As gold drops, ETF traders pile in

Something odd is happening in the gold market. Despite heavy losses in recent days, it looks like ETF traders are buying the dip. That doesn't seem like a good sign for those with a contrarian bent.

Since gold peaked in August, assets in GLD and other funds have steadily climbed. According to Bloomberg calculations, total known ETF holdings of gold have increased by 1.7 million troy ounces since the metal peaked on August 6.

Zooming out, we can see that ETF assets tend to closely track the price of gold. Partly that's due to traders reacting to price changes, and partly it's due to those very flows driving the price itself, especially as these funds get larger.

The trouble with assuming this is a negative for gold is that it's knee-jerk contrarianism, the worst kind. So let's go back as far as we can and look for similar declines in gold that were accompanied by increases in ETF assets.

Other times gold dropped by at least 9% over a 34-day period while gold ETF assets rose at least 1% during the decline, gold rallied over the next 2 months every time. Granted, only 2 of those were since the bear market began in 2011, but still that may be a surprising result.

For gold miners, it also tended to be a good sign, with one major medium-term loss in 2008.

Are there troubling signs for gold here? Sure. The breakdown out of its triangle pattern is concerning. While the initial move out of these patterns is often a fakeout, the longer gold declines, the more likely it denotes a change in trend. But this supposed "buy the dip" mentality among ETF traders is not a reason to join the sellers.