With gold, silver, and gold stocks all
in typical technical bottoming patterns, sentiment among
precious-metals investors is understandably rotten.
When prices feel low people feel bad. It is always this
way near major interim bottoms.
While I receive countless e-mails laden with despair
during times like these, one this week did a fantastic
job of summing up how so many investors are feeling
today. This gentleman, talking about gold stocks in
particular, wrote to me
"I am so tired of losing money on these stocks,
it seems like we've been in a bear market for the last
2 years with occasional rallies that seem to get weaker.
How can guys like you figure that these stocks are going
to someday do well? When do I just give up? I'm at the
end of my rope with everything related to Wall Street.
It makes me sick and seems impossible to make money.
I'm so frustrated I don't know what else to say."
It is not difficult to detect emotional extremes in
others, but it is hard to remain detached enough to
see into our own hearts. One of the greatest struggles
in any speculator's journey is the constant war to overcome
one's own destructive emotions of greed and fear, euphoria
In my own evolution as a speculator, the most effective
way I have found to keep myself on an even keel and
strive for total emotional neutrality is to focus on
the hard data. While our personal feelings about the
markets are capricious and often misleading, the underlying
data is absolute. It provides a solid intellectual reference
point at which to anchor to weather out the storms of
sentiment that periodically batter the markets.
Last week I discussed the irrationally
sentiment that is seducing investors into selling low,
at what is almost certainly just another typical major
interim bottom. This week I would like to address another
fear factor that I keep hearing about over and over
again, the gold futures Commitments of Traders report.
A growing number of investors are worried about the
state of the gold futures CoT.
Like all bearish theses, bearish interpretations of
the CoT gain much ground when prices are low and investors
are therefore naturally predisposed to seeking out negative
theories. I continue to get e-mails concerned about
the commercials being short, worried about extreme bullishness
in small futures players, and generally concerned that
gold futures portend rough sailing ahead for gold.
Futures Trading Commission releases its Commitments
of Traders report once a week, each Friday. It summarizes
changes in futures positions in all major commodities
by all major players. While tremendously useful, the
CoT is so complex that an air of mysticism has sprung
up around it.
If you download the raw text file of 2004
futures data, for example, it is a whopping 4mb and
contains 129 columns and nearly 3500 rows of solid data!
Incidentally the single largest Excel spreadsheet I
have ever created, while working on an analysis of S&P
500 CoT data a couple years ago, weighed in at 40mb.
For comparison, a typical Zeal essay
usually runs well under 1mb of raw data underneath the
charts and maybe only 10 columns of data. Raw CoT data
is voluminous, complex, and intimidating.
Since the raw CoT data is so specialized, not many
investors or analysts bother getting into it. Those
who do tend to be revered, kind of like high priests
privy to some arcane knowledge. And just like with high
priests' decrees in religion, often the CoT data interpretations
by gurus usually go unquestioned or uninvestigated by
the faithful. In some cases this blind faith in others'
CoT interpretations can lead to problems.
While I have received lots of e-mails in the last couple
months about the alleged dire state of the gold futures
CoT reports, whenever I look at the data myself I fail
to see any looming threats or even notable anomalies.
Thus this week I would like to dig into the gold futures
CoT from a strategic perspective, over the entire gold
bull to date. Hopefully viewing the gold CoTs within
their strategic secular context can help dispel the
growing fear that their tactical interpretations seem
to be causing.
We will start with gold futures open interest
and then zoom into the breakdown of the various major
players in the gold futures market. Charted out over
the long term, the gold futures CoT slices through some
of the week-to-week CoT mysticism and reveals a surprisingly
bullish picture for gold.
The futures world is very different from the stock
world with which most investors are familiar. Unlike
stocks, futures are a zero-sum game. Every dollar you
win in a trade is a direct loss for the counterparty
on the other side of your trade, or vice versa. In addition,
the total number of longs and shorts are always equal.
Every trade has two sides so overall longs and shorts
Open interest is the futures term used to quantify
the total number of futures contracts outstanding. Since
every single futures contract always has a long and
short side, open interest equals the total number of
longs (or, but not and, shorts) outstanding at the end
of any given trading day. Over time, open-interest trends
can reveal much about the state of the particular market
traded, gold in this case.
The chart above overlays the gold price during the
past five years or so over the gold futures open interest.
