Speculators Short Copper, Cover in Silver and in Gold

The weekly Commitment of Traders report is out, seeing that it is Friday afternoon, so we can now once again proceed with our entrails-reading and tea leaf-divining as we dissect the internals of some of these commodity futures markets.

I thought I would start with my favorite indicator market, namely copper. Here is the COT chart. It looks like it was a case of - for the Hedge Funds - "If you can't beat 'em, then join them". They finally abandoned the copper market on the long side and moved over to join the other Large Reportables camp on the net short side of the market this past week. Those of you who have been following the site will recall that I have been fascinated by this battle between titans over the fortunes of the red metal. The "large reportables" camp has been winning that war.

I should point out, however, that it does appear we had a big round of short covering among these speculators that took place on Wednesday and continued into today's session. Here is the Daily Chart.

As you can see, I made a pointer to the Wednesday bar; the day on which the FOMC released their statement and Janet Yellen gave her now infamous testimony. Copper put on some $.06 per pound since then. No doubt those who were short the metal were just as spooked and shell-shocked as anyone else when her testimony began getting considered and studied more closely. I suspect they ran strongly for the exits as many shorts did across the entirety of the commodity sector, especially on Thursday when "the Yellen" unleashed havoc on the commodity bears. ( I want to recall that scene in the Russell Crow movie, "Gladiator', at the beginning when the Roman army is fighting in Germania and Maximus tells his officer; 'at my signal, UNLEASH HELL").

I think the shorts all felt like the barbarian army after the Romans finished with them in that battle scene. I know I sure did in my feeder cattle positions. They had gone limit down the previous day and ended limit up on Thursday! Everyone was panicking trying to figure out what the hell was going on.

Silver experienced a round of significant short covering this week, much more of which continued on Thursday and Friday's sessions. The hedge funds underwent a HUGE SWING of some 11,000 contracts in favor of the buy side as they covered  9800 short contracts. They only added about 1450 contracts on the long side however. That probably changed Thursday and Friday however based on what I have been able to glean thus far from the open interest data and volume readings. Prior to those two days, hedge funds, who had been net short silver nearly 6000 contracts were now net long by some 5000 contracts! That did not take long did it?

I would suspect that what silver, and gold, have undergone this week, is pretty much indicative of what happened to many commodity market bears. They were forced out by index fund buying and by hedge fund short covering, which was unleashed by Janet Yellen.

Here is a look at the gold COT chart noting the positioning of the hedge funds on a net basis.

You can see that the Net Long positioning of the hedge funds shot up through Tuesday of this week. As it did, it is not hard to figure out what happened to the gold price - up it went. And remember - this is only through Tuesday and did not include that wild ride higher on Thursday. I cannot even imagine at this point how many speculative shorts were blindsided by Maximus Yellen.

There was a swing of about 15,300 contracts towards the net long side among the hedgies as they covered some 13,600 shorts and added some 1700 new longs. I should point out here something that I have commented on during previous rallies in gold over the last few months - If one is bullish, one does not want to see a market moving higher led by short covering. One should expect to see short covering but they also WANT TO SEE NEW BUYING. That means, in subsequent COT Reports, we are going to want to see the number of new longs, especially on the hedge front side of things, outnumbering the amount of short covering. If this is the case, it will augur for further strength in the metal. If however, and this is key, we do not see that development, I will be concerned about the staying power of this current rally.

It is way too soon to be declaring the bear market in gold is over, especially on the basis of a week's price action but especially with a move higher led mainly by short covering. Let's see what we get for the next week. Also, please keep in mind that weekly chart of gold I posted yesterday showing the rectangular boxes denoting the range trade that gold has been undergoing.

From a technical analysis standpoint, gold has been in a bear market since it broke down below $1530. It has now stopped going down but neither is it in a bull market. It is RANGE BOUND - pure and simple. It will have to break out above the top of the year long range near $1400 before one can make declarative statements that "the bear market in gold is over". That is someone talking their bias and not being objective.

