Perhaps the first thing I ever learned about the importance of tracking asset flows was when I started to keep a notebook (not a computer, the paper kind - remember those?) of daily changes in futures open interest on the trading floor of the Chicago Mercantile Exchange (NASDAQ:CME), which is where I started my career some 30 years ago.
Identifying important changes in the flow of investor assets (which we have greatly expanded upon over the year to include mutual funds, ETFs, etc.) can help to identify a buying opportunity in an asset at the beginning of a new bull market. Perhaps more importantly, as was the case in early October of last year in the gold market, it can keep you from getting run over by an emerging bearish reversal.
The following charts and text (green highlights), an excerpt from our October 5th report (access requires subscription) on gold prices, is a good example of how to use futures open interest to identify important changes in market direction, often before they actually happen.
What We're Watching Today: Long Liquidation In Gold
Posted on: Friday, October 5th, 2012
Chart 1 plots COMEX gold, daily close only, since January along with its 200-day moving average (orange line) in the upper panel. The contract's total open interest (red line) and 10-day moving average (blue line) are plotted in the lower panel.
(Note: Total open interest is the total number of open futures contracts, both long and short, that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery. Open interest measures near term investor conviction in a price trend. As such, it typically expands in the direction of the trend, and begins to contract once the market decides that the trend is no longer sustainable.)
The pink arrow on the right edge of the chart shows that total open interest is starting to contract, below its 10-day moving average, indicating that those traders who were smart enough to start accumulating the contract in early August (see chart) are beginning to take a profit. Note that this same kind of liquidation, from a similar level in open interest, took place in early March - shortly after the late February peak was established - and led a significant $269 dollar per ounce, 15% decline in gold prices into the May lows.
Chart 2 displays a daily bar chart of COMEX gold since 2011 highlighting important overhead resistance at $1786 to $1821 per ounce, which represents the November 2011 and February 2012 benchmark highs (red) and the 61.8% retracement of gold's larger September to December decline (pink). This resistance is currently being tested.
This chart indicates why gold traders are apparently starting to take some profits. As long as this liquidation as shown in Chart 1 continues, then today's decline should continue.
COMEX gold actually peaked on the day this report was posted to our Research Center (subscribers can use the big gold button at the upper right corner of this screen to login), at $1802 on October 5th , and through this morning has thus far declined by $222 per ounce or 12%.
Meanwhile, total open interest in the contract has been slowly rising for the past 2 weeks…