The Myth of Commercial Superiority in the Futures Markets
Dan Norcini
Once again we see that many in the gold community are anxiety-laden with dread over the prospects for poor "ol Yeller. As can be expected, the "I never met a gold rally I could not pick a top in" expert advisors are warning of impending disaster for gold bugs. Some of these gold perma-bears, and I hate to sound too piquant, remind me of roaches that emerge as soon as the lights go out in the kitchen. They run hither and thither defiling everything they come in contact with only to scurry back into the cracks and crevices as soon as the lights come back on. "Gold is finished". ""The top is in and we are looking for gold to move back down in earnest". "The nth super-cycle has combined with the xth sine wave that has harmonized with the zth multi-year squiggly whatever to tell me that the golden goose is cooked". And so on and so on and so they pontificate, ad infinitum, ad nauseam!
To buttress their claims, they trot out the war-wearied, old soldier argument that the Commercial category, comprised of the "genius, boy wonders, miracle working, epitome of wisdom and knowledge" traders have amassed a sizeable net short position against the poor, dumb, ignorant, hapless, witless speculators who have moved over to the net long side of the market. Obviously, the "smart" money is betting on declining gold prices while the dim-witted speculators are long and wrong or so the argument goes.
Is this really the case however? Are the commercials the superior traders? Do they always make money? Can the hapless speculators, especially the feeble small traders ever hope to beat the commercials? If the answer to this last question is, "NO", then I submit the futures markets might as well be shut down since no small trader should ever attempt to defy the powerful commercial interests. Happily for us, the answer is not, "NO", but is rather the opposite. The small specs and the large specs are quite capable of regularly taking money out of the market and right out of the commercial category's pocketbooks if they trade smart.
Let's examine once again this "Myth" of commercial superiority. To begin, please examine the chart of the Commitments of Traders for the CBOT Corn contract.
The "zero" line in the center of the chart delineates the net long and net short standing of the players. The blue line is the number of NET positions of the trading funds. The Black line is the number of NET positions for the Commercial category. The Yellow line is the NET position of the small specs.
The small speculators have been net short corn since May 2003. Their take on the market has not changed in over a year. The funds on the other hand were net long earlier in the year while the commercials were net short. Currently that has reversed with the commercials moving over to the net long side while the funds are net short.
Now I am the first to admit that sooner or later market imbalances are always corrected which leads to an unwinding of positions. Huge imbalances are always dangerous and should never be ignored. This obviously occurred in March 2004 when funds were outrageously long against commercials who were heavily short. However, market imbalances can last much longer and get much further out of whack than many people often think possible. No one, and I repeat no one, knows how far this imbalance is capable of going until AFTER the event.
Refer to the above chart once again and observe how commentators could have claimed that the fund net long position (blue line) in December 2003 had surpassed that same category's exposure back in August 2002. The exact same claim could have been made (and was indeed made) in regards to the commercial category's net short position (black line) at the time. It too exceeded their previous net short position size in August 2002. In December of 2003, I recall corn market "experts" beginning to warn of an impending top in the corn market due to this gross imbalance of funds vs. commercials or so they claimed. Dire predictions were made that the market was going to collapse since the savvy commercials were heavily net short and after all, they are the "smart money". "See - look how large their net short position is" these people claimed.
The only problem with this prognostication was that any trader who has actually took these "experts" seriously and bailed out of the corn market watched from the sidelines as corn went on to run from near $2.50 bushel all the way to $3.30/bushel - a move of some $4,000/contract (see the chart below)! All the while the same ninnies continued to spook the small specs and convinced them a top was imminent. This of course led them to add to their net short position (see the yellow line above) at that time with disastrous results - they were forced to cover their fresh short positions at a hefty loss as the market powered upward. Guess what? EVENTUALLY, those who were crying for a market top got one. Boy howdy - were they clever or what? They had called the top in the corn market (only took them 3 months of trying to get it) and could now run around gloating to their paid clients that they had gotten it right. SURE! Try telling that to those who actually took their advice and sold corn at $2.50/bushel! The point is that anyone calling for a market top will sooner or later get one. So what does that prove? As the old saying goes, even a stopped watch is right twice a day!