This reveals a lot about the state of the gold market
and the gold futures market, since open interest is
ultimately a measure of the continuing willingness of
traders to maintain opposing positions, to put their
money where their mouths are.
Gold futures OI is rising over time along with gold.
As any secular bull market marches on, more and more
speculators get interested in playing the market. Nothing
begets interest and excitement like higher prices! Just
as there were far more tech-stock traders in 1996 than
there were in 1991, there are far more traders interested
in the gold market today than there were only a few
This is a healthy and typical bull-market
sign in a futures market. A larger gold futures OI indicates
ever more capital is betting on gold. And the more capital
that bets on gold, the more volatile it grows as its
uplegs and periodic corrections are amplified. This
volatility attracts new traders to a market like dogs
to a steak, as traders thrive on volatility which gives
them more opportunities to profit. And the more capital
interested in trading gold, the higher its price can
ultimately run in this secular
In contrast, in order for gold futures open interest
to be bearish as so many investors fear today it would
have to be falling. A falling OI would indicate traders
liquidating positions and vacating the market, a sign
of capital flight. And the less capital bidding on gold,
the lower its volatility and potential interim highs.
If speculators take their capital elsewhere, the gold
bull would have a chance to wither and die. Obviously
the chart above could not be any more opposite from
this bearish scenario.
While OI has risen with the gold price, it is interesting
that the OI has a steeper upslope than gold itself.
I zeroed both axes on this chart to eliminate distortion
so the visually steeper OI upslope is technically accurate.
This is also another sign of a healthy and thriving
futures market. As this gold bull marches on, traders
are increasing their bets on gold at a faster rate than
gold itself is climbing.
If these disparate growth rates continue, eventually
the potential grows for an explosive move up in gold.
With OI and hence capital bet on gold rising faster
than the gold price, gold may have to surge at some
point to catch up. I am really interested to see how
this situation resolves itself, whether the OI upslope
moderates or the gold upslope accelerates.
Another interesting, yet typical, observation is that
gold futures OI generally peaks with interim tops in
gold. This makes sense. Just as speculators grow too
fearful and despairing during times like today when
gold is carving bottoms, they wax too greedy and euphoric
when gold is nearing major interim tops. The higher
prices rise, the more traders want to bet on them and
get in on the hot action.
For me the most fascinating, and unexpected, attribute
of this chart is the fact that gold futures OI has carved
its own fairly well-defined uptrend channel. Just as
if it was price data, the OI has bounced consistently
at the same linear support and collapsed roughly near
the same linear resistance zone. When OI is at the top
of this trend channel it tends to signal a major interim
top in gold.
More relevant for today though, when gold futures OI
is near its lower support line it tends to mark major
interim bottoms in gold! Since this gold bull launched
in early 2001, every single time that gold futures OI
was near its lower support line gold rallied strongly
in the subsequent months without fail. In fact, every
major gold upleg was preceded by a support approach
in gold futures OI.
Once again today gold futures OI is near its support,
implying that a major rally in gold is again imminent.
This strategic and undoubtedly bullish OI data flies
in the face of CoT-based predictions for bearish gold
action in the months ahead based on current futures
data. Just as in virtually all market-related endeavors,
the raw data analyzed in context effectively neutralizes
any emotional waves buffeting the markets. Bearish sentiment
or not, there is nothing remotely bearish about this
Now that it is clear that gold futures demand is growing
healthily just as it ought to, we can dive into even
more arcane CoT realms that inspire even more fear than
gold OI. A little background is in order to lay the
foundation for understanding the following gold futures
A common bearish gold theory gaining adherents today
goes something like this. "The commercials are
heavily short and they are actively capping gold. There
is no way gold can rise in the face of all this shorting
pressure. Therefore it makes little sense to be long
gold or gold stocks right now." If you have been
interested in gold longer than a nanosecond, you have
probably heard these CoT-based bearish gold theories.
As you consider the logic of this school of theories,
it is crucial to remember one key indisputable fact
of the futures world. In any futures market, longs and
shorts are always equal. There are two sides to every
trade and each long is perfectly matched with each short
at all times. Therefore statements decrying big shorting
in gold futures without elaboration are irrelevant and
pointless in isolation. Big shorts necessitate big longs
directly offsetting them!
