Yesterday afternoon's attempt by gold to stay the course in the face of declining oil prices failed as far as today's trading session was concerned. Gold prices got caught in the rough wake left by crumbling crude oil and traded as much as $32 lower than yesterday's early (and promising) highs. Buyers in India remained on the sidelines, expecting more substantial declines in the price of their favorite metal.

Western investment buyers also proved scarce today as economic slowdown expectations battered industrial as well as precious and noble metals. In this particular case, the 'stag' component overtook the 'flation' worry and sellers emerged in numbers despite once again rising open interest levels. As we mentioned yesterday, the $20-$30 intra-day ranges are becoming more the norm than the exception as turmoil churns away in various markets during this summer adjustment phase.

Oil lost anywhere from $4 to over $6 on Wednesday on top of yesterday's worst fall in over 17 years. Values fell to near $132 (almost $15 beneath recent peaks) as clear signs of strong demand destruction and further potential for more of the same turned sellers into the dominant crowd in that market. An unexpected rise in US inventories confirmed the fact that driving, flying, and running machinery turned into carefully measured activities among American users of late.

A possibly deeper slowdown in the world's largest economy has oil longs wondering where the additional gains in their positions will come from in future months. According to the Bloomberg Global Confidence index, the majority of respondents expect a tough second half for the global economy as the U.S. works its credit problems out. Open interest in oil shrank yesterday but some of it can also be attributed to the new aggressive agenda of supervision and restrictions that the SEC is adopting.

New York spot bullion attempted a few comebacks in the morning hours but eventually gave way to selling pressure and continued orbiting near $960 in the after-lunch hours. Today's core and headline CPI numbers did little to alleviate inflation concerns on Wall Street, Main Street, or Capitol Hill. At least as far as CPI is concerned, it appears that Dr. Ben knew very well what he was talking about yesterday when he fretted about the oil-induced (and dollar-assisted) recent rise in all kinds of prices. CPI rose by the most in 26 years in June, courtesy of spiraling energy and food costs.

Stagflation appears to be taking hold in the US economy and while everyone knows how to combat it, few are willing to take that bitter pill just yet. The dollar rose to just above 72.00 during the day, while oil gave up yet another substantial portion of its recent premium. Talk of $90-$100 oil has once again emerged from various analytical quarters. The Dow certainly took the drop as a signal to celebrate with a 160-point gain on the day. Silver fell 15 cents to $18.76 while platinum lost $52 to $1908 and palladium shed $13 to $428 per ounce, amid growing fears about the possibility of shrinking auto production and of a shift towards small cars with small engine displacements.

Indications are that stock short-sellers enjoyed their best month in over seven years during June, as the stock market swooned on a raft of bad news. Apparently, not every such trade may have been conducted with borrowed stocks in someone's pocket. Some traders, in fact, may not have had any pockets to speak of, as the were...buck naked. This has caught the attention of regulators who were at first just focusing on Bear and Lehman trades and possible rumours. Now, they are casting a much wider net in order to catch some very interesting fish that are possibly lurking out there in marketland. In our continuing focus story today, The Wall Street Journal reports that:

"The big news on Wall Street today is the SEC’s announcement that it will attempt to curb improper short-selling in the stocks of struggling Fannie, Freddie, as well as those of 17 financial firms, including Goldman, Lehman and Morgan Stanley.

First of all, what the heck is short-selling? A primer, for those curious: Short selling, the WSJ explains, is a legitimate trading strategy in which traders aim to profit from falling stock prices. In a short sale, a trader borrows stock and then sells it, in hopes it will later fall in price. If it does, the short seller then buys the stock in the open market at the lower price, returns what was borrowed, and pockets the difference. The SEC said Tuesday’s move aims to stop “unlawful manipulation through ‘naked’ short selling” — the practice of selling stock short without taking steps to borrow it.

So what prompted the SEC’s move? We’re not sure, but at least two influential folks urging reform, Wachtell Lipton's Ed Herlihy and Theodore Levine, recently weighed in with a client memo, which encourages the SEC "to undertake additional bold measures to constrain abusive short-selling and rumor-mongering." So far, there’s much chatter, apparently, over whether the SEC’s plan, which is expected to go into effect on Monday and will expire in 30 days, will actually work. But based on the history of efforts to curb short selling, prospects don’t look good.

• In 1733, in the aftermath of the South Sea Bubble, the British House of Commons banned what today would be called naked short selling. The law remained in force for more than 150 years, even though, as financial historian Charles Duguid noted in 1901, "it was at no time seriously operative."
  
  
• In 1792, the New York state legislature banned short selling. Five weeks later, two dozen stockbrokers banded together to sign the Buttonwood Agreement, which created what became the New York Stock Exchange, where short selling occurred with abandon.
  
  
• In the 1990s, Hong Kong temporarily banned short sales, and the Malaysian finance ministry proposed that anyone caught short selling should be punished by caning. Neither measure prevented those markets from falling during or after the 1998 Asian crisis.

"In the near term, short sellers may see some marginal increase in their cost of borrowing, as brokers adjust their operations," said Laurel FitzPatrick, a partner at Ropes & Gray who advises hedge funds. "Ultimately, neither this rule, nor the SEC's indications that they are looking to bring enforcement cases against sellers spreading rumors, will reduce short selling if sellers believe a stock is overvalued."

Excerpts from the SEC emergency order (full text here: http://www.sec.gov/rules/other/2008/... ) read as follows:

"False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by "naked" short selling. As a result, the prices of securities may artificially and unnecessarily decline well below the price level that would have resulted from the normal price discovery process. If significant financial institutions are involved, this chain of events can threaten disruption of our markets.

In these unusual and extraordinary circumstances, we have concluded that requiring all persons to borrow or arrange to borrow the securities identified in Appendix A prior to effecting an order for a short sale of those securities is in the public interest and for the protection of investors to maintain fair and orderly securities markets, and to prevent substantial disruption in the securities markets.

This emergency requirement will eliminate any possibility that naked short selling may contribute to the disruption of markets in these securities. We described in the releases in which we proposed and adopted Regulation SHO the bases for the current requirements Regulation SHO imposes. We believe, however, that the unusual circumstances we now confront require the temporarily enhanced requirements we are imposing today.

IT IS ORDERED that, pursuant to our Section 12(k)(2) powers, in connection with transactions in the publicly traded securities of substantial financial firms, which entities are identified in Appendix A, no person may effect a short sale in these securities using the means or instrumentalities of interstate commerce unless such person or its agent has borrowed or arranged to borrow the security or otherwise has the security available to borrow in its inventory prior to effecting such short sale and delivers the security on settlement date.

Today's market gyrations reveal just how firmly oil was and is seated in the driver's position of this turbulent investment and economic cycle. Some will find it...curious that oil started to give up some of its sky-high froth during the very days when practically every U.S. monetary, legislative, executive, and candidate person of import had something to say about it and about its deleterious effects just about everything. Some will say that the dollar has engendered this situation and that it is the one critical item which could make a difference in the equation - if only it ever regains some value. As for gold, now that support near $965 has given way, the attention shifts back to geopolitics and to just how strong the yellow metal's ties to oil remain. It does not appear likely to have $1K gold if in fact oil is aiming for one tenth of that number.

Happy Trading.

Jon Nadler
Senior Analyst