Research Excerpts

Gold Prices Test Their First Upside Obstacle: Watch The Smart Money

Posted on: Tuesday, July 23rd, 2013

In our June 21st report, entitled Gold: Buy The Dip, Or More Weakness Ahead?, we said that gold prices were resuming their Q4 2012 bearish trend and targeted a decline to $1200 per ounce.

From the Wall Street Journal on that date:

“Markets typically move from trend, to indecision, to trend,” said John Kosar, director of research at Asbury Research. He said the sell off into mid April was the “trend,” the stabilization in prices between then and through yesterday was the “indecision.” “Today was a breakdown from congestion we’ve had since April,” Kosar said. “The market has collectively decided that the larger decline is resuming.”

About a week later, COMEX gold met our $1200 downside target.  This from our July 1st Keys To This Week report:

Intermarket Analysis: World Gold Index (XGLD). XGLD met our 1200 initial downside on July 27th, first mentioned in our June 17th Keys To This Week, to capture an 8% decline in just about 6 weeks. Considering that asset prices and indexes typically reverse direction, at least temporarily, once initial price targets are met due to profit taking/short covering, and also the tight and stable inverse correlation between XGLD and the US Dollar Index over the past 20 years, we view last week’s decline to (and Friday’s rebound higher from) XGLD 1200 as potentially being near term bearish for the US currency.

XGLD and COMEX gold have indeed rebounded since then, by 9% / $115 per ounce into Monday’s (July 22nd) highs.  Meanwhile, the US Dollar Index peaked 4 days later, on July 5th, and has since declined as expected, by 3% thus far.

Gold prices dominated much of the conversation in the financial media yesterday as COMEX gold negotiated its 50-day moving average, a level it has remained below since October 2012The big question was (and is): sell gold here, or is this just the start of a bigger advance?  The smart money is better on the latter.

The chart below plots the weekly net position of Commercial Hedgers in the COMEX gold contract since 2000 in the upper panel, with a corresponding weekly price chart of COMEX gold in the lower panel.  Commercials are always “net short” gold. They have the product, they want to hedge the downside to lock in a more steady profit. That is what corporations like…steady profits, rather than big wins and big losses, so they pay for this “profit insurance”, i.e. a hedge.

COMEX Gold & Commercial Hedgers' Net Position

COMEX Gold & Commercial Hedgers’ Net Position

The red highlights on the chart show that, at net short just 19,041 contracts as of July 9th, these Commercials, a.k.a. the “smart money”, are collectively the least bearish (read most bullish) on gold prices that they have been since January 2002.  Note that June 2002 became a major bottom in gold prices that preceded the price of the yellow metal more than quadrupling by late 2011.

So, while the gold market negotiates its first formidable overhead resistance level at the 50-day moving average, currently at $1344 per ounce, it looks like the smart money is looking much farther across the horizon, and making a big bet on what they see.