HOUSTON (ResourceInvestor.com) -- The first full trading week of spring has sprung with gold bulls springing an old fashioned bear trap seemingly out of nowhere. Or is it? While the surge higher on both gold and mining shares was not supported with new gold purchases by the largest gold exchange traded fund, as speculated previously in this report apparently it was the lack of selling while gold declined that was the important signal.
This Week's Observations: Friday, March 31, 2006
Tuesday's U.S. FOMC action put the brakes on gold's early week rally attempt as the Fed not only added the expected quarter point to interest rates, (4.75%) the expected (by many) language in the Fed statement signaling an end to rate hikes was conspicuously absent. Isn't it amazing that the NYBOT large commercials (LCs) apparently sniffed that out ahead of time? Last week's abrupt reversal by the LCs in their collective net short positions was a klaxon sounding for those who listened. (As noted in .) But what now? After covering big, the LCs are layering back in on the short side. Choppy trading persists on the fiat currency markets. See "U.S. Dollar Index" below.
That gold braking action was short-lived, however. By Thursday the upward surge on gold had tripped buy stops. Funds long on gold pounced and put virtually all gold short positions underwater as the spot price registered new bull-to-date highs. The short covering rally extended into the huge short positions in mining shares sending the mining share indexes sharply higher.
How's that again? Now we have Barclays downplaying comments about China converting more foreign currency reserves into gold? Is that like the tobacco companies encouraging people to quit smoking? (Rhetorical quip, nothing more.)
Silver tarnish? On Wednesday Societe General metals analyst Stephen Briggs opined that the new silver ETF's proposed shares, "backed by 139 million ounces - equivalent to nine weeks' industrial demand - are unlikely to be taken up fully." A short-term down draft might result if Briggs is correct and there are not enough takers for 4,300 tonnes of silver right off the bat.
A rare political comment this week. The upcoming election in mineral-rich Peru (April 9) is on the political radar screen. The supposed front-runner is making public statements which suggest that if he is elected he'll sock it to the mining industry, renegotiate (renege on) existing mining contracts, slap higher royalties on them (steal their profits), in order to "share the country's resources with the poor." Oh great, another "Robing-hood." (Misspelling intentional).
While that probably plays well to his potential constituents, translated what that simply says is that if elected Mr. Humala isn't the least bit worried about honoring long-term agreements made in the past by the Peruvian government. Agreements put in place in order to invite in foreign investment by companies with the technical expertise and financial muscle to make resource deposits productive, create good-paying jobs ... and so on. Agreements that those companies relied upon before investing huge sums of money in that country.
Why bother honoring agreements when the trend by governments is clearly in the opposite direction? There seems to be a rash of that lately regardless of the political regime in place. Apparently politicians globally are rediscovering the art of buying votes by promising to give voters other people's money - the fatal flaw of democracy.
Well, actually the fatal flaw is the idea that a simple majority should be able to decide anything. Unfortunately that allows too many uninformed people equal weight with the fewer number that are informed. Eventually democracies end up going to the "highest bidder" - the politician who promises more than all the others, guaranteeing that the country cannot possibly deliver on those promises and sending the people paying the bills and their businesses in search of another location.
It just goes to reinforce the notion that there is no such thing as a secure long-term government contract in any political system. A number of publicly traded resource companies with interests in Peru are undoubtedly hoping that Mr. Humala trips up in what looks like an upcoming runoff. We'll see. Meanwhile the ever-changing political minefield thrown in front of mining companies sometimes adds a premium to metal which has already been extracted and refined.
The ECB sold 57 tonnes of gold? That's it for them until September.
With that, let's look at some of the indicators.
COT Changes. As of the Tuesday 3/28 cutoff date for the commitments of traders report (COT), the Large Commercials (LCs) increased their combined net short positions (LCNS) by 13,910 contracts from 135,802 to 149,712 contracts net short while gold metal gained $12.13 or 2.2% Tuesday to Tuesday ($563.70). That's a one week pace of 1,147 net short contracts added per dollar increase in the metal, well under the average pace which is consistent with continued strength. However, since Tuesday spot gold jumped another $19.25 to close Friday at $582.95. That is after small scale Friday profit taking off Thursday's bull-to-date high close of $589.20.
Point being, Tuesday's data was consistent with continued strength, but have we already seen most or all of the move? If gold manages to hold onto this level or advance further by this coming Tuesday COT cutoff, we ought to have an excellent chance to see if the COT action is re-connecting with the gold price as speculated last week. If so, in connection with the new higher high for gold metal there ought to be a large increase in the LCNS in the next COT report which will be out next Friday.
As of the Tuesday COT cutoff, total COMEX gold open interest jumped by 14,424 lots from 319,618 to 334,042 open contracts. Possibly important, while traders have all but rolled out of the April contract, there was a net increase of over 22,000 contracts in the open interest of the three nearest COMEX contracts from Monday to Thursday.
