The Gold Trend Is Up, But the Trade Is Over-Crowded: Proceed with Caution

On Tuesday, gold made a new break out above last week’s historic high of $1062.70. If this move proves to be sustainable, then the implications for its future price direction are obviously bullish.

Gold normally exhibits such aggressive upward momentum during periods of inflation and/or geopolitical stability. Neither conditions exist. Fundamentally, there is no inflation at this stage of the economic business cycle as the high priests at central banks have yet to fully exorcise the demon of deflation. Geopolitically, things could be more stable. Tensions in the Middle East and central Asia remain tenuous and unresolved. However, members of the G-20 can hardly afford nor are willing to tolerate any further escalation of global conflicts.

The main reason for gold’s bull market is attributed to the demise of the U.S. dollar, which has been brought about by decades of increasingly unsustainable levels of national debt and particularly weak monetary policies in response to cyclical asset bubbles. The dollar and gold, being inversely correlated, are in very powerful primary trends, i.e. respectively bearish and bullish. Support for the dollar could come from raising target interest rates, reducing the Fed’s balance sheet, or shrinking the U.S. national debt. Given the extent of the financial crisis and lack of political will on both sides of the aisle, it is premature and unrealistic to expect any concrete steps toward a permanent resolution of any of these issues. Recent jawboning from the Fed will also prove to be impotent, especially since Australia’s bankers threw down the gauntlet and actually raised rates.

As a side note, Jim Rogers sums up some of these inflationary concerns in his common-sensical homeboy style:

Being somewhat contrarian by nature, I must note the oversold condition of the dollar and my anticipation for a corrective move along with a subsequent continuation of its bearish trend. However, I would not advocate being long the dollar as bears dominate its price trends. Nor would I short the dollar either while it is extremely oversold and/or MACD is signaling a positive divergence. Instead, at this juncture, I think the safe bet is to be neutral on the dollar. (See Chart #1)

Chart #1: $U.S. Dollar weekly as of 10-13-2009

The price of gold, on the other hand, is being driven by investment demand instead of consumers. According to the Gold Demand Trends report (upon logging in or registering, readers may access pdf link to this report) from the World Gold Council on Aug-19-2009, investment demand rose an annual 46% in 2Q-2009 while demand from jewelry purchases and industrial use were down in the same period.

An analysis of the CFTC’s commitment of traders' open interest trends for gold futures and options confirms the increasing speculation by large and smaller non-reporting traders’ percentage of open interest for long and short positions, as well as the long vs. short ratio ratio of open interest (note that percentages do not reflect non-commercial spreads). Personally, the long side of this trade is getting a bit too popular for me and has all the vulnerabilities of a crowded theater subject to a fire evacuation. (See table #1 below)

