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December 27, 2019 | Investigating Alleged Smart Money Positions in Gold

Mike 'Mish' Shedlock

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
What if anything does does the futures position of commercial hedgers say about the price of gold?

I received the following email from Tom McClellan with his thoughts on gold.

The emphasis in italics below is mine. It is on points I am going to dispute.

Gold Cot Data Calls for More of a Drop

Gold prices are seeing a Christmas week pop, getting all of the gold bugs excited again. But the smart money “commercial” traders of gold futures have a different vision of the future.

Every Friday, the Commodity Futures Trading Commission (CFTC) publishes its Commitment of Traders (COT) Report, detailing the numbers of futures contracts held by different groups of traders. They break it down into the commercial, non-commercial, and non-reportable traders. Commercial traders are ones who use the subject item of the futures contract in their trade or business; so think of Cargill or ADM for wheat futures, Goldman Sachs for T-Bonds, etc. Non-commercial traders are the large speculators (think hedge funds). And the non-reportable traders are speculators whose positions are so small that the CFTC does not figure they are worth being reported individually.

The commercial traders are generally speaking the smart-money, and when they get to a big skewed position it usually pays to bet with them, at least in the long run. So they are the ones I pay the most attention to. Every Friday when the COT Report gets released, I cover the relevant insights it has to offer for the markets I follow in my Daily Edition.

This week’s chart is one that features prominently in that lineup, especially in recent months. The commercial traders have moved collectively to a big net short position. A lot of the commercial traders in the gold futures market are gold mining companies, using the futures market to fix a price for their future production. So when they move to a big net short position as a group like this, it is a pretty strong statement that the people who are in the gold business think this is a good price at which to sell.

One important point to understand about the COT data for gold is that the commercials have long been biased to the short side. Since 2001, there has only been one time that they have actually gone to a net long position as a group, and that was in late 2018, when gold was making a pretty important bottom. The rest of the time, they have been net short to varying degrees, and so the game consists of evaluating their net position relative to their recent range. Even on that basis, their current big net short position is a pretty compelling message that gold prices are too high at the moment, and that an appropriate adjustment is coming.

The commercial traders went to this big net short position back in September 2019, when gold prices were topping out at $1540/oz. Even though gold prices have fallen since then, the commercials have not pared their big net short position. That says they really believe that gold prices have a lot further to fall.

Compelling Nonsense

For starters, McClellan fails to point out that commercial traders also include the broker dealers like JPMorgan. Those commercial traders take the other side of bets put on by hedge funds and small traders.

Although have have been proven manipulators it’s important to note that gold rose from $250 to over $1900 with the allegedly smart commercials short the entire way.

Smart Money Discussion

The miners sell their output via futures. There is nothing particularly smart about this alleged smart money. Miners mine gold and sell it. It’s what they do.

McClellan also fails to point out the broker dealers hedgers must take the other side of trades. In the futures world, for every long there is a short. Much of the short position is involuntary.

They are hedgers like JPM are not even net short. Rathers they will be long GLD of gold in some other way to balance they books. In general, they do not care which way gold moves but if and when they do is when the manipulation is likely to happen.

Direction and Movement

Note how gold got hammered for years without the alleged smart money being hugely short.

On the other hand, commercials being net long is rare. And I did write about that.

It’s not so much that the smart money is particularly brilliant (again the hedgers simply take the other side of the bet and somehow hedge it).

Rather those were signals of extreme indifference by the hedge funds to own gold. Sentiment wise it can mark great buying opportunities, but note the first two small boxes amounted to nothing.

Gold Cot Chart Detail

Gold tends to rise most as hedge funds are adding to longs. However, movements are erratic.

Where to From Here?

There may be a pullback or not. I don’t know nor does anyone else.

Ideally, we would see long liquidation, typically misrepresented as “commercials covering their shorts”, accompanied by a small price movement.

Regardless, top are made when speculators are net long and we do not know when that will be, nor will we know the price except in hindsight.

Bottom buy points are easier to spot, but I highly doubt we see commercials net long any time soon. Thus spotting the next time to add may not be easy.

Regardless, the fundamentals of gold are in excellent shape as I noted in How Does Gold React to Interest Rate Policy?

Be my guest if you want to time gold finely to COT reports. And you would have missed this last good rally too.

Regardless, it is irksome to see reports that misrepresent “smart money” and what the COT reports actually reflect.

Mike “Mish” Shedlock

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December 27th, 2019

Posted In: Mish Talk

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