Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Hedge funds are piling into gold. That's great for gold, right?

Not necessarily. It's certainly true that investors are increasing the stakes in their wager on rising prices. Funds' net long position in Comex gold futures rose 26 percent over the two weeks through Nov. 1 to 172,532 contracts, the sharpest such climb since the period that ended June 21.

Shining Future
Managed money funds' net long position in Comex gold contracts is still looking strong
Source: Bloomberg

There's an echo in those dates tied to gold's somewhat legendary role as a hedge against uncertainty. June 21 was just two days before the U.K.'s Brexit vote, probably the biggest geopolitical black swan so far this year. Now the world sits on the brink of another high-risk binary vote, and funds are clinging to their usual anchor.

Those who are tempted to think of that mountain of investor bets as bedrock support for the gold price could be in for a rude shock, however.

Funds don't bet on commodites out of a commitment to abstract theory, after all. They're trying either to make money, or to avoid losing it. When prices climb, selling pressure will tend to rise as funds seek to take profits. Falling prices may have the same effect, though, as the same funds struggle to stop losses. In that sense, a big investment position in a commodity is like a high valuation on a stock: Investors will want to see a strong performance to justify their faith, and may punish any disappointment severely.

Gold Road's Sure a Long Road
Comex gold futures haven't seen much joy since the previous time investor sentiment hit a peak
Source: Bloomberg
Note: July 29, 2011 = 100.

Take the previous record high in gold bets until the dramatic rally this year. Had you bought generic next-month gold futures when investor sentiment was at its old peak around Aug. 2, 2011, you'd have lost more than 20 percent by now just on the price movement. Actually, it's worse than that: Futures investors have to roll over their contracts month-to-month, meaning they'll tend to lose money from negative roll yield, particularly on commodities like gold that are in a state of seemingly perpetual contango.

Metal Sinks
If you'd bought Comex gold ahead of the Brexit vote, you'd mostly have lost out
Source: Bloomberg
Note: June 21, 2016 = 0.

It's a similar picture if you look back to the last spike in investor interest in June. Investors who took the opportunity to cash out in the weeks after the Brexit vote, when the metal surged to a two-year high of $1,374.20 per ounce, came out ahead. Those who held on in the hope the rally would endure ended up under water.

A Republican victory on Tuesday night would almost certainly spark an initial shift into Donald Trump's favorite metal -- not least because of the risk of a dollar rout, which tends to lift all commodities priced in greenbacks. But the movement isn't one way: As Bank of England Governor Mark Carney has seen since June, currency weakness can feed back into stronger inflation, which central bankers may try to tamp down with higher interest rates, in turn decreasing the attraction of holding a commodity like gold that doesn't generate income.

That's the best case for gold. Should Hillary Clinton win, the prospects are considerably worse. Economists polled by Bloomberg already expect the Federal Reserve to lift rates to 1.25 percent by the end of 2017, from the current 0.5 percent, presenting a formidable headwind to dollar investors in the metal. And while that net long position has decreased from the June highs, it's still about 50 percent above its five-year average levels, suggesting there's further to drop if investors shift into alternative assets once the geopolitical storm has passed.

Who's Buying?
Central banks and ETFs are the marginal buyers and sellers of gold, but jewelry and bullion are the biggest consumers
Source: World Gold Council

Jewelry demand is already looking weak at current elevated prices, and without the mass of negative-yielding debt in Europe and Japan, prices would probably be lower than they are. The last time investors turned net sellers of gold, in 2013, prices fell for three straight years. Those net longs should take care: In the right conditions, even the firmest bedrock can turn into a landslide.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net