Is The Pullback In Gold Over?

At the end of May, I cited a few developments in the gold market that merited investor attention, as these factors were indicating that a pull-back in price of the yellow metal was a distinct possibility. Since that time, gold has indeed declined, albeit by a modest 3%. However, continued over-extended market positions in gold futures and the US dollar leaves prices in this precious metal vulnerable. Let me explain.

What Do I Mean By Market Positioning?

Every week, the Commodity Futures Trading Commission (CFTC) releases a report containing the net amount and direction (long/short) of outstanding speculative (non-commercial) futures contracts for gold. Often, this report can be a very useful contrarian indicator. The reason is that at extreme levels, outstanding speculative contracts are susceptible to being washed out as there are fewer investors on the sidelines to continue feeding market momentum. And once the price of the commodity goes against the direction of the speculative contracts, stop loss orders are triggered and a liquidation ensues.

What Is The Current Market Positioning In Gold?

The speculative gold futures market is currently net long 64,175 contracts. Although this number is below the all-time high 85,599 contracts set on June 3, these are nonetheless extremely high levels. In fact, the market was net long 66,814 contracts on Feb 4th (then an all time high) before the price of gold pulled back 16% in the subsequent trading periods.

What Is Market Positioning In The Currency Markets Telling Me?

First, let me point out that the price of gold is inversely correlated with the value of the US dollar-- that is, when the greenback moves up, gold moves down and vice versa. In fact, for the past year, there has been a -.83 correlation (-1 and 1 are the two extremes) between the price of the two commodities.

As with gold, current market positioning in the currency markets favors continued upside for the US dollar (remember, that is bad for gold prices). Net shorts against the greenback are still near their highs for the year. Specifically, US dollar shorts against the euro register 28,123 contracts; the UK pound at 17,448 contracts; the Japanese yen at 10,862 contracts; the Australian dollar at 10,956 contracts; and the Canadian dollar at 18,454 contracts. So, again, we should expect further US dollar strength to lend itself to weaker gold prices in the intermediate term.

I should point out that on a fundamental level, the current effort by the world's major central banks to reflate prices will eventually lead to higher gold prices. But on an intermediate basis, gold prices are vulnerable to the downside.

Gold Miners

Gold miners, such as Newmont Mining Corp and Barrick Gold Corp , have thus far shown little down-side participation with the actual price of gold.

Edward Allen