By Chris Igou, analyst, True Wealth
“It’s hot, don’t touch it.”
I remember hearing that often as a kid.
I wasn’t allowed in the kitchen much. My parents couldn’t trust me.
The problem was that I hadn’t been burned yet. And the excitement of seeing what was on the stove made me forget the concept of consequences.
Of course, after getting burned a few times, it didn’t take long for me to stop reaching. It’s not always so easy to learn the same lesson in investing, though.
As contrarians, our goal is to avoid betting with the crowd… But it can be tough. Seeing everyone pile in during a rally can make you feel left out. You want to reach out and see what you’re missing.
History shows that following the temptation is how you get burned. And that’s the big risk in the gold market right now.
Let me explain…
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Following the crowd is a surefire way to get burned… It’s a simple as that. And thanks to recent global tensions, the crowd loves gold.
That’s no surprise. Gold is often referred to as catastrophe insurance. It goes up when bad stuff happens. In recent months, we saw tensions flare between the U.S. and Iran. Then, the coronavirus fears took over.
Both events pushed investors to bid up the price of gold. And it has led to hugely positive sentiment for the metal.
Bullish bets on gold prices recently hit record levels based on the Commitment of Traders (“COT”) report. The COT report is a weekly report that tells us what futures traders are doing with their money.
Importantly, if futures traders are all betting in one direction, the opposite is likely to happen. And futures traders are all betting on higher gold prices today. Check it out…
To put it simply, a high reading on the chart means futures traders are bullish. They hit hugely bullish levels last July… And now, recent events have pushed us back to those highs.
History says that this is a bad sign for gold bugs.
Remember, futures traders tend to pile into a trade at the worst time. Extreme bets in either direction can lead to major reversals. We saw this in 2011 and 2016…
Futures traders were “all in” both times… and gold prices fell hard.
Bullish bets on gold peaked in early August 2011. Gold prices peaked just weeks later and fell 19% by May 2012.
We saw a similar move in 2016. Futures traders hit peak bullish levels in early July that year… And gold prices fell 17% by mid-December.
Gold prices have spiked recently. But history says it’s now a crowded trade. That makes avoiding the metal a smart bet for now. Otherwise, you’ll likely get burned…