Skepticism about Gold's Recent Rally Remains High
Gold has risen nearly $250 from its intraday low in late June to its intraday high in August. This was a rise of more than 20%, which according to the absurd mainstream definition of bull and bear markets, should mean that it is now in a new bull market. You wouldn't know it though, as the same mainstream media that were screaming 'bear market' at the top of their voices after it had declined by 20%, have been curiously silent on the matter.
In spite of this significant rally, sentiment on gold has barely shifted. According to the data measuring the sentiment backdrop, only silver has seen a marked increase in the bullish consensus. In gold, the consensus is almost as subdued as it was at the recent low in June, which is rather remarkable. Below we show a number of charts illustrating the situation.
First up are sentimentrader's very useful 'public opinion' charts on gold and silver, which show an average of the bullish consensus calculated from the most important and most widely used sentiment surveys.
Gold, public opinion. The bullish consensus has barely gotten off the mat so far – click to enlarge.
The situation is different in silver: many traders have jumped on the bullish bandwagon by now. However, it should be noted that silver sentiment is just as volatile as the metal itself. Large swings are not unusual – moreover, the improvement comes from an extreme low in bullish sentiment (which undercut the 2008 low markedly) – click to enlarge.
Closed End Bullion Funds
Next we take a look at closed end bullion funds. What informs us about the state of sentiment is the degree to which such funds trade below or above their net asset value. Contrary to open-ended bullion funds like GLD and similar ETFs, it is not possible for market participants to immediately close any deviations from net asset value by means of arbitrage. Whenever demand for these funds is very pronounced, they therefore tend to trade at often sizable premiums to their NAV, and conversely, in periods when demand is falling and there are many sellers of the shares, they tend to trade at a discount to their NAV. These deviations from their NAV therefore tells us something about sentiment in the precious metals markets.
There are two funds we are going to look at. One is GTU (Central Gold Trust), which is a pure gold bullion fund, the other is CEF (Central Fund of Canada), which is a fund holding both gold and silver bullion. In order to bring the recent data into perspective, we show both short and long term charts of the NAV deviation from price. These charts are published by Carl Swenlin's excellent Decisionpoint chart site.
GTU continues to trade at a historically very large discount to its NAV. Note that the discount was at its widest right at the recent low in the gold price in late June – click to enlarge.
A long term chart of GTU's deviation from its NAV shows how unusual the recent period of large discounts is. The fund retained a premium to NAV until gold broke below the lower bound of its 2011-2013 triangle formation. Ever since, it has traded at a discount. The current level of the discount shows that skepticism about gold's recent rally remains very high – click to enlarge.
The deviation of NAV to price of CEF, a closed end fund holding both gold and silver bullion. The NAV discount of this fund has eased a bit from its June wides, but remains historically large – click to enlarge.
A longer term view of CEF's NAV premium/discount history. As can be seen, such an extended period of large NAV discounts is rare. It shows that sentiment on gold has not yet turned bullish – click to enlarge.
Rydex Precious Metals Fund Data
Luckily, the Rydex precious metals fund remains one of the larger vehicles of the Rydex family of funds, in other words, it has not yet been obliterated by the competition from ETFs. We say 'luckily' because this means we can continue to glean useful information from the fund's data. First let us look at the Rydex pm fund data published by sentimentrader.
Here we see the fund's total assets (middle panel) and what percentage of all Rydex fund assets combined the precious metals fund's assets represent (bottom panel). As can be seen, when sentiment becomes very bullish, this percentage can climb up to 40%. The current level (approximately 7.5%) is one of the lowest ever recorded – click to enlarge.
Decisionpoint shows an additional data point that strikes us as quite informative. It calculates the net cumulative cash inflows and outflows from the fund, by comparing its net asset value to its price. From observing these data for many years, we know that there are always divergences between the fund's price and the net cumulative cash flow index near major turning points. This can be observed both at highs and lows in the gold sector. We have previously discussed that such a divergence has developed and it has so far been maintained. We suspect that 'smart money' is moving in and out of the fund close to turning points, which is why cumulative cash flows tend to diverge from prices ahead of the turns.
The Rydex pm fund with its cumulative cash flow index (bottom panel). As can be seen, a substantial and long-lasting divergence between price and the cumulative cash flow index has been put in place – click to enlarge.
Lastly, here is a recent chart of U.S. and euro area inflation expectations, which are measured by comparing the yields of nominal and inflation-protected government bonds (in short, what is measured is 'expected CPI', not actual inflation). As we have pointed out previously, there may be a degree of distortion in these measures at the moment, caused by the unwinding of leveraged bond positions in recent months. U.S. inflation expectations have been trending down in the course of August, but seem to have found a floor recently. Euro area inflation expectations have been in an uptrend over the same period. In this context it is worth noting that U.S. true money supply growth has decelerated a bit lately, while euro area true money supply growth has by contrast accelerated in recent months. Since these measures of inflation expectations concern only expected CPI, they are of course not really a reflection of underlying monetary inflation. However, per experience they do show a certain degree of directional correlation with it. This is probably because market participants tend to react fairly quickly to central bank announcements regarding future policy.
Inflation expectations in the U.S. (orange line) and the euro area (yellow line) – click to enlarge.
Gold sentiment continues to reflect a lot of skepticism. Since a fairly big rally has occurred in the meantime, this divergence between market expectations and the price of gold is likely a bullish sign. However, there is one important caveat: for the rally to be sustained, this sentiment must actually change. In other words, bears and neutral investors that are sitting on the fence need to become convinced that a new bull market trend is underway. Unless they are so convinced, they won't turn into buyers. Sentiment data after all serve mainly to inform us about how many investors have already committed themselves to a specific market. As long as there are many bears, there remains a large pool of potential converts – but they must actually be converted at some point.
Note that there haven't been any big changes in futures positioning yet either, although a certain amount of short covering by speculators has, of course, been seen in the meantime. In terms of futures positioning the same principle applies: bulls want to see speculators turn bullish and increasingly enter into new long positions. In the gold futures markets, the big speculators specifically tend to be right about major moves in the market – investors bullish on gold therefore definitely should want to have them on their side.