Gold: to Correct or Not to Correct?

Gold: To correct or not to correct?  

Gold has had a nice move from the lows of late July. Will it continue or correct? We are firmly of two minds on this issue but if we had to decide, we would say that a correction is probably more likely.

The Commitments of Traders (COT) data is the most useful short-term indicator of gold-market sentiment. Friday's COT data (as of Tuesday, October 20) appears to favor a correction in the gold price, as do the rising dollar and stock market.

After being bullish for about three months, gold's COTs turned neutral during the week ending 9th October. But as of the 20th October, the data is bearish due to a continuing rise in the Speculative net-long position (the red bars on the following chart).

Chart Source: Sharelynx.com

In the latest data, Commercials increased their net short position by 35% to 163,300 contracts. That's the biggest net short position since 170,591 contracts on Feb 10th of 2015. Small Speculators also beefed up their net long to 11,999 contracts, which is the largest net long position since 15,317 contracts on the same Feb 10th of 2015. The Small Speculators are usually a contrary indicator.

These COT readings are at levels that have made prices vulnerable over the last four years. The rate of change is just as significant as the absolute levels of the data. The change in the Commercial net short position last week was an amazing 44,806 contracts, one of the biggest week-over-week increases on record.

According to Institutional Advisors in their October 24, 2015 report, the relative strength (RSI) for Speculators was at 67, indicating an overbought position. The last time we saw this level was at the January highs. This is the opposite of the bullish levels seen on July 23rd & 30th at the gold low.

On the other hand, the performance of gold stocks and gold stock ETFs such as GDXJ and GDX has been very bullish and in an up market, the gold stocks tend to lead the metal. The miners tested and held above support every day of last week, holding most of their recent gains in the face of a very strong US Dollar and closing the week above their late August peaks.

If gold does correct, we expect it to be relatively short and shallow. In our opinion, the psychology of the gold market is slowly improving as we move into a nascent bull market.