We had the same sort of talk back when gold bounced off of the $1530 level the second time some while back. The same chatter was" the move lower in gold is over- expect it to go on and make new life time highs". We all know how that played out!  

What we can say, and say with a great deal of certainty, is that the recent leg lower in gold has been halted. The market has found support first near $1200 and now again at $1240 ( a higher low within the range as I pointed out yesterday). But it has not yet broken out on the charts. It can run as far as $1400 and still remain rangebound.

Please remember this when we start getting the predictions again and confident assertions. Just stay unbiased and objective, respect the price action for what it is, and go with the flow. Above all, KEEP YOUR EMOTIONS out of it.

One can always tell those whose trading/investing decisions are based on emotions and not objectivity because they will be the first to insult those whose technical view of the markets contradicts their positioning as well as the first to crow when the market moves in their favor.

Trading/investing is not about emotions - it is about remaining objective to the point of becoming almost cold-hearted. That takes years and years of exposure to learn.

Incidentally, one last thing for now, some of you very kindly have suggested I put some sort of "Donate" button on my site. I have opted not to use ads as I feel they clutter the site up anyway and detract from what I am trying to convey. I have long resisted putting anything up here for monetary purposes but I must admit that there are times when trying to keep posting interesting and hopefully useful articles and such does take its toll on me. I am first and foremost a trader and as such I must give my trading my full attention and efforts.

However, the website does take a lot of my time and I am finding that I spend more and more of it in front of the computer to the point where I am wondering if it is worthwhile for me to continue this. I do have another life besides that of a trader. I think every man should try to leave the world a bit of a better place than he or she found it but I also have a legacy to think of in regards to my own kids and wife.

Please send me a bit of feedback about this. I do not want to do anything that would come across as unseemly or blatantly or obscenely mercenary. I would rather however go with a Donate button rather than make this site, fee paid or clutter it all up with ads.

Going the ad routine tempts people into surrendering their objectivity to cater to a particular set of the population ( call them "the choir") and moving towards sensationalism and other efforts that are designed to attract as much viewership as possible to generate more ad revenue. I abhor that personally. I would much rather have a clean conscience and a much less visited web site than one that makes lots of money but ends up harming people because it clouds their objectivity and keeps them in poor investments by marrying them to one point of view only. That is a dangerous and financially destructive path.

Going to a fee paid site might prevent some of those who cannot afford such things from reading the site and maybe learning something that might help them become better investors or traders.

The Donate route seems to me to be a good alternative as it is completely voluntary and not tied in whatsoever to the amount of website clicks that many use to generate revenue.

Let me hear from you on this please.

To those of you who have been reading here regularly, thank you for your continued patronage. I want you to know that I am honored and humbled by your viewership and that I take very seriously what I am writing and my analysis because I realize I have earned the trust of many of you. That trust cannot be valued too highly. The last thing I would ever want to do is to do anything that might be misconstrued as being dishonest or disingenuous. I try to call things as I see them - sometimes I am wrong - sometimes I am right but I do try to stay objective. Hopefully that has been conveyed over the years here.

Again, thanks.
Dan

Inflation Expectations Rise this week

I made mention of this chart not too long ago as another way to try to keep tabs on what market participants are thinking in regards to inflation expectations.

Here is the longer-time frame chart showing the TIPS spread and the gold price.

The chart is valuable in the sense of seeing how well or not so well, gold is tracking the ebb and flow of inflation expectations currently in the market.

I wanted to pull a close up and take a look at this chart on a bit more shorter-term basis so below is the same chart using November 2013 as a starting point. I chose this month late last year as a starting point because gold lost around $100 during that month before a final plunge to $1180 in December.

