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Although there is no sign of lineups outside of coin shops, there are strong signals that gold has regained its status as the investment of choice during times of financial crisis. To be sure, with the USD index off only 1.5% this year, the price of gold is up by more than 8% and is hitting all-time highs. Silver has recently joined in this rally and is already up by 11% in 2008.
Some potential negatives to consider
In the case of the COT data, the commercials have been net short (futures and options) more than 200,000 contracts in each of the last 16-weeks (a record). Clearly the commercials are waiting for a correction in the price of gold to reduce their massive short exposure. Conversely, small speculators are now carrying their largest net long position since March 20, 2007, and with last weeks surge there is every reason to suspect that long small spec interest has grown. Are the commercials about to panic and scramble to cover the 26+million ounces they are short (to say nothing of the unknown OTC short positions)?
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Expressed as a percentage of open interest, the net short commercial position tends to follow the price of gold (i.e. the commercials tend to add to their shorts as gold rises and cover their shorts as gold falls). On a very basic level this suggests that the commercials sometimes control the market by the sheer size of their trades. For example, properly timed commercial short sales have, historically, had a tendency to depress the price of gold and make the longs to run scared. In other words, the commercials spark a sell off by shorting gold and as this sell off intensifies this gives the commercials room to cover their shorts. A closer look at the data (compared to open interest) shows that the commercials did try to aggressively stop gold when it bounded above $700 an ounce but that they were less inclined to try and throw up a wall at $800 an ounce. This makes this week’s data of particular interest as gold has rallied above $900 an ounce.
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Another potential negative for gold is that central bankers appear unwilling/unable to break their dependence on the U.S. dollar. Yes, there are signs that central bankers are slowly diversifying reserves away from USD, there is the growing threat that OPEC annoyance with the slumping dollar is about to reach a breaking point, and central banks are not exactly in agreement with Bernanke’s ‘substantial’ easing plans. Nevertheless, the U.S. dollar remains the world’s reserve currency! In other words, a USD crisis would be a global problem that could, potentially, spark a global solution.
In short, as delightfully bullish as FX volatility may seem for the price of gold, it could foreshadow a more united central bank effort to support the dollar (obviously this speculation has proven erroneous thus far in 2008, as central bank posturing is anything but united).
More Questions Than Answers
With Bernanke recently confirming his allegiance to monetary inflation the outlook for precious metals would appear to be exceptionally positive. Moreover, with financial market uncertainties relating to the subprime/credit crisis threatening to intensify over the near term and gold reconfirming its safe haven status, the outlook for precious metals would appear bullet proof. But beyond these bullish appearances sits the commercials and their massive short position and central banks and their universal interest in preserving a fiat (unbacked) paper regime. Will the commercials soon panic or will they try to regroup and shoot gold down at $900 or $1,000 an ounce? Will central bank interventions be successful thus sparking inflation as the unintended consequence, or will reflation efforts fail as asset price deflations takes root?
Unsure of exactly what the near term holds, one conclusion is nonetheless obvious: gold is not done making headlines yet.
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