This week, we’re going to take a step back and look at the big picture in the gold futures market through the eyes of the Commitments of Traders report. We’ll discuss how to use it to spot tops in the gold market, specifically but note that the fundamental thesis behind this piece holds just the same for every commodity market we trade. Finally, we’ll look at the current projections for the commercial traders’ most bearish net position since December of 2012 when gold was trading at $1,700 per ounce.
Our trading is based on the analysis of the Commodity Futures Trading Commission’s (CFTC) weekly Commitments of Traders (COT) reports. This report separates the market’s largest players into four primary groups – Producer/Merchant, Swap Dealers, Managed Money and Other Reportables. These categories are pretty self-explanatory. The Producer/Merchant category is made up of gold miners’ and refiners’ production against end line industrial and jewelry production for consumption. These are the people who pull it from the ground or need it to fuel their business model. Swap Dealers exchange physicals for futures. Managed Money is exactly what it sounds like. It’s made up of CTA’s and RIA’s and all the rest. Other Reportables are the large individual and family office positions, endowments, etc. Most of our research focuses on the relationship between the Producer/Merchant and the Managed Money categories. Although this week, we’ll also look at the impact of the Swaps Dealers on the underlying futures markets.
Let’s begin with a look at the CFTC’s weekly COT report. Notice the column headings are exactly as we discussed. Moving onto the data, you’ll see that they report total long and total short positions for each category along with the corresponding net change from the previous week. The Commercial/Merchant category stands at 24,190 long positions and 150,685 short positions. Gold producers are six times more likely to sell their forward production at $1,225 per ounce than end line gold users are willing to purchase gold at the same price. This is a large disparity even after it has drawn a bit closer over the last week as evidenced by the 4,332 long positions added as opposed to only 560 new short positions added. Finally, note the Swap Dealer action. Swap dealers are the hedge intermediaries. Physical gold bought by a swap dealers on the open market is then sold in the futures market. The swap dealer hopes to keep the physical metal advantageously priced against the futures. For this purpose, notice that swap dealers took on 8,604 contract’s worth of physical gold over the last week and that their total position shows they’re executing short hedges at nearly a 2.5 to 1 pace.
Let’s look at how this action plays out in the underlying market. Remember, we’re tracking the collective actions of the gold miners and their counterparts, the end users. Their actions are based on the business decisions, pricing models and consultations of the biggest brains in each of their respective markets. Their livelihoods are tied directly to the accuracy of their forecasts without the ability to broaden the portfolio or simply side step a choppy or irrational market. You can see profit and loss from their gold trading and other markets in this equity curve as well as constructing your own to meet your individual investment needs.
Each vertical red line represents a selling climax in a given move by the gold miners. Many of these tops represented multi-week highs even on the way up towards $2,000 per ounce. Obviously, on the way down, general market momentum acted in their favor with January’s rally being the first significant new high in more than two years. This rally pushed the market above the sideways channel that had been the market’s dominant feature. The action that has taken place since breaching the channel in February is the determining factor of whether gold has reversed and will find support to trend higher or, if this is a sucker’s play.
We’re betting on the sucker’s play…and so is the most bearish net commercial position since December of 2012 when gold was trading at more than $1,700 per ounce. Perhaps, even more telling is the notion that the commercial traders tried their best to support the market, having set their most bullish position since December of 2001 just this past November. Very rarely do we see the commercial trader population switch sides that quickly and that forcefully. Additionally, their currently bearish net position becomes even stronger when deeper analysis reveals they’re also carrying the largest total position in 18 months.
All of this points to the current rally above the channel as being an important price level. I’d add that the market could come back to long-term moving average support near $1,185. We also expect to see small speculators come back on the buy side upon a return to the $1,150 – $1,185 area. We’ll track the commercial traders’ actions and publish our Commitment of Traders’ signals, accordingly Finally, we’ll determine if the market is settling for new, structurally lower prices as producer selling pressure continues to push their totals through the upward trend of their net position in the bottom pane of the included chart.
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