Here is the close up look:

 

This week, the TIPS Spread has run up 6 basis points as of yesterday afternoon. It is currently sitting a 2.25. Interestingly enough, the spread bottomed out early this month at 2.17. These changes may not seem like all that much but interest rate movements and gold are tied quite closely together. As a matter of fact, the TIPS spread is now at its highest level in nearly 6 months ( Jan 22, 2014). What this is telling us is very simple - there has been a shift in regards to the rate of inflation that the market is now expecting as we move forward.

The sharp spike upward this week, I believe, can be laid completely on the shoulders of the Janet Yellen Fed, especially in regards to her testimony and comments. For whatever the reason, and I suspect that the market is beginning to grow increasingly nervous about this Fed, traders are starting to worry about inflation.

It could be that to some, the Fed is already behind the curve on raising short term interest rates.

That being said, can you see why the price of gold has shot up as sharply as it has this week? With the breakout higher in the Goldman Sachs Commodity Index, and this move to a 6 month high in the TIPS spread, gold is reacting to these increased inflation expectations. Silver, especially, being much more sensitive to inflation concerns than is gold, is reacting ever better.

The market is obviously sending a message to Ms. Yellen and to the rest of the Fed - the question is are they hearing it?

One suspects that they are not.

One sign that they might finally wake up from their stupor and see what their policies of ZIRP ( Zero Interest Rate Policy) is doing to the commodity sector would be a rash of speeches and appearances from various Fed governors starting to talk hawkishly about raising interest rates. That would support the Dollar and undercut some of the strength in the commodity sector in general. If they do not do so very soon, they are going to have some real problems on their hands as the markets will have gotten way out ahead of them.

Keep in mind something that I have mentioned for a while now - I believe that the Fed actually did not want to see the gold price collapsing lower, along with the rest of the commodity complex - that would be a dangerous signal ( to them ) that deflation is gaining the upper hand, and we all know that the Fed, as well as all modern Central Bankers, are terrified of the deflation spectre. They believe that they can handle the inflation genie but the deflation boogey-man is an altogether different and quite unwelcome entity to them.

The problem for the Fed is that they might be able to generate some upward pressure on commodities, perhaps by design, perhaps not, but they run the very real risk of letting things get completely out of hand. One cannot give speculators a green light to blindly buy commodities in general without unleashing a dangerous wildfire. Apparently the Fed thinks that they can handle a campfire but they had better watch out!

Let's continue to track this, along the GSCI, and the Dollar, to see how things proceed as we move forward into this summer.

Silver Takes the Lead over Gold

Long time readers of this site will already know that it is my opinion that silver requires an environment in which inflation expectations are alive and well in order to outperform gold. In an environment in which traders are more concerned over deflationary pressures, silver will fare far less well than the yellow metal.

In other words, one's investment or trading decisions need to take into account the sentiment among players when deciding to approach either or both of these markets. Even more so that than however is the signals that can be derived from tracking these markets. When rightfully understood, it can help one discern what is on the minds of some of the large speculators that dominate these markets and whose buying or selling decisions most greatly influence price direction.

Take a look at the following charts where I have created a comparison for you and you will see what I am getting at.

The top graph, the blue line, is another one of my pesky ratio charts ( Yes, I know, I am addicted to these things). I am essentially taking the price of silver and dividing it by the price of gold. By looking at the direction of the line, one can easily see which one of these metals is performing better than the other.

It is my contention, that if the market is expecting Deflationary pressures to win out, the line will move lower as the price of silver will lag gold to the upside on rallies but lead it on moves to the downside in both metals. If the market is expecting the opposite, namely inflationary pressures, silver will lead gold on the moves to the upside in the metals or will not drop as hard as gold during moves to the downside in the metals.

Below this ratio chart, is a graph of the Goldman Sachs Commodity Index, which I follow religiously to get a bird's eye view of what is taking place in the larger commodity complex as a whole. By closely monitoring these commodity indices, one can see any rise in prices at the wholesale level, long before most other folks have the faintest clue what is happening. The futures market are just that - "Futures" markets - they are not "past" markets nor are they "present" markets. They look ahead.