Table #1: COT Futures & Options Open Interest Trends for Gold

Report	Large Speculators			Commercial Hedgers			Non-Reporting
Date	Long	Short	Ratio	Long	Short	Ratio	Long	Short	Ratio
1/6/2009	35%	3%	10.90	30%	66%	0.45	11%	7%	1.56
1/13/2009	34%	3%	10.37	31%	65%	0.47	10%	7%	1.52
1/20/2009	33%	4%	8.77	32%	65%	0.50	11%	7%	1.52
1/27/2009	36%	4%	8.22	31%	67%	0.47	11%	7%	1.55
2/3/2009	39%	5%	8.70	30%	70%	0.43	11%	6%	1.79
2/10/2009	40%	4%	9.49	30%	71%	0.42	11%	6%	1.97
2/17/2009	39%	4%	8.91	29%	69%	0.41	12%	6%	2.02
2/24/2009	38%	5%	7.18	29%	68%	0.43	12%	6%	1.93
3/3/2009	38%	5%	8.15	30%	69%	0.44	12%	6%	2.05
3/10/2009	35%	5%	6.55	31%	67%	0.47	12%	6%	1.97
3/17/2009	34%	4%	9.58	33%	69%	0.48	11%	6%	1.91
3/24/2009	34%	4%	9.60	34%	70%	0.49	11%	5%	2.17
3/31/2009	38%	4%	8.99	31%	70%	0.44	12%	6%	2.03
4/7/2009	36%	7%	5.33	31%	66%	0.47	12%	6%	1.97
4/14/2009	37%	6%	5.67	30%	65%	0.45	12%	6%	1.87
4/21/2009	36%	7%	4.97	30%	64%	0.48	11%	6%	1.78
4/28/2009	37%	7%	5.35	29%	65%	0.45	12%	7%	1.85
5/5/2009	38%	7%	5.01	27%	64%	0.42	13%	6%	2.09
5/12/2009	39%	7%	5.21	26%	65%	0.41	12%	5%	2.27
5/19/2009	39%	5%	7.90	26%	66%	0.39	12%	5%	2.33
5/26/2009	42%	5%	8.06	25%	67%	0.36	13%	7%	1.89
6/2/2009	42%	4%	10.46	24%	70%	0.35	12%	4%	2.70
6/9/2009	43%	4%	10.44	25%	70%	0.35	12%	5%	2.50
6/16/2009	41%	5%	8.34	26%	69%	0.37	12%	5%	2.41
6/23/2009	40%	6%	7.13	27%	67%	0.40	12%	6%	2.11
6/30/2009	40%	6%	7.01	27%	68%	0.39	12%	5%	2.43
7/7/2009	40%	5%	8.20	28%	69%	0.41	11%	5%	2.15
7/14/2009	38%	5%	6.93	29%	67%	0.44	11%	5%	1.95
7/21/2009	39%	4%	9.05	27%	68%	0.40	11%	5%	2.23
7/28/2009	40%	5%	8.39	27%	69%	0.39	11%	5%	2.37
8/4/2009	43%	4%	11.51	25%	71%	0.35	12%	5%	2.51
8/11/2009	43%	4%	11.82	25%	71%	0.35	12%	5%	2.41
8/18/2009	42%	5%	8.44	26%	69%	0.38	11%	5%	2.13
8/25/2009	42%	4%	10.74	26%	70%	0.37	11%	5%	2.16
9/1/2009	42%	4%	10.91	25%	70%	0.36	12%	5%	2.30
9/8/2009	43%	3%	13.09	23%	71%	0.32	13%	5%	2.64
9/15/2009	44%	3%	14.60	21%	71%	0.30	14%	6%	2.47
9/22/2009	44%	3%	14.32	22%	71%	0.31	14%	5%	2.54
9/29/2009	45%	3%	14.53	22%	72%	0.31	13%	5%	2.47

Source: CTFC.gov and Hillbent.com’s proprietary database

Unlike the dollar, gold’s momentum, although not as robust as previous upswings, is increasing with prices. Stochastics show the yellow metal is in overbought territory, but in bull markets, such conditions can persist for a stubbornly long period of time.

Chart #2: Weekly Gold as of 10-13-2009

So where to from here? Well gold has already retraced slightly more than 100% of the move from its March 2008 high to November 2008 low. While it trades in uncharted territory (no pun intended), a 161.8% Fibonacci move could push it up to $1265 to $1300 levels (see Chart #3 below). Whether buyer exhaustion sets in before or around these levels remains to be seen. The trend is up, but the trade is over-crowded. Therefore, proceed with caution.

Chart #3: Potential Fibonacci Retracement Levels for Gold

Disclosures: Hillbent.com, Inc. or its affiliates may own positions in the equities mentioned in our reports. We do not receive any compensation from any of the companies covered in our reports.

Comments

[przem23:]

At what point would banks have to cover their long held shorts?

Oct 14 09:28 AM

[Steve in Gr...:]

Thanks, Mr. Hill, for the helpful note.

You mention two fundamental factors which ordinarily drive gold up in USD (USD inflation and geopolitical instability), and state that "neither condition exists." I don't this this can be right.

On USD inflation, you seem to contradict yourself a couple of paragraphs later when you state that "...The main reason for gold’s bull market is attributed to the demise of the U.S. dollar..." The fact that the CPI isn't going up just means the additional USD is going places other than CPI items (e.g. gold, equities, etc.)

On geopolitical instability, I think you are understating current conditions. You say that "...members of the G-20 can hardly afford nor are willing to tolerate any further escalation of global conflicts..."

Paraphrasing Leon Trotsky, the G-20 may not be interested in war, but war is interested in the G-20.

Oct 14 10:38 AM

[J Clinton Hill:]

btw, love the Trotsky quote....

there will be more wars, but only when the lords of war figure that we can afford them, barring anything crazy from one of the world's deluded and self-aggrandizing despots... i think containment is preferred to confrontation for now... unlike prez bush, there will be no unilateral thrusts by the USA... unlike prez bush, prez obama does not have the luxury of inheriting a budget surplus from the likes of a prez clinton... our lenders have us on a short leash and are in no mood to tolerate or finance conflicts which they deem unnecessary...

it may appear that i am contradicting myself, but i'll concede that i could've been more specific with my selection of words. i believe it is the "anticipation of future inflation", which i also anticipate, that is driving gold prices to rise at such a furious. right now, there is no serious inflation (even taking into account all the lies & manipulations with the CPI reports).

like Noah building the ark, it may be that the wiser investors are not willing to wait for the storm to arrive without preparations for survival...

thx for your comment....


