INTERNATIONAL (BI-ME). The relation between the US currency, oil and gold  is well documented. A weaker dollar makes dollar-denominated commodities cheaper to non-dollar based investors. High oil prices have been known (more so in the past) to generate inflationary pressures and to drive investors into metals as a hedge against inflation.

While this model tends to be simplistic it has a good track record as an indicator of short term price movements: When there is a convergence of weak dollar and strong oil , the only way for gold is up.

Spot gold remained firm in London trading on Monday, holding to the gains of last week as oil was slightly down and the dollar continued its downward fall testing new lows against the Euro and the Pound. Monday as a whole was a day of consolidation. 

By 1.00pm GMT (5.00pm Dubai) on Tuesday, gold stood in London at US$685.85/685.35 a troy ounce up by US$4.45 from the Monday close and above the US$685 level.

Gold was up US$20 last week as higher oil and a weaker dollar drove investors to metals.

Much of the gains last week were due to speculators buying back gold they had sold short on expectations of lower prices. Data from the US Commodity Futures Trading Commission showed higher net long gold positions as investors increased holdings in gold exchange traded funds(ETF)

Silver also saw good gains. This in turn persuaded investors and speculators to increase their holdings in silver ETF.

The next test for gold will be US$700, followed by the highs of May 2006 of around US$730. When will these levels be reached and breached will depend on many factors mainly affecting the dollar and oil.

The US Dollar continued its downward momentum from last week hitting a record low against the Euro and Sterling on Monday as worries surrounding risky subprime US credit continued to signal trouble for the US currency.

The US currency dropped to 120.41 Yen, on Tuesday, the weakest since 16 May. It also touched US$2.0654 versus the pound in early London trading, the lowest since May 1981. It was at US$1.3809 per Euro just above the all time low of US$1.3844 reached on Monday.

Paul Chertkow, head of currency strategy at Bank of Tokyo-Mitsubishi in London, told Bloomberg: "The subprime market is a concern and the US economy is going to be slower than anticipated. There's no good reason to think the dollar's going to appreciate."

The dollar weakness is broad-based with low-yielding currencies such as the yen doing well, as well as high-yielding currencies. "We are not witnessing the effects of a strong Pound or a strong Euro", said an analyst in Dubai. "This is a weak dollar driving all other currencies up".

There is a growing school of thought that believes the Bush administration wants a weak dollar and will not do much to support the currency through intervention in the foreign exchange markets or other available fiscal means. The US Dollar has lost 13.2% since January 2001, when the current US administration took office, the most under any President since the 1970s.

OPEC President and United Arab Emirates Energy Minister Mohammed al-Hamli said on Sunday that oil's strength was a worry but the world economy was still growing in spite of it.

As oil hovers near record highs - last week Brent was 25 cents shy of the all time high of US$78.65 - global economies are proving resilient  and oil consumption has remained strong. Jeff Rubin at CIBC World Markets predicts US$100 a barrel as soon as next year.

"We're only a headline of significance away from US$100 oil," said John Kilduff, an analyst in the New York office of futures broker Man Financial.

"The unrelenting pressure of increased demand has left the market a coiled spring,'' he said. New disruptions of Nigerian or Iraqi supplies, or any military strike against Iran, might trigger the rise, Kilduff said in a 20 July interview with Bloomberg.

Crude oil futures ended last week at US$75.57 a barrel on the New York Mercantile Exchange, up 51% since mid-January. A record number of options have been sold that give the buyer the right to buy crude oil at US$100.

In an environment where everything is pointing to a weaker dollar and higher oil, the only way for gold is up.

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