Net Wrong

Positioning in Gold Futures is now very similar to late 2005's surge of 60%...

GOLD REMAINS in a bullish technical environment, writes Gene Arensberg in the Got Gold Report from Houston, Texas, as people all over the world are still in the mood to convert their sickly fiat currencies into precious metals, probably wishing they had done much more of that a while back.

One of the principal drivers of this Great Gold Bull Market is the continued erosion of confidence in under-backed paper currencies and the governments that print them. It's a point we have been making since Day One of the Got Gold Report.

Lately we can heap on a growing fear by the productive class in the United States (the dwindling number who actually earn enough to pay income taxes) that the current "leaders" of government are on the wrong path – fear for good reasons.

The bottom line? Our bias remains cautiously bullish for gold, silver and mining shares, but with emphasis on the word "cautiously". Our stops are tight, but not too tight.

The signals are mixed. This week we see slightly positive money flow into some Gold ETFs, and minor positive money flow into the biggest US silver ETF (slightly bullish). Both gold and silver ended last week in minor backwardation on the Comex futures markets, with the cash price actually higher than the front-month active contracts (bullish).

Price action suggests a consolidation is underway, with much narrower gaps between the highs and lows, but with silver weaker (neutral to slightly bearish).

The US Dollar remains the sickest member of the global fiat currency leper colony, and the big commercial currency players put on only a modest number of new net long Dollar positions last week, despite new 12-month lows for the "buckster" (bullish for gold). Meanwhile, well-financed mining shares continued to perform in underwhelming fashion, but great merciful joy, many of the smaller companies on our Vulture Bargain Hunter list (for Gold Letter subscribers) caught significant bids over the past two weeks. (Neutral to slightly bearish for the big miners, bully for the little guys!)

Finally, we note that the largest of the largest Gold Futures traders – the always net short traders that US regulator the CFTC classes as commercial – are currently net short of gold in record proportions nominally and net short of silver in a somewhat lesser, but still material way.

Having said that, we note with some wonderment and cautious optimism that as both gold and silver have advanced over the past two weeks, the commercials have been either unwilling or unable to add to their net short positioning in very large, or frightening amounts.

With a nod to the Trading Gods (so as not to offend them too much), the action right now is reminiscent of the last time the short-happy Comex commercials were overrun – for months and months – beginning in August 2005, as gold first challenged, then tested, then blew through the very staunch defenses thrown up by the hedgers and short sellers in the $450-475 region.

Gold went on to test $730 the following May, some 60% higher than where the commercials took their stand. (A similar move in this event would take gold up to around $1520 an ounce, give or take $100. That's not a prediction, just an observation.)

So, we have to keep the caution flags flying because of the enormous net short positioning of the Comex commercials (aka the "smart money"). But in this case, that caution extends equally to both bulls and bears.

While it is usually bearish in times of such extreme commercial net short positioning as we detail below, it is also exactly the condition we expect to be in place when the "Big One" – the seminal technical move higher we have been expecting – finally occurs. We almost certainly cannot have one without the other.

With the over-sized commercial net short positioning and minor backwardation in play, dips should, repeat should, be well bid while advances could potentially be explosive.

But now is no time for short-term traders to be a hero.

Note that Gold Newsletter subscribers received this issue of the Got Gold Report on Monday morning, October 19th. Subscribers enjoy access to all Got Gold Reports, technical charts, analysis and information, as well as Brien Lundin's timely and actionable analysis of specific resource related companies. For more information or to subscribe visit the Gold Newsletter home page...

Now, a closer look at this week's indicators:

Gold ETFs: SPDR Gold Shares (GLD), by far the largest gold exchange traded fund, reported no change to its 1,109.314 tonnes of gold bars held by a custodian in London.

Barclay's iShares COMEX Gold Trust (IAU - in December it will become BlackRock's) reported adding a small 0.64 tonnes to 75.26 tonnes of gold held in COMEX warehouses.

