Introduction
Gold prices first found their way onto our radar screen back in July 2013 because of some unusual investor positioning data from the Commodity Futures Trading Commission (CFTC), which we first displayed and discussed in our July 23rd report entitled Gold Prices Test Their First Upside Obstacle: Watch the Smart Money.
These data showed that in late June/early July gold producers collectively moved to an essentially unhedged position the futures market for the first time in more than a decade. This rare, unusual positioning indicated that the smart money was collectively convinced that gold was undervalued at $1200 per ounce. Unbeknownst to us at the time was that gold prices actually bottomed for the year just a few weeks earlier, at $1180 on June 28th. Prices then proceeded to spike higher to $1419 by the end of August, a $239 per ounce or 20% advance in less than 2 months. However, prices then subsequently collapsed right back down to $1180 by the end of the year, convincing many investors that this was just a bounce in a bear market, and that the larger 2011 bear market had resumed.
Then something interesting happened at the end of the year: the gold producers moved right back to that unhedged status in the futures market, just as gold prices dipped below $1200 an ounce. This further identified the $1200 area (at least to us) as a value area by the smart money. So far in 2014 gold prices have again aggressively rebounded, rising by $151 per ounce or 13% just since the beginning of the year.
In today’s report, we display and discuss a number of different market metrics including investor asset flows, investor sentiment, relative performance, price and trend structure, and intermarket relationships in an effort to answer the following questions:
- Is the 2014 rebound in gold prices just another correction with the 2011 bear market, or is this a sustainable new bullish trend?
- How much higher can gold prices realistically go? Where are the next upside targets?
- How long can the 2014 price advance potentially last?
- What’s the better place to be for bullish investors: outright gold or gold miners?
- How is a sustained rise in gold likely to indirectly affect the prices of other US financial assets?
[Related: What's the Safest Way to Buy Gold Stocks?]
Investor Asset Flows
The red line in the upper panel of Chart 1 below displays the data series that first shifted our focus to gold prices back in July 2013, the Commercial Hedger category of the Commitments of Traders data. Once per week the CFTC breaks down futures open interest into three categories, Commercial Hedgers, Large Speculators, and Small Speculators, and makes the data available to the public via their website.
As the name suggests, Commercial Hedgers use the futures market to hedge the value of their physical holdings in a commodity, and thus they atypically accumulate a net position against the trend.
One of the first things that you notice when you look at this chart is that the hedgers are almost always net short, because they are holding the physical asset. The green vertical highlights between both panels show that least net short (least hedged) extremes in December 2001, February 2005, and November 2008 all coincided with important intermediate to long term bottoms in the price of the gold contract (lower panel). The most recent of these extremes took place in July and December 2013, just as gold prices moved below 00 per ounce, which identifies this as a value area for the smart money.
Since December, the hedgers have become collectively a bit more net short, at 72,654 contracts as of the latest data. However, this still qualifies as an historic least hedged extreme that, assuming history repeats, suggests that significantly higher gold prices are in store over the next one to several quarters.
Chart 2 takes a more near term look at investor asset flows via the daily total assets invested in the SPDR Gold Trust ETF (GLD), which is plotted along with its 21-day (1 month, red line) moving average in the upper panel.
The green highlights point out that expanding total daily assets during August 2013 and most recently since January 17th, above their 1 month moving average, coincided with the two most significant periods of rising gold prices since July 2013. This chart tells us that, in addition to the smart money establishing value near 00 over the past 9 months, enough investor assets are now moving into gold on a day-to-day basis to establish and fuel a positive price trend. As long as these assets remain above their moving average, we will expect the current 2014 price advance to continue.
[Hear More: Ross Hansen: All Quiet on the Precious Metals Front – Metals Ready to Roll]
Investor Sentiment
Chart 3 below measures investor sentiment according to a daily survey of near to intermediate term oriented individual futures trader bullishness on gold prices, which is plotted by the blue line in the lower panel. Unlike the commercial hedgers shown in Chart 1, these traders accumulate a position with the trend, which ultimately leaves them the most collectively bullish at market peaks and the most bearish at market bottoms.
The green highlights on the chart show that, at 67% bullish according to the latest data, these futures traders are currently becoming more collectively bullish following a least bullish extreme back in December, an extreme which had previously coincided with every important bottom in gold prices (upper panel) since 2010. However, the green arrow points out that these traders are only about halfway to reaching opposite most bullish extremes (red highlights) which have coincided with or led most of the significant peaks in gold prices during this period, which suggests that there is more near to intermediate term upside potential for prices from an investor sentiment standpoint.
Chart 4 below measures investor sentiment for gold prices from the more intermediate to long term perspective of brokerage and advisory firms and commodity trading advisors (CTAs) via the Market Vane survey, which is plotted since 2000 by the blue line in the lower panel.
