November 9, 2005
Gold: Second Stage of Bull Market or Suckering Stage?
By Brady Willett

The good news for gold bulls is that the commercials have reduced their net short position in each of the last three weeks.  The bad news is that the commercials only started covering after accumulating a record net short position of 227,566 contracts (as October 11 – futures & options).  In other words, as of the latest COT report the commercials were still short 171,877 contracts.  If there was not a widespread belief that gold has entered the second stage of its bull market, this figure would paint an extremely negative picture for the price of gold going forward.


Given that the commercials probably covered more contracts during last weeks price slide, the numbers may not be as negative as they appear. Rather, it is entirely possible that the commercials covered an additional 50,000+ contracts last week (as of yesterday).  If so, the COT could still be readying for a seasonal year end rally.


Needless to say, baring a serious price collapse the commercials will not reap the type of profits they have come to expect during the gold bull.  To be sure, in late 2004 the commercials were on the right side of a $40+ an ounce price collapse.  Today (specifically as recently as August 30, 2005), the commercials are running for cover on less than a $5 correction.  Thus, 2005 could, in fact, be the year that gold enters the second stage of its bull market.



Second Stage?

Whether or not the gold bull has entered its second stage is highly interpretative.  On the one hand the commercials are having to acquire a larger and larger short position to extract smaller and smaller profits, which suggests that the price of gold is breaking free from commercial control. On the other hand the commercials have not given up and started covering their position for losses, which suggests the patient commercials are simply awaiting another major price collapse.

Beyond COT, whether or not you think gold has entered the second stage of its bull market depends on your definition of second stage:

“We are now in the early part of the second phase of the great gold bull market. This is the phase where gold starts to make the news. And when an item makes the news, the great unwashed public notices and begins asking questions...”
Russell. Oct 7, 2005.

Although gold has caught more headlines since October, Mr. Russell’s contention that the public ‘asking questions’ constitutes the ‘second stage’ is vague.  In late 2004 just as many questions about gold were being asked, the outlook for the US dollar was almost universally negative, and yet the price of gold still crashed.

The more common definition of ‘stage two’ is when gold starts to decouple from the US dollar.  Mr. Hamilton covered this angle last year:

”During Stage One bulls gold trades like another currency...Now after three or four years of Stage One, Stage Two arrives. Stage Two marks a momentous event when gold decouples from the local-currency devaluation.”
Hamilton.  Sept 3, 2004.

In Mr. Hamilton’s opinion the ‘momentous event’ in question recently arrived.  Judging by the price action in gold in September - even as the US dollar strengthened gold rallied - it is difficult to disagree.


Before painting too rosy a picture, it is worth remembering that not only are the commercials firmly planted in the bearish camp, but the US Fed will do its utmost to keep its ‘dreaded secret’ exactly that - secret.  Moreover, with the rising dollar/declining gold trend threatening to reaffirm itself in November, the commercials showing no sign of covering their massive short bets for losses, and traditional inflationary pressures thought to be under attack, the argument could be made that gold is setting itself up for another serious correction.

With that said, one thing can, and likely will given the imbalances festering in the US economy, mark the beginnings of next stage of the gold bull.

During the next financial crisis money moves into the safety of gold, not US Treasuries.

When this happens people won’t be asking questions, and no one will be worried about decoupling or COT. Rather, everyone will know that the only defense against the unwinding of the global liquidity bubble is gold. 

Until then the worthless US dollar will continue to be treasured by foreign investors, and gold will likely remain below $500 an ounce; with each sharp rally sucking new speculators into the ‘second stage’ dream. Exactly when the dream will become reality remains a mystery.

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