Is It Too Late To Join The Gold Rally? Here Are Our Thoughts Based On Speculative Trader Positioning

by: Hebba Investments



- For eight weeks in a row speculative traders have sold their gold positions.

- For the second week in a row gold has risen despite speculative traders selling gold positions.

- At 35,000 gold contracts net-long, there remains a significant upside if gold reverses to its average net-long position seen in 2016 of 168,000 contracts.

- There remains a good reason to own gold based on solely speculative traders positioning, and an even better reason to own gold based on its fundamentals.

- We think this early 2017 rally in gold has much more room to rise.

 
The latest Commitment of Traders (COT) report shows that traders continued to reduce their net long in gold for the eighth week in a row - despite gold rising for the second week in a row.
 
This is a very unusual occurrence and it tells us that despite the bearishness shown by traders, other factors must be supporting gold. That is usually a bullish factor, and taking into consideration the relatively low net-long position of gold traders, it shows that if trading sentiment turns then there can be significant upside in gold.
 
We will get 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 showed a drop in speculative gold positions for a eighth straight week as longs decreased their positions by 2,324 contracts on the week. On the other side, speculative shorts increased their own positions by 4,363 contracts on the week. After the COT reporting week closed (Tuesday) gold continued to rise to around $1172 per ounce, which tells us notwithstanding a big drop in gold early next week, we should see our first positive week in COT net-long positioning next week.
 
With slightly over 34,000 net speculative gold long contracts outstanding, there is plenty of room to move up if trading sentiment changes. After eight weeks of declines in speculative trader positions, we wouldn't be surprised to see gold rally a bit here as the gold trading pendulum swings from bearish to bullish.
 
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, the decline in speculative traders continues as the net long position in gold reaches 35,000 contracts. It seems all the speculative froth in the gold market from the mid-summer highs is now gone, and a move up to 100 or 150 thousand net long contracts would not be historically high - which would lead to a gold price easily over $1200 per ounce.
 
As for silver, the action week's action looked like the following:
 
 
 
The red line which represents the net speculative positions of money managers, showed a slight increase in speculative positions for the week of around 3,000 contracts. Silver has been a bit counter-intuitive as the silver net long position is still hovering near some of the historical peaks and is not close to decade low positions as we see in gold. We are not sure what to make of this except that when it comes to silver, speculators are holding to positions at a much greater comparative rate than with gold.
 
That can be either positive or negative - we simply do not know.
 
Our Take and What This Means for Investors
 
Based on the latest COT report, we saw something unusual as speculative traders continued to sell gold positions but gold rose during the COT reporting week. At current levels, solely based on speculative positioning, gold remains very attractive with a lot of room for speculative traders to add to positioning.
 
For comparison's sake, the average net speculative gold position during 2016 was around 168,000 net long gold contracts. That means based on current levels, we could see another 130,000 net speculative gold contracts added to simply bring traders to their 2016 average - which could easily mean $100 added to the gold price.

Even based on mean reversion, gold has further to move to get back to its short-term average.
 
 
 
All of these things do not include any of the fundamental factors we mentioned in our Uncomfortable Truths piece about gold and the economy looking forward.
 
Despite the rise in gold to begin 2017, we believe there is plenty of room for traders to add to positions if sentiment changes, which should move gold much higher as we reach historical averages. Thus we do not believe it is too late for investors to accumulate gold and the ETFs such as the SPDR Gold Trust ETF (NYSEARCA:GLD), and Physical Swiss Gold Trust ETF (NYSEARCA:SGOL).
 
Traders are holding silver positions much tighter than with gold so by that variable alone, it is not oversold. But its historical correlation with gold should keep its price in tow with gold on any moves up, so the silver ETF's such as iShares Silver Trust (NYSEARCA:SLV) also make sense for investors looking for at least a reversion to the mean.

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