Reading CFTC Commitment of Traders Data

S

Steven.Davis

I am starting this thread to split a discussion.

Quote from Locutus:

Well the problem with the COT right now is that the open interest is pretty low on a lot of it so it doesn't really matter as much, however like you probably know then the commercial group is pretty massively (and suddenly) short equities across all indices (and commodities show the same overall pictures by the way, commercials are pretty much short everything but natural gas and a few others).
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I follow Steve Briese at www.InsiderCapital.com. He does a smart job of aggregating and interpreting the COT data. It is with his newsletters in hand and my own opinions, that I respond.

US Equities: It is an amazing state of things that the "smart money" is so strongly short (especially NASDAQ 100) since the breakout in September. With the Facebook fanfare, the market doesn't look weak. Since smart people only hold onto a losing position so long, I am looking for a commercial capitulation.

US Debt: Commercial have been buying after a big plunge. Simultaneously, the markets have gone sideways. Looks like interest rates are headed lower again.

Commodity Prices: Yes, the COT data has been quite bearish since August of last year. If smart money capitulates, we could be in for a long ride up as quantitative easing could finally deliver massive inflation. On the other hand, perhaps smart money is thinking that the high prices are funded by emerging market hoarding, and that at some point, the lack of buyers must affect the manufacturers. Even if the hoarders don't dump into the market, the run-up prices will settle back quickly and excessive inventories should dampen demand even at much lower levels. I really don't know, but we are watching a big play unfold. Perhaps it is gold buyers overflowing into more marketable products.

Gold:
Quote from Steve Briese:
The key take-away points are:
1. Unless commercial shorts (miners and central banks) are forced to capitulate and start buying back their shorts, it appears that this gold rally is running on borrowed time.
2. If commercial shorts capitulate in gold, it will be a first.
3. When large trader longs (commercial manufacturers and speculative funds) reach their buying limits and all prospective buyers have bought, prices will fall of their own weight.
4. The record speculative long total is heavily leveraged. A price reversal will force record long liquidation. The bigger they are, the harder they fall. A sane trader will not attempt to ride out the next gold correction.
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Generally, I would love to see COT data on all kinds of instruments. I assume that there is plenty of gossiping coming out of Exchange Clearing Members, but the small guy only gets to see the week-delayed futures positions. At least we have that.
 
I find the analysis proposed here on current state of affairs to be highly unlikely.

Things to remember:
-Commercial does not necessarily equal "smart money" but equals "insider knowledge". The two things are usually the same but not necessarily equal
-Smart money nor insider-traded knowledge capitulates! Unless something drastic in their knowledge base changes. The point is commercials (in commodities and equities) believe that the stuff is above fair value. If it continues to go up it will only get more above fair value hence they will only get more short, unless economic climate changes (proof of hyperinflation or some such).
-Non-commercials drive price in a trend (speculate) and commercials react (invest/hedge). It's very simple, the real value of something almost never really changes as fast as a financial-market trend makes it seem. However these trends can continue for some time while more speculators pile on, creating buying pressure.

The argument in another thread that "for every buyer there's a seller thus commodity prices are always fair" is absolutely nuts. Markets move towards prices that people are willing to pay (auction model). It's like saying that on any bet zero-sum bet both betters are never wrong. If I have a few billion to invest in some commodity you can bet the price is going to move because you can't find that much supply in the time I have to invest it. Further the other side of the contract better not be a speculator also because then the price will move even higher come settlement. The model only works if all market participants are hedging and breaks down terribly once you add non-commercial money to the equation.

Either way the current state of affairs is that current prices are deemed high by the commercial parties. If nominal value of the stuff changes a lot then they may "capitulate". However said newsletter you quote has only one purpose and that is to feed speculative greed. Unfortunately what makes the COT hard to interpret is you never know the end of the line for greed or fear to take over the other.