Since longs and shorts are perpetually equal in gold,
period, the gold futures CoT must be analyzed at a more
granular level. The CFTC's weekly report divides the
futures traders into three groups known as commercials,
non-commercials, and non-reportables. Understanding
these three groups and their varying motivations is
essential to properly interpreting CoT data.
Commercial traders meet the CFTC's guidelines on hedging.
In gold, commercial futures traders usually deal in
the underlying metal itself in some way (mining, refining,
etc) and therefore use futures trades to hedge their
normal business risks. Commercials are best thought
of as hedgers who want to minimize their exposure to
potential gold moves and use futures to offload price
risk to willing speculators.
Non-commercial traders do not meet the guidelines on
hedging, they are the pure speculators. They typically
do not have any business interest in physical gold like
the hedgers. They are generally trading gold futures
to increase their risk, to bet on price movements for
a pure speculation motive. Since all a futures market
ultimately does is transfer risk from the risk averse
to the risk seeking, hedgers are the risk averse and
non-commercials, or large speculators, are the risk
The final, and much smaller, group is the non-reportables.
These are gold futures traders that deal in such small
volumes of contracts that they are not subject to formal
reporting requirements. This group is the small speculators,
people like you and I who either dabble in gold futures
or consistently deploy positions under the reporting
So in the futures world, long and short is only relevant
relative to these three groups of hedgers, large speculators,
and small speculators. While total longs and shorts
are always equal, sometimes one group has more long
positions than short or vice versa. Over time we can
chart the net long and net short positions of each CoT
group and glean some valuable insights on gold.
Our next two charts look at the composition
of gold futures positions between these three groups
over the entire secular gold bull. Two popular theories,
both bearish, are immediately obliterated by this strategic
view of the gold futures scene.
One of the most common bearish CoT arguments I hear
is the dangers in the commercials being heavily short.
If one is not familiar with the futures markets it is
easy to see how this idea can spook investors. In reality
though, as this chart shows, there is nothing new or
anomalous about the hedgers taking the short side of
the gold futures trades.
In fact, for the entire gold bull to date the net short
position of the commercials has been rising relentlessly
yet gold still powered from $250ish to $450ish! If you
had believed the naysayers who I remember well from
2001 that claimed at that time that the commercial shorts
meant gold was capped and could not rise, then you would
have missed the entire gold bull to date. The logic
behind fear of commercial shorts is just as flawed today.
Remember that commercials are hedgers,
they are usually involved with physical gold in some
way and have business risks directly tied to it. In
miners' cases, they dig up gold and sell it. They can
wait to sell it until it is actually mined and refined
into rough dore bars or they can try and lock in today's
prices for actual future sales. Now even if you loathe
producer hedging as much as I do, the underlying
logic is still easy to understand.
Gold miners, just like us mere mortal speculators,
cannot know the future gold price in advance. Yet, they
have very high fixed costs that they have to pay. If
they fear gold may go lower, even if only for a temporary
correction, they may want to sell gold at higher prices
today for delivery six months from now. They accomplish
this risk management by selling a gold futures contract.
They are "short" but they have or will soon
have the physical gold to deliver.
This forward selling allows them to lock-in
future cash flows and pay their employees. While I am
opponent of bull-market hedging by gold producers
and will only own companies who have low or no hedges,
I can still understand why decisions to lock in today's
prices are made. These commercial hedgers are not necessarily
shorting gold to manipulate its price lower, they are
just selling gold tomorrow at today's prices to better
forecast their operating cashflows.
Hedging is common in all commodities businesses. This
is the stone-cold reality regardless of one's philosophy
on it. And since the futures market is a zero-sum game,
the only reason that you or I can even go long gold
futures is because some other counterparty, probably
a hedger, is willing to sell them to us. The higher
the gold price goes, the more hedgers will try to lock
in prices and the higher their net shorts will rise.
