Gold Breakout Supported By Market Forces

In my last article on gold, I made the following remarks:

“…I do not like the patterns where gold prices break out (below a strong support or above a strong resistance) on the so-called “news”… I believe that any relevant price move is driven by demand / supply forces or/and sentiment.”

Then, last week gold prices broke above their strong support at around $1,250 per ounce. I realize that some people may say that this move was triggered by Donald Trump’s statements about the US dollar or the deployment of the US aircraft carrier to the Korean peninsula. Maybe these people are right, but this month, apart from political events, gold prices have been supported by market forces. Let me discuss this thesis in more detail.

COT data

As usual, let me start with a quick look at the data delivered by Commitments of Traders reports:

Table 1

Source: Simple Digressions

The table shows net positions held by big speculators (mainly hedge funds) in gold/silver futures and two other precious metals-related futures markets (10-year US treasury notes and the US dollar).

It is easy to spot that speculators increased their net long positions in gold and silver futures by 17.2 thousand and 4.1 thousand contracts, respectively. It means that these big traders are getting more and more optimistic about gold prices:

Source: Simple Digressions

Note that the last week breakout was accompanied by a similar breakout in a net long position held by speculators (point B). On the other hand, the position held by big traders is still much lower than that held last summer (point A), when speculators were overly optimistic about gold prices. Using different wording, the increased optimism among speculators drives gold prices up, but the position held by these traders is not indicative of excessive optimism. Hence, there is plenty of room for gold prices to continue their rally.

Interestingly, the silver market seems to be very hot now:

Source: Simple Digressions

As the charts show, the silver futures market is at its historic highest readings now:

  • The total open interest stands at 1.1 billion ounces of silver (the circle marked in red)
  • The net position held by big speculators stands at around 48% (measured against the total open interest in silver futures)

Well, as I discussed in my previous articles, it is not a “normal” situation. Generally, both markets (gold and silver) go in tandem, but now the pattern is totally different because there is excessive optimism among speculators in silver and relatively low level of optimism among gold speculators. To be honest, I should be very cautious about silver and optimistic about gold, which is utter nonsense (I have never seen gold prices going strongly up and silver prices diving at the same time). That is why my readers should understand that it is not easy to analyze these markets now.

What is more, the data, delivered by the US dollar and US treasury notes, does not make this analysis easier. As Table 1 shows, the positions held by big speculators in these futures remained generally unchanged, compared to the previous week.

Physical market

In a search for clues, let me look at physical markets. Firstly, the silver market:

Source: Simple Digressions

To be honest, nothing special has happened in the silver market since the beginning of 2017. The Shanghai Futures Exchange and the COMEX added a little bit of silver bullion to their vaults, but the iShares Silver Trust ETF (NYSEARCA:SLV), the largest private holder of silver, cut its holdings by 13 million ounces. So, high optimism among big speculators in silver futures is not supported by the physical market. Oh, sorry, maybe there is one exception:

Source: Simple Digressions

As the chart shows, JPMorgan (NYSE:JPM), a large and very active speculator in silver, since the beginning of 2017 has been adding silver to its COMEX vaults. What is more, this month this bank added additional 6.8 million ounces to its holdings (which is a very high inflow). It looks like JPMorgan’s additions of silver correlate with the paper market (silver futures).

Now, the gold market:

Source: Simple Digressions

Well, quite a different situation. This year two large holders of gold bullion, the SPDR Gold Trust ETF (NYSEARCA:GLD) and the iShares Gold Trust ETF (NYSEARCA:IAU), have added significant amounts of gold to their vaults (860 thousand and 214 thousand ounces, respectively). What is more, after a short pause (March), these entities renewed their accumulation in April, adding 534 thousand and 97 thousand ounces, respectively. So, the gold paper market is supported by the GLD and IAU accumulation of gold bullion.

Further, although the COMEX reported a decrease in its gold holdings this year (189 thousand ounces), JPMorgan did the opposite:

Source: Simple Digressions

As the chart shows, in April, the bank has added as many as 381 thousand ounces of gold to its COMEX vaults (the highest amount of gold added this year so far).

Inter-market analysis

Going deeper, let me look at two inter-market patterns. Firstly, the gold and US dollar market:

Source: Simple Digressions

The charts above confirm the fact that most recently the gold price action has been much stronger than the US dollar action. As a rule, gold and the inverted US dollar index go in tandem (or, gold and the US dollar go in the opposite direction). It means that if gold prices make a new high, the inverted US dollar index should make a similar high as well. However, as the points A and B show, this was not the case when gold broke above its strong resistance at around $1,250 per ounce. In my opinion, this pattern is indicative of the gold’s relative strength, compared to the US dollar.

Next chart:

Source: Simple Digressions

This time the chart shows gold prices against 10-year treasury note prices. Note that the last week’s breakout in gold prices was accompanied by a similar breakout in US treasury note prices. I would say that the breakout in gold was confirmed by treasuries.

Final remarks

Summarizing, the gold and silver markets are sending misleading signals now:

  • The silver futures market is very hot now (speculators are overly optimistic about silver prices), but its gold counterpart is not
  • Silver bullion is not aggressively accumulated this year but gold bullion is
  • JPMorgan has been aggressively accumulating both gold and silver this year
  • Technically speaking, gold is now very strong

In my opinion, the main takeaway is that there are more facts supporting gold prices than those acting against them. While a near-term correction in gold prices is possible (for example, a correction that would synchronize the gold and US dollar price actions), in the medium term (6-12 months), I am optimistic about gold. What is more, the point and figure chart (below) shows that gold is currently in its upward trend (look at the red arrow):

Source: stooq.com

Disclosure: I am/we are long GDXJ.

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.