By Tom McClellan
Back in June 2013, when gold was making its lowest price low since early 2011, I pointed out that commercial gold futures traders were at a really low net short position according to the Commitment of Traders data, and that this was a meaningful sign of a price bottom. Now we are seeing a similar condition in the commercial traders’ net position, which is conveying a similar message.
The Commitment of Traders (COT) Report is published each Friday by the CFTC, showing traders’ positions as of the preceding Tuesday, and broken down into 3 groups: Commercial traders (big/smart money), non-commercial traders (large hedge funds), and non-reportable traders (small-time traders who as a group typically do the opposite of what ends up being a good idea). The commercial traders are generally the ones to bet with, but there is a big fat caveat: often the commercial traders will get to a big skewed condition early, and so while they may end up being right in the long run, betting with them too early can get expensive.
The last time that commercial gold futures traders were actually net long at all was back in late 2001. Since then, they have been continuously net short to varying degrees, and so the game consists of evaluating their comparative net short position. The reason for that bias to the short side is that a lot of the commercial traders are the major gold producers who use the futures market to sell forward their future production. Selling what you don’t have yet makes you a “short” trader.
When the commercial traders were at this same sort of low net short position back in June 2013, that marked a nice price bottom for gold prices. Now we are seeing the same sort of sentiment condition, and with gold prices retesting that June low. Gold stock prices (XAU and GDM) have already broken below their June 2013 lows, as stock traders seem to be uniformly pessimistic about the future for gold.
One of the big fears that is voiced about gold is that the presumptive end to QE will be bad for gold prices because the Fed will stop printing excess money. But what those voices seem to forget is that QE has not been all that helpful to gold over the past couple of years. Gold topped at $1900/oz in 2011 when the Fed’s balance sheet was smaller than it is today, and that increase in the balance sheet since then has not stopped gold from falling. So if the end of QE is really a bad factor for gold, then why was the continuation of QE since 2011 not helpful for gold?
Zooming in closer, we can see the comparison between the current condition in the COT data and what we saw back in June 2013:
The recent drop in gold prices has had the commercial gold traders paring their collective net short position, perhaps due to hedging less of their future production, or perhaps out of outright smart-money speculation on a bullish outcome. We cannot know which motivation is the operative one, but we are able to say that the last time the commercials were at a similar level, it marked a pretty decent bottom for gold prices.
Sentiment readings like this represent potential energy; when they get skewed in a big way, they show us how much potential there is for a big move the other way, but they don’t tell us when the avalanche is going to cut loose. For that we have to turn to other tools to tell us when a move is actually getting going. But seeing the skewed sentiment conditions tells us which way to start leaning, and which directional signal to start looking for.
COT Report data are reviewed every Friday in our Daily Edition, since Fridays are the day each week when these data come out. These data do not always have a big message to convey, but when they do, it is usually worth listening to.
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