Gold Decline Nearing Exhaustion

Much has been written recently regarding the record speculative short position in the gold futures market. Markets move in trends followed by periods of consolidation, sideways action and reversals. Most speculative trading is trend trading due to several factors outside the scope of this piece. Commercial traders on the other hand are swing traders. This is also referred to as value trading or, mean reversion trading. Their decisions are based on the perceived value they see between the commodities they need or produce and how current market prices impact the forward outlook of their businesses that use or, produce the commodity in question. The commercial traders in the gold market have just established their most bullish position since December of 2001.

The gold market’s decline has been a long slow grind. This has provided several trading opportunities on both sides of the market as noted by the Commitment of Traders trading signals on the chart below. We track both the commercial trader total position and commercial trader momentum. This allows us to track the relative size of their position and recognize important price levels by the degree of commercial trader activity at a given level.  Commercial traders have been buyers for five straight weeks, purchasing about 75,000 contracts between $1,080 and $1,140. It’s also important to note that the commercial traders may not be done buying. Their most bullish position since 2001 pales in comparison to the entire late 90’s when gold was near $300 per/oz. During this period, their nominal position remained above 0 and was frequently net long between 50,000 to 100,000 contracts.

Building congestion along with an increasingly bullish commercial trader position suggests a breakout above T1 at $1,100 could lead to a sharp short covering rally.
Building congestion along with an increasingly bullish commercial trader position suggests a breakout above T1 at $1,100 could lead to a sharp short covering rally.

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Technically, the gold market’s recent consolidation under $1,100 per ounce is clearly building some tension between the market’s major players. Over time, large imbalances in market positions between the commercial and speculative trader categories usually resolve themselves in the commercial traders’ favor. Frankly, it is the history of speculative traders to be the most wrong with their biggest positions at the most inopportune moments. Hence, the high failure rate of the retail, speculative trader. Friday’s unemployment report has yet to push gold to new lows below $1,073. As long as this low holds, we believe the best trading opportunity will be buying gold on strength above the T1 trend line coming in at $1,100 per ounce. If this order is filled before gold trades below $1,073, we’ll place a protective sell stop at the recent congestion lows around $1,080. Finally, we would expect a quick short covering rally back towards $1,150 where we would re-evaluate our position.

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