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Watching the price action in gold this past
week and the week before has been most disappointing for the
gold community as it seems gold has slammed into a brick wall.
What has been particularly distressing to many gold bulls
is gold's lack of response to the rout in the U.S. stock markets
which for the first time in a long while, has instilled some
fear among the general public and has some waking up even
if belatedly to the fact that all is not well in la-la land.
An analysis of this week's release of the Commitments
of Traders data reveals the reason.
Most of this short essay will be in the form
of graphs to detail what is taking place in the gold market.
I will add a few comments hopefully clarifying the situation.
To begin with, what caught my eye was the continued
build in the commercial net short position that has accompanied
a market in which total open interest continues to decrease.
That is a very odd pattern that one does not normally see.
I give up exhibit A, a chart of the total open
interest in gold going back to the beginning of 2003.
You will notice that since mid March of this
year, the total open interest has declined from its peak of
335,503 to where it currently stands as of this release of
the COT, 279,545, or a reduction of 55,958 contracts. Previous
to that it had reached a high of 362,336 back in November
of last year when it collapsed all the way down to 253,16
before rebounding.
Now notice the following graph, which is a chart
of the COMMERCIAL NET SHORT position in gold covering the
same dates.
What immediately caught my eye was the inverse
relationship existing between this graph and its "normal"
relationship to a declining open interest environment.
Let me lay the two sets of data over each other
so that you can see it.
Notice the near perfect symmetry that exists between the two
patterns beginning in 2003. As open interest climbs, the commercials
would meet all the buying with selling and match the funds
contract for contract thereby building their net short position.
As the open interest peaked and prices set back, the funds
began selling and the commercials began covering or buying
back their short positions with the result that their net
short position decreased right along with the decrease in
total open interest. It is almost a perfect correspondence.
The last three reporting periods beginning 3/29/2005,
that pattern changed. I have circled the area on the chart
for your convenience. As total open interest set back, commercials
initially covered their shorts and reduced their short position.
However, beginning the week of 3/29/2005, they did something
quite unusual - they did not cover instead they actually either
held steady or increased their net short position.
To add another perspective, below is the same
chart. This time I have added the actual number of Commercial
Short positions; not the NET short, but the actual short positions.
On the chart below, that is the solid blue line. The area
in question has a rectangle drawn around it to single it out
and allow you to make the comparison to the falling open interest
graph just above it. Again, you can compare the dark blue
line with the blue line and if you didn't know better, you
would believe you are looking at the same data flow since
the corresponding moves are almost identical going back more
than 2 years - except for the last few weeks.
It is very obvious that the commercial shorts thus far have
not let up their pressure on this market in the last three
weeks. Typically, we can count on them to buy as gold descends
from its highs. Their buying helps to offset the fund longs
who bail out. This time they are not buying but appear to
be sitting tight or adding more shorts. Granted it is only
a few weeks where this pattern has emerged but to me it appears
that someone is very serious about keeping the price of gold
from moving up as the news concerning the U.S. economy continues
to deteriorate.
Once again, another chart provides a perspective.
This time it is the Commercial Short Positions as a Percentage
of the Total Open Interest. As you can see, the commercials
have the largest number of short positions as a percentage
of the total open interest since April 20 of last year. They
are currently sitting at 73.75%. In other words, the commercials
make up 73.75% or nearly ¾ of the total short positions
in gold with the specs holding the other 26.25% or ¼.
(please note, I am ignoring the spreaders for analysis purposes).
Readings of this magnitude typically accompany price peaks
in gold although they have always occurred as open interest
has been increasing, not falling as it has of late. By comparing
this chart to the chart of the gold price directly underneath
it, you can see that each time the commercials have built
a short position of this magnitude percentage wise, the gold
price has moved down within a short period of time if not
almost immediately.
Again, what makes this so strange is that it
is occurring not as open interest builds but rather as it
decreases.
The final two charts reveal exactly what is going on in this
market. The first chart contains only the positions of the
trading funds against the open interest. The blue line is
the total number of fund longs; the red line is the total
number of fund shorts. The Dark blue line is the total open
interest.
It is not that easy to distinguish but if you
observe closely enough you will see that in the majority of
instances, as open interest climbs upward, there are always
some funds who prefer to play gold from the short side. They
have always been in the minority during this gold bull market
but nonetheless, they are there. Typically what we see is
funds piling in on the long side (blue line) and some funds
joining them with new short positions on the short side (red
line). Fund interest is increasing from players on both sides
of the market. This continues until the open interest peaks
and the gold price declines and the funds begin to bail out.
