At last – despite North Korea launching another missile, last week gold prices retreated 1.9%. And I am not surprised - as my readers know I have never considered political events as the drivers of gold prices. Quite contrary, the only factors I look at are market forces (physical demand in the long term and market internals in the short term). That is why I want to begin this article with the chart showing the strongest pattern driving gold prices in the long term:
Source: Simple Digressions and multpl.com
The chart shows US 10-year real interest rates and gold prices. The left panel is a long-term picture, while the panel on the right draws a medium-term picture (October 2013 – now). The main takeaway for investors is this:
In the long-term the downward trend in US real interest rates supports gold prices. However, since late 2013 the 10-year real interest rates in the US have got stuck between 0.0% and 0.8% and…gold prices have been mirroring this pattern.
Next week the FED will announce its decision on interest rates but the market does not expect a rate hike. For example, since late April 2017 big speculators have been holding very large net long positions in US 10-year treasury notes (between 180 – 360 thousand contracts) – they definitely bet on stable or even lower interest rates.
That is why I also do not expect anything special as far as gold prices are concerned. In my opinion, as long as US 10-year real interest rates do not break from a medium-term range (0.0% - 0.8%) gold prices should fluctuate below $1,375 per ounce (the strong resistance). However, in the short-term the most important thing is whether gold prices are able to hold above their strong support at $1,300 per ounce.
And in the short-term the gold market is sending warning signals:
Money Managers are overly optimistic about gold prices…
According to the last week’s Commitments of Traders report (COT report), Money Managers were holding the largest net long position in gold futures since the last bottom in gold prices (December 2016). What is more, the current position held by this group of traders is very close to the position held in the summer of 2016 when gold prices were topping (the red circle):
Source: Simple Digressions and the COT report
For comparison reasons, I measure the net position held by Money Managers against the total open interest in gold futures
Definitely, it is a sign of over-bullish conditions…
…and they are also over optimistic about silver
In just a few weeks the silver market has caught up with the gold market. As the chart below shows, now Money Managers hold a large net long position in silver futures:
Source: Simple Digressions and the COT report
What is more, that position is very close to the record established at previous price peaks (the blue circle).
Similarly to the gold market, it is a sign of over-bullish conditions…
Gold prices against 10-year treasury prices
One of my favorite short-term indicators is the relationship between gold prices and US 10-year treasury notes prices. Most recently this indicator went into a new territory (the area marked in orange):
Source: Simple Digressions
As the chart shows, between April 2017 and late August 2017 the indicator (the lower panel of the chart) was trading in a narrow range. Then, in late August it violated this medium-term pattern and broke above its strong resistance at 10.2 (together with gold prices). What does it mean? Well, the change is imminent – my old trading signals are not valid any longer. Between April 2017 and late August 2017 each time the indicator was close to two horizontal red lines (the lower panel of the chart) gold prices were bouncing up or down. However, in late August the old pattern was broken (the area marked in orange) and now another, new pattern is emerging. The old resistance is the new support now so, probably, the current correction in gold prices should stop at this new support at 10.2 (the indicator on the lower panel of the chart).
A few days ago the Shanghai Gold Exchange (SGE) released its report on gold / silver market in China. In my opinion, the data is very good for gold bulls – the demand for gold and silver is strong in China. For example, between January and August 2017 the Chinese investors withdrew 1,290 tons of gold from the SGE (a 4.4% increase, compared to 2016):
Source: the Shanghai Gold Exchange
A similar, or even more optimistic, pattern is emerging from the silver market:
Source: the Shanghai Gold Exchange
As the chart shows, in August the Chinese investors withdrew the largest amount of silver from the SGE this year (270.3 tons compared to 102.8 tons per month withdrawn between January and August, on average).
In my opinion, metals withdrawals should be considered as a good proxy for the demand for precious metals in China. In other words, the more withdrawals the stronger demand.
So, despite the fact that gold and silver prices went higher in August, the demand reported by the SGE was strong. It is a good long-term indication – precious metals prices are still supported by the Chinese demand for gold / silver bullion.
An interesting pattern is emerging from gold holdings reported by the COMEX:
Source: Simple Digressions and the COMEX data
The chart shows the amount of gold held by the COMEX warehouses, excluding JPMorgan. Why is JPMorgan excluded? In my opinion, this bank is an active player in the North American gold market and it does not qualify as a typical COMEX warehouse (a place where gold is stored by the certified entities and their clients). I know that I have many opponents that have a different opinion on this matter but...let it be.
Going back to the chart – since the last top in gold prices (summer 2016) the COMEX has been reporting gold outflows (the red arrow on the right). Note that it is not a typical pattern because, generally, gold prices and the amount of gold held at the COMEX go in tandem. However, this time, despite higher gold prices, gold is going out of the COMEX. Where is it going? I have no idea but, keeping in mind the strong demand reported by the SGE, I am not risking too much saying that the gold goes from the West to the East. And it is not a truism because this time gold goes to the East despite higher prices. It looks that Western investors have totally lost their interest in gold - even higher prices cannot attract them to this metal. Simply, they prefer amazons, googles and apples than precious metals…
Last time when this pattern was at play was the bear market in gold between 2013 and 2015 (the red arrow on the left). We know how it had ended – after reaching a critical level of 6 million ounces held at the COMEX, the gold market started another bull phase. It looks like we are slowly approaching a critical level at the COMEX so…let the pattern get filled…
In my opinion, the gold market has entered its correction phase. My short-term indicators support this thesis – for example, Money Managers are overly optimistic about gold and silver prices. Now the most important thing is the way the gold behaves above its strong support at $1,300 per ounce. If it holds above it, the gold bulls should feel comfortable. If it does not – a bullish thesis on gold would have to be verified.
In the long-term, the precious metals bulls obtained a strong, bullish signal from the Shanghai Gold Exchange. Last month the Chinese demand for silver was the strongest this year. Additionally, gold withdrawals, calculated for the period January – August, were higher than last year.
What is more, the US COMEX, despite weak data from the US Mint, supports a bullish thesis on gold in the long term. Despite higher gold prices, the stocks at the COMEX are going down.
If you liked this article, please, visit my Marketplace service (Unorthodox Mining Investing) where I am doing my own research. However, this time I also want to say this:
If you are looking for a guru or a person that instructs you when buy / sell gold, I strongly advise you that my service is not for you. I am not a guru or a talking head – I am just an independent analyst trading stocks and financial futures and…making mistakes.
On the other hand, if you are looking for new ideas, an unorthodox approach to investing, decent mining picks (since the inception, my Unorthodox Mining Portfolio once again delivered better returns than the broad precious metals market) and open discussion, this service is definitely for you.
Disclosure: I am/we are long GDX, CEF.
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.