Now, there are other variables that need to be considered when monitoring commodity indices that I have spoken to here at this site many times - most notably the forward structure of the Board. I have noted this quite frequently in recent posts as I discuss my reasons for expecting lower food prices by Q4 of this year and certainly by Q1 2015.

That being said, I tend to look too far ahead at times as I like to have some idea where things might be headed. However, for the purposes of trading and understanding what the "crowd" is thinking, one can take the commodity indices at face value and draw the proper conclusions.

What do you see when you examine the ratio chart line and the line of the GSCI? Can you see a connection? Yes, you should. When the overall commodity sector is moving higher ( wholesale prices are rising) the ratio moves higher as a general rule ( again - it is not a 100% relationship but it is very close). When the overall commodity sector is moving lower ( wholesale prices are falling) the ratio line moves lower.

In other words, Silver will outperform gold if the market expects to see inflationary pressures in the commodity sector.

What is the GSCI doing right now at this moment and what is the ratio line doing? Both are moving higher. This tells me that the sentiment in regards to the commodity sector at the moment is that players are becoming concerned about rising commodity prices.

Keep in mind that the biggest component of this particular commodity index, the Goldman Sachs Commodity Index, is the energy complex so this index does tend to skew the perception of the complex as a whole in favor of what the price of energy is doing, but ever since my beloved Continuous Commodity Index or CCI, went the way of the dinosaur, I have used the GSCI. The CCI was the best balanced commodity index in my opinion and most accurately reflected what was going on in the entire commodity complex because it was weighted more evenly than any other index out there. We have to use what we have to use however and thus the GSCI, which by the way is a major benchmarking index used by INDEX FUNDS.

I mentioned these index funds in a separate response to a post here at the site yesterday. They are not hedge funds. In my profession, we often call them "long only" funds. The reason is because they mostly take only the long side of the commodity futures markets that they invest in. These funds essentially exist for the purpose of providing investors exposure to the commodity complex as an alternative investment class. They receive monies from clients and buy a basket of commodities exactly the same as the index that they are benchmarking against.

During the big boom in commodities back during the initial rounds of QE, index funds were very active in the commodity futures markets buying huge blocks of commodity contracts. I think it is important to understand that this group DOES NOT TRADE FUNDAMENTALS in individual markets. They must buy every single commodity that the index they benchmark against includes in its basket in the same percentages that comprise the index. These weightings change every year so the index funds who roll their positions from month to month are forced to realign their holdings in early January or February each year.

The thing to come away with however is that whenever one experiences rising interest in commodities as an asset class, these index funds become more influential in the markets because the size of their buying increases. As a trader, they cause me more grief than the hedge funds because of the reason I stated above; they will buy and take long positions no matter what the markets might be doing or what the current fundamentals of that particular market are. In other words, they buy BLINDLY.


However, and this is key - when index funds begin investing more money into the commodity sector, the asset class is coming back into favor and that only happens when investors are worried about potential inflationary issues.

I maintain that something is happening in the marketplace in regards to its confidence in the Yellen-led Fed. I am not sure exactly what Yellen said in her comments this week, but ever since those comments were made, things have heated up considerably in the commodity sector overall. One gets the distinct impression that the market currently has not exactly given her a ringing vote of confidence.

Yet, the VIX, or Volatility Index, has continued to sink lower indicating that COMPLACENCY remains incredibly widespread at least in regards to stocks. However, in watching this climb in the silver/gold ratio and the move higher in the GSCI, I see signs of cracks appearing.

I will leave you for now with this daily chart of silver. Note a couple of things - the market has recaptured the $20 level in very convincing fashion. So far today it has even run to $21 where some profit taking has emerged. Price is above the 50 day and the 200 day moving averages and the 50 day is turning higher. The ADX is rising but it remains below 30. That means the potential for a trending move higher is growing. Bulls are in control

If the price can power through psychological round number resistance at the $21 level, it should be able to make a run at $21.50 and the area just above that, which is the next level of chart resistance.