Hedge funds turn bearish on the gold price

On Friday, I suggested that, because trader sentiment has turned very bearish towards gold, we may see a decent counter-trend rally sometime soon.

I realise this would disappoint the army of gold bears, who believe gold is heading for the $1,000 level – and beyond.

This may occur in time, but the market usually has a way of delaying nirvana for a group of traders that have suddenly jumped over to the opposite camp.

According to the latest commitments of traders (COT) data, the switch has been striking:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of 100 Troy ounces) Open interest: 403,840
Commitments
144,062 82,710 29,266 190,317 256,102 363,645 368,078 40,195 35,762
Changes from 11/05/13 (Change in open interest: 17,044)
-4,969 24,815 5,614 11,603 -16,512 12,248 13,917 4,796 3,127
Percent of open in terest for each category of traders
35.7 20.5 7.2 47.1 63.4 90.0 91.1 10.0 8.9
Number of traders in each category (Total traders: 289)
102 94 74 58 60 203 197

 

The stunning change in sentiment

The hedge funds (non-commercials) have not only reduced their traditional overweight long positions, but have increased their short positions by a whopping 23% in the previous week.

Hedge funds are, contrary to popular opinion, big herders and group together in the same way as individual small traders.

That is a stunning switch of sentiment – no doubt helped along by Goldman Sachs’ forecast in September that gold could clearly trade below $1,000, which I quoted in Friday’s post.

This is in addition to the latest DSI (daily sentiment index) reading of only 10% bulls among trading advisers.

Also note the position of the commercials – generally regarded as the smart money – who have swung net bullish.

Keeping your options open

I offered this as my first tentative small-scale tramline pair for the most recent rally:

Gold price spread betting chart

I wasn’t entirely happy with them, because of the large overshoot on Wednesday. And when you are not convinced that your tramlines are secure, it pays to keep your options open until more highs and lows are put in.

Then, when you can find more precise touch points, you may need to make adjustments, as I did here.

This proved to be true on Friday.

The decline progressed later that day and hit a new low at $1,280, just short of my above target.

And that allowed me to try that low as a touch point. This was the result:

Gold price spread betting chart

That’s better! Now just admire the lower tramline first – it lies across all three lows and hits them right on the nose in all three cases.

And my new upper tramline takes in the one touch point – and has the multiple PPPs (prior pivot points).

Now I have a very reliable tramline pair which will guide my trading.

Be prepared to redraw your tramlines

So, let’s just recap what I have done. On Friday morning, I set my best guess for a tramline pair with limited high and low points. But when a new low was put in later that day, I quickly re-drew the tramlines, where I found the fit was much better.

This is something you must be prepared to do as trading develops and gives you new highs and lows.

And since the new low was a Fibonacci 38% retrace of the entire rally, that gave added weight to my new tramlines. This is because the $1,280 low has good Fibonacci support, as well as the support provided by the new tramline.

So, how are we placed now with respect to the down-sloping, longer-term tramline?

Gold price spread betting chart

Again, I have slightly re-drawn the down-sloping tramlines and the market is currently testing the upper one.

If it can break up through it, then where is my likely first target?

At the upper up-sloping tramline in the $1,300 – $1,310 area.

The safest strategy for novice traders

As with any relief rally, I like to apply the Fibonacci tool as soon as possible after I believe a low is in:

Gold price spread betting chart

So, provided the market can break above the $1,290 area, the next Fibonacci targets are shown in pink.

And remember, a crossing of a tramline with a Fibonacci level makes especially strong resistance.

But at this stage, any rally will be counter to the main trend. This means any long trades need to be watched carefully because the main downtrend could resume at any time.

This is much more dangerous than trading with the main trend, of course. I do not generally advise a counter-trend strategy for novice traders.

The safest strategy is to trade in the direction of the main trend, with entry near the end of a counter-trend move (the example of EUR/USD in my 11 November post is a good one).