Gold: Buy the Dip or the FOMO Trade?

Specifications and Statistics

For centuries, many have sought gold for investment and industrial reasons. Demand for gold is global, with India being the most significant consumer, accounting for approximately 24% of the demand. Known for large gold purchases during their wedding season, India can significantly impact gold prices. Throughout the year, other various fundamental factors influence gold prices.

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Central banks worldwide hold gold and paper assets to help diversify their currency. During geopolitical issues, much like the Russia-Ukraine war, they tend to accumulate more gold for safety.

The US Dollar and interest rates also act as fundamental drivers of gold prices. The US Dollar is typically inversely correlated with gold. Depending on the world crisis causing a flight to quality, the US Dollar or gold can act as a haven.

Gold does not pay interest or dividends and is purely a capital appreciation asset. High-interest rates are competition for gold investment dollars. As rates go higher, investors can seek the safety of an interest-bearing investment.

Gold has always been in high demand for jewelry and ornamental decorations. Around the holidays’ demand for gold can increase, causing prices to go higher as consumers purchase gifts made from gold.

Another large demand area is Exchange Traded Funds (ETF). State Streets SPDR Gold Trust (GLD) owns physical gold for all the shares they issue. Their securities filings show they hold approximately 1,000 plus tonnes of physical gold.

Source: CMEGroup

As measured by open interest, liquidity is the fuel behind market prices moving. Reviewing the CMEGroups, the world’s largest and most liquid futures exchange, liquidity has been returning to the overall futures markets. During the holiday season in the latter part of December, large traders are less active, reducing liquidity. The graph illustrates that the open interest (white line) has increased by approximately 16 million open positions since the first of the year.

Recent Performance

In a recent article, “The Gold Bugs are Starting to Stir,” I discussed the upcoming lack of liquidity and how the bull market should continue its bullish seasonal pattern after the first of the year.

Gold prices have rallied approximately 20% from their seasonal lows in late November 2022. Managed money has supported this uptrend since the commercial entities built the seasonal low.

Unfortunately, prices don’t go straight up or down. At some point, uptrends lose the new buyers needed to keep the trend advancing, resulting in current prices retracing back to lower prices until demand again outstrips supply.

As we review the technical, seasonal, and Commitment of Traders (COT) report, traders may see patience as a virtue.

Fundamentals Impacting Market Behavior

The public holidays of the Chineses New Year have come to an end. Before this event, the Chinese public was informed that the government would be relaxing the zero tolerance of the pandemic lockdown.

The euphoria of freedom for the citizens to begin moving around freely created demand in the gold market. The question is, will the Chinese government uphold this promise to its citizens?

The February gold futures contract experienced its First Notice Day (FND) on January 31. FNDs are the first day to deliver an intent to make or take physical delivery of a commodity. During the days leading up to the FND, managed money had significant long positions that must be rolled over to the June contract or liquidated before FND, or else face taking delivery of 100 ounces of gold per long contract.

FNDs only impact long positions, not short positions. Due to the 20% rally in gold prices, many open long positions had to be rolled over or liquidated, leading to several days of gold price consolidation.

Technicals

The April gold futures chart illustrates how the market moved down(red line) as the liquidity left the market in December. During December, the open interest (liquidity) did not change much, leading to flattening price action. In January, as liquidity returned, the open interest began to increase, and prices continued their seasonal rally.

The daily gold chart displays a significant resistance level above the current price of $2,000 per ounce. In March 2022, the gold market moved $79 per ounce above this resistance but could only close above it for one day and was immediately rejected back to lower prices. A retest of the resistance in April proved solid supply was waiting there.

Currently, the market is just under this resistance. Next, we will review the COT report and see some exciting stats about current prices and open positions held by managed money.

The Commitment of Traders (COT) Report

Source: CMEGroup

Here is a unique view of the COT report and how it reflects where managed money has run out of new longs in the past resulting in a price correction. Currently, managed money is in control of this uptrend in gold prices.

The left side of the graph illustrates the % of the open interest that managed money has control. The yellow line represents the gold futures price (scale on the right side.) the vertical blue bars represent the number of long positions in that managed money is in control.

Historically, gold prices have tended to correct once managed money had control of approximately 28-30% of the cumulative open interest. Reviewing last week’s “Pct of Open Interest” managed money held long positions of 26.3% of the open interest, revealing that gold may be approaching a short-term over-bought condition.

Seasonal

Source: Moore Research Center, Inc. (MRCI)

MRCI has extensive research revealing the seasonal patterns of gold. The timely seasonal low arrived early in November, indicating a potentially more substantial rally in price and duration than average cycle lows.

Notice the sideways action that gold historically has in the latter portion of January and the first part of February. Consider that the seasonal pattern suggests that the seasonal low is very consistent, indicating that the February FND results in long liquidation and a sideways to lower price action each year.

February has historically been a bullish month for gold prices. The question is, will the market have more price correction to relieve some of the overbought conditions before resuming its bull market?

Looking forward, March has historically ended this particular seasonal buying pattern, and the market drifts aimlessly until the end of June.

Related Gold ETFs and Futures Contracts to Participate

If the seasonal pattern is expected to last long, consider using the exchange-traded fund (ETF) for gold (GLD). Both GLD and GC have options available to trade. The first choice would be trading the standard gold contract (GC), but if that is too expensive, consider the micro-gold contract (GR), exchange symbol (MGC.) Another ETF (GLDM) reduces capital requirements but tracks the GLD closely.

Summary

The long-term outlook for gold is still bullish. Consider finding support under the current prices and buying when gold goes on sale. But entering the gold market at these levels may be less than a reasonable trade/investment.

More Metals News from Barchart

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・Stocks Climb as U.S. Labor Costs Ease

・Dollar Rebounds as Stocks Falter

On the date of publication, Don Dawson did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.