For those investors holding gold and silver ETFs (GLD, SGOL, PHYS, SLV, PSLV) and gold equities, it is critical to know the direction of the gold price. In last week's Commitment of Traders (COTS) report, we started to see some very pessimistic positioning in gold, but in this week's report we are now seeing some very bubbly looking numbers for short positioning and this is something that should interest all GLD investors. Not only is it very BULLISH for gold, it suggests that we could see a significant move upwards.
In my last post I went over some of the basics of the COTS report, which I will not do again this week since there is a lot to cover, but please refer to that post for the basics.
This Week's Gold COTS Report
The COTS report is full of information, but I have found the most pertinent section to monitor is the Managed Money traders. This category of trader represents hedge funds and large non-producer traders, and they tend to be the most active and often change their positions between extreme optimism to extreme pessimism and back - which greatly influences the commodity price.
In the latest COTS report (reported for 2/19/13), we are seeing some levels of shorting by the Managed Money (MM) traders that are at, for lack of a better term, epic levels. I have shown the current levels of short interest below with some prior report comparison points.
In terms of short interest on a percentage basis, the size of this short position has only been higher on THREE other occasions in the COTS report's history (which dates back to 2006) and incorporates over 500 week's worth of data points. That means only 1% of the time has the position of Managed Money ever been this short on a percentage basis.
In terms of this short position on a nominal basis, there really is not much that I can say because it has never happened in this report's history. That is right - we have never seen a position for the Managed Money traders where they have been this many contracts short.
So what has the gold price done in the periods following these points of such large short interest? I have charted the results below for the 2-week, 3 month, and 6 month periods following these data points.
Every time the MM position has been at such a high short interest, we have had a significant rally that followed. Not only has the price risen significantly in the following periods, but as you can see from the two-week data points, the price has risen significantly in a short amount of time - which is a classic indicator of mass short covering.
Finally, the last thing that I think investors should pay attention to is the rising general open interest in this week's COTS report for the gold contract.
As you can see in the chart above, open interest is actually RISING as the price drops. This is important because this signifies that more players are getting involved in the gold market rather than leaving it for equity markets, as much of the financial media has been suggesting. Obviously, a few weeks does not give us certainty on this trend, but it is something that should be monitored in future reports.
The final thing that investors should know is that the COTS report was based on Tuesday's trader positions when gold was trading at $1607.75. Since then gold has dropped another $25, which means that the short data might even be MORE lopsided in terms of MM traders' true short positions - being even larger than what was shown in the report.
GLD, SLV, and gold/silver investors should be very bullish about this report because historically these huge short positions have laid the way to large future gains for the gold market if investors can be patient. As you can see in the previous charts, every single time we have reached these levels of shorted contracts for the MM traders, GLD has been significantly higher over the next 3-6 months.
Additionally, investors should be very careful and avoid trying to play a short-term fall (by trying to short GLD) for a few dollars worth of profit when the gold price could jump very high very fast. That is something you can see with the two-week charts, GLD had very large 2%, 5%, and 8% moves a mere two weeks later. Investors wanting a little more risk may want to invest in SLV or PSLV which usually correlate at a 2:1 ratio to GLD and PHYS - it may not be a bad time for investors to load up on silver to try and add to their gains on any rise in the gold price.
The battle taking place in the gold market has created a very large imbalance in the Managed Money trader positions, where a vast amount of gold contracts are being shorted. These large positions may make MM traders very skittish and any sign of a rising gold price may cause a number of them to head for the exits fairly quickly, and thus push gold up even higher. Gold investors need to be patient because we think there may be some large gains coming up in the next few weeks if something spooks these traders and forces them to cover their positions.
Disclosure: I am long SLV, PSLV, PHYS, SGOL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.