The popular carry trade this year has been shorting the US Dollar and buying gold, oil and US equities. You might say that it is not the commodities appreciating, but the dollar’s depreciating that has led to the high prices of gold, oil and everything else which is denominated in USD. Last week’s worries about Dubai’s debt caused a flight to the safety of the US dollar and US government bonds, and subsequently as the American currency appreciated in value, the price of gold and oil dropped.
Of particular interest is the gold market which had reached a multi-year high in the last few weeks. Below is Daily Price Chart for the April 2010 Comex Gold futures contracts. As you can see the price has dropped from the high of 1229 on December 3 to close at 1161.8 yesterday (December 7). Is this the end of the uptrend in gold or merely a correction which creates a buying opportunity to be exploited? I believe it is the later.
Note that despite the very high volume selloff on Friday December 4, Open Interest has largely remained unchanged. See the red line just above the daily volume bars on the chart below. While short term scalpers and speculators usually close their position the same day, only large well-capitalized players can afford to hold their contracts over many days, weathering the corrections and drawdowns that are inherent part of the trend. Small trend followers often cannot pay the increased adjusted margin after a big correction day like Friday. Typically, you will see a decrease in Open Interest in the last days and weeks of a rally, as the smart money close their profitable long term positions, leaving it to the small speculators and late comers to push the price into a last ridiculous top.
Seeing that Open Interest has remained largely the same, leads me to believe that the big players are still holding their long positions. The large drop on Friday was caused by the short term speculators initiating short positions and by the late buyers (small long-term traders) who bought during the previous high volume days that led to the record high, panicking to close their positions. As there were few buyers the price dropped to a low of 1150, at which point the profitable speculators covered their shorts and some buyers stepped in, causing the price to rally into the close at 1170.8. On Monday December 7, the speculators again pushed the price lower with their shorts, however the late trend buyers were already out as of Friday, and no long position closing was there to add fuel to the fire. In fact the selling was on such low volume, that when a bit of buying came in the shorts covered, causing the price to rally back almost to the open. As a result the daily price bar formed what candle chartists call a “shooting star” which is perceived as a bullish candle.
Previous corrections have usually lasted no more than 4-5 days, before a rebound above the recent high. If this happens, any remaining shorts will contribute to the upside as they cover.
A quick note on the market fundamentals - As I mentioned in the beginning the real reason for the latest uptrend in gold is the depreciation of the dollar . The weakening of the greenback is likely to continue as long as the current record low interest rates in the US remain (barring a major credit default of a foreign country which will lead to a huge flight to safety i.e. back to the dollar). As no other country’s credit default seems imminent, does anybody really believe that Bernanke will raise the rates anytime soon?