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As expected, the commercials padded their net short position in the latest week (by 51,296 contracts, futures & options). Using the 20%-40% rule, this means that commercial short interest as a percentage of open interest now sits at 47.74%. In other words, as of last Tuesday gold was due for a price correction; a correction that permits the conspiring commercials to cover their burgeoning short position for a profit.
As if the jump in commercial short interest was not bearish enough, the price of gold rallied by more than $10 an ounce after the latest COT statistics were compiled. The last time gold was moving this strongly upwards – from June 1 to June 20 ($416 to $440 spot) - the commercials added more than 122,000 contracts to their net short position. It would take just over half of this amount to (or 67,751 contracts) for the commercials to have accumulated a record net short position last week.
Suffice to say, the outlook for gold is negative in the near term for one reason: the last time the commercials were as short as they are today was on December 7, 2004 (when gold was trading above $450 an ounce). There are many traders still licking their wounds from the gold price crash that developed in December 2004.
Motherload?
Many gold bugs disagree with this pessimistic near-term outlook, and instead conclude – by ignoring COT altogether - that the motherload gold rally must be near because gold is near last years highs. For example, following last weeks strong rally John Stafford, editor of Stafford's Investment Strategy Letter, said, “We have achieved lift-off. Those looking for 'one more pullback' will be wrong and have egg on their faces.”
As a long-term gold owner I certainly hope that Mr. Stafford’s words prove prophetic. However, when adorning a set of realistic glasses I cannot help but think that he is wrong; that at least one more pullback in gold is imminent. Quite frankly, COT determines the near term direction of gold, and unless the commercials are scrambling and defaulting in a failed attempt to cover their shorts there is no reason to believe a mad rush to gold is near.
Conclusions
Since 2002 the only time the commercials looked to be losing their grip on the gold market was from November 16, 2004 to November 30, 2004. To be sure, during the 2-COT weeks ended November 30, 2004 the commercials reduced their net short position even as the price of gold rallied. Unfortunately for gold bulls, the commercials added to their net short position even as gold declined for the week ended December 7, 2004. To reiterate, there are many traders still licking their wounds from the ensuing gold price crash that developed after December 7, 2004.
There are reasons to believe that a gold price correction in the near term will not turn into a massive Dec 2004 type sell off. Indeed, in 2005 even as the commercials exert greater energies to control the price of gold, they have failed to engineer any dramatic and lasting price collapses. Moreover, the spikes higher in gold have arrived with increasing frequency recently even as small spec interest remains stagnate, which suggests larger players are trying to battle the commercials.
In short, a price correction leading into what is usually a seasonally strong September would not necessarily be terrible news for gold. After the commercials lock in their profits maybe they will let gold rally to new highs? Maybe the small specs will return to the market for the first time since April 2004 and help gold surpass $500 an ounce? Who knows, maybe the commercials will actually be forced to cover their illogical shorts as a US dollar crisis develops?
Whatever the case may be, I think another pullback comes first, perhaps back to the $430 an ounce area. Given that the commercial short position is probably running near record highs and 95% of the time (in 2005) the commercials only cover when gold is declining, the risk of ending up egg-faced with this forecast is minimal.
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