- The latest COT report shows a drop in gold longs with only a slight 700 contract increase in speculative gold shorts.
- With speculative gold shorts already close to all-time nominal highs and hitting new percentage highs, this may suggest that gold shorts are exhausted.
- With the expected volatility in markets as the Fed increases interest rates, we see a high probability of a violent short cover in gold.
Some of the clues for this volatility can be found in the latest Commitment of Traders report (NYSE:COT) as short positions have once again hit all-time highs in anticipation of the Fed cut.
With so many traders on one side of the trade, small movements in price tend to be exacerbated with funds quickly covering and then re-establishing short positions. We think this is a very nervous market.
We will get a little more into this 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 investor a way to see what larger traders are doing and to possibly position himself 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 different 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
This week's report shows speculative traders decreased their long positions by more than they increased them last week (net loss in longs), while slightly increasing short positions once again.
So essentially, last week Managed Money traders decreased long positions with only a slight increase in short positions - the lowest increase in shorts we have seen over the past six months.
This may be an important distinction because with shorts close to all-time highs at over 110,000 contracts short, and at all-time highs in terms of percentage of contracts short (over 55%) there may not be too many shorts left to jump in. That should be very interesting for investors long gold as it suggests we may have hit a short time low in the gold price.
Finally, we do want to caution investors that due to the report only including data from Tuesday, it doesn't include the volatility we saw at the end of the week. With two sizable up days and one large down day, we think that the net result was an increase in net longs and a decrease in net shorts, but we have no idea how much. The fact that the gold price ended the week around $1066, only slightly higher than the price as of this report, suggests that it wasn't a huge net change in positioning.
What Does This Mean For Investors?
While there are many other factors involved, the fact that six out of the last seven weeks saw increasing short positions by Managed Money traders with this week's rise being the smallest in six months in terms of net short positioning increases, we may have exhausted current short firepower.
While there are no guarantees in gold here because an all-time high position can get even higher, we think that current positioning is very bullish for gold as we see a significant opportunity for a violent reversal based on over-extended shorts.
We think this is only exacerbated by the recent Fed meeting (here are some of our key takeaways for gold investors) which changed the dynamics of the financial markets. Regardless of whether or not this was a policy mistake (we think it was), the fact that there is a significant change to the financial landscape means that by default we should see more volatility in all assets. That is relevant to gold because with gold positioning at such an extreme, there are a lot of nervous traders with very large short positions that may exit positions quickly - volatility is not a friend of longs or shorts at such extremes.
This is a time for patience for gold investors and we continue to believe that building or holding positions here in physical gold and the gold ETF's (SPDR Gold Shares (NYSEARCA:GLD), PHYS, CEF) is the prudent move. Additionally, the miners that have been underperforming gold over the last few months may offer investors considerable leverage to any rise in the gold price. Investors looking for this leverage may want to consider evaluating gold miners such as Goldcorp (NYSE:GG), Agnico-Eagle (NYSE:AEM), Newmont (NYSE:NEM), or even some of the explorers and silver miners such as Tahoe Resources (NYSE:TAHO) (we're not suggesting these companies specifically - only suggesting them for further investor research).
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