Gold And Silver: Comparing Recent COT Trends With XAU And XAG

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Includes: GLD, GTU, IAU, OUNZ, PHYS, PSLV, QGLDX, SGOL, SIVR, SLV
by: Sebastien Winsor

Summary

While net long positions in gold are improving, it's too early to claim a positive outlook beyond the short term, as equities, DXY, and rates are still large unknown factors.

Net long positions for silver in addition to a large price divergence with gold support a bullish outlook beyond the short term.

Although the metals typically trade in pairs, there are significant fundamental differences between the two, leading to separate risk profiles. Adding silver will shelter against the inherent risks of gold.

Despite the mixed outlook, long term positions in these assets will serve as excellent hedges while potentially providing superior overall portfolio returns.

The gold futures data from the latest COT report shows a rather mixed outlook, but we can still draw some important observations for guidance. Managed Money reduced their long positions, effectively eliminating the net increase from the Jan 20 report. Short contracts have decreased substantially as well, while spreading has increased significantly. Swap dealers/specs added to their long positions, albeit less aggressively than on the Jan 20 report, while also reducing shorts and increasing spreading. The significant increases in spreading on both sides indicates that many holders of short contracts are accumulating long positions. At the very least, this data indicates a reversal of the overall bearish sentiment in gold futures, albeit still with significant uncertainty.

The chart below shows COT data from 2014, with spot gold price [XAUUSD] overlay, showing a significant correlation with Money Manager net long-short positions (short positions are shown negative for easy viewing).

Here is the same chart from 2006:

(Source: CFTC)

While these changes are likely reactive actions to the spot-price uptrend that began in mid-December, the changes in futures positions will likely support a continued uptrend over the medium term, but does not provide a clear picture for long term outlooks as of yet.

Silver futures, on the other hand, are much more interesting. As you can see from the historical chart below, Managed Money are collecting a significant amount of long contracts, while holding relatively little short, and even after the large decrease we see at the end of summer 2016, contract volumes are still very high. Even Swap dealers/specs are holding a relatively large number of long contracts. This seems to indicate a positive outlook for silver, as overall positions appear far more bullish than on gold....

(Source: CFTC)

This notion has so far been confirmed with price action over the past year. While the precious metals typically trade in pairs, with gold traditionally offering higher overall returns, this trend has reversed in the past year, as silver continues to provide higher returns, with this trend continuing to accelerate on the daily. The charts below show 5 year, 1 year, and 1 month returns of XAUUSD v XAGUSD. As you can see, while gold returns are much higher over 5 years, this trend has reversed significantly over the past year, continuing strongly over the past month.

(Source: Bloomberg)

Here are the FX charts for the past month for XAUUSD and XAGUSD side-by-side. You can see that yes, while they often trade in pairs, silver has broken away these past few days, breaking through resistance at 17.225 with strong momentum, and has yet to retreat. Gold, however, didn't even get high enough to test the resistance at 1219, above the twin peak pattern from last week, and has since retreated slightly from 1212.5.

(Source: Forex, Spot Prices)

This leads us to believe that holders of gold should consider adding silver to their portfolios. At the very least, the different risk profiles will provide diversification, and at best, silver will provide higher returns with lower downside risk. Silver, rather than gold, appears to be gaining momentum and is currently more attractive over the medium term. Either way, holding mixed positions would be wise.

Over the long term, as previously stated, although gold futures positions are shifting away from a bearish outlook, it is still plagued with significant uncertainty as to long term trends. Therefore, while gold prices are likely to experience a continued uptrend in the short term while DXY, rates, and equities find their bearings, long term positions are best held as effective hedges against equities (NYSEARCA: SPY & DIA) and USD (US Dollar Index, NYE: DXY & NYSEARCA: UUP).

To highlight this point, I've provided a chart showing gains of equities vs USD vs spot gold & silver prices, where you can clearly see the negative correlation on the 5 year chart:

And a much less significant correlation over the past year:

(Source: Bloomberg)

Therefore, we believe there is no better hedge for USD and equities, as recent trends show positive gains despite gains in equities, with positively skewed results for DXY. Anyone holding large equity portfolios should be aware of the many inherent risks facing markets today given the macro and political environment, and hedging is absolutely necessary under these circumstances. Thus, even though the long term outlook for gold is mixed, we still recommend holding this asset over the long term, specifically for hedging purposes. Adding silver to the mix provides similar protection, but with an entirely different risk profile, providing diversification even for your hedges. After all, what is more effective than a hedge that provides downside protection with an added bonus upside potential?

Bringing me to my final comp chart, this can give you an idea of other trades based on DXY. While all the listed assets below share some intertwined fundamental aspects, silver by far is currently providing the best returns, and the return distribution is widely uneven. The right combination of long and short positions would provide very nice returns for plays on DXY and rates while hedging away the risk of Trump accidentally hitting the 'first strike' button over a Twitter dispute. With US equities at all time highs, having priced in Trumponomics to perfection, be mindful of alternatives. Happy trading!

(Source: Bloomberg)

[Side note: Other factors to consider however, include possible gold supply constraints due to mine closures after the price decreased substantially in recent years. Also consider that GLD vaults haven't been getting replenished as we would expect throughout the past month, after selling off vast amounts of gold in November-December, although we have seen a massive increase in call buying (which you can read here). As the largest gold-buying fund in the world, you'd expect it's purchases to contribute to price gains significantly, suggesting other large buyers may be important drivers in the most recent rally, as Russia and China come to mind. Government figures from these countries are required to make any sort of meaningful analysis regarding gold, but is outside the scope of this article. Regardless, the fact silver is a far more useful precious metal for industrial purposes certainly means global silver demand will remain strong, regardless of what happens throughout the world.]

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GLD, SLV, GDX, XAUUSD, XAGUSD over 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.