The fund longs begin to sell and decrease their positions;
the fund shorts begin to buy back their shorts and decrease
their overall exposure. Then the pattern begins all over again
as the gold price begins to recover and move upward.
You will notice that there is a glaring discrepancy that has
taken place this time however. Observe the area inside the
ellipse and you can see it. Open interest bottomed in February
this year after the setback from the peak and began its climb.
You can see that the funds began to plow back into the gold
market by observing the blue line climbing as the dark blue
line increased. However, this time around, the funds who had
been playing gold from the short side decided they wanted
nothing to do with it. Look at how they decreased the number
of short positions they had been playing. Do you see the diverging
blue and red lines as the overall open interest continued
to increase? What this means is that the selling that had
been provided by those funds who prefer to play gold from
the short side has been disappearing from the gold market.
The question is who has been providing the selling then to
absorb all this buying from the funds who like the long side?
It is not the small specs as they are net long themselves.
The answer is the commercial category. That is why the open
interest had initially begun to build even though the gold
bear funds were not interested. The commercials were more
than willing to absorb the buying in this market and take
their place.
One more chart and we are done. This chart contains
the commercial category positions as over against the total
open interest. Notice the area within the ellipse as we did
with the fund category. Do you see a similar pattern?
This time it is the commercial long category that has been
unloading their longs and selling while the commercial short
category continued to plow into the market on the short side
- Exact same pattern only in reverse.
Put these two charts together, the fund chart and commercial
chart, and here is the explanation. The gold price bottomed
in February this year near $411 (see the London PM Fix chart).
From that time until March 15, 2005, open interest began to
rebuild. While the open interest was building both the funds
that prefer to play gold from the short side were bailing
out while the commercial longs were selling out. These two
groups were more of less offsetting each other. That left
the fund longs to do battle against the commercial shorts
who I believe along with GATA are involved in rigging the
gold price. These two groups continued to increase their position
size resulting in an overall increase in the total open interest.
Once the gold price stalled, or should I say
was capped near $442 in mid March, both the fund shorts and
the commercial longs continued their abandoning of the gold
market. Initially so did the fund longs and the commercial
shorts who both began covering as well. That resulted in a
decline in the total open interest; however, neither the fund
long category nor the commercial short category have heretofore
bailed out proportionately near the amount of contracts that
they are prone to do under similar circumstances.
Since about March 25, gold has been trading in a range bounded
by $432 near the top and $425 near the bottom. It cannot seem
to escape from the upper side but has been thus far been held
at the lower side as well. Since both the gold bear funds
and the commercial longs are exiting, the open interest and
commitments data tells us that fresh buying has been provided
by the funds who continue to add longs and fresh selling or
price capping has been done by the commercial shorts. The
fund short category has probably been using the lower side
of the range to close out their shorts and the commercial
long category has been using the upper side of the range to
sell out their longs. The net effect is that the commercials,
both stale longs and fresh shorts are selling up near the
$432 region while the funds, both stale shorts and fresh longs
have been buying near the $425 region or slightly below.
What we are witnessing taking place at this
point seems to be some sort of a showdown in gold. The longer
it continues to trade in this range while both the fund longs
and commercial shorts continue to increase their position
size, the stronger the move gold is going to make when it
finally breaks out decidedly one way or the other. We have
not seen this sort of activity surrounding the open interest
and COT data taking place thus far in the gold market. Rather
we have witnessed players adding positions as the market rallied
and then dumping them as the market set back. This time around,
the funds are getting increasingly long on a percentage basis
while the commercials are getting increasingly short on a
percentage basis at the same time. Something has to give as
this cannot continue indefinitely. One side or the other is
going to either have to blink or somehow recruit more converts
to its side in this war to end the stalemate and break gold
out of this range.
I come back to the point I made at the very
beginning of this short essay. Gold has not responded to the
deteriorating U.S. economic picture thus far as many in the
gold community has expected, especially with the stock indices
now in the red for this year. The explanation can be seen
in the fact that the commercial short category appears to
be digging in their heels in an attempt to hold it from responding.
Again, the question must be raised - what category of seller
is it that in the face of a determined buyer refuses to sit
back and let that buyer drive the price higher so as to maximize
their selling price but rather instead feels obligated to
do everything in their power to squash the price from moving
upward?
The answer is as clear as the noon day sun for
those with an open mind and GATA has it.
Dan Norcini
April 15, 2005
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Dan is a professional off-the-floor commodity
trader residing in Texas and can be reached at dnorcini@earthlink.net
with comments.
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