Gold Looks Headed for Another Dip

There is lots of talk about gold sentiment shifting to a more bullish view. The bulls point that after the metal hit a low just under $1,200 an ounce back in June, it has had a 13% rebound. Technically, the market was oversold and due for a bounce. Is it really gearing up for another bull run?

We can get some clues by looking at the Commitment of Traders report from the U.S. Commodity Futures Trading Commission. In its most recent release, dated Aug. 6, we see that speculators are long, but not by a huge amount. The breakdown goes as follows: Large speculators (commodity funds and hedge funds) are long one and a half times as many contracts as they are short. More telling, perhaps, is that there are 107 traders in that category compared with 98 traders in the short category, which means that the shorts hold larger positions, on average, than the longs.

As for small speculators, they are also long, but by an even smaller margin than the large specs. Small spec long positions exceed the short positions by only about 20%, so there is no frothy bullishness to be seen there, by any means.

The commercial traders are net short: Short positions exceed longs by about 28%. The average long position held by commercials is 3,481 contracts, compared with an average short position of 4,101 contracts. So here, too, it looks like the bigger or smarter money is on the short side.

Open interest can sometimes give an interesting picture, but it's not always accurate in predicting tops and bottoms. Moreover, it's very important to get some perspective. For example, when looking at the same CFTC report, but this time from one year ago, we see that large speculative longs outnumbered shorts by more than 3 to 1. And there were twice as many small spec longs as there were small spec shorts. In other words, speculators were far more bullish on gold last August than they are now.

In contrast, commercials were short two contracts for every one that they were long, and the average size of the short position was 6,860 contracts, compared with 3,100 contracts long. The commercials who were betting on a move down were betting huge. That's significant.

As I said, from a short-term technical standpoint it would appear that gold has done what it needs to do to correct the oversold condition that we saw in June, however, I don't think the bottom is in yet. The market is still vulnerable to Fed actions and shifts in monetary policy, one such shift being the tapering of bond purchases that many people believe is coming in September.

While bond purchases and quantitative easing have not proven to be bullish for gold (for reasons discussed in these posts many times), an official announcement of the Fed starting to roll back its bond purchases is likely to be bearish as traders reflexively sell into that news.

Ultimately, however, the end of QE should be bullish for gold, as it would allow billions in interest income to remain in the economy as opposed to it being "sucked out" by the Fed. That would be a form of stimulus. I don't expect traders to understand this at first, but the gold market will eventually let them know in no uncertain terms.