On Friday I wrote about gold, and how hedge funds are at their most committed at major market turns. The eye-opening multi-year chart below shows the net long/short position of hedge funds compared with the gold price. Note that in every case, major highs and lows correspond almost exactly with lows/highs of the net long position, as highlighted by the dashed vertical lines.
The all-time high in 2011 was marked by an all-time high in net long positions. This is when the hedge funds were at their most committed ever – but should have been in exactly the opposite stance if they wanted to maximise profits.
Conversely, at the July plunge low, hedge funds were actually net short – a situation I believe was unprecedented. Given the large army of extremely loyal always-long gold bugs (who believe in the metal no matter what the price is doing), and the fact that the gold trade (who are always on the other side of the hedge funds’ futures long positions) are usually hedging their mine production by selling futures forward, this is a staggering development.
This demonstrates the extreme bearish sentiment in the market in the summer – and proves the accuracy of the title: “They love ’em at the highs, hate ’em at the lows”.
The market’s changing its mind on gold
As the price of gold rises, we should expect to see a gradual increase in the number of net long positions held by speculators. That is the normal pattern, but sometimes, a rising market produces more speculators selling, because on the whole, they are even more firmly attached to the bearish case. But if a genuine bull trend has started, I want to see a rising trend in net long speculative positions.
So with the market having moved up in recent days, what is the current position? For that information, we turn to the latest commitment of traders (COT) data, which shows changes to the futures make-up during the previous week. Here is Friday’s data which refers to Tuesday, 6 October:
|(Contracts of 100 troy ounces)||Open interest: 625,986|
|Changes from 09/29/15 (Change in open interest: 25,896)|
|Percent of open in terest for each category of traders|
|Number of traders in each category (Total traders: 373)|
Clearly, the speculators have increased their long trades while decreasing their short ones. The trade (commercials) have taken the other side of these trades and increased their hedging activities into the rallies. This is a clear sign that the speculators are switching sides and are gradually buying into the bullish case.
Of course, if this keeps up and the buying pressure can dominate, the market will rise to a point where the speculators are overwhelmingly long – and that will be a sign the rally is about to turn. But that day is some way off, I believe. First, I need to see headlines in the media such as “Goldman Sachs targets $2,500 gold”, or “Gold production down 35% this year”, or “China’s central bank buys 25,000 tons of gold”.
The mechanics of a turning market
One other point about gold bull markets: the sellers are primarily the trade as they hedge their future mine production. Their interests are best served by a rising market, because they can sell some production at higher prices. They do not wish to drive prices lower by aggressive hedging (short selling) – they wish to keep the bull market alive as long as possible.
The attitude of the commercials is directly opposite to that of a bearish short-selling speculator who certainly wants to drive the market immediately lower – as low as possible, in fact.
That makes a huge difference to the shape of gold bull phases. Commercials who hedge are not normally interested in covering their shorts in the futures market – they deliver gold on their contracts when they mature. On the other hand, speculative shorts, who never want to touch the stuff, always have to cover their shorts before their contracts come due, and are therefore a source of buying pressure down the line.
That dynamic is one reason gold bull markets can often carry on much higher than most expect – and can carry an unusually high degree of net long speculative positions before they turn.
This morning, the market has jumped above the $1,250 level and above my major (pink) trendline which starts in 2012:
I also have a valid tramline pair marked in blue. This trendline break is a bullish development.
Here is a close-up:
The move above the August high has helped confirm my original wave count – we are now in a third of a third. This is a most powerful set-up and we are seeing fireworks well before 5 November!