Tuesday, May 10, 2016

Gold; Too Heavy for Funds to Hold

Gold futures are roughly unchanged today on moderate volume following a move lower yesterday on better than average volume and declining open interest.  Yesterday’s decline from open to close is the largest since March 23rd.  Not since mid-February has the front gold contract fell by more from the prior session close. 

A strong technical development centered on the end of last year (bullish ‘rounded bottom’) appears to have quieted the multi-year, 45+% decline.  Of course this development is encouraging, but it happens to have occurred just as the Fed lifted policy rates for the first time in almost a decade.  Generally speaking, higher interest rates or more specifically a restrictive monetary policy is not constructive for gold prices.

It is more widely believed that the tempered view of policymakers rate-firming plans are a bullish driver of gold prices.  Though still lagging the market pricing of likely policy rate hikes, the rhetoric from Fed officials along with economic data have supported a more dovish, thus gold-friendly view since the December hike.  As expectations for rate hikes get pushed further out the timeline, the bullish impact on gold prices seems to have diminished.  Currently there is less than a 50% chance priced for the Fed to raise policy rates even once by the end of this year.  At the December FOMC meeting, as many as four hikes were expected by year’s end. The gold future closed at 1050 on the day after the December 2015 FOMC meeting.   It advanced by 23% from then to the mid-March high of 1287, but has languished since.     

June Comex Gold futures (GCM6) reached above 1300 a week ago Monday (May 2) for the first time since January 2015.  Like back in ’15 the contract only managed to poke a high above that level for a couple of sessions before retreating.  This time around, there were no ‘amazing’ technical formations to usher in a top.  There was a modest bearish ‘shooting star’ and a bearish ‘spinning top’; however these developments are not terribly striking.  Of course, not all market tops and bottoms are painted with dramatic technical formations. 

Instead, it appears to be positioning that has generated an overbought condition that could undo the bullish trend.  We should note that CFTC described ‘non-commercial’ accounts hold the largest EVER net long position in gold in the last report of May 3.  It didn’t take long for funds to get involved in gold.  Their position in gold at the start of the year (23K) is a mere speck of the 300K they hold as of last Tuesday.  Aside from being the largest net-long position on record, that position was accumulated in record time. 


As one of the few positioning strategies that hedge funds have found successful this year, it will be very interesting to see how this position is managed.  There could be a very strong interest in taking profits immediately as momentum in price action stalls.  Some participants may instead insist on holding onto this winner until the pain of doing so increases. 

Looking to the volume of trade for further insight, we should note that since the start of the year, volume has been roughly 50% higher than the longer run average of the prior year(s). Strong volume combined with rising open interest and price gains is ‘the’ definition of a strong bullish trend.  Given the amount of volume and the extent of bullish positioning, we are right to wonders if the stagnant price action since the mid-March high of 1287 is enough to encourage hedge funds to remove long positions.  

Higher aggregate open interest has supported the gains in ‘large spec’ net-long positions.  Open interest increased from a January low of 372K to 529K on Friday.  Like volume and ‘non-commercial’ (‘large spec”) positioning, open interest has moved dramatically higher from the start of the year.