The Commodity Futures Trading Commission (CFTC) provides the Commitments of Traders (COT) report on a weekly schedule detailing long and short positions for the derivatives market. A trader can discern a lot of interesting statistics from the report to see who is long or short a market and when these statistics change. Some free websites can provide this data in chart format, like www.timingcharts.com.
Besides net long and short positions, another important statistic in the report is open interest. Open interest is the total number of open derivatives contracts in which traders have built a position. Whether a trader is short or long a contract, they have a position that can be totaled. Open interest rises as traders build positions, and falls as they close them out. Open interest is useful in understanding sentiment and momentum for an underlying instrument.
In August of 2009, dollar bulls pointed towards the overly bearish sentiment on the U.S. dollar as a contrarian signal of a bottom – and rightly so; it was clear to see that traders were overly bearish. Looking at the COT report, Large Traders began to unwind their short position near August 21, 2009 when we can see that the Large Trader short position divided by the Large Trader long position peaked (red line)—just like they did in late 2007. After the Large Trader short position had peaked in both time periods, we see that Large Traders eventually went net long in mid 2008 and in early December 2009 (blue arrows in chart below) right before a bullish trend began.
Source: www.timingcharts.com, CFTC data
An interesting item of note throughout the period between July 2009 until February of 2010 is that open interest (the aggregate count of open derivative contracts—both long and short) increased in the U.S. dollar (blue line in chart above). In other words, the U.S. dollar trade was getting more play.
Currently, it looks like Large Traders have been closing out long positions as indicated by a falling net position statistic and a falling open interest statistic. In fact, Large Traders have almost cut their net long position in half since February—selling into the U.S. dollar’s strength. Open interest in the dollar has been on decline since early February 2010 as all traders close out their long and short position and “lose interest” in the dollar trade. Overall, declining long positions while open interest is dropping has bearish implications for the U.S. dollar.
Where has this interest gone? It has gone to gold. Open interest has been rising of late (blue dotted line below) just like it did in the second half of 2009. Currently, gold is the popular trade as we can see from open interest. Open interest had peaked in late 2009 just before gold corrected 5 down in the derivatives market.
Source: www.timingcharts.com, CFTC data
So far, the COT report is showing that Large Traders are continuing to increase their net long position and open interest is continuing to grow. While both of these have bullish readings, from a contrarian prospective it has bearish implications for the near future. As far as the COT report is concerned, buyers of gold should be cautious here as Large Traders have already piled 75k long contracts (net) to their book since March and will have no qualm unloading their positions to small retail investors late to the trade. I’m watching for both open interest and the ratio of Large Trader net long positions to peak for such a signal.
If you’re trading in gold, the U.S. dollar, or other commodity plays it’s a good thing to check on the COT report on a regular basis. Net position trends and open interest are great statistics to follow to get a sense for how much hype is following a commodity, currency, or index. The next report will be on May 21st so be sure to check it out. Hopefully, this Market Observation will show you what to look for.
