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August 8, 2005 |
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With the net commercial short position sitting at 32% of open interest – almost right in the middle when using the 20%-40% buy/sell rule – the outlook for gold would, at first, appear to be neutral. Indeed, the long-term COT chart paints the picture of neutrality; sometimes the price of gold has rallied from current COT configurations and sometimes it has fallen.
Obviously the problem with the dated COT data is that does not show important price shifts (and commercial shifts) until after the fact. For example, the commercials could have added 60,000 short contracts since last Tuesday or reduced their net short position by 35,000 contracts - we have no way of knowing for sure until this Friday’s report is release. And yes, by the time this Friday’s report is out it will also be dated… Reading Between The Lines One statement that has been more useful than any archaic ratio(s) or triangles since the gold bull began is as follows: When gold is rising the commercials tend to add to their net short position and when gold is falling the commercials tend to reduce their net short position (almost always for profits). In 2005 this theory has held true almost every single week, and I believe that it will also hold true this week: meaning that last weeks gold rally has brought with it a massive amount of commercial short selling. If I am correct in my COT speculations then gold will not embark upon a rally above $500 ounce before, at minimum, another price correction occurs. Only a dollar crisis can change this outlook.
Revenge of the small specs? In early 2004 the small specs tried to hold their ground as the price of gold fell from $420 an ounce to around $400 an ounce. However, when the bottom fell out of the gold market the small specs ended up panicking and dumping their positions en masse. The sell off was brutal: gold declined by more than $50 an ounce in just over 1-month. The small speculators were completely crushed. Suffice to say, the last time the small speculator (non reportable interest) held a net long position above 13% of open interest was back on April 20, 2004. Last week the net small spec long position was standing at 12.6%, having risen sharply in recent weeks.
On the one hand an otherwise ordinary trading in gold can be turn into powerful rally when the small specs take charge. However, every rally during the bull market that has been supported by small accumulation has ended badly. In short, as the small speculators acquire more long positions this all but guarantees an engineered sell off to shake these hand loose. Only a dollar crisis can change this outlook. Conclusion In my opinion this weeks COT report – which will be released on Friday and current as of tomorrow – is the most important COT report this year. To be sure, with yuan revaluation(s) adding some excitement to the gold market, and gold only weeks away from entering what is usually a seasonal strong period, that the expected COT configurations are turning bearish makes the market worth monitoring closely. Maybe the commercials are not adding shorts as aggressively as they usually do? Maybe, after being beaten up on countless occasions, the small specs are reentering the market with longer term aspirations? I think the price of gold will correct from current price levels based solely on ominous COT expectations...but maybe - hopefully - I am wrong. Whatever the case may be, the recent uptick in volatility and uncertain dollar outlook, combined with the strange return of the small specs, is undoutably going to make for an exciting gold market in the months to come. |
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