For investors holding gold ETFs (GLD, SGOL, PHYS) and gold equities, it is critical to know the direction of the gold price. For that purpose, we analyze the weekly COTS report issues by the U.S. Commodity Futures Trading Commission (CFTC) to get a reading on where large traders are positioning themselves in the gold market. I will not go over the basics of this report, but investors unfamiliar with the report can read an earlier post where I discuss what it is in a little more detail.
In last week's COTS report, we saw a slight decline in the nominal Managed Money (MM) short positions and that they had stabilized slightly below the all-time record highs achieved 2 weeks ago (COTS Report for 2/26/13).
This Week's Gold COTS Report
This week's report shows that speculative traders were once again very bearish on gold and increased their short position to a new all-time high - surpassing the previous high we witnessed two weeks ago.
The MM short position hit a new all-time high of 68,760 short contracts, with traders making up for last week's brief short covering with a larger increase in shorted contracts. On a percentage basis, the 38.81% short percentage is the third highest ever for the COTS report and is inching closer to an all-time high on a percentage basis as well.
As I have mentioned before, the report is always a bit dated and shows the positions as of Tuesday. But since the price closed around $1579 for the reporting period and is still at that level as of this article's publishing, we would not be surprised if the real-time positioning is very similar to the positioning detailed in this report - which would make this report much more important.
Below is a table that shows all the previous data points that have a short interest greater than this week's short interest. In addition, we have added a table that shows the corresponding gold price change that followed the previously listed positions.
Click to enlarge
Click to enlarge
As you can see, almost every time that there has been this large of a MM trader short position there has been significant rallies that followed. Though to temper the enthusiasm, the only time that we have not seen a rally over the following two-week period was the most recent period - which we saw a slight decline in the gold price.
We do believe that the short-term sentiment towards gold and silver has changed and there is now starting to be a very positive bias. One example of this was evident last Friday (3/8/13) when a positive US jobs report caused a large initial drop in the price of gold and silver, but after that drop, buyers came in quickly and propelled the price of both metals back up to the pre-jobs report levels. This was a significant change in behavior than what we have normally witnessed over the last few months in the gold markets (which would have probably seen the gold price drop lower and stay low for the day after that report). Investors should pay close attention to this behavioral change because it may signal that the long-awaited bottom in the gold price has finally come.
In relation to the COTS report, any change in sentiment is very important because it may catch quite a few MM players on the wrong side of an upward move in the gold price. The COTS report is telling us that the MM traders are at historic short levels, and if a move upwards does occur, a very large amount of these traditionally fickle traders will rush to cover their shorts - which should lead to a significant increase in the gold price.
Sentiment is changing in the gold market and a very large number of MM traders still have huge short positions in the yellow metal. This is setting up gold (and silver) for a major short covering rally that may catch investors by surprise. Short-term traders need to remember that the major money is made when a trader is able to correctly position himself for these "change in sentiment" moves.
We have been warning investors for the last few COTS reports that they should not trade small price fluctuations in the gold and silver price for tiny profits. By doing so they may risk missing a major move to the upside - which we fully expect with this very large short positioning. It is a huge MM short position (the largest on record in the COTS report) and is a ticking time bomb for the shorts, and could provide for a very quick jump in the gold price if a few decide to cover and throw the rest into a panic.
GLD, PHYS, and gold investors should hold their positions or increase their exposure and not play the price - the biggest gains could be seen over a single or a few trading days. While those 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.
Disclosure: I am long PHYS, PSLV, SGOL, SIVR. 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.