Despite A Stronger U.S. Dollar, I Remain Neutral About The Precious Metals Market

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Includes: CEF, GDX, GDXJ, GLD, SLV
by: Simple Digressions

Summary

There is high uncertainty among the players trading precious metals now.

It looks like the US dollar has just entered its bull market phase. If I'm correct, the precious metals market can be negatively impacted.

On the other hand, US Treasuries seem to hold above their strong support. As a result, gold and silver prices are supported by treasuries.

As a result, I remain neutral about the precious metals market now.

Last week the precious metals sector remained relatively stable - gold lost 0.2% and silver gained 0.5%. Mining stocks also delivered opposite results: VanEck Vectors Gold Miners (GDX) lost 0.6% while its junior counterpart, GDXJ, returned 0.1%. Simply put, it looks like there's a great deal of uncertainty about the direction the precious metals market is heading for.

Commitments of Traders report (COT report)

This uncertainty is confirmed by the COT data:

Source: Simple Digressions and the COT data

Note: spreading figures show the amount of off-setting long and short positions held by money managers. I measure this uncertainty by matching the spreading figures against the total open interest in gold / silver futures.

For example, as far as the gold futures market is concerned, last week the spreading figure reached 13% (the left panel of the chart), the highest level since late March 2017. The similar pattern is visible on the silver market (the right panel of the chart).

Gold

Now, as I discussed in my latest articles on gold, the selling pressure demonstrated by money managers is dissipating. For example, since September 19, 2017, the money managers have been cutting their net long positions held in gold futures (the column titled “change in net long position”) but most recently (since October 17) these cuts have been lower (1 – 2 thousand contracts a week):

Source: Simple Digressions and the COT data

Interestingly, the market is driven by the longs cutting their long positions. For example, last week the money managers reduced their gross long positions by 10.0 thousand contracts while the shorts cut their position by 7.6 thousand contracts. As a result, the net long position was cut by a mere 2.4 thousand contracts with the longs controlling the market.

Therefore, in my opinion, the current leg down in gold prices should be perceived as a typical correction. At that stage of the bull market the longs are cutting their bets on higher gold prices but the shorts are generally inactive (compared to the longs).

US dollar

It looks like the US dollar has entered its bull market stage at last. Last week the big speculators trading US dollar index futures cut their gross short positions by 5.8 thousand contracts. In my opinion, this significant cut is the best evidence that the shorts are leaving the market en masse. In other words, most likely the US dollar is in the first stage of a bull market cycle. At that stage the market is dominated by the shorts cutting their bets and the longs being rather inactive. If I'm correct, we should see higher US dollar quotations in the coming future with the longs increasing their exposure to the greenback.

Of course, a stronger US dollar may / should have a negative impact on gold and silver prices so the precious metals market is going to be severely tested now.

US 10-year Treasury notes

Over two weeks before the Fed announcement the big speculators trading US Treasuries changed their minds a few times. For example, two weeks ago they increased their net long positions held in 10-year Treasury notes by 47.3 thousand contracts but one week later they cut their exposure to these notes by as many as 150.8 thousand contracts. As a result, now the big speculators are generally neutral about US Treasuries (look at the green arrow and the green circle on the chart below):

Source: Simple Digressions and the COT data

However, the last report was released just one day before the Fed announcement so it did not disclose the current stage of the market. And, on the Fed announcement the prices of 10-year Treasury notes made an impressive move above their strong support (the area marked in yellow on the chart below):

Source: Stockcharts.com

As a result, now the prices are once again above their support and the latest drop should be (most likely) considered as a typical bear trap.

Summarizing – if I'm correct and the Treasuries hold above their support, the precious metals market should also gain kind of support. In other words, if Treasury notes prices hold, the precious metals market should be hedged against significant drops (stable Treasury prices mean stable interest rates and, in some way, could be a natural hedge against lower prices of gold and silver).

Precious metals physical market

A few days ago the Shanghai Gold Exchange (the SGE) released the October report on the amount of gold and silver withdrawn from this exchange. In my opinion, the figures are a little bit weaker but the overall picture is still positive:

Source: the SGE

As the chart above shows (the panel on the right), in October the Chinese investors withdrew 152 tons of gold (a decrease of 29%, compared to the amount of gold withdrawn in September). However, since the beginning of 2017 the cumulative withdrawals were 6.1% higher than in the comparable period of 2016 (1,656 tons vs. 1,560 tons – the panel on the left). It means that the Chinese demand for gold is still strong.

The second chart shows the silver withdrawals:

Source: the SGE

Similarly to gold, the October figures are a little bit weaker – the Chinese investors withdrew 134.6 tons of silver in October. On the other hand, this figure is still above the 2017 monthly average (128.9 tons) so, the demand for silver is firm.

Summary

In my last report on the precious metals market I made this statement:

“If I am correct, the precious metals sector should be strengthening in the medium term or, at least, remain stable. Interestingly, a stronger US dollar should not have a big negative impact on the precious metals sector.”

I hold my general opinion on the precious metals market but, this time, I would put emphasis on the second part of the first sentence ("remain stable"). In other words, I remain neutral about gold and silver in the short term.

Although it looks like the US dollar is in its bull market stage now, gold and silver hold above their bottoms established in October. Keeping in mind that the greenback is above the last local peak made in October, the precious metals market looks relatively strong now. I believe there are two factors positively impacting the precious metals market now:

  • US Treasuries – the bear trap discussed in the section “US 10-year Treasury notes” makes me optimistic about Treasuries.
  • The hyperboles drawn by US equities and the bitcoin – these two markets are, in my opinion, highly speculative now. As a result, prudent investors should be, most likely, leaving these markets and entering safe harbors as, for example, the precious metals market.

Note:

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 a human being 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 much 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.