The dynamics of the real interest rate and the recent actions of hedge funds indicate that the price of gold has almost certainly reached its current peak, and the correction in this market is likely to follow, as well as in the SPDR Gold Shares ETF Fund (NYSEARCA:GLD) (a fund that tracks the price of gold) price.
The price of gold has traditionally reflected the U.S. real rate, which is confirmed by a strong inverse correlation between these indicators.
Over the last five years the ratio of inverse correlation between the gold price and the real rate has been 47%, however, in recent days it has reached almost 90%. In other words, the dynamics of the gold price is now by 90% determined by the dynamics of the real interest rate.
If we consider the formed linear interdependence between the gold price and the real interest rate, we'll notice that the current balanced gold price is at least $80 lower than the actual level.
To be more specific, within the framework of this model, the actual gold price is now deviating from the balanced level by more than two standard deviations, corresponding to the maximum value of the deviation range for the period from 2016 onwards.
So, fundamentally, the price of gold is clearly overstated, which is largely due to the record number of the gold contracts purchased by the funds. The bad news for the gold market is that their activity is decreasing, and further purchases are unlikely.
According to the COT report, over the last 9 weeks, the funds have been net buyers of gold (COMEX). The market hasn't witnessed a similar strike at least in the last three years. However, the buying activity has markedly dropped in the last two weeks.
The current funds' net long position in gold is 264,934 lots - only 22 thousand contracts below the three-year maximum.
It is worth noting that the liquidity of this market has also risen sharply over the past month. But despite this, the relative size of the funds' position (the ratio between the net position and the open interest) has reached 31%, which is also critically close to the five-year maximum.
In addition, the current ratio between the sold and the bought gold contracts is 4.8% - this is the minimum indicator for the period from 2014 onwards (I have not analyzed the earlier periods).
So, taking this into account, I highly doubt that the hedge funds will continue to actively buy gold. Moreover, the funds are now very close to the beginning of the profit-taking process, which is a strong impediment to the further growth of the gold price.
There is one more important factor, which further convinces me that the gold market rally is over. On September 15, North Korea launched another missile over Japan. It is the best evidence that the strong geopolitical risks, which have been a driver for gold in the last two months, persists in the region. However, the gold price fell by 0,75% at the end of that day, indicating that this factor is already incorporated in the current gold price.
Putting It All Together
So, the gold price is critically overstated relative to the current level of the real interest rates. Therefore, it highly probable that the funds will soon start (if have not already started) to lock in profits on a record amount of gold contracts purchased in the past two months. Given that the market reaction to the global geopolitical risks became less intense, I believe nothing is deterring this market from correction.
In my opinion, one should expect the gold prices to decrease to $1281 in the next month.
Applying the foregoing to the dynamics of the SPDR Gold Shares ETF Fund I expect the fund price to drop to $122 in the next 30 days.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in GLD 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.