Hedge Fund Short Squeeze Continuing in Gold

Since the last week of 2013, through Tuesday of this past week ( 1-7-2014), Gold has rallied from the vicinity near $1180 to a high near $1245 reached Tuesday. That is some $65.

It is no coincidence that over that same period, the hedge fund category has covered nearly 8,000 short contracts. As of the week of Christmas last year, hedge funds held a rather small net long position of some 28,702 contracts (futures and options combined). As of this Tuesday past, their net long position has regrown to 40,229.

To get to that point they have covered 7,345 shorts to be exact while adding 4,182 new longs over the period mentioned above. Another way of saying this is that the buying in the hedge fund category has been dominated by large short covering, not so much by fresh new long position taking.

While the results are the same, namely higher prices, I prefer to see a market dominated by fresh buying outnumbering short covering when I look for a trend to persist. Short covering can catch you off guard because it is so furious and comes in such large blocks when it tends to come. The problem is it can also peter out as quickly as it began.

Think of a market as a rocket engine taking off. It requires THRUST to counter the downward force of gravity. As long as the thrust persists, the rocket can move higher. If for any reason the rocket runs out of fuel, gravity takes over and back down it will come.

Gold can be likened to a rocket that is being driven higher AT THIS TIME, by thrust coming from short covering which is the dominant feature. This short covering needs to be replaced by FRESH BUYING to keep pushing it higher.

That fresh buying will only come as upside resistance levels on the chart give way since that movement generates momentum, which is what the hedge fund computers are looking for. Remember, they do not care which direction the momentum is taking a market, up or down alike make no difference. All they care is that the momentum is present.

That brings us to the price chart. This short covering on the part of the hedge funds has taken the market very near to a strong resistance zone on the price chart ( $1255 - $1260). It will be up to the bulls next week to take price through this zone if they are going to create a trending move in the metal to the upside.

I will be honest and say that I am dubious as to their ability to do this but one thing I have learned is that the market could care less what I think it might or might not do. The last two years of Fed bond buying programs have not undercut the Dollar nor have they generated any strong buying across the general commodity sector. If anything, that bond buying has served to reinforce the idea that the economy is too weak for the Fed to cut back on the QE. During that time, deflationary pressures have dominated and we all know what that has done to gold by now. I see no reason to believe that another year of unabaged Fed bond buying is going to produce anything other than what we have already seen in the last two years.

Only recently did the FOMC start up with the talk about tapering. That talk was based on the Fed's view of a gradually improving economy with a bit of an improvement in the labor markets. November's strong payroll numbers fed into that thinking doing nothing to dissuade the Fed from acting to Taper.

Today's weak payrolls number, coming as so shockingly poor as it did,  rekindled the idea of a Fed on hold when it comes to tapering. If we get subsequent economic data that comes in strong, or stronger than expected, look for that notion to begin withering away again.

I am especially interested in watching interest rate yields on the Ten Year Treasury at this time. Any further rise there should support the Dollar and bring pressure to bear on gold. Conversely, if the yields begin sinking lower on the Ten Year, gold should be able to catch a bid and remain firm.

The sharp rise in the GSCI today is evidence to me that the Dollar holds the key to the overall commodity sector as far as these speculative money flows go. When I survey the general global economy and compare the economic status of the major nations of the West ( I am including Japan in that block), the US still seems to be experiencing the best "growth" out of the bunch. That would lead me to believe that if there is going to be any nation out of that group that can see interest rates move higher, it is going to be here in the US. This should bring buying into the Dollar which should tend to bring pressure across the commodity sector in general. But as always, that is a view that must be confirmed by price action.

Next week is therefore an important test for this market.

Have a good weekend all....

Go Hawks...