Janet Who? An Important Driver Shift Is Occurring In The Gold Market And Investors Need To Be Prepared

by: Hebba Investments


- Speculative bullish positioning over the past week declined just as gold was about rise.

- The Fed meeting was a let-down and that was shown in the rising gold price, but we still expect a pull-back.

- Moving forward, the Fed will take a backseat to some major geopolitical events over the next few months such as US elections and the Italian referendum.

- Gold investors need to re-establish some previously sold positions but wait for the pull-back before getting fully invested again.

 
So, we finally made it through the highly anticipated Fed decision, and in this week's Commitment of Traders report, we see speculative traders choosing their sides - and it seems most of them chose wrong. Additionally, we will take a look at the Fed decision and what it means for gold moving forward.
 
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 the 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 shows that speculative longs continued their declines by a significant amount for the second straight week as they closed out 26,490 contracts. Once again, shorts have not shown much in the way of courage as their positions only increased by 3,234 contracts for the week - much less than we would have anticipated considering the decline in speculative bulls.
 
This suggests to us that much of the action in gold right now (at least for paper traders) is all on the long side with movements in the gold price primarily driven by longs initiating and closing positions.
 
That is in stark contrast to when we see shorts driving the market and is probably why we have not seen many of those "waterfall type declines" that gold investors may remember from the past few years (see the example below).
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The reason being that when shorts are in the driver seat of the market, their purpose is to drive the market lower because that's how they make their profits. Thus, despite the questionability of it, they concentrate their trading on these types of "shock and awe" gapping price declines to initiate long selling - no gold long, speculative or not, would decide to abandon positions so suddenly.

Thus, our takeaway here is that with longs driving the gold market and shorts MIA, we don't expect to see these types of massive gap declines - until we see speculative shorts re-join the market.
 
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 continued closing out their position in preparation for the Fed meeting. Currently, those positions sit at a net long position of around 219,000 contracts, but obviously, with the post-meeting rise in the gold price, that was the incorrect decision and we expect next week's report to show a large increase in speculative positions.
 
As for silver, the week's action looked like the following:
 
 
 
The red line, which represents the net speculative positions of money managers, saw a slight decrease on the week but nowhere near the decline we saw in gold for the week. In fact, it was a bit strange as gold speculative positioning got hit hard but silver traders barely did anything on the week.
 
Gold Moving Forward and Our Conclusion for Gold Investors
 
Another week and another Fed driven gold market as the FOMC met this week and they decided to keep interest rates on hold - pretty much what we predicted last week with their "Lainard Telegraphing." Yes, it was the first time since December 2014 that we had three dissenters, but of course that had no immediate consequences as interest rates didn't rise for another year.

The big takeaway here is that the Fed either doesn't have the courage to raise rates or is very concerned about the consequences for the economy with a rate rise. That is awfully strange considering the supposed improvements in the labor market and stable economy - we aren't talking 5% interest rates here that would suffocate the economy, just an itsy-bitsy .25% rise in the fed funds rate. Something's up and we believe gold's uncertainty hedge antenna are perking up and that's why investors are buoying the gold market despite relatively weak physical demand from the East.
 
Since the Fed meeting ended with a whimper, we think the gold story is going to shift from "What is the Fed going to do with interest rates?" to "Who is going to win the US elections?"
 
That is a key shift because there is some major uncertainty in US elections and one of the candidates has the potential to really shake up the world economy if he does what he says.
 
Additionally, both candidates have promised to increase infrastructure spending to stimulate the economy, which may put some pressure on the US dollar as deficits will increase. As we get closer to the US elections in early November, if Clinton's lead over Trump starts to narrow further (which we think it will), then we believe the gold price will gather strength.
 
We do still expect a bit of a pull-back as sentiment is extremely bullish, which we see clearly in the COT speculative positioning and even in some of the surveys of analysts and investors. The Kitco survey below for next week shows everybody bullish on gold.
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  Source: Kitco
 
 
Despite expecting a pull-back, investors need to own at least some gold at this juncture moving forward as there's a lot of significant economic and geopolitical uncertainty in the world that may come to a head over the next few months. We wouldn't completely buy back all of our previously sold positions, but we certainly are re-establishing many of the positions in the gold ETFs such as the SPDR Gold Trust ETF (NYSEARCA:GLD), the ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), and the iShares Silver Trust (NYSEARCA:SLV) that we sold earlier.

In summary, investors should not buy back all previously sold gold positions as the likelihood of a pull-back is high, but they definitely could reinitiate some of their previously sold positions.

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