Why focus on the fundamentals impacting a market
when it is market movements that impact the fundamentals?

August Gold reached $444.20 on June 23 and closed at $419.40 yesterday. For many – including newly adorned conspiracy theorist Peter Grandich – the latest sell off in gold has been brought about by the evil gold manipulators.

“Why at 7:20AM EST does the gold community believe gold deserves to be up $5 but in just one hour (and no new news) do players on the Comex hit the ground selling hard and lead gold to be up less than a buck????...I have not been a card-carrying member of the "gold is manipulated" fringe group within the metals and mining industry. But after Friday's trading pattern on the Comex and the opening today, I think I will be contacting them for an application.” Grandich.

Enthralling as the great gold conspiracy is, it is difficult to believe that knowledgeable gold bulls do not see these recurring gold price declines coming beforehand. To be sure, the latest price decline is just the latest signal that the commercials control the gold price (whether they do this legally is open for interpretation).

Before looking ahead, let's first take a look back: The commercials added a remarkable 60,765 contracts to their net short position for the week ended June 21 (the fourth largest weekly net short addition on record) and the commercials added an additional 25,152 short contracts to this position for the week ended June 28.  Incidentally, Grandich and company could not have known about the 25,152 short contracts before the alleged ‘bear raid’ on July 1 (the COT statistics were not available when the bear raid began). Nevertheless, the statistics told us that the commercials were adding to their net short position in dramatic fashion as gold rallied to $434 an ounce and the only speculation to be made was that commercials were padding this position as gold rallied above $440. Suffice to say, the sell signal on gold was so obvious leading into the last week of June, it almost defied mention.

To simplify things: when the commercial net short position is above 40% of open interest expect a sell off and when the commercial net short position is below 20% of open interest, expect a rally.

Conspiracy theorists can easily argue that the above chart is proof that the price of gold is being manipulated. After all, in no other major market, save silver, do the commercials consistently accumulate shorts and accurately time (and profit from) every major near term top.

While it is impossible to refute this logic, the issue nonetheless boils down to one question: Is it illegal to try to move a financial market with the goal of igniting and profiting from subsequent movements? The answer, of course, is YES (think Citigroup in Eurobonds). But, with regulatory oversight being uncooperative, the only way to prove and/or stop the gold manipulation is to make the commercials (and their backers?) come up with the hard gold to cover their paper trades. Think of the commercial rigging as a giant naked short trade. With the commercials having deep pockets, forcing them to cover gold they do not have is difficult to do.

Looking Ahead

Gold is declining and this means that the commercials are covering their shorts for profits. Accordingly, and assuming that more than 3-years of infallible statistical events hold firm, the outlook for gold – based solely on COT - is negative, but improving.

Another area of interest for gold watchers is the US dollar. With the Euro having fallen and not likely to get up in the near term, and no other major currency backed by the yield/growth combination being offered by America, the dollar could take a few moments more before resuming its decline. However, with the dollar commercials – which are not as proficient at generating a sell off as their gold counterparts – continuing to add to their record net short position (futures & options), the outlook is anything but positive.

With the threat of global rebalancing not about to vanish anytime soon, gold should avoid walking the plank and retesting $400 an ounce. But don’t be surprised if gold walks the line until the US dollar resumes its downtrend. The line in question is drawn by the commercials and can be studied each Friday when the COT statistics are released. While these statistics do not comment on global supply/demand trends in gold, they are nonetheless what usually move the gold market.

In short, the next time gold falls by $5 an ounce, don’t go looking for what ‘new news’ development made the decline possible.  Rather, understand that the $5 decline is the new news. Like it or not, with volatility being shorted since 2003, hedge funds awash with cash, and ‘conundrum’ infecting various financial markets, price movements themselves are an important fundamental today.

© 2005 Brady Willett
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