Tuesday, May 28, 2013

Huge Rally Fuel in Place for Gold Futures

HOUSTON -- Sometimes the data we gold analysts track tells a story that looks unbelievable in the current environment.  That’s assuming we apply our usual analysis to it and ignore the flood of news flowing at us by the minute.  By unbelievable we mean in an epic, potentially explosive sort of way. 

A case in point is the positioning of the largest traders of gold futures on the COMEX bourse, which is what this short memo is about.

Looking first at a longer term chart of gold, with the HUI index of relatively larger miners thrown in, it would be difficult to make a bullish case based just on the signature showing today, Tuesday, May 28, 2013.  Clearly both gold and mining shares have been in a cascade sell down so far this year. 

20130528 Gold HUI


Contrarians will quickly point to the obvious – that gold is very strongly oversold on standard momentum indicators (RSI and MACD) and therefore overdue for a technical bounce.  They might also point to the fact that the HUI has been driven so far down that it is currently at levels first reached in 2005 (eight years ago) when gold changed hands well under $500 the ounce.  Both observations are accurate, but they don’t move markets by themselves.

What can move markets is the action of the largest traders of gold futures.  As long time members of the Got Gold Report know we track the positioning of the largest traders of futures through their reported positioning to the Commodity Futures Trading Commission (CFTC) in weekly commitments of traders reports (COT).  

Tracking the large trader positioning won’t tell us what they will do tomorrow, exactly, but when we compare large trader positioning today with similar periods in the past, we can gain at least some insight into what the largest, best funded and presumably the best informed traders of gold futures might do looking ahead.

Extreme Positioning in Gold Futures

We track and chart about a dozen different trader positions each for gold and silver, but today we will tell the story we are seeing using just a few of the graphs. 

Only rarely do we see truly anomalous or extreme positioning in large trader positioning, but the positioning today certainly qualifies as both anomalous and extreme as we think you will agree.

Take, for example, the chart below, which tracks the positioning of the very large traders the CFTC classes as Producers, Merchants, Processors and Users – the natural hedgers of gold via futures.  This category includes the largest bullion merchant/dealers, the refiners they buy from and who buy the rough gold from producers; as well as the producers themselves. It includes jewelry merchants and manufacturers, bullion management firms and it also includes the bullion banks that many of them end up trading through. 

20130528 PM Gold Net
(Source, all COT charts: CFTC for COT, Cash Market for gold, GGR.)

Please note:  The Producer/Merchants are always net short, so their positioning shows up as a negative number.  So the higher the blue line on the graph the lower the actual net short positioning.  The net position is simply the long contracts minus short contracts.  Spreading contracts, which are simultaneous long and short contracts in different months, are ignored.

What is this graph telling us? Well, for one thing, the Producer/Merchant (PM) commercial traders of gold futures currently have a very, very low net short position for gold futures.  Specifically, as of May 21, the PMs reported a net short position of 34,334 contracts in the futures-only COT report.  That’s actually up 7,268 contracts from the prior week (May 14), when the PMs reported a tiny 27,066 contracts net short, the lowest PM net short position in the entire disaggregated commitments of traders report dataset (data begins in 2006).

The PMs are near a record low net short position.  Hedgers are reluctant to put on hedges with gold in the $1,370s in other words.  Let that sink in a moment. 

While that is sinking in, below is another chart showing the positioning of the large speculative traders the CFTC calls Managed Money (MM) – hedge funds, commodity pool operators, commodity trading advisors and other large speculative funds who trade gold futures for clients. 

20130528 MM Gold Net
As of May 21, the Spec Funds, or just the “Funds” as we sometimes call them, held just 36,358 COMEX 100 ounce contracts net long – the lowest MM net long position since June 26, 2007 (26,494 then with $642 gold). 

So, on the one hand the Big Hedgers are at a near record low number of hedges at the same time the Funds are at 6-year low number of contracts net long.

Note please, that since last October there have been absolutely huge changes in the positioning of both classes of traders shown.  On October 9, 2012, with gold then about $1,763, the Producer Merchants (first graph) held a very high 216,654 contracts net short.  So as of May 21, as gold had corrected a big $387 or 22%, the Big Hedgers reduced their net short positioning by a whopping 182,320 contracts or 84%. (Gold -22%, PM net hedges -84%.) 

