Top Advisors Corner

Gold - COT Report

 | 

Every time I write about my concerns with the Commitment of Traders report (COT), I get a lot of pushback about it not being worthwhile or not predictive of price action. Yesterday, I met with a couple of hedge fund managers that are very bullish on gold; they told me that my COT concerns are unwarranted. Like all prognostications with asset price predictions, time will tell.

Today, I thought I would lay out my COT concern. First of all, I care not about the commercial short position as a standalone data point. The commercials are price takers, have deep pockets, know their industry and tend to not be "market movers." The managed money is the group that concerns me. Whether it is hedge fund money or CTA money (Commodity Trading Advisor), it tends to be trend-following money. And trend followers are usually wrong at the trend change. 

Source: Software North, 1/6/20

But what really concerns me is the leverage. Commercials have very deep pockets and are mostly hedging, so their net risk isn‘t nearly that of managed money. As of the latest COT data, managed money is net long 263,170 gold contracts, which is 26 million ounces. At $1,560 per ounce, that is a $41 billion notional value of gold. To control that $41 billion, managed money only needs to put $1.1 billion in equity (gold futures margin is $4,500 per contract). Think about that for a minute. $1.1 billion to control $41 billion is roughly 35x leverage. 

Why do I care so much about managed money? Because they are price makers. It is their buying and selling that moves markets. So, when they reverse course, they sell or buy aggressively and are, to a large part, why you see some large red or green candles on a gold chart. It's not the commercials that push gold prices around, contrary about what the "market is rigged" crowd will tell you. It's trend-following managed money changing direction. Add to that the fact that a large number of CTAs will operate an SAR program (Sell and Reverse) and you begin to see how price change can come fast and hard. Remember that an SAR is adding 2x the buying or selling pressure because a CTA that is long 1,000 contracts needs to sell 2,000 contracts to SAR – they sell 1,000 to get flat and another 1,000 to get short.

The bottom line is that I am more worried about the downside in gold than missing the upside. We are at record open interest with managed money at a historic long position. If the managed money crowd decides that they want to lock in some profit and that moves the gold price enough to trigger an apparent trend change, selling can beget selling and gold could easily correct back under $1,500 or lower. Time will tell.

Source: StockCharts.com, 1/8/20

Questions and comments are always welcome: ttaschler@sprottglobal.com.


Tim Taschler, CMT

Sprott USA


Past performance does not guarantee future results. The views and opinions expressed herein are those of the author's as of the date of this commentary and are subject to change without notice. This information is for information purposes only and is not intended to be an offer or solicitation for the sale of any financial product or service nor a recommendation or determination by Sprott Global Resource Investments Ltd. that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the objectives of the investor, financial situation, investment horizon and their particular needs. This information is not intended to provide financial, tax, legal, accounting or other professional advice, since such advice always requires consideration of individual circumstances. The products discussed herein are not insured by the FDIC or any other governmental agency, are subject to risks, including a possible loss of the principal amount invested.

Generally, natural resources investments are more volatile on a daily basis and have higher headline risk than other sectors, as they tend to be more sensitive to economic data, political and regulatory events as well as underlying commodity prices. Natural resource investments are influenced by the price of underlying commodities like oil, gas, metals, coal, etc., several of which trade on various exchanges and have price fluctuations based on short-term dynamics partly driven by demand/supply and also by investment flows. Natural resource investments tend to react more sensitively to global events and economic data than other sectors, whether it is a natural disaster like an earthquake, political upheaval in the Middle East or release of employment data in the U.S.. Low-priced securities can be very risky and may result in the loss of part or all of your investment. Because of significant volatility, large dealer spreads and very limited market liquidity, typically you will not be able to sell a low priced security immediately back to the dealer at the same price it sold the stock to you. In some cases, the stock may fall quickly in value. Investing in foreign markets may entail greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. You should carefully consider whether trading in low-priced and international securities is suitable for you in light of your circumstances and financial resources. Past performance is no guarantee of future returns. Sprott Global, entities that it controls, family, friends, employees, associates and others may hold positions in the securities it recommends to clients and may sell the same at any time. The author received no compensation for writing this article.

Subscribe to Top Advisors Corner to be notified whenever a new post is added to this blog!
comments powered by Disqus