In terms of how they position themselves in gold futures the commercial traders are almost always on the wrong side of the market. This is particularly the case when the gold price is trending strongly in one direction or the other because the commercials usually become progressively more 'long' as the price falls and progressively more 'short' as the price rises. For example, the 'commercials' were net-long COMEX gold futures during almost the entire 1997-2000 period, a period during which the gold price was in a relentless downtrend . They then became net-short in the early stages of gold's current bull market and have remained net-short the whole way up. In fact, as the gold price has moved higher over the past 2 years the commercials have progressively increased their net-short position in COMEX gold futures. This propensity to lean against the prevailing trend in the futures market means, of course, that the commercials will invariably be positioned correctly when an important trend change occurs.
It is said that the commercial traders are the ones with the best information on a commodity's supply/demand situation, that is, that they are in the best position to know when a commodity's short-term price trend has become extended based on fundamental factors. In this respect, though, the gold market might be an exception because changes in investment demand have a vastly greater influence on the gold price than do changes in fabrication demand or new mine supply. This means that in the gold market the non-commercial traders (the speculators) aren't necessarily at a disadvantage to the commercial traders (a speculator is just as capable as a commercial trader of understanding the inter-market relationships that drive the gold price). It also means that a rising price, rather than reducing demand for the physical commodity as is the case with commodities purchased for consumption (all commodities other than gold and, to a lesser extent, silver and platinum), will tend to spur an increase in demand.
One (probably the main) reason that the commercial traders in COMEX gold futures usually appear to be wrong while the gold price is trending and invariably appear to be right at the turning points is that they often use the futures market to counter-balance (hedge) positions in the cash market (a commercial trader is a large operator in the futures market who also deals in the commodity on a cash basis). In other words, commercial traders with net-short positions in the gold futures market might not be betting that the price of gold will fall because these traders might not actually be net-short when their total exposure to gold is taken into account.
The commercial net-short position in COMEX gold futures is presently near an all-time high (it is only slightly below the peak reached during the 1993 gold rally). However, further to the above it doesn't make sense to assume that a continuation of the current short-term uptrend in the gold price will eventually pressure the commercials into covering their 'shorts' (buying gold futures) into a rising market. It is far more likely that the commercials will continue to increase their net-short position in the futures market until the medium-term trend in the gold price finally reverses (from up to down) and will then cover the bulk of their short position during the ensuing gold price correction.
The large commercial net-short position in gold futures should not be ignored. It is a warning signal, but as stated in our 30th December commentary it is a warning signal that should only be acted on when it is confirmed by other indicators or by price action. In terms of its usefulness as a sentiment indicator the Commitments of Traders (COT) data is not as important as the price-performance of gold stocks relative to the bullion. Also, in our analysis a bearish COT situation shouldn't be permitted to override bullish price action because there is no telling how net-short the commercials will become before the inevitable correction occurs.
The very bearish COT data for gold and the very bullish COT data for the US$ strongly suggest that we will see intermediate-term extremes for gold and the US$ (a peak for gold, a bottom for the US$) during the first quarter of this year. However, the COT data don't give us any clue as to what prices gold and the dollar will be trading at when these intermediate-term extremes are reached.
Interest Rates and Gold Stocks
Last week's close in the T-Bond price was below the uptrend-line dating back to May-2002. The bond chart has therefore taken a bearish turn, although bonds are yet to make a lower low on an intermediate-term basis. In any case, doing any standalone technical analysis of bond futures has become almost futile since the inverse correlation between stocks and bonds is dominating the bond market. For example, last Friday's employment data were very bullish for bonds and bond futures spiked sharply higher (long-term interest rates moved sharply lower) after the news was released, but when the stock market rebounded from its opening losses the bond market quickly gave back its gains. The big test for bonds will come when the stock market commences its next significant pullback.
The trend for the US$ is the single most important influence on the gold price and, therefore, on the prices of gold stocks. However, as discussed many times in the past, trends in interest rates also have a significant impact on gold stocks. In particular, the price of the average gold stock has a tendency to move in the same direction as the yield spread (the yield on the 30-year T-Bond minus the yield on the 13-week T-Bill). Therefore if long-term interest rates follow through on their recent upward reversal and the Fed continues to hold short-term rates near current low levels, the upward pressure on gold stock prices will increase. The below chart illustrates the positive correlation between gold stocks (as represented by the TSI Gold Stock Index) and the yield spread.
The above chart is one reason why gold stocks look good at the moment irrespective of warning signals such as gold's bearish traders' commitments. If the stock market defies gravity and continues to work its way higher then the T-Bond yield will also move higher, thus causing the yield spread to rise because the Fed is not going to hike short-term rates any time soon (the Fed seems to be under the absurd impression that it needs to fight deflation). However, if the stock market falls then the T-Bond yield would probably fall and so would the yield spread, but in this case the US$ would likely come under increased selling pressure.
January 15, 2003
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