Interest in gold has come back to the market with the intensity of a flaming love-affair, which means that fundamental measures or reasons for movement in the gold price won't be of much use when trying to predict the future price of gold. There are a number of variables that have an effect on the gold price, such as inflation, the dollar, interest rates, and uncertainty of various flavors, but here, we will not be looking at causes, but rather at gauges that allow us to measure the probability of price changes in gold. In particular, the commitments of gold-futures traders (COT).
The COT report is released every Friday after the market closes, and reflects the commitments of traders on the prior Tuesday. This means we must wait until the following week's report to get a read on the positions of the last three days of the week. Because of this delay, the COT report is not useful for very short-term trading.
The COT in aggregate form, shows the net long or short positions of three broad trader categories; commercial dealers, large speculators, and small speculators. The chart below, shows a 12-month comparison of the gold price compared to the weekly COT levels. Notice that the commercial traders tend to be maximally short when the gold price is at a local maximum, while the speculators, both large and small, are maximally long.
The pattern implies that the speculators are mostly wrong about the future price of gold, while the commercial traders are mostly correct about the future price of gold.
The COT information is also available in 'disaggregated' form where the commercial category is split in two; producers/merchants/processors/ users, and swap dealers. The former being the fundamental 'insiders' of the physical gold market, while the swap dealers could be considered the 'insiders' of the paper gold market. The large speculators (managed money) and the small speculators (other reportables) are not disaggregated. They are the financial players (gamblers) sitting at the table, playing the game with no intentions of receiving or delivering any physical gold.
When we look at longer-term data (chart below), we see that, even though the commercials are always short, because they produce and sell gold, their relative level of shorting still follows the pattern of predicting future price changes in gold. The speculators, on-the-other-hand, show the opposite pattern; their long positions max-out at price tops and can be used to predict corrections in the price of gold.
The chart below, shows the COT for 2009-2011 when gold was in the middle of a bull market. Notice how the maxima in the speculator long positions, and the commercial short positions line-up with local tops in the gold price. At the end of 2009, the COT predicted a 14% drop in gold; during the summer of 2010, the COT predicted a 9% correction; and at the start of 2011, an 8% drop in the price of gold.
Looking at the 2011-2016 bear market, we can see (chart below) that the predictive pattern is even more pronounced.
The present extreme positions in both speculator longs and commercial shorts, indicate that, even if we are at the start of a new bull market in gold, we should be able to use the COT to predict price corrections with a high degree of confidence.
The commercials are happy to sell gold to the speculators above $1225. The speculator's long trade is extremely crowded at the moment, and if the hedge funds need to exit that trade, there could be a shocking drop in gold-especially if the Brits vote to stay in the EU.
Some might argue that the commercials' short trade is just as crowded, but the difference is that the commercials HAVE the gold to deliver. They don't have to go into the market to buy gold, unlike the speculators who must go into the market and sell their contracts in order to get out of the trade.
In conclusion, while there is a myriad of influences on the price of gold, we are comfortable following the 'insiders' of the gold market, as opposed to the momentum-chasing hedge fund speculators.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.