Forbes: More Upside for Gold Prices

Article by Simon Constable on Forbes

This month's rally in gold prices may not be over. That's because investors are still heavily betting on a decline in the value of the precious metal. When speculators overwhelmingly bet in one direction then a move in the opposite way is often the result.

On October 1, I wrote that speculators were betting so heavily on a further decline in gold prices that we'd likely see a rally. Starting late January gold prices tumbled until they reached a recent low in mid-August.

However, even as the price stabilized traders held onto those so-called short positions, also known as bets on a decline in prices, and kept betting on further falls in the price.

By early October the negative bets became extreme and hence increased the likelihood of a gold price rally.

Indeed, the price of gold for immediate delivery surged to $1,220 a troy ounce recently, up from $1,189 on October 1.

The move was almost certainly prompted by increased volatility in the stock markets and the uncertainty around the U.S. mid-term elections which are set for next month.

However, the upward move is probably not entirely over.

"Gold positioning has rebounded from its lows but still remains short, suggesting the potential for additional upside in a short squeeze scenario," states a recent report from Macro Risk Advisors.

In the simplest terms, the bets on a further decline in gold prices are no longer as abnormally high as they were at the beginning of the month. Back in early MRA highlighted the fact that the level of short bets was more than two standard deviations from the normal level. In other words, it was a rare thing to see such a negative bet.

The bets on a continued downward trend in gold are now lower than they were. But they are still far higher than the bets on an increase in the price of gold. And that is why the price is likely to rise.

When investors mostly bet in one direction, then a move in the opposite way becomes increasingly likely. In this case, the overwhelming bets on declines in reality point to a jump in prices.

This phenomenon is known as a "contrary indicator." In other words, when the bearish bets indicate the contrary, an increase in prices.

MRA makes reference to a "short squeeze," which helps explain why prices can jump with speed.

Here's what happens during a short squeeze. When the price of the metal moves higher, then all the speculators who have bet on a decline will start to lose money. Some of them will choose to dump their bets by purchasing gold in the market. As they buy, so the price will get bid up even further and so, cause even more speculators who have bet on a decline to lose money. The fact that many speculators make bets with borrowed money amplifies the resulting price rally, which can sometimes be rapid.

In the simplest terms, the continued bets on declines gold prices point to a rally which might be fast. At least for now they do.

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