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colchure
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I am a macro investor focused on gaining value from current deviations away from historical norms. In particular I am interested in the psychological behavior of investors, more specifically how cause and effect can be misinterpreted. I believe such 'logic inefficiencies' can create great... More
  • Commitment Of Traders Report 3rd September 2012 0 comments
    Sep 10, 2012 11:53 AM

    Last Monday I updated members on the large shifts in trader positions in the gold and silver futures markets. I noted that the managed money had aggressively taken off its short hedges and at the same time the commercial traders were happy to go short against them and take the other side of the trade. My theory was that the managed money were getting exuberant on the metals and as usual the commercials were happy to oppose this and wait to cash in on the inevitable correction. Historical COT data shows that when managed money gets very long, large corrections are usually near. Likewise when the commercials are getting aggressively short, the same applies. Therefore the shift in trader positions was suggesting that a correction was looming. However I wrote the following warning at the end of last weeks pieces:-

    "I want to add a warning however, to those who are almost certain of an imminent PM correction. We have come from an unusual positioning by the commercials and managed money. Over the last months they have in essence both been positioning contrarily as far as historical data shows. So although the changes last week in their positioning were large, due to their odd positioning of the last few months they have not returned to extreme levels, but are rather neutral- in a sense they are saying they do not know which way PM's will go from here. My experience of PM's says they can far exceed all reasonable technical indicators, chart patterns and resistance, before reversing. Therefore I am not going heavily short yet, but want to see one more rally into the end of this week- hopefully this will convince everyone that PM's are going to the moon- then, although it will be tough to do so, is the time to go short. IMHO"

    This week's action has proven my warning prescient and we have seen the PM's exceed all reasonable expectations in such a short time. Technical indicators are now at breaking point, resistances have been smashed and most importantly traders are getting incredibly bullish. Even on this site members are talking about 'bears getting smashed', 'puts becoming worthless' etc. Now these views may be proven correct, but the strange thing about PM's (especially silver) is it's near mystical ability to sweep traders along with its extremity. We see this time and time again- traders begin to short silver, it then makes a huge move against them, and then those who get caught feel annoyed and start to completely change their view to the long side. Then of course silver drops like a lead balloon.

    So, against this background what does the COT say this week?

    I noted last week in a chat with a member that if the short position of the commercials did NOT increase and the managed money did not increase their longs, then I would actually become very bullish as this would imply that we have not reached the extremes of COT that usually prefigure corrections. Well I needn't have worried about that, as the data shows the complete opposite- Managed money reducing their short positions even more aggressively and adding longs and commercials grabbing as many shorts as they can find. This in my opinion is NOT bullish- it is in fact exactly the behavior we see before major corrections.

    For silver the following occurred:

    Commercials increased their short positioning from 32k to 38k contracts net short- this is their largest short position since Feb. 28 2012 (the leap year massacre as i call it) Managed money reduced their short hedge by a massive 46% and added 46% to their longs. (since July 21st Managed Money has covered 71% of their short hedge!) This short covering is no doubt the reason behind the price behavior of the white metal. Surprise, surprise, Managed Money now has its highest long position since Feb. 28 2012- the day before silver plummeted 4.7% in a day.

    One interesting detail is that open interest actually declined overall- this suggests that more shorts were covered than new longs bought and that a lot of the recent price action is being dictated by the physical market rather than the futures. The physical market is much more robust than the futures and so this suggests that a correction may be less extreme than if the futures market was calling the shots.

    For gold the picture was much the same:

    Managed money is showing no fear and has added 21k lots to their long position- -their largest long position since march (gold about 1645 and in midst of correction) Since May managed money has covered 64% of their short hedge. Commercials increased their shorts by 18.9%- the biggest one week increase since July 2011.

    Conclusion:

    The COT data is showing the same action it always shows before major corrections in the PM's. This is no guarantee of a correction tomorrow, but it is food for thought. From my point of view one has to weigh up the risk reward here. Yes, PM's could go parabolic (they have done before despite equally extreme technicals) but there is mounting evidence that they are overextended and that the traders who usually make all the real dough (the commercials) are not buying this spike for a second. Two months ago the commercials were signaling that they did not see much more downside in the metals- i wrote at the time that although it may take time the likely direction was therefore up. This eventually has come to pass. Now they are saying the opposite- and if you add this to the technicals, the over bullish sentiment and the fact that QE has not even been announced let alone implemented, you have to wonder how much legs this rally has left.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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