Speculative Money Still Backing Gold - Investors Need To Be Careful

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Includes: GLD, GTU, IAU, OUNZ, PHYS, QGLDX, SGOL
by: Hebba Investments

Summary

Despite a drop in the gold price speculative longs continued to add to their positions.

The latest COT report shows nominal speculative longs at the highest levels since October of 2012 when the gold price was close to $1800 per ounce.

We think investors would be wise to wait for a further drop in gold prices before adding to non-core gold positions.

In the latest Commitment of Traders report ((NYSE:COT)), we saw both speculative gold longs and shorts increase as traders positioned themselves for the end of the quarter. This was also a post Fed meeting report, so we have seen that the response to the Fed's dovish meeting has resulted in longs becoming more confident in their positions despite the drop in gold prices.

We will get a little more into this but before that let us give investors a quick overview into the COT report for those who are not familiar with it.

About the COT Report
The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.

Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investor a way to see what larger traders are doing and to possibly position himself accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.

The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.

There are many different ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the exports on it. What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.

This Week's Gold COT Report

This week's report shows that both speculative longs and shorts slightly increased their positions post-Fed meeting.

Click to enlarge

As is clear in the table above, speculative positioning significantly favors the long side as speculative longs hold 193,139 contracts versus the speculative shorts at 28,193 contracts.

This is the highest nominal speculative long position since October of 2012, when gold was close to $1800 per ounce, as seen in the table below.

Click to enlarge

As gold bulls this worries us a bit as the boat is getting pretty crowded in terms of speculative traders taking the long side of gold and it means there is a greater opportunity for surprises to the downside.

Our Take and What This Means For Investors

In addition, the increase in speculative longs was despite a drop in the gold price which suggests that speculators are providing quite a bit of support to the gold market. We are a bit concerned that physical gold demand may be much weaker than speculative gold demand, and that would explain falling gold prices despite speculative investment buying. We may be wrong, but we'll be eagerly awaiting some of the import and export reports from India, China, and Switzerland as they'll give us a much better idea of actual physical demand. Investors need to remember that a healthy gold rally which can take it back up to $1400 or $1500 per ounce will require both speculative and physical demand - we don't know if we see both yet.

That means we are lukewarm on non-core gold positions and remain out of the market as we need to either see some speculative long liquidations, more chaos in the financial markets, or a drop in gold prices. Thus we are holding off on increasing gold positions in ETF's and miners such as the SPDR Gold Trust ETF (NYSEARCA:GLD), ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), Tahoe Resources (TAHO) and Randgold (GOLD) - we are waiting for a better entry point that we think will come over the next few months.

We want to emphasize that despite our belief that gold is significantly overbought in the short-term, we think there are plenty of reasons to be bullish on gold in the long-term so this is not a "get outta town" call on gold. At this point we think that the risk for a drop in the gold price below $1200 is fairly high as fast-money speculators abound and physical demand seems a bit sluggish - we think having the discipline to not act is the best course here.

Disclosure: I am/we are long SGOL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.