As a student of market history, I always find it interesting, and even sometimes quite comical, how certain fallacies about markets are continually propagated by investors and analysts alike. Throughout my career in writing about metals, I have tried to bring many of these to light and explain why so many of the fallacies should be ignored.
The latest in the string of fallacies relates to the Commitment of Traders (COT) report.1 The common argument suggests that, as long as commercial traders are shorting gold heavily, then gold cannot rally. And much has been made of late regarding the heavy commercial short positions pointing to a major drop in the gold market. Yet, history suggests this argument is false.
If you look at the 20-year chart below, you will see that, during the parabolic gold rally of 2010-2011, commercial traders were heavily short gold. In fact, you can see that, during that entire period of time, commercial shorts remained at 200,000 or greater. Yet that was during a period of time where the price of gold rallied $800. For those counting in percentage terms, that means gold rallied 70%+ during a time where commercial traders were heavily short of gold.
You see, just like technicals have to be read differently during bull markets versus bear markets, so does the COT. During bear markets, when the technicals reach an overbought level, then it often suggests the market will likely begin a selling phase. However, in a bull market, when the technicals reach an overbought level, rather than suggesting selling will result, the technicals often embed during the strong advance of a bull market. The same will often happen with the COT. So, applying a linear expectation to the COT data will not often result in the appropriate trading result.
This really means that technical support and resistance are much more important to metals investors/traders than the COT report. Moreover, the structure of the move in the metals complex will also tell us a lot more than the COT report. Remember, history has shown us that if the market is in a bullish phase, then the COT report will be meaningless.
So, at this point in time, there are several ways you can view the COT report, if you really care about it. Either the commercial shorts will cover their positions on the next corrective pullback, which I expect in early 2020, or the market will simply continue on its merry way with the commercial shorts being . . . well . . . short, no different than what we saw in 2010-2011. But, as I said, history has told us that this report is not going to provide any predictive value when the metals are in a bull phase. If we do morph into a bear phase, then it will mean a lot more. But, until we break some support (137 on the GLD), this report should not be heavily weighted within trading/investing decisions.
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1The Commodity Futures Trading Commission (CFTC) publishes the Commitments of Traders (COT) reports to help the public understand market dynamics. Specifically, the COT reports provide a breakdown of each Tuesday’s open interest for futures and options on markets in which at least 20 traders hold positions equal to or above the reporting levels established by the CFTC.
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Equities Contributor: Avi Gilburt
Source: Equities News
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