All five of the Gold ETFs sponsored by the World Gold Council collectively added a net 1.69 tonnes of new gold metal last week, to a combined 1,308.93 tonnes worth about $44.1 billion. So apparently, there was slightly more buying pressure than selling pressure in the world's Gold ETF. The authorized market participants for Gold ETFs add gold (and increase the number of shares in the trading float) in response to more buying pressure than selling pressure and vice versa.

Silver ETFs: Barclay's sponsored iShares Silver Trust (SLV) reportedly added a very small 18.35 tonnes to show 8,612.57 tonnes of average 1,000-ounce allocated silver bar inventory for the week.

We can take note of a tiny bit more buying pressure than selling pressure for the largest silver ETF, but we would also like to highlight the tighter-than-normal spreads for SLV late week, most notably on Friday, October 16th.

We often see metal added to SLV shortly after we see tight spreads between the share price and the net asset value (NAV). By "spreads" we refer to the difference between the share price of SLV versus the real-time spot price of silver relative to the implied net asset value for SLV shares.

As of Friday, for example, the posted NAV for SLV was shown as 98.288%. Thus, with silver trading at $17.40 the ounce, that implies a "fair value" for SLV of $17.10 or about 30-cents less than the spot price of silver.

For much of the time on Friday, October 16, we noted spreads in the 23 to 25-cent range with good volume – a slight premium or below "normal" spreads. So, at least on the surface, that suggests a bit more buying pressure than selling pressure for the silver ETF then.

Unfortunately we cannot know in advance if those tighter-than-normal spreads lasted long enough to allow the authorized market participants of SLV to arbitrage them into new shares in the float and more metal at the custodian. If it was long enough, then we should see at least a little metal added the first couple days of next week.

Some newcomers to the silver ETF arena are taking miniscule market share from SLV and that may be contributing in a small way to apparent reduced buying pressure for the largest silver ETF. ETF Securities' Physical Silver Shares (SIVR) is one of them. With about 7.9 million ounces accumulated so far (about 245.5 tonnes), the "new guys" have some considerable catching up to do. Until they re-work their irritatingly difficult to navigate website, however, we won't be covering them very much for the time being. We wish that all the metals ETFs would carefully study the GLD website for a model to go by.

Here at Got Gold Report, however, we continue to believe that with premiums for physical silver metal at very reasonable levels, even at discounts for some silver products, right now is an excellent time for longer-term investors to "exchange" their SLV shares for the real deal physical metal, provided the investor has the ability to store silver safely or, for larger amounts, is satisfied with exchange receipts or warehouse certificates for allocated metal from well-established, respected or official sources.

For actual physical silver to store at or near home, we continue to prefer US pre-1965 90% silver dimes, quarters and half dollars, usually sold in $1,000 face value bags. Currently they are at "par" or slightly discounted locally.

Moving to the price action in Gold, the yellow metal recorded a substantially higher weekly low ($1,043.44 Friday) and a higher cash market high ($1,070.73 Wednesday, a new nominal record). In contrast to the prior week, it seemed like gold had a lot more difficulty advancing last week, but failed to gain any downside traction either. High-low spreads tightened considerably as shown in the closing table above. The last trade on Friday printed $1,052.85 on the cash market, edging up $3.70 or 0.4% for the week.

Silver was the weaker of the two precious metals. After posting a new high for this move Wednesday with a probe above $18.00, heavy resistance kicked in with the "feel" of profit taking more than anything else. That continued in Thursday's net 50-cent mini-sell down to the $17.30s before late Friday short covering and late posturing resulted in a net weekly dip of 24 cents or 1.4% to a last trade of $17.46 on the cash market. Both the weekly high ($18.08 Wednesday) and low ($17.17 Friday) were higher week on week, but like gold, silver saw meaningful Thursday profit taking.

Once again the US Dollar was unable to gain any ground this past week. The US Dollar index (DXY) ended the week at 75.62, down another 80 basis points from the prior week's Friday close as shown in the US Dollar index graph below in the charts section. The greenback cut yet another 52-week low in the 75.20s along the way.

