Sunday, October 4, 2009

Pro Trader Positions in Gold, Crude and Implications for Stocks, Forex

The following is a brief look at 2 of the most popular commodities traded, gold and crude oil, using the Commitments of Traders Report as an indicator of the likely future direction of these commodities and what that says about other overall global asset markets – stocks and foreign currencies.


Two bits of background info you need.

Commitments of Traders – An Explanation

The Commitments of Traders charts illustrate the directions in which three different categories of investors believe a given commodity is headed. These three categories (Commercials, Large Speculators and Small Speculators) are based on the following definitions:
Commercials (aka hedgers) are people or companies that deal with actual commodities as part of doing business. They trade in those futures as a hedge against the risks they run in the course of that business. Commercials are exempt from position limits and post smaller margins than speculators.
Large Speculators are traders whose trading levels are high enough that they require reporting to the CFTC (Commodity Futures Trading Commission). These trading levels vary from one commodity to another, and often from one year to another.
Small Speculators are the traders remaining after the Commercials and Large Speculators have been subtracted from the total open interests.
These three divisions are not quite as well-defined in reality as shown above. Successful small traders become large traders while unsuccessful large traders become small traders, and commercial ‘hedgers’ often trade on speculation.
Though there are no hard and fast rules about the success of each of these divisions, it is generally assumed that the Commercials are the most successful. The large speculators used to be successful as well but in recent years have done poorly as a group. The small investors are often looked at as the example of what not to do in futures trading.
The motivating factor of a given group should also be taken into account. It should be remembered that the commercials are often short because they are hedging while the small investors are often long due to unflagging optimism.
The actual values are less important than the current trend. Are commercial traders reducing their position or increasing it? Also compare to past years to get an idea of typical holdings particularly for the commercials.

The significance of gold and crude oil

In general, commodities go up in price with optimism about future growth prospects and the concomitant willingness of traders to take extra risk in order to reap greater returns from economic growth than those of safe but low yielding high quality government or corporate debt.
Why look at these 2 specific commodities?
They are very widely traded and thus both liquid and provide a good sample of risk appetite
They reflect different kinds of risk sentiment. Oil is closely tied to actual economic activity, and thus rises mostly with optimism on growth (though at times it is definitely influenced by temporary supply/demand factors like inventories or threats of supply reduction from geopolitical instability. Gold is more of a hedge against inflation or economic collapse, and thus rises when sentiment favor either growth or its diametric opposite, the collapse of currency.
For both of these, key price factor can change, but the above are the current main price drivers for these two.


Commitments of Traders 1 Year Chart For Gold As Of Latest Report (Far Right)


Both large and small speculators long positions are near 12 month highs. Commercial traders’ short positions are near 12 month highs. Commercial traders are reputed to be the most consistently correct. The small speculators are reputed to be the most consistently incorrect, and big speculators are said to be in the middle of the smart money spectrum.
Together, large and small speculators represent majority market sentiment


Smartest money is short gold, dumbest money is long gold. Short/long positions are near 12 month highs, suggesting extreme conditions that imply a move in the opposite direction.
Those with long gold positions should have tight stop loss orders on them. Our bias for new gold positions is to short gold. Note however, that its the speculators that define market sentiment, and gold chart patterns are holding up, so a near term break higher is not out of the question.

Crude Oil

Commitments of Traders 1 Year Chart For Gold As Of Latest Report (Far Right)


For the prior 4 weeks, speculators had been increasingly long and commercial traders increasingly short and reached near 12 month highs. In the most recent week (9/21-5) both sides reduced positions as speculators sold back to commercial traders, suggesting reduced risk sentiment even while stocks and other risk assets were still climbing.


Given the pullback in risk assets over the past week (9/27—10/2), the rising trend towards close to 12 month highs in risk appetite among speculators (who represent market sentiment) was indeed a bearish sentiment indicator to be traded against.


The decline in long speculative crude positions may suggest that the decline in risk appetite that appeared only this week in stocks and currencies was already underway.

Continue to watch trends in COT for crude oil as a possible leading indicator for stocks and currencies.

Forex traders: Bias to short high yield and commodity currencies [AUD, NZD, CAD, EUR]over the next week, bias to go long safety currencies [ JPY, USD, CHF].

Commodity Traders: Bias to short commodities over the next week

For stock investors: Both gold and crude move with stocks, often following major global indexes like the S&P 500. Both gold and crude, especially the more volatile crude oil futures, suggest declining risk appetite, which suggests more pullback in stocks.

DISCLOSURE AND DISCLAIMER. The opinions stated herein are not necessarily those of AVAFX. The author has short and long positions in the above instruments.

1 comment:

  1. Hi,

    U have provided great overview.

    Thx 4 details