I spend a large amount of time analyzing how different types of traders are positioned in the futures markets. If hedge funds are super short the S&P, if copper miners are hedging their forward production at current prices, etc. I use something called the Commitments of Traders, or CoT, report for this. The CoT report is released each week by the Commodity Futures Trading Commission (CFTC) and reveals the trades made by different types of market participants. There are two main types of traders in a CoT report: commercials and money managers.
Commercials are the actual producers and users of a commodity that use the futures markets to hedge. A commercial producer in the corn market could be a farmer who sells corn futures to lock in his selling price. Likewise, a commercial user could be a coffee company that buys coffee futures to fix the price of their future inventory. Commercial traders are thought of as the "smart money," since they are in tune with the physical commodity business and likely have superior supply/demand information. The commercials for non-commodity markets are called dealers. Dealers use the futures markets to hedge the price risk of the financial products they sell to their customers.
The other main CoT trader type, money managers, is composed of hedge funds, mutual funds, and commodity trading advisors. These are speculative traders who have no interest in the underlying physical commodity business. Money managers are typically trend followers, going long when price has trended up and going short when price has trended down.
The CFTC releases four variations of the CoT report: 1) aggregated 2) disaggregated 3) futures only and 4) futures & options combined. Aggregated reports are a legacy format where swap dealers were included in the commercial category. Swap dealers can initiate a position in the futures market for a variety of reasons, and for that reason this site excludes analysis of swap dealers. The report below is disaggregated, where each trader type is broken out. The futures and options combined report converts positions in the options market to futures on a delta-equivalent basis. This website bases its analysis off of the disaggregated futures and options combined report.
The image above shows a raw CoT report from the CFTC's website. The commercials, or producers and users, are long 374,212 contracts and short 634,755 contracts of corn. Each contract is a commitment to buy or sell 5000 bushels. On a net basis, commercials are short 260,543 contracts. You might assume that this report is bearish since the commercials, or "smart money," are net short corn futures. This is not the case.
Analyzing any one CoT report in isolation is pointless. It is crucial to know not if commercials or money managers are net long or net short, but rather how extreme their position is relative to the past. The image below show how I analyze CoT data. The two lines at the bottom are five-year percentiles for the net position of each trader type. Consider the position of commercial traders over the past five years. If their most bullish position has been net short 12,363 contracts, and their most bearish position has been net short 664,368 contracts, then the CoT report figure of net short 260,543 contracts translates to a five-year percentile of 62%. A percentile of 100% would translate to commercials being more net long than they've ever been in the past five years.
CoT data is most meaningful at extremes, when either commercial traders or money managers are super net long or net short. I define five-year percentile extremes as being above 90% or below 10%. Look at the above graphs. In late 2013, commercial traders (black line) were more net long corn futures than they had ever been in the past five years. Commercial traders, the people who know the most about the underlying commodity business, were basically saying a combination of the following two statements: "We don't want to hedge and sell too much corn production here, we think prices are going up" (commercial producers) and "We want to lock in our future corn inventory needs here, we think prices are cheap" (commercial users). The commercial CoT percentile of 100% was followed by a 20% rise in the price of corn.
Knowing how money managers are positioned is also useful. If you come up with a thesis that leads you to believe stocks will fall, but you check CoT analysis and see that money managers are extremely net short S&P 500 futures, you might want to hold back on your short. Examine the following CoT analysis for the S&P 500 futures contract.
The market was quickly selling off in the fall of 2015. Everybody was offering up a reason to sell stocks. At that point in time, money managers got more net short S&P 500 futures than they had ever been in the past five years. Both positioning and negative sentiment were at an extreme. The S&P went on to rally 9% in a month. When money managers reach an extreme position, long or short, it indicates a potential for less buying or selling pressure. In this example, with money managers so short, who else was there left to sell? Money managers made the same mistake during the U.S. debt-ceiling crisis in the summer of 2011.
It's easy to understand the concept of a "smart money" category in the commodity markets. Producers and users, like an oil driller or a copper user, have a clear link to the cash commodity business. In financial futures (bonds, currencies, stocks), there are no producers or users. The group of traders that's analogous to producers and users are called dealers. Dealers are sell-side companies that sell their price risk to offset the products they sell to their institutional and retail clients.
In addition, money managers are different for financial futures. In the commodity markets, money managers are composed of CTAs (commodity trading advisors), CPOs (commodity pool operators), and hedge funds. In financial futures, money managers are composed of asset managers and leveraged funds. Asset managers are institutional investors like mutual funds, endowments, and pension funds. Leveraged funds are made up of the previously mentioned CTAs, CPOs, and hedge funds.
So after seeing how I analyze CoT data, let's address some of the current extremes in positioning. My CoT analysis focuses on four asset classes: bonds, commodities, currencies, and stocks. Starting with bonds, money managers have not chased the rally in long-term Treasuries (NYSEARCA:TLT). This is strange because money managers are in aggregate trend followers. You typically see a high CoT percentile as they add on to long positions as price trends up. The graph below shows how money managers (green line) have shunned the rally in 30-year Treasury futures.
In contrast, sell-side dealers are extremely short both the 10-year and 5-year. This translates to them expecting lower prices and higher rates. Knowing that dealers are both very long the 30-year and extremely short the 5-year and 10-year, you can say dealers are positioned for a flatter yield curve.
There are a number of extreme positions in the commodity complex. Commodity producers and users are extremely long natural gas (NYSEARCA:UNG) and extremely short WTI crude (NYSEARCA:USO). Money managers are extremely short corn (NYSEARCA:CORN) and wheat (NYSEARCA:WEAT). With a CoT percentile of 100%, producers and users are more net long natural gas than they've ever been in the past five years.
As for WTI crude oil, there's something interesting going on. Both producers and users and money managers are extremely short. Who's on the other side of the trade? Most likely retail investors, using either oil futures or ETPs like USO and UWTI.
Money managers are extremely short both corn and wheat.
The only real extreme positioning in the currency markets is in the British pound (NYSE:FXB). The pound has recently lost value against the USD over fears of the UK leaving the European Union. Money managers have piled into shorts as GBP/USD has trended down. Recently, money managers have started to cover their short as evidenced by the rising CoT percentile (green line).
Finally, within stocks, money managers are still very short all U.S. indices. They're currently not as short as they were during the August 2015 lows, but the positioning is still extreme. During the early February 2016 lows, the money manager CoT percentile for the S&P 500 reached 1%. Since then, U.S. stocks have roughly bounced 10%. Going forward, it will be interesting to see if money managers aggressively cover their shorts as they did last fall or if they remain pessimistic.
- Money managers are not chasing the rally in long-term Treasuries
- Sell-side dealers are positioned for a flatter yield curve
- Commodity producers and users are extremely long natural gas and very short WTI crude oil
- Money managers are extremely short corn and wheat
- Money managers have started to cover their huge short position in the British pound
- Money managers are extremely short U.S. stocks (NYSEARCA:SPY)
I hope this article served as a clear introduction to CoT analysis. CoT data doesn't always work though. Sometimes producers and users are on the wrong side of a trade for months. Sometimes money managers are at a 0% five-year CoT percentile and price keeps on going down. With that being said, I consider this type of analysis to be a useful tool when incorporated with other fundamental and technical approaches.
I plan on writing a weekly summary article on SA to cover the changes in each CoT report. Let me know if you've got any questions in the comments section.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.