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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
  • Weekly Precious Metals C.O.T Report 21/09/2012 1 comment
    Sep 25, 2012 6:00 AM | about stocks: GLD, SLV

    Trading and Poker have a lot in common. They are both zero sum games. I win chips, you lose chips; your clever winning trade is my miscalculated loss. Both involve chance, but equally they can also be dominated by someone who has an edge; someone who can pick up on 'tells', apply the odds and execute a well-conceived strategy. Poker pros and pro traders always stress the importance of money management and swear by the maxim 'the first cut is the cheapest'- in poker parlance- don't be afraid to fold your hand. Equally, when the situation warrants, to be successful you also have to be aggressive. Traders talk about 'running their winners', poker players about 'not being pushed off a good hand'. As the old song goes-

    'You got to know when to hold 'em, know when to fold 'em,
    Know when to walk away and know when to run.'

    Clearly this knowledge is a product of experience. The more hands you play, the more trades you make, the greater your understanding of the potential situations you are likely to be faced with. I am a trader who believes that markets are not simply random, but actually follow repeatable patterns and so past lessons can be put to good use in future trades. The market is simply a very large poker game- and as any poker player will tell you, people bring their personality to the game. They do not act randomly, or at times even rationally. While the cards remain reliably constant, it is how those cards are played that counts. One man's raising hand is another man's fold.

    So what has this got to do with the C.O.T? Well in essence the C.O.T is a measure of trader sentiment- it shows how the largest traders of silver and gold are positioning. Those traders have distinct personalities. What may be bullish if held by one group of traders, is actually very bearish if held by another. Like in poker there are often two competing interpretations- 'is he raising big because he has a good hand and wants me to put more money in; or is he raising big because he has a terrible hand and wants to scare me into folding?' Both are possibilities, and it is only after careful study of the player and the situation that the likely interpretation can be extracted.

    The traders listed in the C.O.T have various characters. In a poker game, there are the suckers and there are the seasoned pros- those that just dabble, and those who play all day long. I like to think of the 'commercial' category of traders as the sharks in a card game. They spend all their waking hours exclusively playing this one game. They have the biggest bankrolls, and the greatest patience. They've seen it all before and aren't intimidated by some of the more casual players who try their luck. Some of these commercial traders are known as 'Producer/merchants'. They are a bit like a house player working for the casino- employed to generate 'action'. The casino is of course the mining companies and they back these traders with a huge bankroll- hey they make the chips! The Producer/merchant traders can therefore make some very big raises. And equally they can call some very big bluffs. Only rarely can other players make these traders fold- but when they do get the better of them, the pot is huge. Another type of commercial trader is the Swap Dealers. They are a slippery bunch- very aggressive, but equally able to change their mind at the slightest hint of trouble. Unlike their friends the Producer/merchants they don't answer to the casino and are not expected to create action. They can sit out the game for long periods and then appear with a huge raise when they feel they have an edge. The Swap Dealers are also very confusing players. Often they will have hedged their exposure with other pros, so even when it looks like they are 'all-in' sometimes they have nothing to lose.

    Then there are the 'non-commercial' traders. I think of these as the amateurs at the table. Usually the commercial traders get the better of them. However, within this category, some fare better than others. Traders classed as Managed Money are wealthy and clever players who have very large bankrolls. Sometimes their bets are so big, even the producer merchants get scared. Unfortunately they have a weakness- after a few winning hands they get over-confident and make bigger and bigger raises. The commercials get wise to this and eventually call their huge bluffs- it takes the commercials a while but usually the Managed Money give all their winnings back. Finally there are the small category traders, the 'Non-Reportables'. These are the real suckers. These traders lack discipline and patience and get easily distracted by nearby craps games and roulette tables. Usually they sit at the sidelines watching the big action brought by the Managed Money, but are too nervous to get involved. Finally they work up the courage to sit down and play. They try and replicate what they have learned from Managed Money. During a huge pot the Producer/Merchants raise All-in. After some thought Managed Money finally folds. The Non-Reportables, having waited all night to play, can't bear to give up their hand. They call the All-in. The Producer/Merchants smile and show a pair of Aces. In horror the Non-Reportables watch helplessly as the dealer sweeps all their chips towards the commercial traders.

    Most of the time the various traders listed in the C.O.T report play according to type. Last week was a good example of this- nothing much to report. The Managed Money had got excited and was increasing their bets. The wily Producer/Merchants were happy to call the Managed Money raises, but were not yet re-raising themselves. The Swap Dealers were siding with the Producer/Merchants and the Non-Reportables had begun to dip their toes in, influenced by the big bets of the Managed Money.

    This week however something has changed. If you simply looked at the headline numbers then it would look relatively normal. In Silver, as the white metal gained $1.32, the Commercial category added 3K short contracts to their large 47K net shorts to make a high 50.5K net shorts (highest since April 19th 2011). This is what one would expect to see. However delve a little deeper and something very strange is going on with the Commercial category traders. The Producer/Merchants, who almost always increase shorts as Silver rises actually reduced, their net shorts by 9.7k contracts! The main C.O.T report only shows the total position of the Commercial traders- this is what most people look at, and it hides the individual positions of the traders within that sector (to see the individual trader positions you have to look at another report called the D.C.O.T). The D.C.O.T showed that while the Producer Merchants were unusually getting longer, the Swap Dealers actually went from 5K net long to 7k net short- a total change of an enormous 13k contracts! The change in Swap Dealer positioning was so large it cancelled out the strange Producer Merchant long positions and made the headline C.O.T report look normal- i.e silver rises Commercials get more net short. What on earth is going on? The picture gets even weirder when we add the Managed Money into the mix- they have been adding longs with gusto the last few weeks, but this week only added a tiny 837 lots to make a total of 27.5k net long. Yes, you read that right- the Managed Money who usually gets overexcited as silver rises and raises even larger, suddenly lost interest.

    In Gold the picture is weirdly similar. As Gold added 39$ the Commercials added a reasonable 5.3% of 12.5k shorts to increase their net shorts to a very large 249k net shorts. The D.C.O.T reveals that within the commercial category the same thing was happening as in Silver- Swap dealers changing their positions in such a big way it cancelled out the Producer Merchants actually getting longer (the Producer Merchants reduced their net shorts by 1.5k and the Swap dealers went short a massive 14k contracts)! The report also showed another worrying development- the Non-Reportables (remember them- the suckers) increased their longs by 3K to a 58k contracts net long- the highest long position they have ever had since records began.

    So what do we conclude? Well as mentioned earlier the traders have very distinct personalities. If they begin to change their personalities, and the report is showing some unusual activity, then we have to reassess how reliable our reads are on these players. At present I would advise caution until we get more information on why these players' styles have changed. As they say in Poker- If you can't spot the sucker at the card table, then it's probably you!

    Stocks: GLD, SLV
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    hmm. Not sure I understood much of this (not my field, really) but did come away feeling beware the hand that feeds, lest it turn round an bite unexpectedly...
    12 Nov 2012, 05:44 AM Reply Like
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