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Precious metals markets are clearly messed up at the moment, and are likely to get ever weirder. The piling on of short positions raises the distinct possibility of a short-covering rally that will offer the skittish owners of gold and silver a chance to get out of this volatile market segment.
Short positions in the gold futures and gold ETF markets have exploded in 2013. According to the Commodity Futures Trading Commission (CFTC), non-commercial short interest (not the miners themselves) in bullion has more tripled to over 100 million contracts since mid-December.
In the ETF space, units borrowed to short the SPDR Gold Shares (GLD) have almost doubled to 28 million shares since the beginning of April.
The gold spot price, however, has bounced higher since April 16 from $1,365 per ounce (U.S.) and is looking to stabilize at higher levels.
At some point, the fast money that shorted bullion is going to start getting nervous – or at least bored – if the price doesn't resume heading south, and they will be looking to close their positions. In the futures market, holders of put options will just sell their contracts and take the loss. This may or may not affect the bullion price (our chart shows that declining short positions may have helped the gold price in April and December of 2011).
The ETF is a different matter. Holders of short positions will have to buy back units in the open market, which will directly affect the market price. Importantly, there is so much short interest at the moment that a rally could cause a stampede of buying to close out the position.
Sentiment in gold markets in fragile and if I had to guess, I'd suggest that this type of rally would only continue until the shorts are reduced. Sentiment in the sector remains fragile and the U.S. dollar looks reasonably solid next to the euro and yen.
Nervous investors with existing gold investments will get a chance to sell their holdings into this rally if it occurs. They should have quick trigger fingers over the sell button for at least a good portion of their holdings.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.
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Scott Barlow