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.
A common question here would be, “What do gold and soybeans have to do with each other?” The short answer is that they are both the most speculatively overbought commodities we trade. The deeper answer is that both of these products come from the ground and the producers of these commodities have used this rally to lock in bonus money as there is no way they collectively subscribe to the inflation thesis suggesting structurally higher commodity prices in a near zero percent interest rate environment. Our experience has shown that the huge imbalance in positions between the commercial producers selling forward production and the speculators’ buying of anticipation typically resolves itself in the fundamental direction of the commercial traders’ collective prediction. The gold and soybeans rallies are about to find themselves lout of gas.
It’s one thing to hypothesize that a market is in a speculative bubble; it’s another to let the data write the story. According to the current Commitment of Traders report, large speculators just set e new net long record of 301,920 contracts. This eclipses their previous record of approximately 266,000 contracts set just this past May. We moved out to a weekly chart in order to provide some context for the current situation.
Our trading is focused on the thesis; “No one knows the value of his markets like those who pull it from the ground.” While individual companies or operations may be prone to mismanagement or other bad decisions, the collective actions of the companies within a given sector are rarely wrong. The tug of war between those who pull it from the ground versus those who process it determines true price discovery within the commodity markets. These are the elephants bulldozing the macro moves while the speculators compete for the remnants with the dung beetles. Recently, large speculators have been stocking up on gold futures at a record pace and the gold miners are selling all the forward production they can lock in above $1,220 an ounce. This could lead to quite the washout as speculators are forced to take losses under $1,280.
This week, we’re going to take a step back and look at the big picture in the gold futures market through the eyes of the Commitments of Traders report. We’ll discuss how to use it to spot tops in the gold market, specifically but note that the fundamental thesis behind this piece holds just the same for every commodity market we trade. Finally, we’ll look at the current projections for the commercial traders’ most bearish net position since December of 2012 when gold was trading at $1,700 per ounce.
We’ve discussed the first quarter commodity rally in detail over the last two weeks. Our general opinion has been that these rallies are temporary as commodity producers use this opportunity to hedge forward production at decent prices for the first time in over a year. This week, we’ll discuss the metal markets – gold, silver, platinum and copper. We’ll detail how we used the Commitment of Traders report to pinpoint the market’s bias as well as how to factor external shocks into the current picture. Finally, we’ll provide some support levels as we look to take profits on the current decline.