On October 9, the Managed Money traders (second graph) held a quite high 167,473 contracts net long.  By May 21 they had reduced their net long bets by a huge 131,115 contracts or 78% to just 36,358 contracts net long.  (Gold -22%, MM net longs -78%.) 

What is pretty clear is that as gold has corrected by a large 22% since October, the traders who use futures to (mostly) hedge against price declines in gold, the PMs, are now at an extremely low, near record low level of hedges, meaning with gold in the $1,370s they are not positioning like they believe gold has much downside left.

What is also pretty clear is that at the same time the speculative Funds – the traders we normally associate with the long side of gold futures – have gotten the heck out of their NET long positions in almost as big a way.  Importantly, note the word “net” in that sentence.  Because as it happens, the Funds really haven’t reduced their long contracts at all since January. 

You read that right.  The Funds held 111,076 long gold contracts on January 29.  As of May 21 they held 113,088 long contracts.  The Funds have not been selling off their long gold contracts, but they have been adding to their short contracts, and as the graph below shows, they have been adding shorts in a very big way.

20130528 MM Gold Shorts
As of May 21, Managed money traders reported holding a huge 76,730 short gold contracts, the highest in disaggregated commitments of traders history.

The very low NET long position now held by the Funds is not because they have sold off their long contracts.  It is because they have added a record high number of short contracts.

It can be said that the Funds are momentum following traders without much of a dogmatic point of view on gold.  Since October 9, when remember gold changed hands in the $1760s, as gold corrected $387 or 22%, the Funds increased their gross short contracts by 66,559 contracts or 650%,  from 10,171 to 76,730 shorts.  (Gold -22%, MM shorts +650%.)  Hello!

Perhaps now one might have an inkling of why we have been saying that the COT reports have become “very imbalanced” and “dangerous for both sides of the battlefield.”  On the one hand the largest hedgers of gold are positioned as though they see very little downside left, while on the other the Funds, while still net long gold, have put on their largest gross short position since the disaggregated data begins in 2006. 

Simply put, as long as the price of gold continues to fall, the Funds seem determined to increase their short positioning.  But by doing so, they are sowing the seeds of the next important rally for gold.  There is no stronger or more powerful “fuel” for a gold rally than Spec Funds covering shorts.  That’s when both sides of the battlefield are on the buy side and that is almost certainly exactly what is about to happen – once a catalyst emerges for gold.

When, not if, but when a bona fide reversal shows itself, the hedgers will more than likely add to their long contracts as some of the hedgers are hedging against higher gold prices.  Typical hedgers won’t be too quick to add to their hedges when prices begin to rise either, so there could be a short term vacuum of sellers for a period of time.

But the Funds (and smaller non reportable traders who also have a very high short position) will find themselves eager to close their shorts (while also adding to their longs), again once it is clear that the downward momentum has exhausted itself.  With so many shorts to cover, local traders and other mercenary types will undoubtedly attempt to front run the rush to cover that record high short position.  

We here at Got Gold Report see the gold market as being oversold to the downside, even if momentum currently still favors the bears.  We have no way of knowing what it is, in advance, or when a catalyst will show itself.  However, at major turning points there usually is at least one primary trigger we can end up pointing to in retrospect. 

The one thing we are pretty confident in predicting is that the current downward impulse for gold will exhaust itself at some point.  When it does, there is a tremendous amount of “high octane rally fuel” already in place to make watching for it very interesting. 

We have to admire the courage of those willing to sell gold short in this, very imbalanced environment, knowing that a reversal could occur any moment and that it could be epic in its violence.  Rest assured we have neither the courage nor the inclination to do so ourselves.

That is all for now, carry on. 

Gene Arensberg for Got Gold Report.


The Original
Vulture Speculator

Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

"I've been a huge fan of Gene and his amazing work for years..."

Brien Lundin, CEO, Jefferson Financial, Host of the annual New Orleans Investment Conference and Publisher of Gold Newsletter

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