Most nearly every week we try to give an update on the Commitments of Traders in certain markets. This week I would like to focus on gold since it has been one of the best, if not THE best performing commodity futures market this year.

Those of you who have followed my writings for any length of time know that I place great importance on SENTIMENT when it comes to discerning market price action and behavior. Sentiment moves markets; understand it and you will be on your way to being a successful trader. Fail to grasp it, and you will more often than not end up losing money.

One of the ways we can gauge sentiment is by looking into these CFTC reports. As we watch the movements and positioning of all the various categories of traders, we can get a sense of whether bullish sentiment is growing or ebbing and conversely, whether bearish sentiment is rising or declining.

Let’s start with the total open interest [including futures and options].

I have drawn in some lines on the graph to help make my points a bit clearer.

One of the things that concerned me with recent rallies in gold during the last few years is that they never seemed to generate enough bullish enthusiasm to last more than a relatively short time before flaming out. The reason was evident in this chart – open interest was not growing in a consistent fashion but continued a general trend of declining. Notice the slope of the line from left to right and how it continued to decline.

While we would get fits and bursts of open interest increases, the pattern was still one of lower highs and lower lows. Much like what we look for in a stock or commodity price chart, this tells us that the general direction was down.

Why is this important? Think of price as a type of rocket. A rocket needs a constant force to propel it higher against the downward pull of gravity. While it may climb, as soon as the fuel or force subsides, gravity exerts its influence and back down it comes.

Price is exactly the same. It requires CONSTANT FORCE to keep pushing it higher. Remove it and gravity takes over and down it comes. You might say it this way – Bull markets require constant buying to drive them higher while bear markets can fall without the application of force. Gravity can pull them lower.

In the case of gold, this series of lower highers and lower lows tells us that the market was in a bearish posture, no matter what any commentator or so-called analyst would have had you believe. This is especially true of the gold cult, which never saw a gold price chart that it could not somehow spin as ultimately being bullish.

The force required to drive gold higher and maintain that elevation was simply not there; not as long as this declining trend in open interest was present.

So what to make of where we now stand at the end of this week? Notice the sharp spike upward in total open interest that occurred this week. That is very constructive from a sentiment perspective as it shows a renewed appetite for gold among market participants here in the West.

This renewed interest in gold has definitely been felt in the effect it has had on the gold price. See how the price has spiked upward as open interest has climbed?

There is something however that I would like to see yet occur in gold to convince me that we are witnessing the start of a new and powerful trend higher.

Look at the bottom graph showing the gold price. Notice how it has now exceeded the last peak made in October 2015. Now look up at the open interest line and see where that same peak occurred in October. See how far it is above the current level of open interest? Whereas gold exceeded the October price peak, the total open interest has not.

This tells us that while gold’s recent move has been very powerful, it has come mainly as the result of short covering. While nearly all bullish moves kick off with strong short covering, then cannot maintain themselves without new buying as we noted above in our rocket example.

If we were getting more new long positions being added in gold than we were shorts getting out and covering, open interest would be rising even more substantially. Remember, as shorts exit a market, open interest declines.

Ideally, total open interest will keep rising to the point where it will EXCEED the October 2015 peak and climb above that horizontal line I have sketched in on the open interest graph. Even more ideally, it will keep climbing until it blows past the peak of November 2014.

What I am saying thus far can be condensed down to this. While gold’s price chart is very strong on a shorter term basis, on an intermediate term basis it still has more work to do turn the sentiment more strongly bullish and in order to accomplish that, it will require the influx of ever-increasing speculative interest which will be evidenced by steadily rising open interest.

Case in point, here is the weekly or intermediate term price chart.

See how gold has broken out of the declining price channel. That is a great start. But see how it remains below $1300? It will take a big build in open interest to enable it to do just that. If that were to occur upside momentum would increase ever further attracting even more speculative interest into the market which would cause a yet further increase in open interest which could conceivably power the market upwards through the 2014 high near $1400 made in March of that year.

At that point, the major support level near $1530-$1525 that gave way in 2013 and heralded the onset of this multi-year bear market would then be vulnerable to a test from below.

I do not wish to be misunderstood so I would like to be most detailed in what I am saying here. The current chart for gold is very strong, especially on the daily. The weekly chart is also vastly improved with the breakout from that declining price channel and the breach of $1200. However, as what happens so often whenever gold starts moving higher in price, all the usual wild predictions begin to emerge once more. This “gold fever” then gets usually sober-minded traders/investors all “bulled up” to the point where they lose all sense of objectivity and caution. Do not make that mistake.

If this market is going to indeed begin to make some sort of extended move higher, it is going to require increasing interest among speculators and that will show up and confirm the bullishness by a strong surge in open interest totals.

Will this happen? I do not know nor does anyone else for that matter. What I do know and what is safe to say is that we can let the market itself confirm that the bullish sentiment is growing and this will be unmistakably clear if we know what to look for.

Moving along now to a bit more analysis of this week’s COT.

Here are the outright positions of the hedge funds compared to the price of gold.

Look at the sharp jump in the number of new longs by this category of traders. However, do not miss the sharp fall in the number of hedge fund short positions as well. Can you see how the gold price has responded to this combination of short covering by hedge funds and outright new buying?

Since peaking in November of last year near 110,000, the number of outright short positions by hedge funds has fallen to 57,000 as of this past Tuesday. That is a decline of some 53,000 short positions.

Over that same period of time, the number of longs has increased from near 93,000 to its current 130,000. That is an increase of some 37,000.

You can see my point made in the earlier part of this missive – short covering among the hedge fund category alone has exceeded new buying by some 16,000 contracts. What we would like to see if gold is going to really take off, is the exact opposite of that sort of thing. In other words, we want to see more new longs coming in than shorts getting out!

Here is yet another look inside the hedge fund positioning in gold.

See how the NET LONG position is growing. I would still like to see it exceed that October 2015 peak.

The combined chart showing the net positions of all the players is next:

All the speculative categories are net long while the Commercials and Swap Dealers are doing what they always do during moves higher in gold, they are net short.

Here is a close up view of the latter two categories’ positioning.

This is typical Commercial/Swap Dealer action – notice how they increase their net short positioning as gold rallies. While the size of those net short positions has increased quite rapidly, it is not yet at extreme levels, especially among the Commercials.

A brief note on the HUI before closing this missive.

The index continues to breach upside resistance levels in rapid succession.

Friday’s impressive move higher in the face of a stronger dollar and weaker gold price bodes well heading into next week. Of course, all eyes will be on the Chinese stock markets on Sunday evening.

The next upside target zone for the HUI is near 168-170.

Downside support emerges first near 154.

Let’s see what next week brings.