It Is Time For Prudence In Gold - Here Is What That Means

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Includes: DGL, DGLD, DGP, DGZ, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, PSLV, QGLDX, SGOL, SLV, UBG, UGL, UGLD
by: Hebba Investments

Summary

Gold speculators closed nearly 50,000 long contracts last week, which was one of the largest speculative sell-offs of the year.

Despite this drop in longs, gold moved very little on the week.

Normally that would be bullish news, but weak demand in Asia and a hawkish Fed makes us very cautious.

At this point we remain very cautious of gold's short-term picture and suggest investors remain on the sidelines.

Speculative Gold Longs Sell the Most Contracts In Over 5 Years

The latest Commitment of Traders (COT) report showed a week of massive speculative gold selling despite only a moderate drop in the gold price. Despite the big selling by speculative longs, we saw little action with speculative gold shorts suggesting that maybe shorts are hesitant to forecast a lower gold price or are already at comfortable positional levels.

Indian gold premiums finally rose last week after selling at a discount the previous week, while Chinese gold buying was lackluster. Finally, looking forward to next week we see little in the way of economic events, so many analysts think gold will be tracking major moves in oil and the US Dollar.

We will get more into some of these details 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 small investors a way to see what larger traders are doing and to possibly position their positions 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 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

*Gold price data reflects the COT week (Tues-Tues) not a standard week (Mon-Fri)

For the second week in a row, speculative longs cut back on their long positions by a massive 49,827 contracts, which was one of the biggest speculative long drawdowns of the year. Despite this, the gold price only dropped 1.57% for the COT week and we would have expected a bit more considering the size of the long selling.

Meanwhile, speculative gold shorts closed out a tiny 147 contracts on the week, a bit unusual considering we usually see speculative shorts ADD to positions on these types of down weeks. It may suggest shorts are a bit trigger-shy or are already comfortable at their short levels and are reluctant to get "uncomfortable" and add more.

Moving on, the net position of all gold traders can be seen below:

Source: GoldChartsRUS

The red-line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, we saw the net position of speculative traders decreased by around 50,000 contracts to 105,000 net speculative long contracts. It looks like we continue to zig-zag from average to above average levels over the past six months, with the current positions at average historical levels.

As for silver, the action week's action looked like the following:

Source: GoldChartsRUS

The red line which represents the net speculative positions of money managers, showed a decrease in the net-long silver speculator position as their total net position fell by around 17,000 contracts to a net speculative long position of 27,000 contracts.

Silver is now starting to look attractive from this perspective as we are starting to see some of the lowest net speculative levels in silver since early 2016. But we do note, which we have mentioned before, the actual fundamentals of silver remain a bit weak as physical demand has been extremely poor with silver bullion sales slow across the board.

Asian Demand

Gold traded at a premium to official domestic prices in India this week for the first time in about a month, while demand remained lackluster elsewhere in Asia despite a drop in prices.

Demand in India improved slightly, with dealers charging a premium of up to $1 an ounce over official domestic prices this week, against a discount of $3 last week. But jewelers seem to still be implementing the new goods and services tax and are reluctant to make new purchases.

In China, premiums remain unchanged as consumer sentiment remains weak despite some gold buying as prices dropped under $1250. According to Cameron Alexander, an analyst with Thomson Reuters-owned metals consultancy GFMS, "In China consumer sentiment is weak. People are not spending money and also looking to fashion jeweler rather than investment-driven purchases."

What this means for gold investors is that caution should abound as Asian demand remains lackluster.

Our Take and What This Means for Investors

From a COT perspective, gold and silver look to be getting to healthier levels as speculators close out bullish positions. Additionally, gold total speculative short percentage of 27% is where we start to become much more interested about buying back positions - all else equal.

But we are a bit concerned about the lack of Asian demand especially considering the hawkish comments from regional Federal Reserve presidents - most notably, New York Fed President William Dudley. Gold HAS held up very well despite this backdrop, but we are very cautious and we have seen this before as gold holds up well and then proceeds to drop.

Perhaps if we see more COT speculators selling we will change our short-term view, but without any new catalysts, weak Asian demand, and hawkish comments from the Fed we have to remain short-term Neutral-Bearish on gold and silver.

Investors need to be VERY CAUTIOUS here as despite gold holding up fairly well to these negative catalysts, that can all change in a session as most of gold's strength is coming from "paper traders" - they can sell in an instant. At this point we continue to think the prudent short-term move is to wait on purchasing additional gold and silver positions (SPDR Gold Trust ETF (NYSEARCA:GLD), iShares Silver Trust (NYSEARCA:SLV), Sprott Physical Silver Trust (NYSEARCA:PSLV), and ETFS Physical Swiss Gold Trust ETF, etc).

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.

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