by Marin Katusa, Katusa Research:
***Every week, the agency that oversees the U.S. futures market (the CFTC) releases a report that shows how companies and hedge funds are positioned in the futures market.
This report is called the Commitment of Traders (or COT for short) report. Various participants with various goals come together in the futures market.
You have producers (like farmers and oil companies) selling their production. You have users (like big food companies and manufacturers) buying raw materials. And then you have speculators (both large and small) who are simply looking to trade the market for a profit. The regulators categorize these participants, track their positioning, and distribute the data.
Right now, the COT report for the gold market indicates we could see a powerful gold rally soon. Here’s why…
My team and I like to watch the relationship between large speculators and producers and users of a commodity (often called “commercials”). The commercials deal in their market every day. It’s their business. Farmers know the corn market. Copper miners know the copper market. ExxonMobil knows the oil market.
Most of the speculative money in the futures market is managed by computerized trading systems. These systems buy markets that are trending higher and sell short markets that are trending lower. This “trend following” money tends to group together and tips heavily to one side of the boat at market extremes.
***In the futures market, every short position has an offsetting long position. So, when hedge funds are extremely short a market, it means the commercials are extremely long (and vice versa).
While I never trade on COT data alone – and no indicator is perfect – I do take note when trend following hedge funds are all betting in one direction. It can indicate an extreme in market sentiment and a potential opportunity. The market loves to punish the speculative crowd.
For example, in 2014, hedge funds made near-record amounts of bullish long bets in crude oil. The commercials took the other side of that bet. As increased U.S. shale production flooded the market, oil prices crashed and many hedge funds took a bath.
***Based on COT data, we may be about to see a rally in the gold market.
Below is a chart that displays the short gold positions held by speculators (the hedge funds) since 2015. As you can see, they are high right now. You’ll also note that when speculator bets against gold got this high in the recent past, gold enjoyed strong rallies.