The green highlights show that, at just 47% bullish as of the latest data, these professional trend followers are at a decade-long least bullish extreme, and that similar but less severe extremes coincided with or led important bottoms in gold prices in April 2003, October 2006, November 2008, and May 2012.
This chart indicates favorable investor sentiment for a much larger and more sustainable rise in gold prices than the one suggested by Chart 3 to emerge from at or near their current level near 20 per ounce.
Outright Gold or Gold Stocks?
One common question that we have heard from clients over the past few months is, “should I be in outright gold or in gold mining stocks?” Chart 5 below plots the Market Vectors Gold Miners ETF (GDX) since mid 2010 in the upper panel (black bars), with a corresponding relative performance chart of GDX versus GLD in the middle panel (blue line), and quarterly momentum of GDX versus GLD plotted in the lower panel (black line).
The red ellipse in the lower right edge of the chart shows that GDX (gold miners) is currently at a quarterly overbought extreme versus GLD (outright gold), while the red vertical highlights between all three panels show that similar instances of this coincided with the beginning of periods of relative underperformance by the miners in December 2010, April 2011, and September 2012.
Basically this chart suggests that, after outperforming (leading) gold prices higher since December, the miners may be becoming temporarily “played out” from a quarterly relative performance standpoint, and ready to yield the leading role back to gold prices in terms of upcoming relative performance.
Now that we’ve determine that GLD is amid favorable conditions to outperform GDX over the next 1-3 months, Chart 6 below looks at GLD by itself to determine trend and upside potential. The green highlights point out that, after “double bottoming” around 9 in June and December 2013, GLD has recently risen above its 200-day moving average (orange line, widely watched major trend proxy) for the first time in a year.
This suggests that a major bullish trend change is emerging in the ETF, and clears the way for an eventual, additional 8% rise to the next overhead resistance level at the 137.55 August 2013 benchmark high. Above there, the next resistance level is the 148.27 May 2012 benchmark low, which is 16% higher than GLD’s current level.
Chart 7 below addresses another question we have been asked: “do you think gold will outperform the S&P 500 over the next several months?” To answer this, we utilize the same metrics used on Chart 5, but this time we measure the relative performance of GLD versus the SPDR S&P 500 ETF (SPY).
The blue relative performance line in the middle panel shows that GLD has underperformed SPY since August 2011. However, the green arrow in the bottom panel shows that quarterly momentum in the relative performance line is now rising, towards relative outperformance by GLD, even while GLD continues to underperform (red arrow, middle panel). This positive momentum divergence typically precedes a change in the trend of relative performance, which in this case would mean an emerging trend of relative outperformance by GLD versus SPY, while GLD (upper panel) continues to rise on an outright basis.
Intermarket Implications
Chart 8 below plots gold futures (black line) alongside the yield of the US 10-Year Treasury Note (blue line) since 2000, and shows that these series have maintained a tight and stable inverse correlation to one another over the past 22 years.
Per the correlation, a significant and sustained rise in gold prices is likely to coincide with a decline in long term US interest rates as long dated US Treasury prices rise which, by the way, is counter to conventional wisdom right now.
Chart 9 below takes this intermarket relationship tack a step further, by showing that the yield of 10-Year Treasury Note has maintained a tight and stable positive correlation to the S&P 500 since 2012, as an apprehensive stock market has looked to the bond market (and to the Fed trying to control interest rates) for direction.
Per these relationships, a significant and sustained rise in gold prices that indirectly puts downward pressure on US interest rates, as investors move back into defensive assets, also suggests the potential for upcoming weakness in US equities as investors leave more risky assets.
Conclusion, Investment Implications, Strategy
The latest investor asset flow data, plus surveys of retail and professional investors, concur on favorable conditions for the 13% rise in gold prices thus far in 2014 to continue at least into the 2nd Quarter, and potentially much deeper into 2014.
Relative performance metrics suggest that, although gold miner stocks have appreciably outperformed outright gold since December, this relative outperformance appears to be played out from a quarterly standpoint, setting up favorable conditions for gold prices to outperform gold stocks in the months ahead. Moreover, GLD’s recent rise above its 200-day moving average, for the first time in more than a year, suggests that a major bullish trend change is emerging in gold prices and clears the way for an additional 10% rise to the next overhead resistance level.
Current and historic intermarket relationships suggest that a continuation of the 2014 rise in gold prices would likely coincide with a decline in long term US interest rates and, taking this a step further, current relationships also suggest that a decline in long term US interest rates would also likely coincide with a corrective decline in the US stock market. The common denominator in all these relationships, and what creates them, is investor asset allocation. A rise in gold prices, a rise in long dated US Treasury prices (i.e. declining long term US interest rates), and a decline in the US stock market are all defensive in nature, and collectively warn of a potential US stock market correction to emerge between now and early to mid Q2 2014.
