Oil has tested below the 122.00 level for the first time since early-Jun, lessening inflationary pressures and the resulting drag on the US economy. Brent spot crude is holding support at 121.29 (05-Jun low) thus far, but the short-term bias remains vulnerable.

OPEC's chief, Chakib Khelil, said over the weekend that oil should be trading between $70 and $80 bbl if the dollar strengthens and tensions surrounding the Iranian nuclear crisis are defused. As for the dollar, it's tough to tell at this point if falling oil is pushing the dollar higher, or visa-versa.

With respect to Iran; comments by President Ahmadinejad that his country wants to seek "common ground" with the US were viewed by the market as being conciliatory. However, Iran has yet to respond to the latest incentives to halt their uranium enrichment program. Additional sanctions against Iran are likely to be implemented if Iran fails to accept the package by this Saturday's deadline.

US Secretary of State Condoleezza Rice called on Ahmadinejad to back up his "common ground" statement by accepting the incentives and halting their nuclear program. To my knowledge the Iranian president has not responded to this challenge, but his latest speech was laced with his typical anti-Western rhetoric.

Democratic presidential hopeful Barack Obama, just back from an overseas trip that included a stop in Israel, suggested that an Israeli strike against Iran was likely if sanctions fail to work. Meanwhile, Bush administration officials have reassured Israel that a US attack is also still on the table.

Any heightening of tensions in the Middle East in the latter half of the week -- as the deadline approaches -- are likely to send oil higher. If that happens, we would look for gold to rebound as well.

While weaker oil may be lending some support to the stock market, it is unlikely that the recent gains are sustainable. Oil is under pressure primarily as a result of demand kill stemming from a slowing economy. A weak economy is ultimately bad for stocks.

The stock market should be paying more heed to Merrill Lynch's fire sale of $30.6 bln in CDOs at 22-cents on the dollar. This suggests that CDOs sitting on the balance sheets of other financial institutions are grossly overvalued. Additional significant writedowns throughout the financial sector are likely to result in further weakness on Wall Street.

Devaluation of CDOs and related assets is also likely to drive up the cost of the GSE bailout. Additional writedowns for Fannie Mae and Freddie Mac could end up being a combined $100 bln. The GSEs total exposure to subprime and Alt-A mortgages is estimated to be a whopping $780 billion. That's slightly less than the $800 bln increase in the national debt ceiling that was buried within the Housing Bill that was signed by President Bush this morning.

Like we always say, ultimately the health of the banking sector, and to a large degree the entire US economy, comes back to housing. Yesterday's weak S&P/Case-Shiller home price index, along with today's reported plunge in new mortgage applications for last week indicates that a bottom in housing may still be a long way off.

Arguably, speculation that the greenback has bottomed is also premature, with the dollar index less than 4% off its all-time low. In fact, given the dismal Eurozone economic sentiment readings that came out earlier, I would say that today's moves in the FX market are probably more attributable to euro weakness than actual dollar strength.

The Swiss franc also weakened today after the KOF leading indicator fell to 0.90 in Jul, a 5-year low. Weak consumption was cited as the primary reason for the sharp drop. KOF for Jun was revised lower from 1.01 to 0.99.

As for yesterday's better than expected US consumer sentiment print for Jul; 51.9 is still a very weak reading, just slightly better than the Jun reading of 51.0 -- a 16-year low. The positive reaction to these data, both in the dollar and in equities, is overblown.

Signs that recent gains in the dollar and stocks may not be sustained would bolster the gold market. We also expect to see confirmation of good physical demand for gold at these levels. A rebound above 912/915 would ease short-term pressure on the downside, favoring a return to the 930/950 zone. Such a move would be a strong confirmation that the seasonal lows are in place.

Gold Market Movers:

US treasury announced $27 bln quarterly refunding.

ECB and SNB announce enhancement of dollar facilities and new 84-day operations.

Fed extends special lending facilities through Jan-09.

US ADP employment survey for Jul +9k, above market expectations, versus -77k in Jun.

US MBA mortgage index for the week ended 25-Jul plunged 14.1%; refis -22.9%, purchases -7.8%.

Eurozone economic sentiment indicator for Jul tumbled to 89.5, well below market expectations, versus 94.8 in Jun.

Swiss KOF leading indicator for Jul fell to 0.90, a five year low. This was well below market expectations and the Jun reading was revised lower to .99 from 1.01.

Huge writedowns forecast for banks after Merrill Lynch's cut-price sale of debt

Fed extends emergency lending for banks

SEC extends emergency order on short-selling

US credit crunch set to last for months

America's oil addiction: Chronicle of a crisis foretold

Strike on Iran still possible, U.S. tells Israel