a counter-intuitive intraday boost from hawkish comments by the Fed's Plosser, which sent oil tumbling.

Nonetheless, the inability of the DJIA to sustain the recent tests above resistance at 11,505/10 leaves the more important 11,650/91 level intact and the overall tone of the market vulnerable. A short-term move back below the 20-day moving average at 11,363 would signal renewed weakness, shifting focus to Fibonacci/chart support at 11,307/11,290. Penetration of the latter would target 11,198 initially (50% of the rally from 10,731.96 to 11,663.40), although a complete retracement of the recent corrective rally would have to be considered.

The Congressional Budget Office says the rescue of mortgage giants Fannie Mae and Freddie Mac could cost taxpayers $25 bln. While some have suggested the GSEs may have no need to tap the proposed new line of credit, the CBO thinks the chances are about 50/50.

However, there is plenty of evidence to suggest that the housing and financial sectors will continue to decline. Further pressure on an already shaky system could drive the GSEs to the new lending authority. Together Fannie and Freddie own or back nearly half of the $12 trillion US mortgage market.

Physical gold is a convenient and liquid hedge against systemic risks. Gold also offers protection against expansionary US monetary policy that is necessitated by various bailouts and rescues. As money supply is expanded, the value of the dollar declines and inflation results. Of course, gold is the classic hedge against both a weak dollar and inflation as well.

Gold Market Movers:

US OFHEO home price index for May -0.3%, down 4.8% y/y.

Italian consumer confidence for Jul tumbled to 95.8, much weaker than the market was expecting, versus 99.9 in June.

U.S. plan to aid GSEs has $25 billion price tag: CBO

Wachovia plunges on $8.9 bln loss

Why no outrage?

Busy start heralds bruising Atlantic hurricane season