This is natural and expected, hedger forward sales are
The second misleading theory that this chart dispels
is the notion that small speculators are getting euphoric
on gold. If I had an ounce of gold for every time someone
e-mailed me and told me that the little guys are just
too bullish, I could probably launch my own private
The red line above highlights the evolving
net long position of small speculators, individuals
like you and I playing the gold futures market. The
bull-to-date high of net longs for small specs happened
way back in early 2003 when gold first hit $375. Interestingly,
back at that time sentiment was too euphoric and a 200dma
pullback was due
Since early 2003 though, the trend of small spec net
long positions in gold futures has been down. Yes down,
you read that right! If the net long position in gold
futures by small speculators is a valid indication of
popular euphoria, then gold sentiment is no more euphoric
today than its was way back in late 2001. For nearly
four years now small spec net longs have generally hovered
between 25k to 50k contracts. The thesis that gold is
in a small-investor-driven speculative mania could not
be farther from the truth!
Meanwhile net long positions by large speculators are
gradually growing as the secular gold bull marches on.
Once again, not surprisingly, this is normal and expected
and is not the least bit bearish.
All speculators start small, and it is
only the successful ones that survive
long enough to build up considerable capital. By
the time they reach the big time, they have made all
the usual mistakes that speculators are wont to make
and they have grown quite sophisticated. Many large
speculators could not care less what they trade, they
only want to be where the action is. If the bull market
is in stocks they will trade the index futures, but
if the bull market
is in commodities they will funnel some capital
These large speculators have learned to ride long-term
secular trends. In gold's case, the longer it powers
higher for fundamental supply/demand reasons, the more
large speculators want to pile on. Riding secular trends
is probably the safest way to multiply a fortune since
it doesn't rely heavily on ultra-short-term trading
savvy or luck. As such, the longer gold moves higher
the more capital large speculators will throw at it
to ride its bull market. Momentum always attracts capital.
The bull-market economy among futures traders is pretty
standard, and gold futures look just as they ought to.
In general hedgers lock in prices for their production
to stabilize their cashflows, taking the short side
of trades. Large speculators come in to ride the primary
trend and take the long side. Meanwhile small speculators
pick up the long crumbs the large specs leave on the
Our final graph zooms in on only the last
few years or so, increasing the resolution of the latest
gold futures action. It reinforces the CoT interpretation
that this gold bull's futures signature looks like any
typical futures bull market and there is nothing bearish
or anomalous to fear.
In all these charts the major interim tops in gold
are highlighted by the vertical transparent blue bars.
I found it fascinating here to compare the hedger net
short position with the major interim tops in gold.
In general, the hedgers had the most net shorts outstanding
just when gold was hitting major new bull-market-to-date
interim highs. This shows some impressive trading savvy
among the commercials.
Love or hate hedging, the commercials were attempting
to lock in their selling prices near the interim highs.
In some cases, in hindsight at least, this could even
be beneficial to shareholders. For example, just as
2004 dawned commercial shorting neared a bull-to-date
record level. It turns out that gold traded as high
then as it would for the next ten months or so. So theoretically
a hedger with impeccable timing could have sold gold
futures in early 2004 and received a better price for
its gold over the next ten months than a non-hedger.
Meanwhile the small speculators, the group that is
supposedly crazy euphoric for gold today, has maintained
roughly the same level of net long exposure to gold
for over three years now! Bull markets climb a wall
of worries and small specs continue to worry and fret
today just as they have for this entire bull to date.
They are the most emotional of all futures traders and
their enthusiasm is waning, not skyrocketing. This pessimism
or skepticism is a bullish contrarian sign.
The bottom line is the gold futures Commitments of
Traders report, considered in strategic context, does
not support the main bearish theories floating around
bearing its name today. The gold futures signature looks
like most bull markets' futures signatures generally
do. There are no obvious anomalies.
Gold sentiment is rotten today only because
the gold price has been weak. As I discussed last week
in the context of gold
stocks, it is always price action that drives prevailing
sentiment. Yet, dire sentiment itself along with relatively
low prices near gold's linear support and 200dma is
one of the surest signs of a major interim bottom. If
historical precedent remains a valid guide, gold is
due to rally dramatically from these lows, not sink
If you are interested in trading the probable
approaching gold upleg, we have been gradually redeploying
into elite unhedged gold stocks in our acclaimed Zeal
Intelligence monthly newsletter in recent months
and will continue to do so as market conditions allow.
us today! Great profits await if the gold bull continues
higher as its fundamentals, technicals, and futures
CoT suggest it ought to.
Any prevailing fear running rampant today based on
the gold futures CoT is simply not supported by the
Adam Hamilton, CPA
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Mr. Hamilton, a private investor
and contrarian analyst, publishes Zeal Intelligence,
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