June 27, 2019
Open interest in Gold futures on the COMEX bottomed at 430k contracts on April 30. They have since risen to 526k on June 18. That’s an increase of 96k contracts.
At the same time, the Swaps (aka the “Banks”) have increased their net short position from 37k to 122k, or 85k contracts. This means that a full 88% of the increase in open interest has gone straight to the Banks’ net short position.
Open interest on Tuesday, June 25, closed at 578k, an increase of 52k in just one week. A huge move. Using 88% as a guide for the corresponding increase in the Banks’ net short position, we get an increase of 46k contracts to 168k contracts. While this is just an estimate (it could be higher or lower), this would mean Banks have the biggest net short position since September 2016. It would also be just 23k contracts shy of their record net short position in July 2016, when Gold peaked at 1377 and subsequently fell 253, or 18%, to 1124 in just the next five months.
At the same time, using a similar methodology, the Funds have increased their net long position to 232k contracts. This would be their biggest long position since the peak in September 2017 at 1362 and just 41k contracts below their record long position in July 2016.
While these are estimates and we won’t have the definitive data until tomorrow, they make sense in light of the increase in price from 1351 on June 18 to their peak of 1443 on June 25. Funds tend to chase the price higher by adding longs, something they have done the whole way up from the low of 1267 on May 2. Banks, of course, take the other and add shorts at the same time.
Could we be about to see a repeat of what happened post the summer peak of 2016, when Funds were record long and Banks were record short? Possibly. The Banks are all about making a quick and sizeable profit, and they would like nothing more to squeeze out all of the weak and late longs to this rally.
This weekend we have the G20 and trade negotiations between Trump and Xi. While we don’t know what the outcome is going to be, there is a high risk that the negotiations fail yet again and new tariffs are imposed on $300bln, or the majority of China’s exports to the United States. Should this occur, the Chinese could respond by allowing USD/CNY to rise above the critical 7 threshold relative to the dollar. Unless there is a commensurate rise in XAU/CNY, Gold in dollar terms would fall. Given the size of Funds’ longs and Banks’ shorts, this could be sizeable.
Alternatively, if we’re surprised by some kind of deal, however insubstantial, and the stock market rallies to new highs, expectations for rate cuts from the Fed may subside, causing Gold to fall (and given the relative positioning, fall hard).
Furthermore, next week is the week of the July 4 th holiday in the U.S., when many traders are out of the office on vacation, making it a more illiquid, low volume week. To the extent we get any kind of momentum on the sell side and longs are forced to cover, this could exacerbate the speed and size of any decline in price. Of course, the same could be said on the upside, but given the positioning of the Funds relative to the Banks, history tells us that the risk is greater that we see a significant fall rather than a further rally higher.
Courtesy of Marketwatch.com:
Looking at indicators other than positioning alone, this just reinforces the downside risk. Sentiment is clearly extremely bullish. One just has to spend an hour on Twitter to understand just how bullish everyone is. Money is flowing into Gold ETFs again. If that weren’t enough, Citibank, the second biggest owner of derivatives on the COMEX, second only to JP Morgan, is calling for $1600 Gold. Bloomberg, Reuters, CNBC, and the rest of the mainstream financial media are all cheerleading Gold recently. Sentiment is a contrarian signal. When everyone is bullish, it’s a good sign that the market is going to reverse, even if just a pullback in the short-term, or something much worse. The risk is that everyone is caught wrong-footed, only looking up to higher prices, and the market falls instead.
From a technical perspective, Gold is clearly extremely overbought according to several indicators and across multiple time frames:
- The daily RSI just peaked at 84, its highest level since February 2016, and is still at 81.
- The daily MACD Line is now higher than the peak in July 2016, at its highest since March 2016.
- The weekly RSI is at 77, its highest since the peak at 1923 in August 2011.
- The weekly MACD Line is at its highest level since September 2016, echoing the positioning data above.
In conclusion, when we consider that Gold is extreme overbought and bullish in conjunction with the extreme positioning data, ahead of the G20 this weekend and an illiquid holiday week, there is a high risk of a pending reversal in Gold after a $276, or near 20%, rally from the low of 1167 in August.
To be clear, having broken key resistance at the 2016 peak of 1377 and 1400 also, we now have a long-awaited higher high, so the trend has turned UP. But an upward trend is defined by higher highs and higher lows. The data suggests we are going to get a healthy pullback to a higher low before the next stage of this rally continues to higher highs.
Support for such a higher low is ~1375, the 38.2% retracement of the entire rally from 1167 to 1443, ~1335, the 61.8% retracement, or ~1270, just above the prior low of 1267.
Silver is likely to fall too, but I expect it to outperform Gold both on the upside and the downside given its superior technicals, sentiment, and positioning data: The Banks are still relatively neutral in Silver.
Gold miners are a beta play on Gold, and one should expect them to decline in tandem with Gold, but to a greater degree in percentage terms, if this scenario plays out.
At the end of the day, if we do get a pullback, and possibly a significant one, I would consider this a gift in anticipation of the rally to follow. Only a break of 1167 would cause me to reconsider the bullish potential for metals and miners going forward. With this in mind, BTFD until proven otherwise, imho.
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