About the COT data:
In order to provide transparency to market users and the public, the U.S. CFTC releases a weekly report called “Commitment of Traders” (COT). This report contains a decomposition of Tuesday’s open interest for the future’s market, in which twenty or more traders hold positions equal to or above the reporting levels established by the CFTC that become available on the following Friday.
The breakdown is structured in three different groups: the “Commercials”, the “Non-Commercials,” and the remaining open positions classified as the “Non-Reportable Category.” According to the CFTC, the Commercials are mainly taking hedging positions, and one can, therefore, conclude that the Non-Commercials are primarily large speculators (hedge funds, CTAs).
The Commercials (represented by banks/brokers) are mainly mining gold and trying to sell part of their future production, to diminish the effect of price fluctuations. This makes the business more stable and projectable, but may, in general, cost as much as every other insurance (risk transfer to the speculators).
Are the banks manipulating the gold market by having record amounts of short positions?
No, their positions (commercials) are classified as mainly “hedging positions”. They have offsetting positions and/or an agreement to make a settlement with a third party.
Which of those categories is making money with their future’s positions?
Results over a broad commodities dataset show that in general the large speculators (hedge funds, CTAs) are making money. They make money by participating on the bigger trends (trend-following). Therefore, the commercials are rather paying for their “insurance”.
Is a short squeeze imminent in gold or silver?
Unlikely because the shorts (commercials) are having an offsetting business, there is simply no need to panic if the price rise. To the contrary, they like rising prices because they hedge only part of their business.
Short squeezes in commodities are most of the time supply driven. For example, if a farmer sold most of his expected crop and suddenly bad weather destroys his harvest, he has to buy his position back (unable to deliver the physical good). Because the weather is affecting also a lot of other farmers, there is simply a lot of buying pressure and the price has to rise to balance supply and demand.
What is my opinion on the recent COT data in gold and silver?
New record highs in the positioning is rather a sign of a new bull market. As the trend progresses, it is expected that we see even more extreme figures. A better measure would to be to normalize the net positions by the open interest.
Further, I see a lot of people comparing the recent numbers to the last years when gold was in bear market or basing pattern. Better would be to compare an adjusted measure with years during a bull market. It is a common mistake to give recent years more weight (recency bias).
Also true is the fact, that there is no indicator which has a very good track record in calling tops. It is easier to find good indicators for spotting bottoms.
A hidden risk could be the rather low volatilities and strong trend signals in most asset classes (= high positions). If an event triggers volatilities to rise and correlations to increase, a hedge funds/CTAs will reduce risk by decreasing positions in nearly everything (including gold).
In summary, recent COT data shows the typical behavior of an ongoing bull market. The recent high net positions can be considered as slightly negative to neutral in the short-term. COT data is only a part of the tools a trader/investor should use. Don’t miss the whole bull market by waiting for every indicator to be perfectly aligned.
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