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Speculators' scepticism is a sign for the bulls

SINCE establishing a low at US$1,160 in August, gold has made a moderate recovery.

Despite the rebound higher in gold price over the past six weeks, speculators remained sceptical about the bullish rebound and continued to bet on the short side. Based on the Commitment of Traders (COT) report, the speculators are excessively short on gold futures, expecting gold to remain in the doldrums.

Nonetheless, our study has shown that the speculators tend to get it utterly wrong when they are all betting on the same side of the trade. In other words, the speculators are an accurate contrarian indicator especially when they are singing the same tune.

Historically, when the net speculator positioning falls below 20,570 contracts, a short squeeze in gold price is imminent, lifting price back into an uptrend shown by the vertical lines in the chart. For example, the most recent rebound higher in gold price that was signalled by a massive short squeeze from the herd was the bottoming price action in December 2015. The net speculator positioning was at a low of 9,750 contracts. Once gold started to edge higher, the short sellers were forced to cover their positions by buying back gold to minimise loss.

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This short squeeze will then continue until the negative outlook on gold rebalances out. During the December 2015 short squeeze event, gold formed a significant bottom at US$1,058 and staged a strong bull run of 25 per cent over the following eight months.

Keep in mind the negative sentiment for gold when referencing the 20,570 contracts as the benchmark is a rare occurrence. For the past 13 years, the net speculator positioning has only gone near 20,570 contracts on four occasions, and all succeeded in signalling a bottom and rally higher in gold. More importantly, the negative outlook on gold was also the reason for gold forming a sharp reversal as the short squeeze unfolded. On average, gold rebounded 25 per cent after the short squeeze happened.

Moving back to current time, the net speculator positioning is in the danger zone once again. To make matters worse, it is at an extreme short side at -10,844 contracts. With the current extreme bearish outlook on gold as the net speculator positioning enters into the negative territory at -10,844 contracts, expect the current short squeeze to be more severe. This short squeeze could take price higher by the average recovery of +25 per cent to approximately US$1,500.

From a near-term perspective, the US$1,212 range high has been relentlessly keeping a cap on the recovery since late August. For the short sellers to feel the pain, gold needs to break above the US$1,212 range high convincingly to kick-start the short squeeze process. After which, the depressing bearish sentiment since April should be reversed to the bullish side where a significant rally will take over. A retest of the US$1,350 April's high should be the next target for the bulls.

  • The writer is chief technical strategist, Phillip Securities Research.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.