Gold fell almost 1% early in the session, then pivoted higher as speculators bought spot contracts, and futures to cover bearish bets ahead of Wednesday's release of the minutes of the FOMC July meeting.

 

Silver also recovered mightily after tumbling 4 percent early on.

 

Gold has gained about 8 percent over the last ten sessions. This has helped turn the gold option market more bullish with high volatility premiums on puts falling. Some calls are no longer being offered at a discount.

 

"I have noticed a small reversal in call skew. People are starting to bid for calls again and the discount is diminishing," said Albert Ng, a market maker/portfolio manager at Aurum Options Strategies in New York.

 

Some traders are worried that physical demand for gold is slackening, although we think there will be plenty of momentum through September to underpin that side of the market.

 

India will remain problematic. But there is a vast store of gold in Indian in households and dealers will have to make strong price offers to pry it out of individuals' hands. The government doesn't seem to understand that levying high import taxes on gold will hurt their country, which has literally millions of small jewelers working in one-off shops. As we have noted before, smugglers seem happy to take risk and fill the shortages.

"Jewelers will need more gold to manufacture jewelry, as imports have been heavily restricted," Bachhraj Bamalwa of the All India Gems and Jewelry Trade Federation said. "If I sell today and am not in a position to replenish my stocks, then I'll have a problem and then I'll have to source gold from somewhere else." (Smugglers!)

"Jewelers will have to offer incentives to get old jewelry," he said, adding, "If jewelers offer incentives, people will bring in their old jewelry more and more."

 

The dollar hit a 6-month low against the euro, which is good for dollar-denominated trades like gold and silver. It was also down against the Swiss franc. The dollar is in limbo because analysts are divided as to what the Fed might do in its September meeting vis a vis QE3 tapering. Expect more dollar volatility and thus more precious metals volatility as we approach the mid-September meeting.

 

Kathy Lien of BK Asset Management in New York summed up what we should look for tomorrow in the release of the FOMC July meting minutes:

"...The financial market community will be looking for two specific details in tomorrow's release. The first is the level of conviction for easing in September. Most Federal Reserve presidents that we have heard from support some type of action over the next three months with more leaning towards a sooner vs. later move. If the minutes emphasize the progress made in the U.S. economy and the need to act quickly, the dollar could resume its rise as yields extend higher. However, if the minutes contain an overall air of caution with more members wanting to wait for further improvements before changes are made, the dollar could fall sharply as U.S. yields give up recent gains. We will also be looking for details on which assets the Fed will taper. The choice is between Treasuries and mortgage backed securities and if the Fed opts for only one and it would be Treasuries, the dollar should slide as this would represent a smaller initial move. If the minutes reveal plans to taper both, it would be positive for the dollar because it gives hope for a more aggressive reduction. As for how much the Fed will taper, this will be a decision made in September but the central bank could drop some hints on a preferred range."

 

We like to believe that, except for dollar strength fluctuation, gold and silver have already baked in the notion of Fed tapering.