In last week’s Daily Reckoning I mentioned the extreme speculative positioning in the gold futures market and how it would probably get worse. Data out on Friday confirmed this.
According to the commitment of traders report, the ‘managed money’ category (which represents mostly hedge funds) is now short a record 121,000 gold futures contracts. Being short means you’re betting on further falls, and will make money on price declines.
As I said last week, there is no reason why this number can’t continue to grow and become even more extreme. When the herd moves, it moves in size.
It wasn’t only the total short position hitting a record high last week. The ‘net’ position of the market also went into record territory, with hedge funds now holding a ‘net short’ position for the first time since records began in 2006.
That is, when you net out all long and short contracts (that is, the bulls minus the bears) the bears now have the upper hand.
Even Bloomberg picked up on the news:
‘Hedge funds are holding the first ever bet on a decline in gold prices since the U.S. government started collecting the data in 2006.
‘The funds and other speculators shifted to a net-short position of 11,345 contracts in New York futures and options in the week ended July 21, according to figures from the U.S. Commodity Futures Trading Commission.
‘Gold futures on Friday fell to the lowest since 2010 on the Comex, and the short wagers show investors expect the rout to deepen. Bullion has fallen almost every day in July, leaving the metal poised for the biggest monthly decline since June 2013.’
You’re seeing an increase in bearish articles on gold. You’re seeing bearish bets on the metal increase to record levels. That tells you this market is getting close to a bottom.
It doesn’t matter what market you’re talking about, whether it’s coffee beans or soya beans or stocks in Apple. Whenever anything seems so obvious that it’s a sure bet, a turning point is close.
I don’t know if this is the bottom for gold or whether it will first breach the US$1,000 mark, as nearly everyone seems to expect. You could see another decent rally from here before the final, gut wrenching sell-off. But’s it’s getting close.
Gold benefited from some ‘short-covering’ in US trade on Friday on the back of renewed uncertainly about Greece. Short covering occurs when traders buy back the gold they had previously sold in order to ‘cover’ their position. This saw gold rally from just under US$1,080 to around US$1,100 an ounce.
Still, gold (in US dollars) is in a nasty downtrend. The path of least resistance is down. My guess is that you’ll want to see something like a US$50 an ounce short-covering rally to gain confidence that the market might be turning.
The ongoing Greek saga is just one candidate to provide the impetus for an upward move in gold. In an interview published by the London Telegraph overnight, former Greek Finance Minister Yanis Yaroufakis revealed that Germany is still intent on pushing Greece out of the euro.
‘Mr Varoufakis told the Telegraph that the Mr Schauble has made up his mind that Greece must be ejected from the euro, and is merely biding his time, knowing that the latest bail-out plan is doomed to failure.
‘“Everybody knows the International Monetary Fund does not want to take part in a new programme but Schauble is insisting that it does as a condition for new loans. I have a strong suspicion that there will be no deal on August 20,” he said.
‘He said the EU authorities may have to dip further into the European Commission’s stabilisation fund (EFSM), drawing Britain deeper into the controversy since it is a contributor. By the end of the year it will be clear that tax revenues are falling badly short of targets – he said – and the Greek public ratio will be shooting up towards 210pc of GDP.
‘“Schauble will then say it is yet another failure. He is just stringing us along. He has not given up his plan to push Greece out of the euro,” he said.’
You can see why the European ‘elite’ doesn’t like Varoufakis. And you can see why Varoufakis doesn’t like the European elite too! Whether his claim is true or not, I don’t know. But it is certainly plausible enough to make the market doubt the recent ‘Greek resolution’ rally.
And here’s another interesting point to note. For the first time in a long time — since the bull market got underway in 2011 — the Dow Jones Industrial Index looks like heading into a downtrend.
Have a look at the chart below. It shows the Dow Jones index from late 2011 when the bull market took off in earnest.
The red and blue lines are the moving averages. When the blue line (50-day MA) is above the red line (100-day MA) you can generally say the market is in an upward trend.
During 2012 it twice looked like the trend would turn down. But largely thanks to central bank stimulus, the market rallied and the upward trend became very well established.
Throughout 2015 though, the Dow Jones index has struggled to maintain its upward momentum. Now, the 50-day MA is about to cross below the 100-day MA, indicating a potential shift in trend.
That doesn’t mean a nasty bear market is upon us. But it does mean the market’s relentless rise may be over for the time being. The next important area to keep an eye on is the 17,000 point level. If the index breaks below here it will show a ‘topping out’ formation and the bears will begin to growl.
From there, it will be a question of how long the Fed maintains its tightening rhetoric. Since 2008 the Fed has shown a willingness to support the market in the event of any sell-offs.
It will probably do so again if the Dow begins to break down to lower levels. But can the Fed continue to stave off the bear? Pumping more money into the system is good for stock prices, but it can’t really reverse the business cycle or improve company earnings across the spectrum.
The biggest concern is whether there are any lurking problems from the recent commodity price and emerging market currency rout. Which hedge funds or banks might be in trouble for having too much exposure to assets under pressure? How much bad debt is there in the energy space? Where are the systemic risks?
I’ll see if I can unveil any clues on this front and let you know tomorrow. One thing is for sure, given the carnage you’ve seen across the commodities sector and the issues with China, it seems a little too quite out there for comfort. Something is brewing.
For The Daily Reckoning, Australia