Looking at this week’s COT report, long crude oil and short Swiss franc are once again in extreme territory. This is shown below:
CFTC COT (futures & options combined) – December 5, 2017
Notable extremes are bolded, and are highlighted when speculator positioning is more than two standard deviations above historical trailing 1-year and 3-year trends.
Changes in speculator positions are fairly limited this week. Beyond a drop in Canadian dollar and crude oil net positions, there are few big changes. The most notable change is the substantial decrease in both gold open interest (down by 25,318 contracts versus last week) and gold net positions (down by 55,142 contracts versus last week). While gold speculators had been doubting the inflation outlook in earlier weeks (unlike yen and Swiss franc traders), they now appear to be capitulating.
Gold speculator positions have lagged prices this year
Looking at how gold traders have been positioned during the past year, the consensus has failed to position themselves correctly ahead of large moves. Gold speculators were long gold in a big way ahead of the US presidential elections last year. As gold prices sold off sharply following Trump’s victory, speculators were slow to reduce their net long positions.
By the middle of July 2017, speculators had reduced their positions substantially in anticipation of further gold weakness. Instead, gold surged from the low $1,200s to $1,350 by early September. By the time speculators had built up their long positions in the middle of September, gold had started trending down. From its most recent peak above $1,350, gold prices closed at $1,248 last Friday. This is shown below:
Missing the big moves
More recently, gold speculators have once again been caught on the wrong side of the trend. While speculator positions increased in late November, gold had already started to sell off.
Changes at the Federal Reserve not likely to drive gold in the short-term
While the US dollar has weakened significantly relative to gold over the past 100 years, gold has been fairly stable during Yellen’s term. In a broader commentary on the US Federal Reserve, we argued that Janet Yellen’s policies have been largely appropriate looking at gold prices as a measure of US dollar liquidity. While this doesn’t absolve the Fed’s poor historical track record in maintaining the purchasing power of the dollar, it does suggest that recent policies have been suitable for the current high growth environment.
Of course, the real test for any central bank is when prevailing economic conditions are not so benign. Looking at history, the Fed has mostly avoided hiking rates when growth is weak and inflation is accelerating. This explains why gold prices are the strongest when the market begins doubting the Fed’s resolve to hike rates. As Jerome Powell is likely to maintain Yellen’s policies and US GDP growth remains strong, the precious metal is unlikely to gain support from looser monetary policies in the short-term. Once growth inevitably slows down in 2018 and beyond, a new gold bull market is likely to emerge.