'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!

Anyway, back to the COT. What we have seen as Silver and gold have risen hard over last week is an expected heavy resistance by the commercial traders who have sold short into the rally. The commercials have now increased their historically low short positions from an incredibly low 13% to 25% in silver and 37% to 43% in gold. Furthermore this only takes into account the COT cut off date of last Tuesday- I expect that for the remainder of the week they will have added even more shorts. On the other side, the managed money closed their unusual large short hedge in the metals. In gold the managed money closed a massive 32% of their short hedge and in silver 58% of their shorts were closed. This huge short covering explains the very large moves last week- especially silver.

The COT therefore shows what one would expect to see- managed money rapidly exiting short hedges and the commercials more than happy to go short against them. In conclusion, the more usual state of affairs has returned- commercials looking to get short for a coming dip and managed money getting overexcited on the long side. The historical data shows that managed money usually gets burned with PM's- i.e they get too long before crashes and too short before rallies. Their hasty exiting of shorts makes me think that the correction Avi is talking about is likely. Furthermore the commercials, having done very nicely by not being short this last rally are now getting short again- the historical COT shows, commercials usually position correctly.

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

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

"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.

So now we find ourselves after a huge rally in the inverse position we did all those months ago at 26. Instead of more downside being called by many commentators, suddenly it seems everyone is predicting higher targets. Once again as we reach extremes in the market, the COT becomes very helpful if we use it in a binary manner- i.e it either contradicts or supports the historical norm for COT data. For example the most unusual thing right now would be if the COT report was showing a falling short position by the commercials and a low long position by the managed money (if in effect the COT positioning at $26 silver was similar to now, $6+ higher). If the COT showed this I would probably be selling my house and buying all the silver I could find because this would signal that unlike all previous rallies, the commercials were not opposing this one and the managed money were not getting overexcited- in short the COT data would be a massive contradiction compared to its historical norms. Unfortunately for any members who have just sold their house and bought all the silver they could find- the COT is not contradictory at this time. In fact it is running with all the predictability of a finely oiled machine- as prices get higher the commercials get shorter and the managed money gets longer. Last week this situation increased over the week before; this week it has increased over last week. Both weeks the prices of metals were higher than the week before. In essence the COT, if looked at from a binary perspective, is saying what it always says when prices rise too fast too far- this rally isn't going to last!

Lets look at the numbers:

In silver while prices rose 4.7% Tuesday to Tuesday, the commercials increased their net shorts by a large 6.3k contracts, and their shorts as a % of open interest is now 37.6% (up from 31.7% last week) - the highest level since Feb. 28th 2012. The sub section of the commercial category known as producer merchants strongly opposed the rally and added 10% to their net shorts (producer merchants are usually the slowest to react and so once they start opposing rallies heavily with shorts, time is running out for the bulls).

It is worth noting that open interest in silver actually fell this last week- this means that shorts are being covered quicker than longs opened, and suggests that the price rise is being dictated by the physical market. This is unusual and is something to keep an eye on. If it continues then it may indicate something else is going on- i.e there is a shortage of silver available for delivery or that price discovery is being slowly moved from the comex to the physical markets. Until i see mass backwardation in the futures strip, for now this is simply something to keep in mind, especially as it is not occurring in the gold market.

In gold the numbers were even more bearish than in silver. As gold rose 1.7% Tuesday to Tuesday, to 1695 the commercials added 7% to their net shorts and they are now short a massive 49.4% of the entire market. The highest since Feb. 28 2012. Since July the gold price has increased 7.3% but the commercials have increased their shorts by 61%- this is a very large increase relative to the price gain. Unlike silver, open interest rose and so price discovery is clearly being led by the futures market.

Conclusion:

The COT will never tell us with accuracy of a top or a bottom. Most of the time the COT data is useless. However, if used in a binary sense- if the data is looked at relative to past data and only heeded at extremes it can be very useful. Back at $26 silver it signaled a rare contradiction- it showed commercials were unusually small in their short positions, despite price stabilizing for some time in the 26 range. This was very useful and could be traded upon from a longer term perspective (i.e buy Silver 40 puts expiring in Feb. 2013) as it put a floor under the price of silver with high probability. The trader could then exit his position if the COT data began to change, or as happened, simply wait for silver to break out to the upside as the COT report suggested would occur. We now find ourselves in a different situation- in effect we are in a 'normal' COT situation that happens again and again during rallies in Pm's- Commercials getting shorter and managed money getting longer. It is vital to understand that although this is the opposite COT situation as when silver was at $26, it is not equally 'important' . This in fact is the 'norm' for COT reports. Back at $26 we saw something very strange, what we are seeing now is completely expected.

The COT report is a bit like a grouchy neighbor with a very short temper- a party pooper. As the houseparty gets wilder, the COT trying to sleep next door gets more opposed to the revelry. Sometimes the party can go on a long time, the COT tossing and turning getting more and more angry. Often the COT rings the neighbor and screams down the phone- signaling the party must stop. Usually, those partying ignore the neighbor on the phone and continue the party, perhaps even turn up the music. Eventually the COT has had enough- he bangs on the door, orders everyone out and calls the cops. The revelers, who only minutes before were enjoying the time of their life, wander dazed through the cold streets searching for a cab home.

Recently with silver at $26, grouchy COT did something extraordinary he had never done before- he saw his neighbor bringing supplies in for another party, and catching his young neighbor's eye, he said in a gruff voice, 'have a good party, just don't let it get out of hand.'

We have seen old COT begin to mellow. It is a fascinating thing to watch. Although it hasn't happened during this latest rally, I am always looking for the final act- the party to end all parties. You know how I'll know it is beginning?

At midnight, as the party begins to rock there will be a sharp knock on the door. The revelers open it to find grouchy COT standing on the porch, holding a bottle of Jack Daniel's. 'Mind if I join?' he asks, a grin on his face....

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