Gold COT Changes: In the Tuesday 13 Oct. Commodities Futures Trading Commission (CFTC) commitments of traders report (COT) for gold metal, the Comex large commercial's (LCs) collective combined net short positioning (LCNS) increased another 14,062 contracts or 5% higher from 281,864 to a new all-time record 295,926 contracts net short Tuesday to Tuesday as US Dollar Spot Gold rose $22.47 or 2.2% from $1,041.96 to $1,064.43.

The total open interest in US Gold Futures increased 19,880 to 504,187 contracts. So while the LCNS (the commercial net short positioning) is at new record highs, it comes when the COMEX open interest is well below its January 15, 2008 COT reporting record peak of 593,953 contracts. We have to take note that the commercials really do mean business here, but it doesn't necessarily mean they will prevail.

Clearly the largest of the largest gold futures hedgers and short sellers are well-positioned for gold weakness. They have never had a Gold Price over $1,060 to work with before, however, so perhaps their reaction to the record high nominal prices for gold is understandable.

On the other hand, each time the Spot Gold price cuts a new high, we know that all short gold contracts are underwater, all but the last contract opened. Each time gold makes a new thrust at this stage, it is closer to triggering the next wave of short covering.

The chart above looks at just the nominal amount of commercial net short positioning. The chart below compares the COMEX commercial net short position for gold with the total open interest (LCNS:TO). That gives us a better idea of how the largest hedgers and short sellers are positioned relative to the rest of the COMEX traders.

As measured against all Comex Gold Futures contracts open as of Tuesday last week, the commercial net short position is now just under the record levels set on September 22 (then at 61.6%), with the LCNS:TO still equal to 58.7% of all contracts open.

Notice, please, that the LCNS:TO is actually slightly less now that it was four, or even two weeks ago. We think it noteworthy that in the two Commitment of Traders' reporting periods since September 29th – and as gold rose a net $72.13 or 7.3% (from $992.30 to $1,064.43) and the total Comex open interest increased a net 49,602 contracts or 10.9% (from 454,585 to 504,187 contracts) – the LCNS "only" increased 20,692 contracts or 7.5% (from 275,234 to 295,926 contracts net short).

In other words over the past two reporting periods, the Comex commercial net short positioning increased a good deal less than the increase in the open interest. Gold bears will take little comfort in that statement.

One of the "tells" we are always on the lookout for is very large, abrupt changes in the LCNS positioning. Over-sized moves can sometimes signal a significant shift in the near-term thinking of the largest traders and we pay heed to them in proportion to their relative size.

One example of just such an over-sized move in the LCNS was the August 30, 2005 COT report which showed an enormous LCNS reduction of 54,224 contracts as gold was just about to assault the $450 level. That was with gold then at $431 and change, having made a feeble attempt at the high $440s just before then.

That giant plunge in the LCNS told us that the commercials used a very small dip in gold to duck and cover in a big way. An event we viewed very bullishly at the time. Gold went on to blast through the $500 level later that year on its way 60% higher the following May.

The biggest, smartest and best-informed traders aren't always "right" however. Just last month, on September 8th, the commercials piled on a massive 54,089 contracts net short in one week with gold then knocking on the door of $1,000 (at $995.40 that Tuesday).

Both the very high commercial net short positioning and gold's determined advances are very reminiscent of that 2005 defeat of the $450 barrier. In 2005 the gold bears were gradually, but steadily overrun, with the hedgers and short sellers doing the stop-out-fall-back-sell-again shuffle for months, all the way up to the $730s before they were able to gain the advantage again.

That has to be the best example so far of when the always net short commercials got it "net wrong". Given the now record net short positioning of the commercials today, it wouldn't take all that much of an exogenous event now to make that 2005 example look tame by comparison. The stakes are perhaps an order of magnitude higher today versus then.

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