Gold and silver both edged up over the week, reflecting a firm undertone. Gold was up $4.50 from last Friday’s close at $1259 in early European trade this morning, and silver was up four cents at $16.56. On the year so far, gold has risen 9.6%, and silver 4.5%.
On Comex, the August gold contract is running off the board, so speculators must decide whether to close their positions, or roll them over into the next active contract, which is December. The cost of rolling a position is about $6 per ounce, which for a highly-leveraged position is significant.
This report is devoted to the dynamics behind the August expiry, which has an unusual technical background.
Usually, speculators are net long and the bullion banks net short. Therefore, a contract running off the board is an opportunity for the bullion banks drive prices down, triggering stops, discouraging the speculators from rolling positions over, and to close their shorts. Therefore, Comex open interest (OI) usually diminishes at roll-over time, accompanied with a declining futures price.
In the chart above, this broad correlation is apparent, with OI and price tending to move in the same direction. However, after mid-June, OI began to rise as the price continued to decline, breaking this correlation. The divergence indicated speculators were opening fresh short positions and driving prices lower. The bullion banks encouraged the fall in prices, taking the opportunity to close their own shorts profitably.
The gold price bottomed on 7 July, at $1210. OI rose for a further six trading days, while gold lost its downside momentum, and began to rise. And as it rose above $1220, the bears, who by now had become as bearish as it gets, began to be squeezed. Furthermore, when you allow for non-speculative business, such as forward producer-hedging on the over-the-counter market, the bullion banks were on balance net long, and no longer interested in lower prices. This is reflected in their swap positions, which according to the Commitment of Traders reports, became net long on 3 July. This is shown, with the gold price, in the next chart.
This is where it gets truly remarkable. The last two times swaps were net long, they subsequently sold into a rising gold price, giving an almost perfect negative correlation between the price and OI. These were in August 2015, and mid-December later that year. [Note that the swap position in the chart is inverted for illustrative purposes]. Since January, this negative correlation between swap positions and the price has diminished, so much so that by 18 July, the COT figures showed a record net long position. Yet, the gold price had stated to rise from the July low.
These technical positions indicate a strong bear squeeze is now in play, with bullion banks reluctant to go short, and the bearish speculators being severely punished. This conclusion was dramatically confirmed last Friday and Wednesday. These were the two days when the gold price rose most, but instead of OI increasing, it contracted sharply by 13,056 and 17,379 contracts respectively. So, as the August contract runs down, the bears in the managed money category (mostly hedge funds) are being forced to close their positions with significant losses.
This is the opposite of what normally happens at contract expiry. With some 35,000 August contracts yet to run off, it augers well for the gold price in the next few days.
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