Most market participants are bearish on the SPDR Gold Trust ETF (GLD) and believe that it is headed much lower. However, due to position sizing by the smart money in the futures market, this ETF appears on its way to rally and to surprise the investing community.
The Japanese yen and the gold have a positive correlation since 2010. Goldmoney indicates that gold and the yen react similarly to real interest rates. If real interest rates decrease, the better off it is for the gold and yen. One way to look at whether we have positive or negative real rates is to look at the inflation rate vs. the 10-year Treasury yield. If the 10 year is less than the inflation rate, then we have negative real rates. If the 10 year is greater than the inflation rate, then we have positive real rates. The recent correction in gold occurred at the same time the 10-year yield rallied.
Commercial hedgers (smart money) are net long yen futures by over 133,152 as of July 11th. Comparing against the last two decades, these producers are positioning themselves in a bullish position. On the other end, the non commercials (dumb money) are net short -112,125 contracts. Comparing against the last two decades, these trend traders are positioned in a bearish manner.
Gold Hedgers are net short 73,916 contracts as of July 11th. They have covered over 140K short positions in gold since late April when gold traded close to $1300/oz. Although these producers are net short, they haven’t been net long since 2001. They were net short for most of the bull market in gold over a decade ago. Ever since the gold bull market resumed in late 2015, commercial hedgers significantly reduced their short positions. When the gold bull market resumed in December 2015, they only were net short -2911 contracts. A year later, in December 2016, when gold hovered in the 1100’s, they were net short approximately -150,000 contracts. From the trends over the last few years, shorting gold may not be the best idea as commercials are covering their shorts.
Inflation numbers for July should trend higher as the CRB index increased from approximately 166 to 176.49. The CRB index is heavily weighted towards crude oil and RBOB gasoline, and both have rallied since late June. Assuming commodity prices don’t plunge in the next two weeks, inflation rates should exceed the 10-year Treasury rate. This should be bullish for gold as these numbers are released in early August. Although inflation numbers will most likely increase this month, the CRB is approaching its 50 -day moving average and the RSI is at 56.93. From a trading perspective, the CRB is getting close to a temporary top.
As long as the federal reserve raises continues to raise the fed funds rate, this will be bullish for gold. This may be contrary to what mainstream economists state. Mike Norman, a contributor for the street.com, indicates that “rate hikes are price increases and price increases are inflationary, all else equal. There’s another thing that rate hikes are — and that’s fiscal expansions. The government spends more when rates go up. These things are bullish for gold.” As I mentioned above, gold’s bull market re-emerged 1.5 years back at the same time the federal reserve raised the fed funds rate 25 basis points. Two rate hikes after that, gold rallied close to $200, and is most likely going to rally again.
The commercial hedgers are both getting bullish on the yen and gold by covering their short positions in the paper markets. On the other hand, hedge funds and trend followers are on the other side of the trade. It appears that these speculators may get burned on gold and the GLD ETF as they usually do at position extremes.
Disclosure: I am/we are long AEM.
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.
Additional disclosure: I am short GDX as a hedge, long GDXJ, long various mining stocks. I also have sold a 1175 put option in the gold futures market. I plan on adding more positions.