The dollar index fell back to a 2-week low from its recent 1-1/4 year high as concerns over the European debt crisis receded.  The EURUSD popped up to a 2-week high on short-covering, while USDJPY continues to move sideways moderately above its all-time high of 75.35 per dollar.  Bearish factors include (1) reduced safe-haven demand for the dollar after the IMF proposed to expand its lending resources by $500 billion to insulate the global economy against any worsening of Europe's debt crisis, which also aided a rally in the S&P 500 to a 5-1/2 month high, (2) reduced demand for dollars after the 3-month cross-currency basis swap, the rate banks pay to convert euro interest payments into dollars, fell to 78 bp below the euro interbank offered rate, a 5-1/4 month low, and (3) fuel for short-covering in the euro after data from the CFTC showed that traders had increased their short euro positions to a record 155,195 contracts in the week ended Jan 10.  Bullish factors include (1) the larger-than-expected increase in the Nov long-term TIC flows, (+$59.8 billion), a sign of strong foreign demand for dollar assets, (2) increased safe-haven demand for the dollar after the Managing Director of Fitch Ratings said Greece is insolvent and will default on its debts as it is unlikely to be able to honor a Mar 20 bond payment of 14.5 billion euros, and (3) Standard & Poor’s recent downgrade of the credit ratings of 9 Euro-Zone countries.

Fundamental Outlook—Bullish Correction—The dollar’s trend remains bullish as it corrects recent gains due to a temporary respite from European debt concerns.  The dollar is seeing support from the stronger U.S. economy, while pressure on the euro continues from deteriorating interest rate differentials with the 50 bp ECB rate cut since early Nov and prospects of a recession in the Euro-Zone economy.

Gold prices rose to a 5-week high.  Bullish factors include (1) demand for gold as an alternative asset after S&P downgraded the credit ratings of 9 Euro-Zone countries, (2) demand for gold as an inflation hedge after the ECB lent European banks a record 489 billion euros for 3-yrs, the PBOC cut banks’ reserve requirements for the first time in 3 yrs and the Fed and 5 other central banks cut the cost of emergency dollar funding for European banks, and (3) the Fed’s pledge to keep interest rates “exceptionally low” through at least 2013 with the possibility of “QE3.” Bearish factors include (1) dollar strength that fueled long liquidations after gold holdings in ETP’s rose to a record 2,360.8 tons last month and (2) reduced inflation concerns after Dec Euro-Zone CPI fell to a +2.7% y/y increase from a 3-yr high of +3.0% y/y in Nov.

Fundamental Outlook—Short-Term Bullish—Gold prices rallied further to a 5-week high on increased safe-haven demand from the European debt crisis.  Gold continues to see downward pressure from the recent dollar strength, but the long-term trend remains bullish due to the European debt crisis, uncertainty about the Chinese economy, and extraordinarily easy G7 monetary policies.

Copper prices climbed to a 4-month high as they broke out above their former 4-month consolidation range.  Bullish factors include (1) supply concerns after Rio Tinto, the world's third-largest mining company, said its copper production fell -23% y/y in 2011, (2) Dec China copper imports up for a seventh month, (+48% y/y to a record high of 508,942 MT), (3) the plunge in LME copper inventories to a 13-month low, and (4) the prediction from ICSG that deceased mine production will push the global copper market into a 201,000 MT deficit in 2011 and a 256,000 MT deficit in 2012.  Bearish factors include (1) recent dollar strength, (2) the action by the World Bank to cut its 2012 global growth estimate to +2.5% from a June estimate of +3.6%, saying a recession in the Euro-Zone threatens to exacerbate a slowdown in emerging markets and (3) concern that Chinese copper demand may wane after Q4 China GDP grew at a +8.9% y/y pace, the slowest in 2-1/2 years.

Fundamental Outlook—Short-Term Bullish—Copper continued to firm on supply concerns, although global economic concerns may limit future gains  Long-term supportive factors include (1) continued strong Chinese demand, (2) long-term emerging-market demand for copper, and (3) lagging copper mine investment and production.

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