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Early last week, gold (GLD) declined sharply to a three-month low of $1,251 an ounce due to speculation that an agreement to raise the U.S. debt ceiling would be reached. Nonetheless, during the second half of the week, the yellow metal took off following the deal between Democrats and Republicans due to the U.S. credit downgrade by Chinese rating agency Dagong and the recent comments of Chicago FED president Charles Evans about Quantitative Easing (QE).

Market Positioning Analysis

Futures market positioning is crucial to understand how gold is driving.

Even though Commodity Futures Trading Commission (CFTC) data have not been published yet due to the U.S. government shutdown, open interest data are still available.

Open interest combined with price direction shed some light to the recent developments in the gold market.

Exhibit1: Comex Gold Open Interest


(Click to enlarge)

Source: Bloomberg

As seen in Exhibit 1, the COMEX Gold open interest has been increasing from October 1, 2013 (the day of the U.S. government shutdown). As gold prices have declined during this same period, it is likely that new shorts positions have been added, which means that gold traders had been positioned on the short side ahead of the U.S. debt ceiling deadline. Consequently, the gold rally of October 17th combined with a falling COMEX Gold open interest can be mainly attributable to short-covering.

The sustainability of the upside momentum comes into question because:

There are No Fresh buyers ...

We are seeing a failure of gold to attract new longs and major changes in market positioning are the result of short positions rather than long positions.

With ETF in liquidation mode ...

The SPDR Gold Trust experienced a fourth consecutive weekly outflow. Holdings declined by 8.75 tonnes last week reaching a new 4.5 year low of 882.23 tonnes.

But Strong Physical Demand ...

Indeed, one major factor could lend some support to gold prices: the strong physical demand out of Asia in the U.S.

In India, gold premiums hit records of $100 an ounce as the festival season has just started. There are no supplies in the domestic market to meet festival demand due to the 80/20 (20% of the gold imported has to be exported) of the RBI introduced in order to curb gold imports.

Exhibit2: American Eagle Gold Coin Sales in 2013


(Click to enlarge)

Source: The U.S. Mint

As shown in Exhibit 2, demand for U.S. gold coins has surged in October due to the recent fiscal problems in the US. The U.S. Mint sales in October are already the highest sales in three months with total sales amounting to 22,000 ounces so far versus 13,000 ounces in September and 11,500 ounces in August.

In sum, even though we are seeing stronger physical bids, we need to see increased ETF inflows and new fresh buyers to confirm a bullish trend. Otherwise, gold price consolidation that began in September 2011 will likely continue.

Source: Gold: Where Are The New Fresh Buyers?