Bullish Signal for Gold Stocks

By Alex Roslin       Jan 28 2008 4:08PM www.cotstimer.blogspot.com

While gold and silver firing up to new highs in the clouds, the U.S. dollar index has refused to buckle under as it churns stubbornly within a three-month trading range. Which way will it break? Is this a bearish divergence that suggests bullion is topping?

Last Friday’s Commitments of Traders report gives ammunition to the bullish case. The “dumb money” small traders in gold have steadily reduced their net long futures and options position since an interim peak in mid-December, according to data published weekly by the U.S. Commodity Futures Trading Commission.

In the past two weeks, their net position as a percentage of the total open interest has fallen to a historic extreme of bearishness that has given me two consecutive bullish signals in my trading setup for gold stocks based on this data. The signals specifically are for my setup trading the HUI Gold Bugs Index and iShares Canadian S&P/TSX Global Gold Index Fund (XGD). This setup has been long since the May 8, 2007, COTs report, but now appears to be suggesting the bullish call has more legs. See more details in the table below.

Not so for my setup for gold itself, which is based on fading the large speculators in gold futures and options. This setup remains steadfastly bearish, but was stopped out of its position on Dec. 28. The stop was hit after gold went more than 12 percent against the signal entry point—which was the previous largest maximum drawdown for this setup. The fact that this happened suggests gold’s current ramp-up is witnessing a rare statistical “fat tail” or blow-off. Such wild episodes can continue for who-knows-how-long, and caution should prevail: If you can time the top, you’re laughing; but for too many others drawn into the speculative mania, these events often end in tears!

Silver also remains in bullish mode, owing to the large specs getting supremely bearish with the Nov. 11 COTs report. They’re now slowly approaching a level of excessive bullishness, but so far have yet to hit an extreme that warrants a flip to a bearish signal for this setup.

The U.S. dollar index, for its part, remains in bearish mode, with the “smart money” commercial traders pulling back from their extreme pessimism of last November and December, when they gave five straight bearish signals for my trading setup. But they are still quite bearish in their positioning, suggesting more downward pressure possible for the buck.

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 25-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.