Checking In On Gold (And What It Means For The Market)

I want to start this week by looking at gold.

I recently opened up an email with a subject line that sparked my interest in the yellow metal:

“Precious Metals Were the Winners in H1 2020… And It Wasn’t Even Close”

This report included a chart showing the performance of various commodities. Clearly, gold was the winner with silver a distant second in the commodity race. Most commodities lost money in the first half of the year.

Source: U.S. Global Investors

Now, gold usually goes up for one of two reasons. The first reason is inflationary pressures; the second is fears of inflationary pressures. There are currently no inflationary pressures. So fear is what drove the price gains.

The next chart shows us that fear is likely to continue. The chart shows the Commitment of Traders (COT) data at the bottom, and that data is bullish.

COT data is based on what traders are doing in the futures markets.

In futures markets, the Commodity Futures Trading Commission (CFTC) issues a weekly report showing how many contracts various groups of traders own.

The CFTC assigns all positions to one of three groups – commercials, large speculators, and small speculators. In the chart above, commercials are the green line. Large speculators are the black line. I omitted small speculators because their positions are negligible, and the extra line clutters the chart without adding additional information.

Commercials are producers and consumers of the commodity. In the gold market, commercials include gold miners and large consumers like jewelers.

These are companies that know they will always need to buy or sell gold. They use the futures markets to get the best price. When commercials believe prices are going up, they take large positions ahead of the rallies.

Typically, commercials are the “smart money” in a commodities market.

Large speculators are hedge funds. They tend to be trend-followers, and they tend to buy more as rallies unfold and take larger short positions as bear markets drag on. This means large speculators should have their largest positions when markets top or bottom.

The weekly report containing this data is known as the COT report. The raw data tells us the number of contracts each group holds and can be difficult to interpret. To make sense of the data, I convert it to an index that ranges from 0 to 100, with 100 being the most bullish. The solid grey line in the chart is set at 50.

Interpreting The Data

We are at an interesting point in the gold market. As prices moved up, commercials were buying. They’ve since eased up on their buying, and the COT index is falling toward 50 now. Large speculators were bearish but are becoming bullish as their COT index rises toward 50.

COT data tells us that gold prices could accelerate higher as large funds start buying. Commercials are also positioned for higher prices because they are buying less, which indicates they believe prices should rise.

All of this tells me that gold is a good potential investment or trade right now.

If you are inclined to buy gold, then SPDR Gold Shares (NYSE: GLD) is one way to gain exposure to the market. I always like to remind investors that GLD holds physical gold and is taxed as a collectible rather than as a stock or an ETF that holds stocks.

Considering this, I am not certain GLD is the right investment for all readers from a tax perspective. I recommend consulting with a tax adviser before buying this ETF. I believe it’s important to mention that because I know my bullishness could lead some investors to consider GLD… and I don’t want to be responsible for a surprise at tax time.

With that important note out of the way, what’s important to know is that gold has been moving higher on fear and is likely to continue moving higher on fear. Fear will also affect the stock market.

Fear shows up in the stock market as increased volatility. One measure of volatility is shown in the chart below of the SPDR S&P 500 ETF (NYSE: SPY). At the bottom of the chart is my Income Trader Volatility (ITV) indicator.

My proprietary ITV indicator is like VIX, the CBOE Volatility Index, in many ways. It rises when prices fall, and traders begin selling. Both reach high values in market panics. In the chart above, I added a solid blue line to mark the current level of ITV. As you can tell from the bottom panel, the indicator rarely reaches this high of a level.

Action To Take

ITV is falling, which indicates fear is subsiding. But it remains elevated, which shows fear is higher than average.

I expect volatility to remain high as fear continues to grip the market.

In the coming week, we get our first detailed look at earnings with about 8% of the companies in the S&P 500 reporting second-quarter results. By the end of the week, we will know more about the likely direction of the short-term trend in the market.

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