"The credit crunch panic has worked to the benefit of the metals and those who own them, but blindly relying on this to continue without any sort of correction is a risky bet. Another successful retest of the 5-week moving average, currently below $670, would further solidify the strength of the current uptrend.

"The Fed will attempt to placate what is approaching outright panic in some circles and will feel compelled to amend the language of its statement, but ... will resist an outright rate cut for as long as possible, though it will very likely continue quietly expanding bank reserves to mitigate damage to the system and spur liquidity." ~ Precious Points: Tough Love from Bernanke and Co?, August 5, 2007

So much for quietly! After months of writing about the importance of watching the Fed repos, suddenly they're making headlines. What's more, the week played out exactly as described in the previous update: the Fed declined to capitulate and offer the market a rate cut, the panic premium in gold did not withstand the selling pressure as liquidity became threatened, and the Fed gladly injected huge sums of money through its open market activities exactly as would be predicted by an understanding of their interest rate targeting regime.

Any regular reader over the last several weeks had a substantial insight into the events that unfolded over the past few days, the global pressure and mountain of rhetoric on "discipline" that prohibited a rate cut, and the Fed funds target that requires liquidity injections when demand for money grows, the "beautiful machine" as it's been called here in previous editions. What emerged this week, as events perfectly confirmed the outlook framed here over the past several months, is a picture of a Fed that fully believes in the policy it has initiated and a Fed chairman at the controls, calmly conducting the grand orchestra of devaluation.

Whether the increase in demand for money comes from accelerating economic growth or a credit crunch, the Fed's response is essentially the same: create new bank reserves. The details of the operations, and the implications for precious metals, though will vary by situation. In a period of stronger growth, a state of ample liquidity is perpetuated, and this allows metals to appreciate alongside the growing economy. If the injections are motivated by a sudden lack of liquidity, as were last week's, precious metals tend to suffer since they are easily sold to generate needed funds. Of course it's been mentioned previously that this only creates temporary pressure in metals, which inevitably snap back according to the expansion of the money supply.

The chart below illustrates gold coming under pressure midweek when the situation in Paris launched a liquidity panic. The recovery on Friday, though, leaving gold perched right at the 5-day moving average, is probably due as much to speculation of an emergency rate cut and positive fundamentals as alleviation of credit concerns.

The next chart shows the tried-and-true weekly moving averages, where gold has now once again managed two consecutive closes above the 5-week moving average. While this portends strength in the current uptrend, more volatile sessions are almost undoubtedly ahead. The trendline in the RSI suggests resistance at $690 will be a formidable test, but could spark great momentum if broken.

Silver again fared worse last week than its counterpart. After trading back up to roughly the level where its 5- 50- and 200-day moving averages converged, silver failed at the 50-day moving average and dropped back below its recent lows. The longer term chart below shows silver finding support on a trendline stretching back to the June 2006 lows, putting support for next week just below $12.40. Overhead resistance is fairly obvious, but failing this level would leave silver to grab hold near $12.20, or else a retreat to under $10 becomes possible.

It's not at all likely that the credit crunch which plagued the markets last week will be resolved when trading on Monday resumes. But with Bernanke's message to the primary brokers last week essentially being, "All you had to do was ask", it appears the Fed is sensitive to the market and will continue providing liquidity as needed, virtually on demand. The implication then is not that the Fed is looking to cut rates, but that it expects, with the help of these cash infusions, the credit markets will recover and return to normal operation. The pace at which this occurs, and at which the Fed is able to remove the billions of new dollars from the money supply, if at all, will largely determine the direction for metals in the coming weeks. All that is reasonably certain is that if the liquidity situation only deteriorates from here, which would probably have to occur before a rate cut is truly on the table, precious metals, along with most assets, will suffer in the short run. But in either outcome, with Bernanke the Maestro calling the tune, expansion of money supply will be the anthem inevitably calling precious metals back to their rally.