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Gold Rush to Prevail on Demand, Low Rates, Weak Dollar

The latest rush to gold is providing plenty of market buzz even on the quietest days.

Gold Bars
AP
Gold Bars

Wednesday was a good example. The metal rose to $1,141.20 an ounce, after swinging between $1,136 and a new high of $1,153.40. As gold tallied its eighth record session this month, stocks were treading water, with the Dow losing 11 to 10,424 and the S&P 500 giving up less than a point to 1109. The Nasdaq was down 10 at 2193. The dollar was weaker, and many commodities edged higher.

Gold was helped by the weaker dollar but also drew buyers after the higher than expected CPI reading triggered inflation concerns. Another factor taking gold higher was news that influential hedge fund manger John Paulson is launching a new gold fund, including $250 million of his own money.

"I think what we're seeing is gold is surprising most people in the market. It's rising faster than the dollar is falling, so it's got its own drivers now," said Rebecca Patterson, head of global foreign exchange and commodities at J.P. Morgan Private Bank.

"I think for the next 12 months, it could go higher. What makes me nervous, for one, is valuation. It's hard to pinpoint a fair value for the price of gold...Gold certainly feels expensive here," she said. "It's a crowded trade and it seems to be an expensive trade so it's more vulnerable to profit taking. I think it goes up but it's not going to go up in a straight line."

This week's purchase of gold by Mauritius and the recent purchase by India has fueled speculation that other central banks will also be buyers. Patterson said she is bullish on gold from a demand perspective, but she is warning investors to hedge their purchases with options strategies or structured products.

"There's a perception; whether it's right or wrong, in the market that central banks are moving and they are nervous not only about the value of the dollar, but other currencies as well, and they're using gold to diversify and protect the value of their reserves," Patterson said.

"The investment demand has been extremely strong for different reasons over the last year. Anytime there's a little dip on the price, there are people who are happy to get in," she said.

She said there are two factors that could eventually act to derail the gold rush. One would be higher interest rates, and the other would be if the dollar were to strengthen, but not as a safe haven play because gold would rise as well.

Thursday's Wild Cards

On Thursday, several key economic reports could influence markets. Weekly jobless claims are reported at 8:30 a.m. and are expected to be about even with last week at 504,000 new claims.

Leading economic indicators are reported at 10 a.m., as is the Philadelphia Fed Survey. There are a few earnings reports, including from Sears, before the opening bell. and Treasury Secretary Timothy Geithner testifies before the joint economic committee on regulatory reform and other topics, starting at 10 a.m. Investors will also continue to watch the progress of the Senate health care bill which could face a test vote this week.

Ellen Beeson Zentner, senior U.S. economist at Bank of Tokyo-Mitsubishi, said she expects jobless claims to come in below consensus, at 488,000, which would be the first time under 500,000 in months. Traders say a number below 500,000 would have a positive psychological impact on stocks.

Winterizing Your Portfolio - A CNBC Special Report
Winterizing Your Portfolio - A CNBC Special Report

Claims could be affected by the Veteran's Day holiday last week. "Typically, when there's a a holiday during the week .. if the unemployment offices are closed, usually claims always fall in that week," she said.

Zentner said she expects leading indicators at 0.2 percent. "Basically if the leading indicator data comes in at our expectation, it would actually be pretty consistent with the fourth quarter data that shows the U.S.economy is holding onto those third quarter gains," she said.

What Else to Watch

In addition to Sears, several other retailers report Thursday. Ross Stores and Williams-Sonoma report before the bell, and Foot Locker and Gap report after the bell. Dell reports earnings after the bell as well. All will be watched closely with particular interest in their comments about the current quarter and expected consumer behavior during the holiday season.

Milton Ezrati, Lord Abbett senior economist and market strategist, said retail sales this holiday season could be a make or break factor for the stock market. He said he believes the holiday season will outpace the 1 to 2 percent improvement many analysts are forecasting. "I would be surprised if it fell short of 3.5 to 4 percent," he said.

But if sales are worse than expected, watch out. "What we're looking for is moderate growth in the consumer sector. If the consumer fails us, there will be talk of a double dip in the economy," he said, adding that would take drive the stock market lower.

Debt Issuance Nears 2006 High

Ezrati said it is possible the market could correct, but for now he sees the direction as higher. "The outlook hasn't changed. If anything, it's been reinforced. All that we've received in the last few weeks says this economy is going to see at least a modest recovery. The Fed has assured us again that they're going to support the market," he said.

Many traders say they believe some hedge funds and other institutions are ending the year early, happy to sit tight on sharp gains after last year's pain. "There's a lot of people that are unwilling to commit one way or the other. I think here's still a lot of insecurity about the situation," said Ezrati.

He expects fourth quarter earnings to be a positive driver for stocks, since the comparisons will be so easy after last year's weak fourth quarter.

Bonds

Another big wave of corporate debt came to market Wednesday, and this could be a banner year for high yield issuance, Bank of America Merrill Lynch said in a report Wednesday. World wide issuance of junk bonds already totals $151 billion for the year, not far from the record $172 billion in 2006.

Treasurys saw selling in the long end, and the 10-year's yield rose to 3.368 percent. Rick Klingman of BNP Paribas' Treasury desk said corporate debt issuance has been a factor in the Treasury market. "It creates selling way in advance of the deals, but when he deals actually price, Treasurys get bought back. It's a mixed flow," he said.

Wednesday's action in Treasurys though was mostly impacted by comments from St. Louis Fed President James Bullard, who said if the Fed follows its past pattern, it would not raise its overnight target rate until 2012 but added there are reasons that it would not wait that long this time. "As soon as you put a date on it like 2012, people just make the assumption that that's where he stands," said Klingman.

"That really shook up the market... a holder of 30-year paper does not want to hear that type of talk. It caused a steeper curve," he said. Klingman said the market is also looking ahead to next week, when the Treasury auctions about $118 billion in notes.

— Questions? Comments? marketinsider@cnbc.

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