GOLD NO LONGER OVERBOUGHT, BUT.... / MACLEOD FINANCE

Gold no longer overbought, but…

Now that the August gold contract is history (almost) and the August 2024 options have expired — mostly worthless thanks to Swap-inspired markdowns — Can look forward to gold rising again? 

ALASDAIR MACLEOD

Unless, of course, equity markets continue to slide, which I’ll come to in a moment.

First, gold’s market and technical position. Open Interest on Comex has fallen dramatically, as the chart below demonstrates.

The solid line at 450,000 contracts can be taken as a rough oversold indicator, because it reflects speculator longs. 

In Commitment of Traders numbers for last Tuesday, Managed Money (i.e. hedge funds) were net long 162,860 contracts having fallen from 184,532 the previous week. 

By Friday, open interest had fallen 51,617 contracts, suggesting that hedge funds net longs had declined towards a neutral 110,000 contracts net long.

We can’t know the actual figure, but the point is that the weak holders in this category have left the stage, which is a positive. 

All else being equal, on this evidence I would expect the consolidation/correction to be almost done and look forward to the next bullish move. 

To put it into perspective, my next chart is of the technical position.

Gold appears to have found solid support at the 55-day moving average, dipping back for a (final?) test of it last week. 

The problem for the Swaps (mostly bullion bank trading desks, it that unless something else comes along, they cannot reduce their net short position much more, and will be threatened with a renewed bear squeeze.

That something else could be developing problems in equity markets. 

Let me explain.

We all know how febrile markets and the entire financial system have become, but what event, if any is likely to trigger a financial crisis? 

There’s a simile from the 1980s about chaos theory which was quoted when markets crashed in 1987: a butterfly flapping its wings in the Amazon can create a disturbance which develops into a hurricane elsewhere. 

Perhaps we are seeing a similar development today centred on Japanese investing institutions.

These investors have struggled for decades to get a decent return on their investments when the Bank of Japan suppressed interest rates to negative territory. 

To do so, they leveraged their portfolios and invested in foreign bonds and equities, which together with the carry trade undermined the yen so much so that it lost 60% of its value in dollars since January 2021. 

This loss enhanced Japanese investor returns. 

But it culminated in a yen sell-off with the yen falling 12% this year to a low of 162 before a bear squeeze commenced on 10 June pushing the exchange rate up to 153 last week. 

On the dot, the Nikkei index turned, falling 10%. 

Leveraged positions are now being liquidated, and the losses are covered by selling of foreign equities. 

Wall Street has been hit hard as the tech bubble coincidently popped.

Time will tell whether this turns into a self-feeding equity market crash. 

But because equities are held as collateral by banks, the rot could easily spread from there. 

In which case, the Fed will be forced to cut interest rates to stabilise markets and prevent collateral values falling and destabilising the banking system.

The initial effect of a developing crisis in equities will be indiscriminate liquidation of other financial assets, except government bonds which will almost certainly be seen as a safe haven. 

Particularly vulnerable will be non-mainstream assets, such as bitcoin ETFs. 

Gold and silver futures could be affected as well. 

It’s worth remembering that during the 2008—2009 financial crisis, gold initially fell, before rising strongly confirming this possibility.

However, if equities do crash, we can expect the Fed to lead the way to abandoning all talk of being worried about inflation and cutting interest rates radically to save the system. 

Inevitably, after short-term uncertainty, the gold price is bound to rise strongly and global investors understanding the implications for the dollar dump it even more aggressively for gold.

The real problem is that credit is becoming dangerously unstable and the probability of entering an existential crisis is rising sharply. 

To get out of credit, you need to get into physical gold and silver. 

Silver looks exceptionally cheap, with a gold/silver ration currently 85.4 times.