In the latest Commitment of Traders report (COT), we saw more of the same as speculative positions in both gold and silver rose to new all-time highs. We have been a broken record, as over the past month or so we have seen new highs breaking new highs, but there are a few observations about the make up of the participants in this report that should be of interest to investors.
We will get a little more into some of these details, but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
About the COT Report
The COT report is issued by the CFTC every Friday to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.
The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three-day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.
There are many different ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the experts on it. What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
This Week's Gold COT Report
This week's report shows another large increase in gold speculators while shorts also slightly increased.
As investors can see, for the fifth week in a row, speculative longs increased their positions by a beefy 18,236 contracts, while shorts got a bit braver and increased their own positions by 4,494 contracts. Speculative long positions are now at an all-time nominal high of 315,643 contracts long - and since the gold price is higher than it was on Tuesday's COT report close, we're probably higher in the current long positions.
The net position of all gold traders can be seen below:
Source: Sharelynx Gold Charts
The red line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, speculative traders are going parabolic as they reach another all-time high in net positions at over 287,000 contracts net long. Of course, with any long there must be an associated short contract, and swap dealers are the ones that are primarily taking the reverse end of this trade.
Before we move on to silver, another interesting tidbit that we commented on last week was the unexpected lack of short interest by the Producer/Processor/Merchant category. In our view, these are the "smart money" in the commodity industry as they are naturally intimate with the market by the very fact that they supply the physical commodity to clients and end users. By default, they tend to be heavily short the commodity simply because they use futures as a means to hedge their existing inventory. That's important because that means they tend to be very unemotional holders of their positions and are less apt to panic on either the upside or downside of a commodity rally.
So the combination of their emotional discipline and their first-hand knowledge of the market makes them the smart money in the report. So what is interesting here is that instead of seeing a large increase in short positions to correspond to the rising gold price (which tends to happen when the price moves up), we actually saw an increase in net long positions on the week - albeit slightly.
While we don't want to read too much into this, for the bulls this is definitely a positive factor as it may suggest that the commercials are hesitant to lock-in current gold prices and they may think the rally has legs. Or it may mean that on hand physical inventories are lower than expected, and thus there is no need to hedge on the short side what is not physically owned in inventory. It is one week and it is only a slight increase, but it is definitely worth noting.
As for silver, the week's action looked like the following:
Source: Sharelynx Gold Charts
The red line, which represents the net speculative positions of money managers, increased by a little more than 2,000 contracts while shorts decreased by a minute 152 contracts. Silver speculators weren't as bullish as gold speculators, but their trend was still similar and the silver market speculators are way above their 2011 all-time highs.
Our Take and What This Means For Investors
Before we get into our investment take, one thing we wanted to make clear to investors is our purpose in writing these articles and how it relates to our position. Unfortunately, gold is almost a "financial religion" where emotions run high and you're either hated or loved based on your stance. While this may make for a lively comments section, it is not a way to invest or to evaluate bullish or bearish articles - there's always a time to buy or sell based on circumstances. That is how we invest our money and we would strongly advise all investors to do the same, but unfortunately there are plenty of very emotional gold bulls and bears out there.
Having said that, our position on gold is that we believe that gold is an excellent long-term bullish investment due to a number of factors which we have outlined in previous pieces. But for the COT related articles, we are not talking about whether gold makes a good long-term investment (it does), but rather, what should investors do in gold in the short term. Just like any other investment, gold can have some very large short-term swings and that can give investors an opportunity to use contrarianism to take advantage of excessive optimism or pessimism. That is why we write these articles.
So based on this latest COT report, what is our stance on gold?
We have been bearish on gold for a number of weeks now based on the fact that speculative traders have just overwhelmed the market on the bullish side, and that has continued this week as we have once again broken an all-time high in net speculative longs. Based solely on that, we would maintain our bearish position.
But one interesting thing that bulls will hang their hats on is the fact that over the past few weeks, we haven't seen commercials/producers significantly increase their short position as they traditionally do in large upward moves in the gold price. In fact, this week we actually saw a slight bullish increase in their positions - very strange considering the large jump in gold prices.
If producers are not increasing their short positions because of a lack of desire or inventory to hedge, then that would completely change our view to being short-term bullish on gold again. Any kind of physical deficit in the market would be a major problem if its paired with growing investment demand and thus we could see gold rise back to the all-time highs we saw in 2011.
It's a bit early for us to say that based on only one or two reports showing a slight increase in commercial long positions for the week, and we are still giving much more weight to the fact that speculators are blowing past all previous highs in terms of their bullish optimism on the gold price. Throw in the fact that the CME is trying to limit volatility by raising gold and silver margins, and there is a strong argument to return to a more normal positional median which would mean a decline in the net long speculative positions and probably the gold price.
It is very tough not to be short-term bullish here as both gold and silver seem to rise every day regardless of news as evidenced by a normally bearish-for-gold excellent jobs report that only led to another rise in the gold price. But we have to be disciplined here and thus we are maintaining our core gold positions and that is it. We believe investors need to be taking profits here in gold positions in the ETFs and miners such as the SPDR Gold Trust ETF (NYSEARCA:GLD), the iShares Silver Trust ETF (NYSEARCA:SLV), the ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), and miners such as Randgold (GOLD) and Barrick Gold (NYSE:ABX).
As we said last week, we think gold will rise much further in the coming years, but emotions and not fundamentals are ruling here and it is too crowded of a trade for us to be long with anything but our core gold position (which we maintain). We want to get back into gold but we want a much better entry point.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SGOL, SIVR over the next 72 hours.
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.