Record Speculative Long Position in Silver Futures

There’s a thing about records. They continue until, they don’t. A string of record weather continues until it changes. Similarly, markets can be continually propelled until they aren’t. Such is the case with the current silver market. Speculators in the silver futures market have set net long and total position records in each of the last three weeks. This has led to a significantly overbought market that is due for a correction. Once a catalyst is provided, whether it be an FOMC announcement or some other data point, the speculative washout should be substantial.

We frequently discuss the imbalance of positions between the speculators and the commercial traders because these imbalances create the turning points we look for as swing traders. Commercial traders tend to push the market in trends. They are the ones who know whether they’re facing a shortfall or, surfeit of the commodity in question and adjust their business plans accordingly. Therefore, when commercial traders are selling silver futures, they’re locking in future delivery prices for silver contracts they intend to mine and deliver. Their actions in the futures market provide an indication of their forward outlook on fundamental prices. This makes the record setting forward selling of futures contracts exceptionally noteworthy as it clearly states that they don’t believe they’ll be able to sell their silver on the open market once it’s mined at the prices currently being traded.

The speculators, on the other hand, base their actions on numerable factors but they’re all subscribed to the task of creating more money from the money they’ve invested. The speculative trading category is prone to, “group think,” and I believe this is a larger repeat of the idea that easy monetary policies across the globe will lead to an inflationary environment. This has pushed speculators into the silver market at an unprecedented pace both in overall bullishness and in total position size. Unfortunately for speculators, their track record since the silver market made its 2011 high has been very poor. Several recent rallies have been led by the large speculators only to get washed out upon silver’s next decline. We see this situation repeating itself, now. Large speculators are traditionally trend followers; this leads to adding on to existing positions as they become profitable. In this case, it has led to the purchase of nearly 37,000 contracts at prices above $17.25 since mid-June.

Below is the recent Commitments of Traders report. This is published by the Commodity Futures Trading Commission and breaks the market’s participants down into four broad categories. For our purposes, we’ll focus on the interaction between the commercial traders labeled as, “Producer/Merchant/Processor/User,” and the speculators labeled, “Managed Money.” The commercial traders are clearly hedging forward production as can be seen by the 77k+ short contracts they’re holding compared to their 20k+ long contracts. These numbers shift as a given market becomes over or, under valued and the commercial traders hand the controlling interest baton from the Producers/Merchants to the Processor/Users. This action helps define the support and resistance levels we find so crucial in our swing trading approach to the markets. Finally, note that the long/short ratio of the commercial trader category stands around 3.7 short contracts for every long contract.

The Commitments of Traders report provides a weekly tally of the market's major players and their actions.
The Commitments of Traders report provides a weekly tally of the market’s major players and their actions.

Now, let’s look at the speculative side of things via the, “Managed Money,” category. This data is compiled on a Tuesday and released on a Friday for the previous week’s action. This means that nearly 6k new long contracts were added by the speculators at prices between $19.77 and $20.615. This also makes the recent lows just above $19.25 incredibly important technical and psychological support. Finally, applying the same math to the speculative position shows that they are long a WHOPPING 12.8 contracts for every contract they’re short. This also stands as a record position. Large speculators have NEVER been this wildly bullish in the history of the silver market.

This weekly silver futures chart with net and total positions as reported in the Commitments of Traders report shows just how wildly bullish the speculators have become.
This weekly silver futures chart with net and total positions as reported in the Commitments of Traders report shows just how wildly bullish the speculators have become.

The alarm bells are ringing as the records continue to pile up. There’s an interesting inflection point in the commercial vs speculator balance of the market. The commercial traders work for existing businesses. These businesses have fairly predictable supply and demand needs. Once their needs are met, they have little interest in further market action. Speculators, however can turn the previously mentioned, “group think” into a stampeding herd as the media draws more and more attention to the developing story. This is part of the reason why record speculative positions alone, don’t immediately dictate a trade. We must first wait for some type of reversal in order to provide us with two key pieces of information. One, that the market has turned. Two, it provides a swing high against which we can place a protective stop.468x60

Moving to the daily silver futures chart below, you’ll see the discretionary trades that have been triggered by this approach. Each red or, blue circle indicates the entry signal. Each signal is sent with its corresponding protective stop order, which is placed at the recent swing high or, low accordingly. Each trade is triggered once our momentum indicator indicates a potential turn back inline with the commercial traders’ forecasted direction.

The daily chart shows the actual trades generated and sent by nightly email through this methodology.
The daily chart shows the actual trades generated and sent by nightly email through this methodology.

As you can see, we are currently short the September silver contract and have placed a protective buy stop, accordingly. Measuring the risk of a given trade should always be the first step in building a trading plan. In this case, it’s to the recent high at $21.225 on our Discretionary Cot Signals program and somewhat less than that on the Mechanical Cot Signals version I trade for our clients and myself.

The Federal Open Market Committee (FOMC) will make an announcement tomorrow that has the financial world on edge. Predicting the FOMC’s actions is difficult. Predicting the FOMC’s actions and the markets’ reaction to their decisions is virtually impossible. We’ve reached a point where every word is so highly scrutinized that it simply makes for unending TV babble. What does matter is knowing the construction of a given market’s internals so that the market’s reaction can be framed in a logical manner. Based on our experience, the markets rarely make it easy on the speculators.

The record position they’re continuing to build has come under no heat. Markets create pain for their participants. Most speculators exit trades due to losses. Remember, most speculators fail. I understand that these are the professionals in the Managed Money category that we’re dealing with but it’s also important to understand that the members of the Managed Money category also come and go. Speculative trading endeavors come and go just like the little guys. Therefore, we expect the FOMC to add considerable volatility to an already wild market. A volatile move lower could easily trigger substantial stop loss selling by the Managed Money sector.

Our plan is to sit with the short positions we’ve initiated and leave our protective stops in place. If history repeats itself, the majority of the action will be lower. Perhaps, considerably so.

Please visit Cot Signals for more information on our mechanical Commitments of Traders program as well as a free trial to the version of Cot Signals.


This material has been prepared by a sales or trading employee or agent of Commodity & Derivative Advisors and is, or is in the nature of, a solicitation. This material is not a research report prepared by Commodity & Derivative Advisors’ Research Department. By accepting this communication, you agree that you are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this communication in making trading decisions.

The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading advice is based on information taken from trades and statistical services and other sources that Commodity & Derivative Advisors believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades.