Keeping an eye on the gold COT report

The Commitment of  Traders (COT) report is released every Friday for data reported as of the previous Tuesday. It gives market participants a lot of information about those who trade futures contracts. The report makes public the long and short positions for commercial traders, large traders , and small traders.

I look at the COT report every Friday. I’m most interested in the net long or short positions of commercial traders. They’re the big boys. They’re the ones who can move markets and they’re the ones with the best information. Let’s call them the smart money.

If you subtract the number of short positions from the number of long positions you will get a positive or negative number. If there are more longs than shorts the number will be positive. If there are more shorts than longs the number will be negative. If the number is positive the smart money is net long. If the number is negative the smart money is net short.

It has been my experience from years of studying the COT reports that when the smart money has the most extreme net long or the least net short position in a market that they have had in a while (I use the last 18 months) it is a bullish sign. It means that commercial traders think the price is relatively low and they don’t see a need to sell futures. Or, depending on the market, they may see an opportunity to buy futures. So they have reduced their short positions or increased their long positions in the futures market.

Conversely, when the smart money has the most extreme net short position (or least net long) they have had in the last 18 months it could be a bearish sign. Commercial traders see the price as high and are increasing short positions. In other words, they are hedging by locking  in higher prices.

The reason I’m bringing all this up right now is the COT report for gold this week is a real eye-opener.  Here is the part that got my attention…

As of Tuesday, September 8 (released on Friday, September 11) commercial traders of gold futures are long 84,842 contracts. They are short 355,639 contracts. Therefore, they are net short 270,797 contracts. It’s an increase of 54,089 shorts from the previous week.

270,797 net shorts is a huge number. In fact, according to my brief review of the historical data, it’s the largest commercial net short position in the history of the gold futures contract. It’s sending us a signal that the smart money thinks gold is getting pricey. Therefore, they want to lock in higher prices by greatly increasing their selling of gold futures contracts. It could be an important bearish signal.

However, it has been my experience — especially with gold and silver — that when commercial traders have an extreme bullish position (more longs in relation to shorts) it is a much more reliable signal than when commercials have an extreme bearish position (more shorts in relation to longs).  I have seen commercial traders have big net short positions in precious metals and the price just keeps going up for a long time. It happened in 2006. It also happened in 2007.

So it’s just a cautionary sign. The prudent thing to do is if you own gold, gold ETF’s, or gold mining stocks, stick with your original plan. There is no question that the primary trend is telling us that gold is in a bull market. But if you don’t already own gold, right now may not be the best time to rush in and buy.