Also I have not seen one single valid argument for hyperinflation. The amount of money being printed is not that excessive (market reaction is) and is certainly not flowing into the economy, nor will it. Not to mention everyone seems to forget the FED has the same power to drain liquidity as it does to add, so once it becomes a real risk they will start to sell bonds (leading to massive interest increases, leading to an appreciating dollar, a weakening economy/exports and thus eventually creating deflation and possibly a depression).

One last argument. The total market cap of the US market is now about $13.5 trillion. That's 13,500 billion. Right before the FED started QE2 (November) the market cap was about 12,500 billion. Assuming that "it's the FED who is buying this market" ALL the FED money must've dropped straight into the NYSE (not likely) and it would still be 400 billion short (more than that but I can't be bothered to figure out how of QE2 is done and still to be done). Speculators are buying this, not the FED, to think the commercials are going to capitulate... If anything we are going to have an outflow of speculative money (400 billion would be a nice target for the NYSE) and short interest seems to indicate this is being anticipated. The inflation that could possibly be created by QE2 is already more than priced into current levels.
 
Commercial capitulation is at most rare. I agree that thinking of commercial positions as being deep underwater is a speculator's mindset. Your point that a long-term hedge based upon economic conditions is still valid so long as the economic conditions persist is cogent. You are right that it didn't occur to me that the FED could drain money just as easily. I appreciate your numbers concerning QE2, and concur that its inflationary effect is likely is already over-priced into the market.

If we take the COT numbers at face value then, we can expect a major bout of deflation. Both commodity prices falling and treasury prices rising. This fits the Real Economy outlook better than the current corporate-profits-are-high outlook. I don't wish to waste your time or mine on that point as I have nothing particularly to contribute.

Given that Silver is trading at an extraordinary price even relative to highly inflated gold, would you think this is a good place to short?
 
Quote from Steven.Davis:

Commercial capitulation is at most rare. I agree that thinking of commercial positions as being deep underwater is a speculator's mindset. Your point that a long-term hedge based upon economic conditions is still valid so long as the economic conditions persist is cogent. You are right that it didn't occur to me that the FED could drain money just as easily. I appreciate your numbers concerning QE2, and concur that its inflationary effect is likely is already over-priced into the market.

If we take the COT numbers at face value then, we can expect a major bout of deflation. Both commodity prices falling and treasury prices rising. This fits the Real Economy outlook better than the current corporate-profits-are-high outlook. I don't wish to waste your time or mine on that point as I have nothing particularly to contribute.

Given that Silver is trading at an extraordinary price even relative to highly inflated gold, would you think this is a good place to short?
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I don't know if it's a good idea to short now but it's defnitely a bad idea to buy into the rally at these levels. You never know how far exactly they'll run her up until reality gets a hold of the markets. I wouldn't be too surprised if we break out of the current range again but I do think it's more likely for a dip to occur soon.

Edit: I didn't see your question related to prec metals. I would stay away from those, they're irrational. Irrational markets are difficult to trade. I'd short some other stuff if I wanted to go short on something, mainly agri. The beauty of agri is that unless the ecosystem suddenly collapses you can easily make more of it so unless inflation goes wild (which it won't) prices are attractive to sellers now... So are equities.

I like Marc Faber's vision personally but I am not terribly bearish on interest rates from a monetary point of view, but I think they could go up anyway due to fear of federal budget concerns. If you're a decent trader I think the best position right now is to be short calls on a lot of things and trading around that position a bit (i.e. trying to catch rides up with futures to minimize losses if things remain to go north again). Shorting directionally right now might be too early.
 
Quote from Locutus:

I don't know if it's a good idea to short now but it's definitely a bad idea to buy into the rally at these levels. ...
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I appreciate your input. I was thinking last night how great scale-trading short calls on gold could be.
I agree that agricultural products, with commercials in the business of actually delivering each harvest as retail food, has a built-in sanity check.
I didn't have to Google to hard to figure out what Marc Faber is about http://new.gloomboomdoom.com/portalgbd/homegbd.cfm.

Thank You.
 
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