Gold Eases on Inflation Jitters

Updated from 12:12 p.m. EDT

Gold and silver edged lower Monday after a report showed surprising strength in U.S. new-home sales in May, reviving interest-rate jitters.

Precious metals finished well above their lows, however, as geopolitical tensions surfaced late in the session. Gold for August delivery dropped 30 cents, or 0.05%, to $587.70 an ounce, after dipping to $580 in morning trade. Silver for July delivery fell 4 cents, or 0.4%to $10.24 an ounce.

Gold, which acts both as a hedge against inflation and a safe-haven asset, received some bids as Iran, the world's fourth largest producer of crude oil, warned it will use oil as a weapon "if the country's interests are attacked."

Crude oil prices had reached $75 a barrel in early May -- helping boost gold to 26-year highs -- as tensions mounted between the U.S. and Iran over Tehran's nuclear ambitions. Crude closed up 98 cents to $71.85 on Monday.

Meanwhile, copper for July delivery advanced 8.2 cents, or 2.6%, to $3.23 a pound as the market awaited the result of labor negotiations at BHP Billiton ( BHP) and other copper producers in Chile.

Workers at Chile's Escondida mine, which produces 7% of the world's copper, threatened to strike if BHP didn't agree to wage increases.

The sector also received attention after Phelps Dodge ( PD) reached a deal to merge with Canadian miners Inco ( N) and Falconbridge ( FAL), creating a new copper and nickel giant.

Precious metals came under more pressure Monday after news that new-home sales rose 4.6% to 1.234 million in May, a five-month high and well above the 1.145 million expected by Wall Street economists.

This was bad news for a commodities market worried that the Fed will not only hike rates when it meets Thursday but might also keep a hawkish stance on inflation in its commentary.

Many observers say the severe corrections experienced by metals and commodities over the past month reflect concerns that rising interest rates will curb growth and subdue inflation.

The latest new-home sales report aside, the housing market is already expected to decelerate, and many worry that the Fed might overshoot, slowing U.S. -- and global -- growth too much.

"For the moment, traders appear satisfied to await the Fed meeting and the results thereof," writes Jon Nadler, investment-products analyst at bullion dealer Kitco. "However, everyone is hoping that the vehemence manifested by Fed Chairman Ben Bernanke does not turn out to yield a half-point increase of the type sometimes seen at the end of an upward series of moves."

Making matters worse for gold on Monday, European Central Bank council member Yves Mersch said the ECB might hike rates at a faster pace than it has so far this year, according to Bloomberg.

German consumer prices, meanwhile, rose at a 2% annual rate, which is above the ECB's ceiling of tolerance.

The report and the ECB comments boosted the euro and pressured the dollar.

The Dollar Index, which tracks the greenback against a basket of key currencies, was recently down 0.5%. A weaker dollar normally boosts the price of dollar-denominated commodities, such as gold, as it takes more of the currency to buy the same amount of gold.

But the dollar -- after weakening further late last year on expectations that the Fed would pause, and even stop, its two-year long campaign to raise rates -- has bounced back since last month, hurting commodities and emerging markets.

"The US currency made a 180 degree turn on the back of largely dollar-bound safe-haven flows from the deteriorating emerging market sell-off, coupled with speculation of more sustained Fed tightening," writes Ashraf Laidi, currency strategist with MG Financial. "With the emerging market sell-off serving as a vital element to the dollar rally, the short-term dollar outlook appears bright," he adds.

Meanwhile, shares of metals miners were trending higher, benefiting from merger news and positive action on Wall Street. Both the Philadelphia Gold and Silver index and the Amex Gold Bugs index were up 0.4% in recent action, while the CBOE Gold index was up 0.3%.

Shares of Phelps Dodge were recently down 8.3% after news that it will pay $13.65 billion to buy Inco, which in turn will buy Falconbridge for $26.6 billion as part of the three-way merger. Inco was recently up 10% and Falconbridge was rising 5%.

Among other copper producers, Freeport McMoRan ( FCX) was up 0.6% and Southern Copper ( PCU) was up 6.9%.

In other merger news, Luxemburg-based Arcelor reversed its previous stance and agreed to be acquired by Mittal Steel ( MT). In recent action, Mittal was down 4.2%.

The recently-launched Market Vectors-Gold Miners ( GDX) exchange-traded fund, which tracks the performance of the Amex Gold Miners Index, was recently up 0.2%.

ETFs tracking the metals themselves were mixed. The iShares Silver Trust ( SLV) was recently down 0.4%, while the StreetTRACKS Gold Trust ( GLD) was up 0.4%.

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