Gold has been able to hold above 772.70 despite fresh 5-month lows in oil on Tuesday. Oil got hit pretty hard after hurricane Gustav hit the Gulf production and refining region with less intensity than anticipated. Oil production and refining capacity should be coming back online over the next several days, following the inspection of facilities.

With gold comparatively supported against oil, the gold/oil ratio traded briefly above 7.5 yesterday. The ratio initially moved below this level back in May and traded as low as 6.4 in early-July. A convincing move back above 7.5 in the ratio would offer further encouragement to gold prices.

The gold/oil ratio has traded below 7.5 three times since 1970. In the previous two periods, which began in August 1976 and June 2005, the ratio rebounded strongly as the dominant uptrend in the yellow metal ultimately prevailed. From the end of August 1976 until the end of that year, gold appreciated 29.3%. Between 30-Jun-05 and 31-Dec-05 gold rebounded 17.4%.

Pretty impressive gains for 4 and 6 month time frames. From a recent research piece detailing seasonal price trends; we know that in the past 35 years, over two-thirds of the average annual gains in gold have been registered between August and December. With August now behind us, the window for realizing those gains has narrowed, while negative price action has provided an opportunity to buy at levels not seen since December.

The gold/oil ratio has historically averaged about 15 since 1970. I have been calling for a rebound to at least 8, with potential back to 10. The recent gains in the ratio bode well for that scenario. Of course that could mean that oil dips to $100 and gold continues to hover around $800. On the other hand, if you believe that oil does not have sustainable potential below $100, we could see a significant rebound in gold.

Of course oil remains incredibly sensitive to any hint of a potential supply disruption. With hurricanes queuing up in the Atlantic, the Russia-Georgia conflict increasing tensions in the Black Sea, ongoing unrest in Nigeria, persistent tensions in Venezuela and the nuclear standoff with Iran continuing to simmer, a lot could still happen between now and the end of the year. If oil finds support ahead of $100 and rebounds to the $115/$120 zone, the yellow metal could easily recapture the $900 level in the near-term.

The recent rebound in the dollar has also played an important role in the sharp correction in commodities. Back in 2005, oil was supported by, and gold was suppressed by a rising dollar as well. Interesting thing about the yearlong dollar rally in 2005: It was fostered by tighter monetary policy. Over the course of that year, the Fed funds target was hiked at every FOMC meeting by 25bp. Fed funds nearly doubled, rising from 2.25% to 4.25%. During that same one-year period the ECB refi rate was 2.0%.

Ultimately the dollar rally of 2005 fizzled, long before Fed funds hit their high of 5.25% in June of 2006. The dollar fell out of favor once again and resumed its long-term downtrend as the US trade and budget deficits grew along with money supply and Eurozone interest rates began to rise.

The recent dollar rally that began in mid-July is not being supported by tighter monetary policy. In fact, just the opposite is true. The dollar is rallying despite easier and expansionary monetary policy. As a result rumors are swirling about coordinated intervention in support of the dollar and against the precious metals.

The dollar has certainly been bolstered by unwinding of long euro trades, as the Eurozone appears to be slipping into a recession, but that does not make for a sustainable rally in the greenback. If the 2005 dollar rally could not be sustained even with dollar supportive policy moves, it is doubtful that this rally will be sustained.

Today's Fed Beige book is expected to confirm that the Fed will hold rates steady at 2.0% when the FOMC meets on 16-Sep. Odds of a hike to 2.25% by year-end are about 50-50. I still don't think that will happen. Even if the ECB cuts rates before year-end from 4.25% to 4.0%, the Eurozone is still offering twice the yield. By the end of 2005, you could get twice the yield in the US and the dollar still fell out of favor.

I like to say that FX flows follow yield, but it's never quite that simple. You have to consider the rest of the fundamentals as well. The deficits that helped to undermine the 2005 dollar rally are even larger today. Money supply continues to grow at a breakneck pace as the government pumps massive amounts of liquidity into a stressed banking system. Everyone seems to agree that the government is also going to have to come up with additional bailout money for some entity, be it another major bank or one of the GSEs.

If the fundamentals ultimately carry the day and the dollar resumes its long-term downtrend, we can expect gold to resume its long-term uptrend. A weaker dollar will also drive up oil and other commodity prices, forcing inflation back into the headlines. At that point, $800 gold is going to seem like a real bargain.

Gold Market Movers:

Fed Beige Book for 16-Sep FOMC meeting at 14:00 EDT.

US factory goods orders for July +1.3%, above market expectations, versus a revised +2.1% in Jun.

US MBA mortgage market index for the week ended 29-Aug +7.5%; purchases +10.5%, refis +2.1%.

Eurozone retail sales for July fell 0.4%.

Eurozone Q2 GDP confirmed at -0.2% q/q.

UK services PMI for Aug surged to 49.2.

Final Eurozone PMI for Aug revised upward to 48.5.

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