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GOLD OUTLOOK: The Commitments of Traders Report

GOLD OUTLOOK: The Commitments of Traders Report

A Brief Overview
The ‘commitments of traders’ (COT) report is published every Friday by the Commodity Futures Trading Commission (CFTC). The COT report provides transparency in the U.S. futures markets by disclosing the trade positions of market participant groups. The groups include commercial hedgers, large speculators and small retail speculators. The CFTC defines each group as follows:
 
Commercial: An entity involved in the production, processing or merchandising of a commodity*. Commercials typically control the majority of open interests and are considered industry experts or smart-money in their respective industry. As a result, commercials commonly have their largest net positions at market bottoms and smallest net positions at market tops.
 
Large Trader: A large trader holds or controls a position equaling or exceeding the exchange or CFTC-specified reporting level*. Large traders represent funds and are characterized as trend followers in the market place; this group tends to have its largest net positions at market tops and smallest net position at market bottoms. Large traders typically take the opposite side of the trade – against commercial interest.
 
Small Trader: Traders who hold or control positions in futures or options that are below the reporting level specified by the exchange or the CFTC*. This group controls a very small portion of open interest but is helpful in gauging retail sentiment.
 
Other key terms:
Net Position: Total number of contracts held long, less the total number of contracts held short, per trading group.
 
COT Chart: Visually depicts the net positions of each trading group, highlighting their operations in the futures markets. COT Charts are commonly analyzed by gauging the current net position of a trading group relative to the last 6 – 12 months.
 
*Definitions courtesy of CFTC.gov
 

 
Outlook for Gold
What does the COT report have to say about the gold market?
 
The following COT gold chart depicts the net positions of the three aforementioned groups (commercials, large traders, and small traders) with the price of gold plotted in the bottom chart.
 
 
The smart-money commercials (green line) have been buyers in the marketplace, as gold prices declined over the last few months. Their net position increased from a low of -269,270 contracts in October 2012 to the latest reading of -84,122. In other words, commercials initiated new long positions and covered previous shorts which increased their total net position by just over 185,000 contracts. This is the most bullish commercials have been on gold since the October 2008 bottom. 
 
Large traders (red line), which include hedge funds, tend to have their largest net position at market tops and smallest net position at market bottoms. Large traders are currently net-long 83,726 contracts – the most bearish reading since the October 2008 bottom. This group is characterized as trend-follows and as a result they are typically the most bearish at market bottoms and the most bullish at market tops.
 
The last remaining participants are the small traders (blue line). Historically, they have been on the wrong side of the gold market at key inflection points. In May 2013, this group had a net position of -1,704 contracts, an extremely bearish position not seen since February 2001 when the gold market was about to embark on a decade long bull market run.
 
The current dynamics between the three groups signal that a significant intermediate-term bottom is forming in the gold market. This does not necessarily mean that prices cannot head lower, but it does mean that prices are attracting commercial buying interest – the smart-money – at levels not seen since the financial crisis when gold declined from ~$1,000/oz and hit a critical low at ~$700/oz.
 
The key is to look for signs of a bottom, including technical breakouts above key levels of resistance. With the current setup in the gold market, breakouts to the upside are likely to result in a sustained rally for gold prices.
 
 
Looking at gold in the short-term, we have April’s reaction low at ~$1320/oz as key support. If support is broken to the downside, we could see a test of the $1200/oz level. However, this would still mean that an important bottom could be forming as long as commercials continue to increase their net position, which is typical of their behavior in a declining market.
 
In terms of upside resistance, in the very short-term we have to get above $1400/oz which will give the opportunity to test $1448/oz which is the 200 week moving average (WMA). Above that we have April’s retracement high forming a second shorter-term resistance level at ~$1480/oz.
 
A decisive break above $1448/oz is an important level for the gold bulls, as it represents a rising long-term moving average which has been violated. The last time gold touched its 200WMA was in early 2002. Since then gold prices remained above this average until breaking below it in April 2013. On a move back above the 200WMA and the aforementioned $1480/oz resistance, the market will be poised to test important resistance at $1550/oz and $1800/oz.
 

 
Conclusion
Considering that all-in sustaining cash costs for certain major producers are over $1100/oz (Goldcorp: $1135/oz and Newmont $1115/oz), it is this author’s opinion that the potential upside in gold prices strongly outweighs the potential downside.
 
The current net commercial position supports this outlook going forward.
 
Stay up to date with the latest COT gold chart by visiting 
http://www.europac.ca/gold-cot-chart every Friday after 5:00pm.
 
 

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