09:20 EST, Tues 26 May

Gold Hit by Options Volatility as Dollar Bounces, Stocks & Oil Fall, Fed Denies "Rooting for Inflation"

THE PRICE OF PHYSICAL GOLD fell hard early in London on Tuesday, returning from the long holiday weekend to drop 1.7% as the US Dollar and Japanese Yen rose sharply on the currency markets.

Global stock markets fell while government bonds rose.

Crude oil slipped back below $60 per barrel despite North Korea further defying the United Nations Security Council and test-firing two missiles as a follow-up to yesterday's 20 kiloton underground nuclear test.

"It is the options expiry on the June COMEX Gold contract today," says today's commodities note from Standard Bank here in London.

"As a result there might be some volatility as participants attempt to achieve certain strikes" - the price at which the option to buy/sell gold in June closes and is thus settled.

"Looking at the dispersion of option strikes and open interest, it appears the market would battle it out for a move either above $950 or below $930."

The Gold held in trust to back New York's SPDR fund - now backing 98.23% of each share in issue as metal is taken to cover storage fees - swelled on Friday for the first time in two months, growing to over 1,118 tonnes.

Speculative investors grew their bullish position in Gold Futures and options to a near 3-month high in the week-to-last Tuesday, according to the latest data from US regulator the CFTC.

More than three times the "net long" position in Gold Futures hit in Nov. 2008, the difference between bullish and bearish bets made by hedge funds and other large speculators remained 25% below the record peak of Oct. '07 and Feb. '08.

"Some physical selling is back in the market" with London and New York re-opening after the 3-day weekend, said Dick Poon, local manager for German refining group Heraeus in Hong Kong, to Reuters earlier.

"This is not the first time [North Korea has tested missiles], so I don't think it's a problem."

But "If a nuclear test cannot produce safe haven buying," counters one London dealer, "surely the short term outlook [for gold] turns negative."

"There are still plenty of problems out there, and I think you are going to continue to see flight to safety be an important factor," reckons Bill O'Neill, co-partner at futures-trading consultants Logic Advisors.

"Inflation seems to be an inevitable development. I think demand for hard assets will continue to be strong, and Gold will slowly but surely benefit from that."

Last week US president Barack Obama said in an interview with C-Span's Mike Scully that "Well, we are out of money now. We are operating in deep deficits" after being asked about the $11 trillion national deficit.

America's unfunded liabilities for retirement and health-care meantime total more than $99 trillion, says analysis from the Dallas Federal Reserve - "a very deep hole" in the words of Dallas Fed president Richard Fisher.

"I don't know a single person on the [Fed policy team] who is rooting for inflation or who is tolerant of inflation," Fisher tells the Wall Street Journal in an interview.

But on a recent tour of China, Japan, Hong Kong, Singapore and South Korea however, "I was asked at every single meeting about our purchase of Treasurys [i.e. Quantitative Easing]. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States. That seems to be the issue people are most worried about."

"The charts suggest the Dollar is oversold, but people are starting to ask existential questions about the United States," says T.J. Marta, chief strategist and founder of the eponymous Marta on the Markets in New Jersey, speaking to Reuters.

Today the US Dollar jumped 1.5¢ better to the British Pound, curbing the drop in Sterling Gold Prices at £598.40 per ounce - down less than £3 from Friday's close.

For Eurozone investors now Ready to Buy Gold, the price was unchanged at €682 an ounce as the Euro briefly dropped beneath $1.39 - the 2009 high first recovered last Thursday.

"The fear is about how much the [US] government can do," says Marta. "It's underwriting the banking system, the insurance industry, the auto sector. At some point, people say, 'Oh my God, is the whole thing going to implode?'"