Gold rallied sharply yesterday, for the third day in a row, on higher oil prices and a weakening dollar. Risk aversion remains the prevailing force in markets as seen in collapsing Treasury yields and shortages of physical bullion and backwardation in the gold market.

Technical resistance is between $820/oz and $830/oz and a convincing close above these levels and the psychologically important $850/oz (the nominal speculative blow off one day high in 1980) should see gold ready to rechallenge $900/oz possibly before the end of the year (and $1,000 soon into 2009).

Asian equity markets were mixed overnight and European ones are again under pressure this morning. While the heard continues to pile into Treasuries and some government bonds the smart money realizes that government bonds look increasingly overvalued and may be in a bubble. A market that needs a government to step in and support it is not normally one that offers great value.

Retail demand for gold bullion from small, medium and even very large investors remains at extremely high levels internationally and the recent backwardation shows that investors are worried about counter party risk and prefer the safety of owning physical bullion now rather than a paper derivative or promise to pay at a future date.

Hard times are as usual leading investors to prefer hard assets and there is no harder asset than the tangible finite currency that is gold.

The Telegraph’s Ambrose Evans Pritchard reports today that the rush to the safety of gold “reflects a mix of fears about the fragility of world finance and concerns that the move towards zero interest rates could set off an inflationary surge further down the road, and possibly call into question the worth of some paper currencies.”

This looks increasingly likely as the Wall Street Journal reports that the Federal Reserve is considering creating US dollars for the first time in order to flood the financial system. This can only lead to severe inflation at some stage in the coming months and years.