Has the commodity rally that began just before the New Year ran its course? We posed the argument in early January that the technical breakout in interest rates would point towards the general economic activity of 2016. The interest rate breakout higher, towards lower rates would ultimately show itself in the form of deflation, which would in turn, weaken the commodity sector. I believe we are at a major inflection point for the year’s trading.
There is a major battle brewing between the bulls and the bears in the metal markets. Arguments on both sides are full of conviction and weight. Even more importantly, traders are putting their money behind their conviction. Finally, as the action has heated up, it’s drawn players from both of their respective camps into the fray. This week, we’ll look at the gold market and one of the problems with the Commitment of Traders report’s data.
Gold bugs always amaze me. Perhaps I’m sensitive to their discovery having grown up finding Goldbug on every page of Richard Scarry’s, Cars and Trucks and Things that Go. All I know they’ll come up with any reason to justify why, “This time it’s different.” I’ve plotted the collective actions of the large speculators on the included chart as well as the actions of the commercial traders. Take a look and tell me which group you’d like to follow.
The precious metals markets have picked up steam fueled by negative interest rates and poor stock market performance. We’ve discussed the dislocations governmental policies can create within the markets extensively since the economic collapse and the new era of Economic Engineering at length in the past. Briefly, in a negative rate environment, investors feel more secure owning something that may be worth more in the future, like gold, than owning something with a guaranteed decay, Japanese bonds. This is not the place to argue storage and insurance versus the cost of the negative rate or, currency valuation versus the appreciation of goods owned. The economic theory is sound over the long run. However, we’re here to make money in the short-term and the long-term. Therefore, we see the recent rally in gold as being fueled by those late to the party. Frankly, anyone who bought gold above $1,100 per ounce may be in for some pain if they don’t lock in profits.
Obviously, China has dominated the news this week. There has been rampant speculation regarding the, “first roach” philosophy which suggests there’s much more to come in the way of Chinese Yuan/Renmimbi devaluation. I’m not very good at projecting political developments along an investment front. However, I do know enough to hunt down the information no one is talking about amid the hyperbole. What follows are a few actionable ideas based on the historical context of recent US economic developments and the transference of these principles to the Chinese economy’s cyclicality.
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 silver market has been remarkably quiet in the wake of China’s destruction of the gold market. This week, we’ll touch on a couple aspects, specific to silver that show while commercial traders have been buying this decline, it may be prudent to wait a bit longer before stepping in. Normally, I take a bottom up approach to putting these pieces together beginning with macro issues and finishing with trade details. This week, we’ll set the stage and then move from myopically focusing on the current setup before discussing the potential dangers of this viewpoint.
Tough week in the markets as we generally got continuation where we were looking for rebounds. This led to a a pair of losers in gold and the Canadian Dollar against a winning trade in the stock indices due to their rebound.