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Gold Revisited


The week before last, I mentioned that there were a few sentiment measures on gold (the metal, and not necessarily the related stocks) that were suggesting the upside may be limited, at least until some of the negatives wore off. While gold has risen slightly since, the sentiment situation, at least by two measures, has gotten worse.

The chart below shows the current Commitments of Traders data for gold futures, plotting commercial traders (in green, right scale) against small speculators (in red, left scale). We can see that commercials continue to build their net short position, which is now close to the largest in history. Small speculators, in contrast, continue to modestly add to their net long position, which is also extremely large historically.

If we take a look at how traders are shifting their money in the Rydex funds, it once again looks like small traders (the predominant market for these funds) are extremely enthusiastic on gold and gold-related shares. The chart below plots the NAV of the Rydex Precious Metals Fund against the NAV-adjusted assets that are currently in the fund. By NAV-adjusted, I simply mean that I have taken the total assets in the fund divided by the NAV of the fund itself, which helps to give a more clear read on the sentiment behind the asset flows. We can see that currently, the assets in the fund are nearly 6.5 times the NAV of the fund itself, which is a new three-year record by a wide margin. This, to me, suggests that these traders are wildly optimistic about the future of the metal.

The standard disclaimer is that these are only two indicators, and extreme can certainly become more extreme. That should always be kept in mind. However, when we look at the "smart money" versus the "dumb money", it becomes clear that the former is quite pessimistic on the future of gold while the latter is at the opposite end of the spectrum. I like to try to align myself with those who know more than I do, and against those who are almost always wrong when they get to extremes, so I continue to shy away from the long side in gold itself because I don't like the risk/reward.

As I said before, sentiment is only ONE part of a three-legged analysis that should include fundamental information (e.g. supply/demand characteristics, flight to safety possibilities in the face of a global crisis) and technical patterns (e.g. the very nice triangle being built that suggests an upside move coming soon). Each of you needs to figure out which carries more weight and adjust your investments accordingly.
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No positions in stocks mentioned.

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