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COMEX Heavy Commercial Gold Shorts Not Always a Sign of a Top

 -- Published: Friday, 4 July 2014 | Print  | Disqus 

By Gene Arensberg

HOUSTON -- Very large net short positions held by traders the CFTC classes as “commercial” in COMEX futures for gold have, in the past, often marked at least an interim top. We have recently seen attention drawn to the commercial net short position by respected market watchers, such as James Turk of GoldMoney fame, John Hathaway, of Tocqueville Asset Management, among many others.

The theory is; who better than the gold trade itself, the traders whose job it is to hedge their natural long position with futures, to know when they need to layer on heavy hedges in preparation for a gold price pullback.

The theory seems sound enough, but it is not foolproof. Far from it. We aim to give at least one glaring example that will shatter the notion that a large number of net shorts or even gross shorts held by commercial traders for gold is always a sell signal. It could be something else entirely...

First the numbers as of June 24 data published by the CFTC. As gold metal advanced $47.61 or 3.8% COT reporting Tues/Tues, the combined commercial traders as a group (including the Producer/Merchants and the Swap Dealers) added a huge 53,282 contracts to their collective net short positioning (from 78,325 to 131,607 contracts net short). We can see a visual on that truly huge jump in net shorts in the Legacy COT tracking graph below.

20140704 LCNS net

Graph: Legacy COT, CFTC for COT data, Cash Market for gold, GGR.

Suffice it to say that as gold advanced 3.8% the gold trade put on a huge number of new hedges. That is inarguable. The other way to say that is that as gold advanced to and above $1300 the commercial interests sold heavily into it. But should they have?

Incidentally, that 53,282 contract increase in commercial net short positioning is the largest one-week increase since the Sept 9, 2009 54,089 lot increase when gold fetched $995.40 the ounce. Let that sink in a moment… Please re-read the last two short paragraphs for clarity before we move on…

That particular huge addition to the commercial net shorts (Sept 2009) came when gold was in an uptrend. As it happens the huge selling by commercial actors into the rising gold price then did not slow the advance of gold. Not at all. By December 1, (3 months later) gold had tested $1200 the ounce, more than 20% higher. What is more, gold was then staging for the rapid gains in late 2010 and 2011, nearly doubling in price before peaking in Sept, 2011 near $1900.

And what of the overly large commercial net short position then? Well, for ease of discussion let’s focus on just one class of commercial trader – in this case the Swap Dealers. And, let’s focus purely on their short contracts during the period the gold price overran the commercial’s shorts.

As can be seen in the graph below, in 2010 Swap Dealers, the mercenary banks who sell complicated swaps, knock-in or knock-out options and other sophisticated bets to producers, other banks and big players in futures (think predatory Goldman Sachs for example), had sold heavily into the gold rally and by September of 2010 had amassed an enormous short position in excess of 207,000 short contracts as gold neared a then record high $1300 the ounce (about where it is now).

20140704 SD Short Graph annotated

Graph: Swap Dealer Short Contracts, Gold Futures

Notice in the graph that from that peak near 207,000 shorts the Swap Dealers started covering those short bets as the price of gold maintained its uptrend. The Swap Dealer’s shorts had become what we call “rally fuel.” The market really does not distinguish between straight up buying pressure and short covering. They have essentially the same effect.

We can see in the chart that the Swap Dealer short covering accelerated significantly as the price of gold really took off in, call it March of 2011. Let’s look at the actual data.

20140704 SD Short Data 2011


By September, 2011, gold had put on $600 the ounce and the Swap Dealers had been forced to cover roughly 67% of their formerly very large short positions. Their 207,000 shorts, along with other traders similarly situated, became the highest of high-octane "rally fuel," helping to push the gold price higher.

So, had someone assumed, in 2010, that the Swap Dealer heavy short position was a sign of a gold top, they would have assumed wrong in a very big way, missing the all-time largest gold rally ever.

Ergo, now when we say that a heavy short position by commercial gold traders is not, repeat not, necessarily a sign of a gold top – and that it could very well be the beginning of exactly the opposite – you can recall this offering for ‘where we are coming from.’

That is all.

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