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Expect Lower Prices Of Gold In The Nearest Future But Then A Bullish Scenario Is Possible – Seeking Alpha

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A few days ago I alerted my subscribers that gold prices were at their pivotal point. In this case the word “pivotal” means that gold prices may go sharply down or sharply up. Look at the chart below:

Source: Simple Digressions

Note that whenever gold prices got close to their long-term downward trend line, they used to bounce down sharply (blue arrows). Now we are once again at such a pivotal point – I am pretty sure that the investors applying the trend-following approach cut their exposure to the precious metals sector or even started betting on lower prices of gold.

This thesis is additionally confirmed by these facts:

  • GDX, the most popular gold mining ETF, reported a huge drop in the amount of shares outstanding from 370.3 million shares at the end of June 2017 to 330.3 million at the end of July 2017 (a decrease of 40 million shares of 10.8%)
  • GLD, the world’s biggest investment vehicle hoarding physical gold, reported a withdrawal of 1.9 million ounces of gold from its vaults In July 2017
  • SLV, the world’s largest ETF investing in silver, reported an outflow of 1.2 million ounces of silver from its vaults (the selling pressure was particularly strong in the second half of July with 8.5 million ounces of silver being withdrawn)

However, I am able to deliver a few facts supporting a bullish or neutral thesis on gold:

The Chinese demand for precious metals is still strong

Since the beginning of this year the Chinese have withdrawn 1,129 tons of gold from the Shanghai Gold Exchange (3.5% more than in the comparable period of 2016). It means that the Chinese demand for gold is still strong

In July 2017 as many as 151.7 tons of silver were withdrawn from the Shanghai Gold Exchange:

Source: Simple Digressions and the SGE

As the chart shows, it was the highest amount of silver bullion withdrawn in 2017 up-to-now.

By the way – it looks like an old pattern of the Chinese accumulating precious metals and Western investors selling them is still valid.

However, investors should keep in their minds that the Chinese play in a totally different league – basically, they invest in precious metals all the time, no matter at what prices gold or silver are trading. In other words, the data delivered by the SGE has no impact on gold / silver prices in the short-term.

Western traders are neutral about gold prices

According to the Commitments of Traders report, last week the big speculators trading in gold futures increased their net long positions in gold futures by 38.8 thousand contracts. It was quite a large increase but I would not say that these traders were particularly optimistic about gold prices because various indicators that I follow are sending signals that the gold paper market is in its neutral state. For example, look at the chart below:

Source: Simple Digressions and the COT data

The chart shows the net position held by Money Managers (definition below). The current reading is 26.4% (measured as the net position held by Money Managers divided by the total open interest in gold futures), which is neither a particularly low figure nor a high one.

Note: according to the COT report:

A “money manager,” for the purpose of this report, is a registered commodity trading advisor (CTA); a registered commodity pool operator (CPO); or an unregistered fund identified by CFTC. These traders are engaged in managing and conducting organized futures trading on behalf of clients.

Further, interestingly, it looks like the last surge in gold prices was made by the short sellers cutting their short positions (short covering). The last three COT reports deliver the following data:

  • Between July 18 and August 1 the short position held Money Managers went down by 58.5 thousand contracts
  • In the same period the long position held by these traders went up by 31.1 thousand contracts

As far as I understand financial markets, the short covering happens at an initial stage of a bull cycle. This stage very often ends with a correction, which brings gold prices back or close to the last bottom.

US dollar – is it the end of a bear market?

The last two COT reports show that big speculators trading in US dollar index futures are extremely pessimistic about the greenback:

Source: Simple Digressions and the COT data

The green circle on the chart above indicates that now big speculators are holding a net short position in US dollar index futures. Note that whenever a similar pattern was visible in the past (red circles) the greenback was ahead of a bull stage / correction to the upside. On Friday we witnessed a strong advance made by the US dollar accompanied by a drop in gold / silver prices so, who knows, we may be ahead of another bull stage in the US dollar.

How to play the gold market now?

Due to the fact that the last, strong move in gold prices was made by short sellers covering their short positions in gold futures, I think that we should see lower prices of gold in the short-term. This thesis is supported by the fact that gold prices are currently very close to their long-term, downward trend line. What is more, if the US dollar is ahead of another bull cycle, gold prices may be negatively impacted (a stronger greenback = lower gold prices).

However, in the medium-term gold prices should be supported by the strong support delivered by the Goldollar index:

Source: Simple Digressions

To remind my readers:

“The GolDollar Index was invented by Tom McClellan (www.mcoscillator.com), and is calculated by multiplying the price of gold by the U.S. Dollar Index. …Its purpose is to cancel the effects of currency fluctuations on the price of gold. By comparing it with the spot gold index we can determine if there is inherent strength/weakness in the price of gold”

Note that there is a strong support line at $1,150 (the upper panel of the chart) initiated in April 2016. Since that time this support line drawn by the GolDollar index could be used as a good tool to set the bottoms in gold prices (blue arrows on the lower panel of the chart). If this support works again, after a short correction in gold prices we should see gold going higher in the medium-term. What is more, if gold prices are able to cross above their long-term, downward trend line we may encounter another strong bull market stage in precious metals.

Last but not least – paradoxically, gold prices may be marching up in tandem with the US dollar…

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Disclosure: I am/we are long GDX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.