A Message to the Gold Bulls: Relying on the CoT Gives You A False Sense of Security / Commodities / Gold & Silver 2019

Goldstocks have repeated their decline once again yesterday while gold and silversoldier on. When will the miners take gold and silver down with them?Underperformance is a critical sign of weakness, there’s no denying that. Wouldtoday’s Fed policy pronouncements provide the spark? These are valid questionsthat we answer for our subscribers on an everyday basis. For you, dear visitor,we have explored everyone’s favorite subject: the CoT report. You won’t get achance to get bored while waiting for the pieces of today’s puzzle to fallwhere they belong. While an evergreen, today from an angle you probably haven’theard before anywhere else. Get wiser and benefit!

Havingdiscussed the very recent developments, we would like to once again discuss theissue of the CoT reports and their predictive power. Once again, because wededicated the very first analysis of this year to this matter. The bottom lineis that CoT’s usefulness as a trading signal has decreased greatly over timeand it’s not wise to read too much into it anymore. Our subscribers know thefull reasoning already as we wanted to have something to link to whenever wereceive more CoT-related questions and comments in order to put it all in theproper context. The thing that we will discuss today is what we recentlyreceived about the part of the CoTreport – the money managers’ positions.

Theupper part of the chart features the price of gold and the lower part of thechart shows the futures positions of the money managers on COMEX. The green arearepresents the long positions, while the red area represents the shortpositions. The black line shows the net positions (longs minus shorts).

Thischart shows high correlationbetween gold and the net positions of money managers. Both have been moving in very closetune in the last few years. We were informed that this supposedly proves orindicates that goldprice is manipulated. The moves being so highly correlated, so it mustindicate that the money managers are responsible for gold’s price moves –right?

Didyou know that the stock market returns are (inversely) correlatedwith the length of women’s skirts? Does it prove or indicate thatthe stock market movement is manipulated by skirt producers, skirt buyers, orskirt users?

Ummm… There must be some otherexplanation, I guess…

Ofcourse there is – in both cases. The above link provides some possibleexplanations behind the skirt correlation and the other possible explanation isthat stocks tend to move higher in the first half of the year. Most trading isdone in the northern hemisphere, which means that it gets warmer in spring andthus short skirts are becoming more popular. In other words, the above may bejust a fancy way to describe a regular market stockmarket seasonality.

Incase of gold price, the explanation is even simpler. Investors’ sentiment movesalong with price. This applies to both: professional and amateur investors.And… That’s it. This is enough to explain the high correlation between themoney managers’ positions and the price of gold. As the price moves higher,investors get more confident and add to their positions and/or other investorsbecome convinced that the price is going to move higher and enter the market.

But shouldn’t the professionalsbe more market-neutral? The investment public can be biased towards longpositions, but the professionals shouldn’t.

It’strue that the investment public favors long positions, but the same can be saidabout the market professionals. The extent is not as big as in case of theformer, but the tendency is still in place.

Onereason is that when one’s running an investment service that allows shorting(for instance a privategold fund),they still have to adhere to the fund’s mandate. If it’s a gold fund, the oddsare that it was presented as being a proxy for gold. Fund clients – oftenprivate investors – are likely going to favor a situation in which the fundinvests in tune with the underlying market, not against it. This means that thefund manager and/or owner will be rewarded (more clients attracted) if theymove in tune with the underlying asset. In our case, it would mean being mostlylong gold.

Veryfew people will have clients that understand that at times it’s a good idea toeither get out of the market or even temporarily enter a position against it,and even fewer money managers will have the courage to do so, even if theythink that it’s a wise decision. Investors may not be willing to forgive awrong decision that moves against their favorite market, but they would be morewilling to forgive a wrong decision that’s in tune with their favorite market.This is really the case and we know this from our experience. We are blessedwith clients who understand our approach, but we also know that if we simplyfollowed the always-buy-gold mantra we would have bigger following. In ourAlerts, we regularly choose doing what appears to be more profitablein the end,not what is more pleasant to read, but we know that it’s difficult and thus the natural drift toward long positionsamong money managers is perfectly understandable.

Justlike there was a more believable explanation behind the stock-skirtmanipulation theory, there is one for high correlation between gold and moneymanagers’ positions. And the correlation is not as high in the very long run asthe last few years might indicate.

Inthe preceding years, money managers’ net position in gold was also correlatedwith gold, but to a much smaller extent. Please note that their net positiontopped in 2009 and then refused to move to new highs while gold was makingthem. In 2012, it was making new lows before gold did. Overall, the positionsof money managers are not as highly correlated with gold as it seems based onthe last few years, and even if it were, it would not be a significantindication, let alone proof that gold price is controlled by the moneymanagers. This is what we can say based on the charts, without even taking intoaccount how big the gold market really is and how many other goldmarket participants there are.

Let’smove back to the previous chart for a minute. The CoT positions are a weaktechnical indicator, but if one insists on using it, we can see some bearishindications on it. There were a few times when long positions in the moneymanagers were at  similar levels (redhorizontal line) and all that indicated was that a bigger move lower has justbegun (marked with red dashed lines). If we take the net position into account,we have a situation that’s similar to two other cases (marked with redellipses) – gold declined in both cases as well. Again, this is not a very reliable indication, but since other techniquespoint to much lower prices of gold, it seems that we can use it as aconfirmation. The outlook remains bearish.

Summary

Summingup, it’s almost certain that the next big move lower has already begun and thatthe 2013-like slide is in its early stage. Based on the updatedversion of the 2013-now link, the implications are even morebearish than we had initially assumed. The downside target for gold remainsintact ($890), and the corrective upswing that we just saw seems to be rathernatural part of the bigger move lower – not a beginning of an important movehigher. And it seems that the correctivemove higher in the PMs is either over or about to be over shortly.
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Thank you.

Przemyslaw Radomski, CFA

Founder, Editor-in-chief

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