Article originally submitted to subscribers on 16th April 2007...

Wow!

The Fed ain't messing around.
Enough is enough!
In an all out effort to pre-empt a rout in the housing market, the Fed has opened the money spigots WIDE open!

The yield curve has duly steepened making monetary conditions even easier (is that possible?) and the Bank of Japan is doing a good job of managing the Yen lower to keep the $800Bn Yen Carry Trade on even keel.

The flood gates have been released and what was once a raging river of Liquidity is now a tidal wave of Debt funded Cash inflating all asset classes in its wake.

The Fed failed to revive the Tech crash with liquidity injections in 2000 - 2002. Similarly, liquidity will do little to levitate the housing market and instead will continue to flow into mammoth M&A deals (do these acquisition really offer shareholder value?)

It's obviously now the rich man's preserve and would be a sight to behold if it wasn't causing so much damage to the average man in the street.
How?
Through a tanking Dollar - more on that later.

As expected the current action has not been lost on our hyperactive friends Mr. Gold and Mr. HUI. As mentioned in the April 12th Article - Fed must allow Gold to rise - the Fed has suddenly become Gold's biggest ally.

Chart 1 - HUI breaking through resistance at 360

The AMEX Gold Bugs Index has peeped above stiff resistance at 360, hopefully ushering in the next up leg we've been waiting nearly a year for. Next resistance is the May 2006 high at 401. If the HUI bettered that, using Fibonacci projections, the target within 6 - 12 months is 750 - a double.

But before we get overly bullish, let's put on our Risk Management Cap and ask, "What could go wrong with this scenario and cause Gold to fall?" Remember, when things look most bullish we should be on the lookout for the bear.

High Beta Stocks

What has bothered me most about the rise in Gold and Energy (GE) stocks is the close correlation with the Stock Market. Instead of counter-cyclical hedges GE Stocks are behaving like high Beta stocks (as we found out in late February).

Therefore, it stands to reason that if increased liquidity is driving GE's and other asset prices higher, a decrease in liquidity would do the reverse. How would we see a contraction in liquidity? I'd say we'd see it in the US Dollar.

Chart 2 - US Dollar Index showing MACD & RSI divergence

Every man and his dog is now bearish on the US Dollar. Increased liquidity means printing new money and increasing the Supply of an already plentiful Dollar.
So far the Dollar has responded by declining slowly.
But what would happen if the US Dollar confounded everyone and began to rally?

A rallying Dollar would contract liquidity and cause the stock market and GE's to fall. What would cause the Dollar to rally?
Possibly bond yields rising to attractive levels.

For now the GE stock rally is intact. April should see the HUI challenge the May '06 highs (10% higher) and the US Dollar will continue to move lower to face the all important 80 level.

As to what happens thereafter we will have to wait and see. My guess is that the Dollar will mount some kind of rally from very oversold levels. This will cause a correction in the Stock Market and GE's. The Fed will respond (in the 3rd quarter) by cutting interest rates and dare I say it, hyper-inflate the money supply. Which ofcourse is good for Gold (but little else).

There's nothing wrong with being Bullish on GE's right now. Even wildly bullish. All I'm saying is don't become blinded by the flashing lights and make sure you keep a little powder dry.

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