On Oct 14 10:38 AM Steve in Greensboro wrote:

> Thanks, Mr. Hill, for the helpful note.
>
> You mention two fundamental factors which ordinarily drive gold up
> in USD (USD inflation and geopolitical instability), and state that
> "neither condition exists." I don't this this can be right.
>
> On USD inflation, you seem to contradict yourself a couple of paragraphs
> later when you state that "...The main reason for gold’s bull market
> is attributed to the demise of the U.S. dollar..." The fact that
> the CPI isn't going up just means the additional USD is going places
> other than CPI items (e.g. gold, equities, etc.)
>
> On geopolitical instability, I think you are understating current
> conditions. You say that "...members of the G-20 can hardly afford
> nor are willing to tolerate any further escalation of global conflicts..."
>
>
> Paraphrasing Leon Trotsky, the G-20 may not be interested in war,
> but war is interested in the G-20.

Oct 14 11:15 AM

[Beach Bubba:]

I go to the grocery store, and yes, even Walmart....I must report that I and my guide dog see no inflation.....I have the food-stamp debit card so there is no load on my pocket-book. There can not be inflation then.

Oct 14 12:27 PM

[Donald Ingram:]

As commodity markets go, gold is a small market with silver even smaller. If just 1% of available global investment liquidity moved into the physical gold market there would not be enough gold to satisfy demand. And price would go astronomic! The bullion banks in collusion with the Fed and the Treasury are working hard to keep the price low. Just look at the amount of shorts that are being held by these banks at the moment and you get the idea. Gold is now the new/old (re-discovered) safe haven. The USD is being shunned as a safe haven and will no longer be seen as one.

Oct 14 04:51 PM

[Steve in Gr...:]

Thanks for the note back. And thanks for the clarification on expectations of future CPI increases. I fully agree.

For what it's worth, we still differ on geopolitical risk. Neither Israel nor Iran are G-20 members, but their actions may create another, much wider war in the Middle East. Today, Putin warned that he is opposed to sanctions against Iran. If Russia won't support sanctions, the West won't act (meaning impose strong sanctions) and Israel will be forced to act (attack Iran's nuclear sites itself). And if Israel's actions precipitate a war, I expect there will be disruptions in oil supplies and then the West will be forced to participate.

The G-20 control a lot of things, but they don't control this.

Do you have an oil ETF you like?

On Oct 14 11:15 AM J Clinton Hill wrote:"...there will be more wars, but only when the lords of war figure that we can afford them, barring anything crazy from one of the world's deluded and self-aggrandizing despots..."

Oct 14 04:58 PM

[Dean M:]

I don't think it's a given that Israel will be forced to attack Iran if the rest of the world doesn't do anything. Their threats are probably just political maneuvering, nothing will contain Iran or any country at this point that wants to build a nuclear weapon - the best they could hope for is to delay it. If a basket case like N Korea could build a bomb then it obviously can't be that hard.


On Oct 14 04:58 PM Steve in Greensboro wrote:

> Thanks for the note back. And thanks for the clarification on expectations
> of future CPI increases. I fully agree.
>
> For what it's worth, we still differ on geopolitical risk. Neither
> Israel nor Iran are G-20 members, but their actions may create another,
> much wider war in the Middle East. Today, Putin warned that he is
> opposed to sanctions against Iran. If Russia won't support sanctions,
> the West won't act (meaning impose strong sanctions) and Israel will
> be forced to act (attack Iran's nuclear sites itself). And if Israel's
> actions precipitate a war, I expect there will be disruptions in
> oil supplies and then the West will be forced to participate.
>
> The G-20 control a lot of things, but they don't control this.<br/>
>
> Do you have an oil ETF you like?
>
> On Oct 14 11:15 AM J Clinton Hill wrote:"...there will be more wars,
> but only when the lords of war figure that we can afford them, barring
> anything crazy from one of the world's deluded and self-aggrandizing
> despots..."

Oct 15 02:48 AM

[Mr. Ed, Jr.:]

I would suggest that economics is indeed part of the definition of "geopolitical", and this as unstable a time as I have seen in my life. Governments have been brought down by this crisis -- Iceland was the first...Romania's was just toppled. More will follow.

Nobel prize-winning economists cannot agree whether we are experiencing deflation or inflation (That seems pretty unstable all by itself).