This past week saw an increase of 751 lots in long-term forwards on the COMEX. While by no means a frighteningly large increase by itself, as of Tuesday the total open interest for Feb '07 contracts and beyond came in at 38,610 open contracts which is over 11% of the total open interest.
The chart below is as of Tuesday's data. To view the commitments of traders report graphically try this link.
Gold Charts. This week's short-covering rally blasted up through the upper line of a slightly dipping consolidation channel which had been forming on the daily chart. As expected, a number of buy stops had apparently found their way to the vicinity of that upper line. Rally fuel. Virtually all short positions in gold are underwater making for a tantalizing target of opportunity for long funds to shoot for (and for the short funds to protect against next week). Please also see the longer-term weekly chart.
Gold ETF. Since the last report, physical gold holdings at streetTRACKS Gold Shares, the largest gold exchange traded fund [NYSE:GLD], remained steady at 347.82 tonnes of gold bars now held by the trust.
ETF Signals? The included: "The jury is still out on this pullback opportunity and so far there has not been aggressive dip buying of physical gold by the ETFs. Then again, there hasn't really been all that much of a dip yet either. We might end up looking back in a few weeks and note that instead of no dip buying the lack of gold selling by the ETFs was the important signal. Interesting, isn't it?"
Following that report two weeks ago we saw the first sale of gold from the streetTRACKS Gold Trust ETF since last summer, but just a small one.
Commenting on that small redemption by GLD, said: "In any event the amount of gold sold was small in relative terms and it is this report's expectation that it will take consistent ETF sales in larger amounts to make a convincing short-term bearish case."
Sure enough, we have a new entry in the trader's notebook. Right under, "Strong ETF gold buying into gold pullback - strongly bullish," we can now write in pencil, "Lack of significant ETF gold selling on significant gold pullback - bullish."
Now we have something else to watch. This new breakout for gold has not been supported by any gold purchases by the largest gold ETF so far. Intuitively that should be a caution signal for gold bulls. At least short-term. Financial data for GLD is updated daily at streetTRACKS Gold Trust.
Euro Gold. Gold once again gained strongly in purchasing power against both the two largest paper fiat currencies, the euro and the U.S. dollar, for the week as seen in the dollar, euro and gold performance comparison chart. Euro gold leapt EUR14.38 higher closing at EUR479.68 (3/31) on the cash market as the currency markets continued their very choppy trade. Are the financial pundits in the electronic media and on TV both here and in Europe trying to out-do each other in talking down both currencies? As the comparison chart above shows, they are succeeding! (But not in the way they want.)
U.S. Dollar. The LCs are jumping right back in on the short side. As of the Tuesday, 3/28 COT cutoff, and since the last report, the combined net short positions of the large commercial traders on the NYBOT for the dollar index increased by 4,529 contracts from 5,296 to 9,825 contracts net short, while the index added 57 basis points from 89.69 to 90.26 Tuesday to Tuesday.
Last week the LCs confidence in U.S. dollar downside fell. This week it's up again. By Friday the index slipped back 52 ticks to close at 89.74. Repeating a comment from last week, "the continued yo-yo like volatility of the dollar would not be surprising, as would the continued indecision on the part of the currency markets over the short term. That just might cause some small fraction of the mammoth sums traded in fiat paper currencies to seek safe haven in real money." And so it goes. Please see the US dollar index graph.
Gold Indexes. As of Thursday/Friday while gold cut new quarter-century nominal highs most of the mining share indexes had not made new highs, but were in striking distance of doing so. The fifteen companies in the AMEX Gold Bugs index certainly did answer the move in gold for the week, powered in part by the very large short positions on mining companies.
As mentioned last week, "with short positions on the miners at such high levels, further advances, if any, could be surprisingly sharp." Please see additional commentary on the 6-month version of the HUI index chart. Bulls will be trying for a break above the 349.48 February turning high. Bears have a chance to score a bearish double top on the index. Using the battlefield metaphor, the bears better have their 16-inch guns blazing come Monday/Tuesday or risk being overrun ... by themselves.
HUI:Gold Ratio: The HUI:Gold Ratio, which measures the relative performance of the HUI index and spot gold, tracked with gold in its breakout move higher, but didn't get ahead of the metal. Please see additional commentary on the graph above and on the one-year version. With gold cranking out new 25-year highs the lower ratio is troubling for the bullish case and suggests a mature move. That could change dramatically on vicious short-covering and renewed fund buying should the indexes thrust above their respective previous turning highs.
The spot gold/HUI spread indicator (spot gold minus the HUI index) just about broke even for the week edging up 0.55 points from 246.08 to 246.63 as of Friday's close, confirming that the miners just tracked with metal for the week.
