Traders Increased Gold Short Positions At The Fastest Clip In Almost 2 Years - Is It Time To Buy?

by: Hebba Investments

Speculative gold traders sold gold en masse last week and increased short positions by the largest levels in almost 2 years

Speculative silver traders also sold silver and brought the net silver positions to net-bearish levels

From a COT point-of-view, both gold and silver look extremely oversold and ripe for a bounce

The latest Commitment of Traders (COT) report showed a fourth straight week of speculative long selling in gold as gold dropped on the week. Not only were speculative longs closing out positions, speculative shorts were jumping into the action as they increased their own positions by over 20,000 contracts on the week – the largest speculative short increase since November 2015.

At current levels, the gold market now has one of the lowest levels of bullishness on the year, and we think is ripe for a bit of a relief rally. While gold looks good, silver looks much more oversold and more rebound potential. Finally, platinum’s fundamentals seems to be the best of all the precious metals (as we explained this week) and we think that’s why it has been seeing some strength compared to the other metals.

We will get more into some of these details but before that let us give investors a quick overview into the COT report for those who are not familiar with it.

About the COT Report
The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.

Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.

The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three-day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.

There are many ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won’t claim to be the exports on it. What we focus on in this report is the “Managed Money” positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.

This Week's Gold COT Report

*Gold price data reflects the COT week (Tues-Tues) not a standard week (Mon-Fri)

For the fourth week in a row, speculative longs cut back on their long positions by a sizable 16,777 contracts, while shorts got extremely bold as they increased their own positions by a huge 22,179 contracts. That was the largest jump since November 2015 – which was within weeks of gold’s bottom.

At a 41.58% short-to-long ratio, we are solidly in the historical buy range on gold, so longs should be comfortable adding to positions here provided they can be patient as in the past it has taken anywhere from a few weeks to months to recover once gold has gotten to this point.

Moving on, the net position of all gold traders can be seen below:

Source: GoldChartsRUS

The red-line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, we saw the net position of speculative traders drop by around 49,000 contracts to 38,000 net speculative long contracts. At current net-long speculative levels, we are approaching some of the lowest levels we have seen over the past decade. While we are not there yet, we are certainly within striking distance – one bad week and we would be there.

As for silver, the action week’s action looked like the following:

Source: GoldChartsRUS

The red line which represents the net speculative positions of money managers, showed another decrease in the net-long silver speculator position as their total net position fell by around 10,000 contracts to a net speculative long position of 2,000 contracts.

There is no doubt that silver is looking very attractive from the COT perspective as we are approaching silver’s historical net-long position lows. While we have mentioned that did not like silver’s fundamentals, our contrarian antennae have perked up with such bearishness by silver traders.

Our Take and What This Means for Investors

In both gold and silver the latest COT report is showing traders reaching levels of bearishness last seen at some of the lows of the last decade. In gold we are approaching the net-zero level of speculative bullishness (currently sitting at 38,000 net long contracts) which has only happened twice in the last decade, which previously were excellent times to buy.

As for silver, the latest COT report shows us at a mere 2,000 contracts net-long, but considering that the COT report is dated to last Tuesday and silver has dropped around 3% since then, we’re almost certainly at net-short levels (i.e. negative net-long levels).

For gold, we have adjusted our barometer on both the short and medium-term levels. Short-term we now think gold offers a great opportunity for a short-term bounce as speculative traders are now at some of their lowest net-long positions of the past few years. Additionally, with speculative shorts increasing their own bearish bets by over 20,000 contracts on the week, their boldness is at the highest levels since November 2015. Finally, the markets already expect the Fed to tighten at least one time this year and we expect the same BUT we think that if there is a data/market surprise it will be in the favor of Fed dovishness (i.e. economic weakness) as opposed to additional tightening – which is good for gold.

As for silver, we are silver bulls for the first-time in months and in the short-term are more bullish on silver than gold. Silver COT speculative positions are almost certainly net-bearish and are approaching some of silver’s all-time COT historical lows. While that doesn’t guarantee silver gains next week, it does suggest to us that the sentiment is so negative in silver that its ripe for a bounce. Investors also should remember the silver market is much smaller than the gold market, so speculative money flowing into it can cause much larger rises – a lot of speculative shorts mean higher potential for a short-term speculative squeeze.

Finally, the silver/gold ratio is sitting at around 78 which is high for this ratio. What this suggests is that silver may make a better bet than gold with higher upside (ratio compression) and similar downside (lack of ratio expansion).

Putting this all together we are changing short-term view on both gold and silver as we are moving from Neutral in silver and gold to Extremely Bullish for silver and Bullish for gold during the upcoming week.

In conclusion, we mentioned last week that our Neutral position meant that we would be buyers on any sizable drops in silver and gold – which we saw on Friday. We are certainly buyers now as we made some sizable precious metals purchases and for the short-term we expect a bounce in both metals. For longer term investors, we believe now is a time to be adding to gold and silver positions (SPDR Gold Trust ETF (NYSEARCA:GLD), iShares Silver Trust (SLV), Sprott Physical Silver Trust (PSLV), and ETFS Physical Swiss Gold Trust ETF, etc). Additionally, we are starting to purchase some of the miners which we sold previously to lower our gold and silver leverage.

Finally, what we are most attracted to in the precious metals sector is platinum, which we wrote about last week and can be invested in via the ETFS Physical Platinum ETF (PPLT) or the Sprott Physical Platinum and Palladium Trust (SPPP) – with the preference being the dedicated PPLT ETF. Investors looking for less risk than silver or gold, but more potential upside than gold, should consider platinum for all the reasons we mentioned in the article.

Disclosure: I am/we are long SGOL, PPLT. 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.