Fed Watching Time: Here's How Gold Investors Should Be Positioning Themselves For The Upcoming Week

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Includes: AGQ, DBS, DGL, DGLD, DGP, DGZ, DSLV, DULL, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, PSLV, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, UBG, UGL, UGLD, USLV, USV, ZSL
by: Hebba Investments

Summary

Speculative gold traders increased their bullish positions in gold for the first time in six weeks.

Speculative silver traders continued to increase their net short positions in silver.

The upcoming week's major event will be the FOMC meeting and policy statement.

Based on the extremely bearish speculative USD positioning, we think any Fed bullishness may cause a USD short squeeze.

Gold and silver investors need to be cautious during this week.

The latest Commitment of Traders (COT) report showed the first increase in speculative gold long positions in six weeks of trading – albeit a small one. Silver traders though continued their bearish bias as shorts outnumbered longs for another week – though based on silver’s strong late week rally (which is not included in this week’s COT report) we imagine that positioning is not as bearish as this week’s COT’s suggest.

In our view though, the real story next week will center on the Fed and what will be its position on monetary policy. That should be the big driver for gold in the short-term, and while nobody expects them to raise interest rates, a hawkish leaning may put a damper in gold’s two week rally.

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.

We are also adding a new feature this week to help our readers gauge positioning from other SA readers. Here is our new weekly gold survey which will close on Monday - so please fill it out ASAP and get insight into what other PM investors are thinking and how they're positioned.

If you have already voted, you can see the updated results here:

https://www.surveymonkey.com/results/SM-695PBSJ6/

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 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 first week in a month and a half, speculative longs increased their positions by a mediocre 5,297 contracts, while shorts continued to increase their own positions by 3,577 contracts. After the positional moves, the current 43.66% speculative short percentage is on the extremely high side of the report, and we would have to go back to January of 2016 to see a similar short-to-long ratio – which as we said last week, is positive for contrarian gold bulls.

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 increase by around 2,000 contracts to 29,000 net speculative long contracts.

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 another decrease in the net-long silver speculator position as their total net position fell by around 1,000 contracts to a net speculative SHORT position of 6,000 contracts. For the second consecutive week traders are at a very rarely seen net short position in silver, but based on the almost 2% rally we saw towards the end of last week, we feel that we’re probably much closer to a net-neutral position in silver than what is reflected in this report.

Time for Some Fed-Watching!

Next week the US Federal Reserve board will meet and issue a monetary policy statement.

Source: US Global Investors

While there is an extremely low probability of the Fed raising rates (markets are currently pricing it at 3.1%), investors will be looking through the Fed policy statement to assess future monetary policy.

The Fed’s policy stance, and its effect on the USD, is very critical to gold and silver moving forward. Previously we have noted that physical buying of gold and silver has fallen substantially in the past year, but investors and paper traders have helped keep precious metals aloof. One of the key reasons why we have seen this bullishness is that the USD has continued to fall and the US Dollar Index currently sits under 94 – which is a 13 month low.

Additionally, USD speculators are now net short for the first time in more than a year, according to calculations by Reuters and CFTC data released on Friday. According to FX strategist Sireen Harajli of Mizuho, “There has been quite a bit of uncertainty regarding the U.S. economy going forward, mainly because of the generally weaker economic performance, as well as high uncertainty regarding policy initiatives by the new administration,” which is the reason for the negativity on the USD.

While we expressed our belief in USD weakness at the beginning of the year when the consensus was to be bullish on the USD, we think that strength in some of the alternative currencies (e.g. the Euro) is a bit overdone with speculators a bit too bearish on the USD in the short-term. When you have sentiment overdone to these levels, traders look for catalysts that would put “the fear of God” back into over-leveraged traders – that catalyst we believe may be a more hawkish-than-expected Fed statement this week.

That would be a bit a worrisome for precious metals as Asian physical demand is fairly weak.

Our Take and What This Means for Investors

As we mentioned last week, the COT report is very bullish for precious metals based on contrarian analysis as traders hold their smallest bullish position in gold and silver in quite some time. But the weak physical demand from Asia made us hold a Neutral position in both metals despite this ordinarily bullish signal in the COT.

With the upcoming Fed meeting the biggest economic event of the week, we think it is time for short-term traders to take some profits considering the potential USD rally that may occur with a more hawkish-than-expected Fed statement. There is a lot of bearishness on the USD and traders hold their largest net-short positions in the USD in over a year.

Coupling a potentially USD-strengthening post-meeting statement by the Fed and extreme USD-bearish positioning by speculators means that precious metals traders need to be cautious during the upcoming week. Throw in weak physical demand in Asia, and we feel the contrarian bullish COT positioning is not enough to be bullish on gold in the short-term.

Thus, we are changing our position in the short-term for gold and silver from Neutral to Neutral-Bearish.

What this means for short-term traders is that it is time to close out bullish positions and take a wait-and-see attitude on the upcoming Fed meeting. Of course, Yellen and friends could issue a dovish statement and push the USD and precious metals up further, but we don’t think the risk-reward is worth it at this juncture. Thus, we think precious metals investors should lower their risk by selling gold and silver positions in the ETF’s (SPDR Gold Trust ETF (NYSEARCA:GLD), iShares Silver Trust (SLV), Sprott Physical Silver Trust (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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