Entries in the Weekly Books
On the bullish side of the gold market ledger, we have the continuous caveat that global political and religious tensions could flare most any time - something bears need to keep firmly in mind. Continued troubling volatility in large currency markets - some managers may seek safety in gold. Modest rise in the LCNS relative to large increase for the metal. Technical breakout for gold, above previous turning high, momentum favors bulls but is nearing overbought. Most gold and majority of mining share short positions underwater. Any further significant rally attempts, if any, could be explosive as enormous short positions probably still remain in place for mining shares. LCs once again positioning for dollar weakness.
On the bearish side, gold rally failed to ignite bullish buying of gold metal regionally and by the ETFs. Mining shares merely answered the move up in gold, but did not lead. Aggressive insider selling of mining shares January and February, which had been tapering off, saw a resurgence over the past three weeks. Very large February/March short positions in the miners suggest the industry types required to file insider trading reports and the largest short-selling hedge fund players expected lower prices as of the most recent short position reports. Long-term forward COMEX contract open interest creeping up, now over 11% of total open interest.
Commentary and Outlook: (Neutral - Continued short covering rally possible)
So far this particular rally has not been supported by gold buying by the ETFs or by aggressive physical gold buying at the regional level. At the local level some bullion dealers report they are being overrun with silver in forms other than the 1,000-ounce "good delivery" bars needed for COMEX contracts and future ETF holdings. (Such as pre-1965 90% silver U.S. coinage.)
April 15th looms once again and income taxes can't be paid with gold or with mining shares.
We may have a set up for a 2003-style double top on the miners, offering a very nice second chance for those who may have wished they had sold during the last surge up but instead held on, or, with a big enough trigger, we may just be about to see the mother of all short-covering breakouts. If the latter, it could be one for the record books given the amount of high octane rally fuel in place. We should know which very soon. Until then an "at resistance" trailing stop strategy seems appropriate for cautious short-term long-side traders. Extreme caution advised for those with large enough round spheres to short this powerful bull market.
High volatility and wide ranging days remain very possible short-term. Careful stop management is a must.
With that said, as always, MIND YOUR STOPS.
Weekly COT comments beginning 2/14/2006: Snapshots of the weekly change in the reported positions of the Large Commercials (LCs) and how they relate to the closing gold price of that weekly period. Remember, the COT data is usually released on Friday after the bell, but it reflects the previous Tuesday's close.
2/14/06 Gold $547.92 (-$0.36 or flat) LCNS 149,205 (-5,233 or -3%) Continued decrease to LCNS on flat gold, normally a signal favoring firmer gold. Open interest dips 3,584 to 338,143 contracts.
2/21/06 Gold $553.55 (+$5.63 or +1%) LCNS 149,953 (+748 or +1%) Insignificant increase to LCNS on $5.63 increase for gold. Just 133 contracts per dollar advance. Total open interest declines 4,733 contracts from 338,243 to 333,410.
2/28/2006 Gold $562.72 (+$9.17 or +1.7%) LCNS 156,861 (+6,908 or +5%) Modest increase in LCNS relative to increase for gold, however this represents the largest LCNS increase for 10 reporting weeks. Caution indicated. Total open interest adds 6,449 to 339,859.
3/7/2006 Gold $552.92 (-$9.80 or -1.7%) LCNS 149,751 (-7,110 or -5%) Moderate decrease for the LCNS relative to the decrease for the metal, well under the average pace, suggesting that the LCs expected lower gold prices as of Tuesday. Normally consistent with continued weakness, however this week's decline completely erased the previous week's LCNS increase and since Tuesday gold has given up another $10.97. Caution strongly indicated for short-term gold bears. Open interest dips slightly by 1,534 lots to 338,325.
3/14/2006 Gold $551.81 (-$1.11 or -0.2%) LCNS 130,336 (-19,415 or -13%) Largest decrease in LCNS since November 2005 on flat gold Tuesday to Tuesday, but reflects dip in gold to $541. Suggests more aggressive pace of LCNS reduction once gold moved below $550. Open interest dives 15,965 lots to 322,360. Lack of new long money flow noted.
3/21/2006 Gold 551.57 (-$0.24 or Flat) LCNS 135,802 (+5,466 or +4%) Notable increase in LCNS on flat gold Tuesday to Tuesday. Suggests LCs expect lower gold prices short term, but follows largest one-week decline in LCNS in months. Open interest edges lower 2,742 lots to 319,618. Lowest total open interest since 11/8/05 (LCNS then 317,076) when gold marked a COT turning low at $461.50.
3/28/2006 Gold $563.70 (+$12.13 or +2.2%) LCNS 149,712 (+13,910 or +10%) Modest increase to LCNS on relatively large increase for gold Tuesday to Tuesday. That's just 1,147 contracts added net short per dollar increase. Consistent with continued strength for gold, however extreme caution is advised as subsequent to Tuesday a strong short-covering rally added another $19.25 or nearly 3.5% to spot gold ($582.95). Open interest jumps 14,424 to 334,042. From Monday to Thursday a net increase of 22,460 open contracts is evident in the three nearest contracts. Good idea to wait until the next COT report to see how the largest paper gold contract players have repositioned following the rally.
The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions.