Bullion "Dumb Money" Not Excessively Exuberant

By Alex Roslin       Jan 14 2008 12:17PM www.cotstimer.blogspot.com

Beautiful! It was a week the gold bugs had to love. As equities continued their rout and Treasuries seesawed every which way, bullion shot to brilliant new highs. A key bellwether was silver, which underperformed gold for most of 2007 and, unlike gold, had failed to breach its November high. Late last week, iShares Silver Trust (SLV) broke above its November high, and so did silver itself Friday. If those breakouts are sustained, the top may still be far off for bullion.

But enough of the price action. What did the latest Commitments of Traders report issued last Friday say about trading in bullion futures and options? Does the data give us any hints of whether a top is nigh?

Some highlights:

• My trading setups for gold stocks based on the COTs data remain in bullish mode. I recently revised my setups for the HUI Gold Bugs Index and iShares Canadian Global Gold Index Fund (XGD). After testing the historic data for the most profitable, statistically robust setups, I am now using the same signals for both U.S. and Canadian gold stocks. My newly revised setups both turned bullish back in May and have been riding the bull ever since. (Disclosure: I’ve been long XGD since last June, when my old setup for XGD flipped to bullish.) The table below shows the new results for both setups. (The results differ because of the different start date; XGD has been around only since 2001.) The setups trade opposite to the gold small traders when they hit specific extremes of bullishness and bearishness. As the table shows, the small traders have a fairly neutral futures and options net position right now, so that suggests buying power still hasn’t exhausted itself.
  
  
• My newly revised setup for gold flipped to bearish with the Sept. 25 COTs report due to the excessive bullishness of the “dumb money” large speculators. This setup uses a 12-percent stop from the entry price, based on the largest past drawdown the setup had seen historically. That stop was hit on Dec. 28 when gold prices closed 12 percent higher than the entry price. So the setup will now be in cash until the setup flips back to bullish or the price falls below the signal’s entry price for the Sept. 25 trade ($750.60). The fact that the trade went that far against the signal suggests gold’s current rise is outside recent historic norms. That’s why my system uses stops and other risk management rules. You never know what twists the market will throw at you! Some readers have asked, Doesn’t this incorrect signal mean there’s something wrong with the trading system? My response is another question: Do you have a 100-percent trading record and catch every top and bottom? Of course not. The fact is anyone looking for something like that just hasn’t been trading very long! The important thing is to have good risk-management rules to limit your losses when you are wrong and be disciplined about following them.
  
  
• My newly revised setup for silver also remains in bullish mode. The large specs, whom I’m fading in this setup too, came very close to hitting a historic level of excess in their very bullish net long position last week. But the latest COTs report shows them reducing their net long position, which means the trade continues for at least one more week. (Disclosure: I’ve been long SLV since last July, when my old silver setup flipped to bullish.)

See my free blog COTsTimer.Blogspot.com for more details on how all this works and for my latest signals for equities, energy, currencies, Treasuries and agriculture. Good luck this week!

COTS SIGNALS FOR 11-JAN-08

NOTES TO TABLES

1. Visit COTsTimer.Blogspot.com to see how I trade new signals.
   
   
2. A “renewed” signal is when a market is already on a buy or sell signal, and traders again register an extreme net trading position in the same direction. The results in this table are based on acting only on new signals.
   
   
3. The COTs Timer Ratio is my reading of the bullishness or bearishness of traders from the latest COTs report. A reading of 1 or more means a buy signal for the commercial traders or a sell for the large specs and small traders. A reading of -1 or less means a sell for the commercials or a buy for the large specs and small traders. The ratio is based on the traders’ net percentage-of-open-interest position compared to the position’s moving average divided by the number of standard deviations I use for this setup.
   
   
4. In parentheses are the dates of the COTs report that gave this signal.
   
   
5. Past return using the signals of my COTs Timer system, starting from a baseline 100. This is the theoretical return from buying the security on a buy signal and shorting it on a sell signal.
   
   
6. Past return from buying and holding the underlying cash market, starting from a baseline of 100.
   
   
7. Ratio of the COTs Timer return versus the underlying market’s return.
   
   
8. Largest past drawdown the setup experienced during a trading signal between the entry price and the lowest price. This was not necessarily the loss at the end of the trade. I use this figure to calculate my maximum portfolio allocation for the setup based on my 2-percent risk threshold of total assets for any one trade.
   
   
9. The group of traders that had the best historic return in this market. My signals are given when this group reaches specific extreme levels of bullishness or bearishness. Unless otherwise noted, my system trades in the same direction as the commercials and fades the large speculators and small traders.
   
   
10. My gold setup sells gold short when the large speculator net percentage-of-open-interest position is 1.9 or more standard deviations above its 32-week moving average. It goes long when the net position is -1 or more standard deviations below its 32-week moving average.
    
    
11. Signals for the iShares Canadian S&P/TSX Global Gold Index Fund (XGD trading in Toronto) are based on the gold COTs data.

Alex Roslin

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Disclaimer: This report isn’t meant as financial advice or a recommendation to buy or sell any security. Please do your own homework before trading. My system isn’t for everyone, involves substantial risk and has experienced large drawdowns in some past trades. Past results are no guarantee of future profits. I’m not a certified financial advisor. While I consider my information to be reliable and accurate, I make no guarantees. Please see COTsTimer.Blogspot.com for other disclaimer information.