The COT report
The CFTC (Commodity Futures Trading Commission) reports the position of major players in the futures market through its COT (Commitment of Traders) report. This report specifies the positioning of various players in the market. The report is released every Friday and shows the open interest recorded on the previous Tuesday.
Net shorts at multiyear highs
According to the COT report for the week ended September 4, money managers resumed building their short positions in gold futures. In the previous week, managers had decreased their bearish bets. The money managers increased their net short positions from 75,772 contracts to 82,722 contracts in the latest week.
Catalysts for short covering
While the funds are bearish on gold given the rate outlook and stronger US dollar, the direction could reverse if gold finds a catalyst. A catalyst would lead to short covering, which would lead to gold rallying.
There are many potential catalysts out there. The trade worries and emerging market (EEM) crisis, which are currently working against gold prices by supporting US dollar (UUP), could easily switch sides to support gold.
Traditionally, gold is seen as a hedge against political and economic uncertainty. During such times, it can rise along with US dollar, despite their mostly inverse relationship. If the Fed decides to decelerate its rate hikes due to increasing worries about trade wars and emerging markets, gold could stage a comeback.
The sentiment for gold has turned extremely bearish, going by the latest positioning of managed money. Historically, whenever this kind of net short position has developed, gold prices have rallied.
When the net short position emerged in gold in November 2015, prices bottomed out soon after that, and a rally ensued. The SPDR Gold Trust ETF (GLD) gained nearly 30.0% in the following seven months.
The current speculative positioning in the gold (IAU) market is ripe for a contrarian position and the more extreme the bearish positioning, more the metal can rally on covering. A short squeeze rally from these levels is expected to result in a rally in gold prices.