The Fed Tipped Its Hand And This Is What Gold Investors Learned Last Week

by: Hebba Investments

- Gold speculative longs closed most of the contracts they opened last week as gold dipped.

- Despite the decrease in longs, gold shorts lacked courage and didn't significantly increase their own bearish positioning which is short-term bearish for the gold market.

- Fed Governor Brainard's highly anticipated Monday speech, which would have given the Fed the opportunity to telegraph a rate hike, was unexpectedly very dovish.

- Based on this failed opportunity by the Fed to warn markets of a rate hike, we believe they will hold interest rates steady.
The latest COT report shows traders reversing last week's bullish positioning as speculative longs closed a significant amount of contract, but not too many speculative shorts built on that momentum to open up bearish positions. It may be in anticipation of the upcoming Fed meeting and the desire of bulls to pare back positions a bit (traders are currently extremely bullish), or it may simply be bulls becoming a bit less enthusiastic as the gold price weakens.
We will discuss this a bit and also give our thoughts on the odd timing (and result) of Fed Governor Lael Brainard's speech on Monday, as it gives us significant clues into the Fed's thinking as we approach this upcoming week's rate decision. 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 exports 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 reversed almost all of last week's large increase in bullish positions as they closed out 27,190 contracts. Surprisingly enough we didn't see a similar increase in short positions as shorts only increased by 2,946 contracts - which certainly did not make up for the number of short contracts that were closed last week.
That's actually something important for gold investors to note as it is telling us much of the movement over the past few months has been all long related - either buying or selling positions. That is not ideal for the gold bulls because that eliminates much of the potential for explosive upward moves because of short squeezes. Additionally, since we're close to all-time high positions in speculative gold longs, there may not be a lot of potential for additional longs to get into the market.
It doesn't mean investors should just abandon gold positions, but it certainly means without some external catalyst, we don't see a lot of potential for a large upside move.

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 are still holding their net positions close to all-time highs. Currently, those positions sit at a net long position of around 249,000 contracts as we continue to see traders see-saw in the 250,000 - 300,000 net long range.
As for silver, the action 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 and has dropped a bit further from its all-time highs than have speculative gold traders. In our view silver's main attractiveness remains its leverage to the gold price as physical investor demand remains weak and we see little in the way of economic growth to spur industrial silver demand.
Ms. Brainard's Monday Speech
As we discussed last week, Federal Reserve Governor Lael Brainard's Monday speech was highly anticipated by Wall Street and was a perfect opportunity for the Fed to telegraph to markets that they were going to raise rates this week. As Peter Hooper, chief economist at Deutsche Bank Securities, wrote to clients before the speech: "As a dovish member, Brainard would carry a lot of credibility delivering a more hawkish message. It could be a coincidence, but it could also be an important opportunity for the Fed to raise market expectations and give the FOMC more room to maneuver at the September meeting."

Well it turns out Ms. Brainard was anything but hawkish. She warned that the Fed shouldn't "move too quickly" on rate hikes as still muted inflation and uncertain developments ahead "counsels prudence in the removal of policy accommodation." Those uncertain developments we believe are the major political risks that lie ahead including US elections and the barely discussed but very important upcoming Italian referendum - all scheduled to occur over the next few months.
Chances of a rate hike at the Fed's next meeting immediately slumped after news of Brainard's speech broke down to just a 15 percent probability, down from 21 percent before the speech and as high as 30 percent the previous Friday.
The Fed obviously knew what Ms. Brainard was going to speak about and we think it would be extremely irresponsible for them to have such a dovish speech right before the pre-Fed meeting "silent period" unless they wanted to calm markets down and telegraph that there would be no rate hike in September.
While we were of the opinion that the Fed would hike rates based on all the previously hawkish rhetoric by Fed governors, we think something has changed in the thinking of Fed voting members. Whether it be Trump's move up in the polls (he's been critical of the Fed), poor numbers in the recent economic data, or the desire not to shake things up in a traditionally volatile season on Wall Street - the Fed isn't looking very bold any more when it comes to interest rates.
What That Means for Gold Investors
The Fed's change of heart has also significantly changed our opinion on this week's Fed meeting as we expect them to keep interest rates on hold and not raise them until at least December. They had the opportunity to telegraph markets that an interest rate hike was coming in this meeting with Ms. Brainard's speech and they didn't take it so it is clear to us that they are still worried about making that move up - at least right now.
While that is positive for gold, the speculative positioning is still not so positive as despite the net fall in speculative gold longs, we saw little in the way of shorts coming back into the market.
The action in the gold market recently has simply been longs buying and selling which is causing the metal to fluctuate in the $1320 -$1350 range, but we're gradually grinding lower here and we wouldn't be surprised to see a test of $1300 if shorts start to get bold.

We are still bullish on gold here as we believe we are in the early stages of a narrative shift in the investment world as we go from monetary stimulus to fiscal stimulus. That means inflation and its positive for gold - which is why a few weeks ago we started buying back some of our previously sold gold positions. It isn't time to go all-in on gold just yet though as long-term fundamentals are good but in the short-term there may be a bit more of a pullback as speculative shorts take advantage of over-extended and stale longs.
So in summary, investors should keep their core positions or initiate positions if they have not already in the gold ETF's such as the SPDR Gold Trust ETF (NYSEARCA:GLD), ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), iShares Silver Trust (NYSEARCA:SLV), and miners such as Randgold (GOLD) and Barrick Gold (NYSE:ABX). This is in anticipation of what we believe will be a politically volatile next few months but keep some powder dry as speculative positioning doesn't suggest a particularly bullish short-term Outlook.
Of course, there is the Fed meeting next week, but now we expect them to stay pat on interest rates and other than a one-day boost, to have little impact on markets as they start to look forward to the major upcoming political catalysts. If gold drops a lot next week because of a hawkish Fed outlook, we would be buyers and would encourage investors to do the same.

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