Governments around the world are printing money in what is just one grand experiment, based on theory. We have no idea how this will play out, as we have never been here before.

Most have not experienced a serious bout of deflation, but inflation is no stranger, and everybody paying attention is familiar with the stories of the Weimar and Argentine runaway inflation of the past. It is fear of inflation and perception of the state of the US economy and the state of the world that drives the price of gold. Fear and perception almost always trumps reality-- at least at the begginning. It can take a long time for reality to get back in charge of the gold game.

Iran marches on toward becoming a nuclear power. Is a shoe waiting to drop ? And what will the ripple effect be if Israel attacks Iran ? An oil price shock could set off a worldwide depression. History is replete with examples of wars or acts of war due to economic conditions, perceived or real. Naval power has often been used to settle matters of economics-- when one nation is choking another economically.

The author is most certainly correct that the debasing of the USD is getting worldwide attention and helping to push gold higher. But in regard to geopolitical stability, it is not always about reality. History teaches us that fear/perception is the better gauge of these matters where gold is concerned.

Oct 15 04:04 AM

[HA65MPH:]

Mr.hill ,this is nobammas war, economy , get over it ...the thugs in the white house are whining , as you are also ....own it ...man up !

Oct 15 10:14 AM

[ZigMeister:]

Mr. Ed, Jr.: wrote:

"Governments around the world are printing money in what is just one grand experiment, based on theory. We have no idea how this will play out, as we have never been here before."

I think most of us know how this will play out...Jim Sinclair has doumented many examples in history where countries and governments have followed the unlimited printing of fiat currency (I believe he listed somewhere between 50 to 100 examples) and ended up with worthless currency. The one thing we have no idea about is timing...this year, next year, 2-5 years, but it will happen.

In fact I remember reading someplace that fiat currencies typically only last somewhere between 38 - 42 years...we went totally off gold backing our currency in 1971 which would put our FRN Dollars
at the 38 year mark.

Oct 15 10:33 AM

[J Clinton Hill:]

for energy or other etfs, you can refer to hillbent's etf market trends monitor (www.hillbent.com/compo.../)

the list is pretty comprehensive and fairly well organized to help you efficiently evaluate various asset classes, industries, and geographical regions...

hope this helps...


On Oct 14 04:58 PM Steve in Greensboro wrote:

> Thanks for the note back. And thanks for the clarification on expectations
> of future CPI increases. I fully agree.
>
> For what it's worth, we still differ on geopolitical risk. Neither
> Israel nor Iran are G-20 members, but their actions may create another,
> much wider war in the Middle East. Today, Putin warned that he is
> opposed to sanctions against Iran. If Russia won't support sanctions,
> the West won't act (meaning impose strong sanctions) and Israel will
> be forced to act (attack Iran's nuclear sites itself). And if Israel's
> actions precipitate a war, I expect there will be disruptions in
> oil supplies and then the West will be forced to participate.
>
> The G-20 control a lot of things, but they don't control this.<br/>
>
> Do you have an oil ETF you like?
>
> On Oct 14 11:15 AM J Clinton Hill wrote:"...there will be more wars,
> but only when the lords of war figure that we can afford them, barring
> anything crazy from one of the world's deluded and self-aggrandizing
> despots..."

Oct 15 01:26 PM

[J Clinton Hill:]

ha65mph,

i have no desire to be baited into a political argument...

anyone with a basic knowledge of how capital markets and economies function will appreciate the fact that a $15trn dollar economy like the U.S. does not find itself in the position it is today because it has endured 10 months of an encumbent administration's policy.... what we have is attributed to multi-generational political administrations and economic policies that span several decades... both parties, i.e. democrats and republicans have contributed to this mess...

as long as both sides waste time, energy, and resources blaming each other, nothing will get resolved... we got ourselves into this shit together and the only way we're going to get ourselves out of this shit is by doing it together... whether we like it or not...

thanks for your comments and feel free to share anything else that adds value or insight to an investment thesis or idea(s)

cheers....


On Oct 15 10:14 AM HA65MPH wrote:

> Mr.hill ,this is nobammas war, economy , get over it ...the thugs
> in the white house are whining , as you are also ....own it ...man
> up !

Oct 15 01:42 PM

[oldman:]

I have a covered call option sold for oct 100, expiring tomorrow. Now to decide if I should buy back the call or let it expire and loose my GLD position. In an IRA with a purchase of 75, so I've made a nice profit but I also bought to be able to write covered calls. So I can also roll the call over. Rather new at this.

Oct 15 08:29 PM