The Gold Trade Is Dead Now

| About: SPDR Gold (GLD)

Summary

According to the COT Report, most recently the so-called "Commercials" radically decreased their short positions in gold and silver futures.

Apart from that, the open interest in gold futures is standing at a very low level now (comparable to that reported during the last bear market in gold).

In my opinion, these two indications support my thesis that the gold and silver markets are close to print a major bottom.

In my last article on precious metals I made the following remark:

"While the gold speculators are still decreasing their net long positions, for the last two weeks the speculators in silver have been increasing their net long positions. I would say that the sentiment among speculators in silver is much different (positive) than that among the speculators in gold (negative)"

I also stated that the COT report, discussed in the article, was dated December 13, one day before the FED decision to raise interest rates. The last COT report (published on December 23, 2016) takes into account this event. Here is the appropriate chart:

Source: Simple Digressions and the COT data

As expected, last week the speculators decreased their net long position in silver futures from 66.9 thousand contracts to 60.9 thousand contracts (a decrease of 6 thousand contracts - find the blue bar on the chart). Putting it differently, despite lower prices of silver the speculators are again less optimistic on silver (they hold lower long position). The same pattern is visible in gold futures - last week speculators decreased their net long position by 14.5 thousand contracts.

However, in this article I would like to look at gold and silver futures from a different perspective. The common knowledge is that it is a group called "Commercials" that sets the price of gold and silver. According to the COT report, "Commercial" is an entity:

"…that it is commercially engaged in business activities hedged by the use of the futures or option markets."

In practice the term "Commercial" refers mainly to the banks involved in futures trading, including the (in) famous bank JP Morgan.

Next, in general, the gold / silver futures market works in the following way:

  • Speculators (also called "Non-commercials) hold long positions in gold /silver futures
  • Commercials stand on the other side of the trade and hold short positions in gold / silver futures

Now, due to the fact that commercials demonstrate tremendous financial power, it is these entities that have stronger position than speculators. Hence, my statement that:

"The price of silver and gold is set by commercials"

Therefore it is important to track the size of positions held by commercials. Let me show it using silver futures as an example.

The chart below shows short positions held by commercials, starting from December 2014:

Source: Simple Digressions and the COT data

The chart documents the general pattern:

  • During a bear market in silver commercials are gradually decreasing their short positions. These periods are marked with blue arrows ("cutting short positions"). For example, between December 2014 and December 2015 the short position held by commercials went down from 99.2 thousands contracts to 78.2 thousand contracts.
  • During a bull market in silver commercials are building up their short positions again. For example, since the bottom printed in December 2015 (78.2 thousand contracts) their short position went up to 158.2 thousand contracts in early August 2016 (look at the area under the arrow marked in red and titled: "building short position").

Now, the chart shows that the current pattern is indicative of a bear market in silver (or a strong correction during a bull market) - since August 2016 commercials have been liquidating their short positions. What is more, the pattern delivered by gold futures is even more dramatic:

Source: Simple Digressions and the COT data

Here the short position went down from 463.9 thousand contracts in early July 2016 to 221.9 thousand contracts last week. As a result, now the short position, held by commercials, is standing at a very low level, comparable to the levels reported during the last bear market in gold (2012 - 2015).

Conclusion? Today I would be looking for a bottom in gold and silver instead of predicting lower prices of both metals. Simply put, small short positions held by commercials are indicative of an incoming bottom in gold and silver. Those expecting lower prices should look for extremely high short positions - the last such situation was in summer.

Note: in my last article on silver and gold I concluded that the silver market was cornered. This statement is confirmed by the chart showing the short position held by speculators in silver futures. Because the silver market is cornered the drop in short positions held by speculators is smaller than in the case of gold.

Bank Participation Report

Apart from the COT Report, the US Commodity Futures Trading Commission delivers also the so-called "Bank Participation Report". In this report the commercial banks disclose their positions in various financial instruments, gold and silver futures included. Below I have plotted two charts showing short positions held by commercial banks in gold and silver futures, starting from December 2014 (when the first report was dispatched):

Simple Digressions and the Bank Participation data

These charts are very similar to the charts showing short positions held by commercials. And no wonder - commercial banks are included in the category called "commercials". So, between July and December 2016 the banks decreased their short positions in gold futures from 216 thousands to 110 thousand contracts. In silver futures their position went down from 88 thousand in August 2016 to 63 thousand contracts in early December 2016.

Open interest

Since the last top in gold (July 5, 2016) and silver prices (August 2, 2016) the open interest in gold and silver futures went down significantly:

Source: Simple Digressions and the COT data

As the table shows, the open interest in gold futures decreased 38.9% and now it stands at the level comparable to that reported during a bear market phase in gold (2012 - 2015). Low readings of open interest mean that investors have lost interest in this trade. I think that it is the good news for gold bugs because major bottoms occur when nobody is interested in trading gold.

Using other words - the gold bugs should be happy that the gold trade is dead now.

Summary

The market data confirm the fact that commercials (commercial banks included) are cutting their short positions in gold and silver futures. What is more, it looks like the gold trade is dead now (the open interest in gold futures is at the level comparable to the last bear market). In my opinion, these two patterns are indicative of an incoming end of the current correction in the silver and gold markets. Unfortunately, the data delivered by the COT report and the Bank Participation report are of limited usefulness to generate reliable short - term buy / sell signals. On the other hand, they are quite useful for medium and long - term investors because they warn about an incoming change in the market sentiment.

Last but not least. Below I have plotted the current chart of the so-called Gold dollar index (as of December 23, 2016):

Source: Simple Digressions

As the charts show, the old pattern:

  • weakness in gold (below its middle - year support marked with the yellow horizontal line)

and

  • strength in the gold dollar index (above its middle - year support marked with the yellow horizontal line)

is still intact. It is positive for gold bugs.

On the other hand, the SPDR Gold Trust (NYSEARCA:GLD) still reports outflows of gold from its vaults. Last week as many as 400 thousand ounces of gold went out of GLD:

source: Simple Digressions and the GLD data

I have stated many times that as long as I do not see the American investors buying gold (and larger amount of this metal in GLD vaults) there are small chances for substantially higher gold prices.

Disclosure: I am/we are long GDXJ.

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.

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