The Strong Jobs Report Drops Gold - Is This A Buying Or Selling Opportunity?

by: Hebba Investments



- For the week, we saw speculative gold longs increase their positions - right into Friday's gold price drop.

- While we expect next week's report to show a smaller net long position in both precious metals, they are still near historic highs.

- We expect a further drop in the gold and silver price as these drops tend to snowball with so many bullish traders already in the market.
 
In the latest COT report, we saw a rise in the gold long speculative positions, which occurred right before Friday's jobs report related drop in the gold price. Based on the position data from Tuesday, we believe a large chunk of gold traders were probably on the wrong side of Friday's trade. Silver traders were a little less bullish into the COT report close (Tuesday), and we would imagine the next report would continue to show that the bearish side of silver does have a pulse. We have been expecting a bit of a pullback in precious metals based on the historically high bullish positioning - is it time to get back in?
 
We will give our view and will get a little more into some of these details, but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
 
About the COT Report
 
The COT report is issued by the CFTC every Friday to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
 
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.

The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three-day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued, it has already missed a large amount of trading activity.
 
There are many different ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the experts on it.
 
What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
 
This Week's Gold COT Report
 
This week's report showed speculative gold longs significantly increase their positions for the first time in a month, while shorts slightly increased their own positions.
 
After a month of decreasing positions, speculative gold longs increased their positions in the latest COT report week, but unfortunately it was directly before Friday's big drop in the gold price. Shorts slightly increased their own positions during the week but they haven't had much courage in a few months now and this week wasn't much different as their positions only grew by a little over 1,800 contracts. It will be really interesting to see how net Tuesday's report shows traders reacting to Friday - will it be primarily longs selling or shorts shorting?
 
Moving on, the net position of all gold traders can be seen below:
 
The red line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, speculative traders have raised their net long positions to 267,000 contracts. Of course, this data doesn't incorporate Friday's drop in the gold price and thus we expect the speculative net long level to be a bit lower; however, we don't expect it to be too much lower since it was only a one-day drop and we'd have to see some more sustained declines in the gold price to expect the net long speculative levels to approach more reasonable historic numbers.
 
As for silver, the week's action looked like the following:
 
The red line which represents the net speculative positions of money managers, finally saw a slight pullback as shorts increased their positions by a little more than 3,500 contracts while longs decreased their own positions by 450 contracts. Having said that, we're still at extremely high net long levels in silver and we would need to see a much larger change to make us more comfortable here.
 
Our Take and What This Means for Investors
 
So what should precious metals investors do here?
 
We have seen a little bit of the pullback that we were expecting based on the extreme net long levels in both gold and silver, but one day will not eliminate some of the froth we believe has been building in the precious metals markets over the past few months. There's still simply too much confidence on the long end of the trade for us to get back into some of our gold trading positions just yet.
 
Having said that this doesn't affect our view on gold in the intermediate and long term as we are big bulls on gold over those time frames as there are too many significant financial questions without answers and policy makers that have no plans to solve moving forward. In fact, recent talk by both US presidential candidates (which we highlighted earlier this week) about large increase in deficit infrastructure spending are certainly making the future bright for inflation-proof assets like gold. That is why we still hold a significant amount of paper and physical precious metals as our core position and have no desire to sell any of those assets.

But for now, in the short term, we are not convinced this pullback is big enough for us to start re-initiating some of our previously sold trading positions in the precious metals. Investors should remember that this drop was initiated by a big jobs report beat, and though we think the report itself (or far more accurately: "the survey") is not a great indicator for the economy, we know other traders do follow it and trade accordingly. With such historically large net long positions in both precious metals, they remain vulnerable to pullbacks that snowball into much larger drops than warranted.
 
Investors have to be careful here as there is plenty of room to drop further and we are really looking for a pullback below $1,300 to shake some momentum players out of the market. Thus, we think investors should hold off or lighten up on gold positions in the ETFs and miners such as the SPDR Gold Trust ETF (NYSEARCA:GLD), ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), and miners such as Randgold (GOLD) and Barrick Gold (NYSE:ABX).

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