Gold has been a miserable investment over the past five months.
The shiny, yellow metal has fallen from over $2,000 per ounce in March to just over $1,700 an ounce today.
In the process, investor sentiment has shifted from wildly bullish – with cheers of a new bull market – to horrendously bearish.
But that’s good news…
You see, investor sentiment – especially when it comes to gold – is a contrary indicator. Investors get wildly bullish on gold just as the price of the metal is peaking. And they get wildly bearish on gold near the bottom.
There is however, one group of gold traders that gets it right most of the time. They’re the “smart money.”
They were turning bearish on gold back in March – when everyone else was turning bullish. And they’re turning bullish on gold today while nearly everyone else is bearish.
Commercial traders are the “smart money” for gold.
They’re the merchants, miners, explorers, and bankers in the gold sector. They use futures contracts to hedge their exposure to the precious metal and protect themselves against adverse downside moves.
For example, if a major gold producer wants to lock in a guaranteed price on its gold production, then it’ll short gold in the futures market – thereby hedging its bet.
Each week, the CFTC Commitment of Traders (COT) report shows the positions (long and short) of the largest commercial gold traders.
The short position in gold is almost always a positive number. Meaning, commercial traders are usually short gold futures contracts. That makes sense since most commercial short positions are hedges against a future decline in price.
When gold is at a relatively low level and commercial traders expect it to be higher in the near future, the COT short interest often drops to less than 200,000 contracts.
That’s what happened in late January when gold dipped below $1,800 per ounce, and the commercial traders’ net-short position fell to 165,000 contracts. That was the lowest net-short position in over a year.
The smart money wasn’t too concerned about a further decline in the price of gold. They weren’t looking to hedge their bets.
They wanted to profit on an upside move. And they got that move as gold blasted above $2,000 an ounce in March.
When gold is trading at a relatively high level and commercial traders expect the price to decrease, the COT net-short interest often rises to more than 300,000 contracts.
That’s what happened in late March when the COT report showed that commercial traders were net short 352,000 contracts. That was the largest net-short position of the past year. And we all know what’s happened to gold since then.
However, last Friday the COT report showed the “smart money” short interest had fallen to just 111,000 contracts. That’s the smallest net-short position in over two years.
Historically, when the commercial traders’ net-short position gets this low, the price of gold tends to rally.
Traders should view the 15% drop in the price of gold over the last five months as an opportunity to buy.
That’s what the smart money is doing. And based on their history, there’s a good chance gold will be much higher in the months to come.
Best regards and good trading,
What are your thoughts on the recent action in gold? Do you think it’s time for it to rally?
Let us know your thoughts – and any questions you have – at [email protected].