This week, we’ll revisit the macro relationship between the gold and the U.S. Dollar Index. Then, we’ll examine the divergent trading behavior in the gold market between the large speculators who’ve recently set a new record position, and the commercial gold hedgers who are clearly happy to sell all of the forward production they can above $1,300 per ounce. Finally, we’ll discuss the relative and quantitative models based on the Commitments of Traders data that leads us to believe that the large speculators may be giving themselves too much credit for their recent success.
First, we need to set the stage. Traders dismiss the relationship between the Dollar and the gold market too often as explicitly negative. While this holds true in a general sense, timing is everything and knowing where are in the correlation cycle can yield better trade placement. Both gold and the Dollar made significant chart points in 2001. The Dollar Index bottomed at 78.17 in May of 20011 while the gold market peaked in September at $1,968 per ounce. Accepting the negative correlation between these two markets suggests that the Dollar’s bottom should have been predictive of gold’s top. The age old question of course is, “How could we have known?”
The following chart isn’t quite as frenetic as it first appears. First, some explanation. The main chart is once again, our weekly gold futures going back to 2011’s high. The first subplot is our COT Ratio calculation. This calculates the imbalance among the particular trader group’s participants. The spikes in the green line highlight extreme large speculator position imbalances of their net position. The current value on the right side of the chart shows that large speculators are currently long 5.19 contracts for every contract they are short. This ratio reached an all-time high of 11.7 in 2009 as gold pushed through $1,100 per ounce and triggered a multi-year inverted head and shoulders rally. The key here is that the large speculators set this ratio record for total position size at just over 300k contracts.
The second subplot shows the total position of the three principal trader groups. The commercial trader total position is usually far larger than the speculative gold position. This leads to two important points. First, the commercial record position is more than 673k contracts as compared to the newly set speculative total position record of 463k contracts. With their current readings of 543k and 419k, respectively, it’s fair to say that the commercial traders have the greater excess capacity to take on new contracts these prices than do the large speculators. The second point is implied but, I’ll make it explicitly. Record positions do not exist in perpetuity. Where will new speculative buyers come from to advance the current rally?
There always seems to be a story that gets the gold bugs and inflation hawks back on the buy side. The truth is, since the 2011 highs, speculators have fared pretty poorly in the gold futures. You can see that each speculative buying spike, post – 2011 has been a failed venture and while we’re not necessarily gold bears, we do think the market remains overvalued at this time above $1,300 per ounce.
See our analysis in action at COT Signals.
We believe that these factors and others are lining up to support the US Dollar and correspondingly, provide resistance in the gold market. The negative correlation between gold and the Dollar is near mid-range, in line with recent inflection points. Large speculators have set multi-year highs in their net position, net position ratio and total positions in the gold futures. Meanwhile, the commercial gold traders, whose selling has provided new resistance, are still within their historical boundaries as they happily contract to make future deliveries at today’s prices. Conversely, these positions can be verified by the opposing positions within the US Dollar Index futures. Finally, the technical levels of both of these markets are lining up in opposing fashion as the Dollar is finding support along the broader upwards trend long-term Fibonacci retracement levels while the gold market is finding itself on exactly the opposite side of the same set of circumstances.
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