Gold Headed to $3,000?

By Alex Roslin       Oct 29 2007 4:04PM www.cotstimer.blogspot.com

As gold inches toward $800, analysts and traders are wringing their hands about how much higher bullion prices can fly. Of course, the usual gold bugs have come out to say gold is headed to $3,000 and that the U.S. dollar is as worthless as “toilet paper,” as one reader informed me the other day.

The latest Commitments of Traders report issued Oct. 26 continues to present a mixed prognosis for precious metals. The “dumb money” small traders in gold futures and options have been reducing their net long position for the past six weeks and are now decidedly bearish when compared to past data. It’s for this reason that I’m still long Canadian Gold iUnits (symbol XGD). I’ve developed a trading setup that buys XGD when the gold small traders are at a bearish extreme in their net position and sells when they’re highly bullish. And this setup is presently still on a bullish signal.

However, my setups for gold itself, the HUI Gold Bugs Index and USERX U.S. Gold Fund all slipped to bearish as of the Sept. 25 COTs report and remain so as of last Friday’s report. These three setups are all based on the positions of the “smart money” commercial gold traders, who have lately gotten super-bearish. Last Friday’s COTs report saw them slightly reduce their huge net short position, but nowhere near enough for me to get bullish again in these three setups.

All this raises an important question about the COTs reports. How do we decide which group of traders to follow? The three groups of traders—small traders, commercials and large speculators—are often positioned such that they give quite contradictory signals. What does it mean, for example, if the commercials are highly bearish, while the small traders are neutral, as happened recently in the gold COTs data. What do we do when the large specs and commercials are both highly bearish at the same time?

My solution was to test the past data to find which one had the best predictive powers. In some markets, trading with the commercials proved to be the best route. In others, it was better to fade the small traders or large specs. In a few markets, it’s actually best to trade on the same side as the large specs or small traders, believe it or not. The lesson is, contrary to popular notions about the COTs reports, each market has quite a different personality. I think it’s important to filter out the noise in the COTs data and focus only the traders who have shown the best, most statistically robust past performance.

For this reason, I fade the small traders in my silver trading setup, and this setup also remains bullish as of the latest COTs report. The data doesn’t tell me if gold is going to $3,000 or if the U.S. dollar is really going to end up worth no more than toilet paper, but my setup for the U.S. dollar index is still bearish, as is my setup for copper. Visit my free COTsTimer.Blogspot.com blog to learn more about these setups and to see my signals in equities, currencies, energy, Treasuries and agriculture. Good luck this week.

COTS SIGNALS FOR 26-OCT-07

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. The gold setup trades on the same side as the commercial traders when their net percentage-of-open-interest position is two or more standard deviations from its 18-week moving average (using the combined futures-and-options data). The same setup parameters are used for the HUI Gold Bugs Index.
    
    
11. Signals for the U.S. Global Investors Funds U.S. Gold Fund (symbol USERX) are based on the gold COTs data.
    
    
12. Signals for the HUI Gold Bugs Index are based on the gold COTs data. See note 10 for more details on this setup.
    
    
13. Signals for the S&P/TSE Canadian Gold iUnits ETF (symbol XGD.TO) are based on the gold COTs data.

Alex Roslin

****

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.