That is the exact reason why one should not attempt to pick market tops or bottoms based SOLELY on the open interest setup and Commitments of Trader data. This data is indeed valuable and should be monitored but it is not intended to be used as a sort of stand alone technical indicator; a type of holy-grail of trading. Who is to say how many positions are too much? Who is to say that the market has no further room for additional players to pile in? How do they know that?
What none of these "experts" could have foretold were the fundamental conditions that led to this further rally in corn resulting in thousands of fund long positions being put on long after exceeding previous peaks in commitment levels. Planting season delays due to unfavorable weather caused traders to believe that there would be a smaller corn crop planted and harvested this year and thus they bid the price up as a result. No one knew when or if the weather would improve long enough for farmers to get the highest yielding varieties in the ground in a timely fashion so as to maximize yield potential. The funds were right; the commercials were wrong. It is that simple. The commercials had no way of knowing whether the weather forecast would improve any better than the funds did. They bet that the weather would indeed improve. Guess what? They bet wrong - So much for the omniscient commercials.
Oh yes, eventually the commercials were right but only after corn had rallied another .80/bushel. In the meantime it was the SPECULATORS, in this case, the funds, who picked the pockets of the commercials. Keep in mind that as the market continued to rise, every single commercial short position was bleeding red while every single fund long position was oozing green or black depending on your ledger. Sure the commercials were able to make money after corn prices began to fall and they began to buy back their newly instituted shorts. But how much they did end up netting after all was said and done? We know the funds made money even after they were eventually run out of the market. As a trader I can tell you that I had much rather been following the funds up from $2.50/bushel and adding winning long positions rather than adding more and more losing shorts from $2.50 simply because the commercials were on the short side of the market.
So what exactly does this have to do with the gold market? The answer is very succinct. There are far too many people in the gold community who are playing right into the hands of the gold cartel by calling for market tops based solely upon this Commitments of Traders data and open interest levels. These people are doing a great disservice to the gold community as traders act on their comments thereby making such comments self-fulfilling prophecies. How do they know that the open interest levels are too high? By what standard? The levels in the corn market were definitely high in December 2003 when compared to previous years but they were no where near reaching a maximum. Is it not possible for more traders to pile into a market that has such bullish fundamentals going for it as gold? Why is it seemingly only the gold market that can have an excess of bullish speculators while the stock indexes can launch to the moon as they did in 1999 and the stock analysts are happy as larks that speculators are bullish? Why is it that bullish speculators are somehow bearish to the gold market? Do you not find that strange?
Folks - The gold cartel is not all-powerful. That is part of the trading tactic that they use to intimidate the gold community. They allow advisors to spread the word that they are. I personally would DEARLY LOVE to have that kind of reputation as a trader. The word would get out that I was short such and such a market and suddenly all the bullish folks would panic and sell out simply because they heard Norcini had gotten in on the short side. Wow! What a dream come true! I would live like a king the rest of my life (not to worry I would send all my friends in the gold community nice post cards from Tahiti). Can these advisors not see that they are doing the exact thing that the gold cartel is expecting them to do? Talk about Pavlovian conditioning! The bell rings; the dogs salivate. The gold cartel piles on shorts; the gold advisors issue "sell" recommendations and then the specs run. What could be easier? Heck, this is as good as having your own personal ATM machine!
I am hereby issuing a challenge to these gold advisors who continue trying to impress people with your so-called "expert ability" to call market tops in gold (why not trying calling for a bottom instead?). If you are so clever and able to do this on a consistent basis then prove to the community that you are and discontinue charging a single penny for your newsletter or advisory service and make your living ENTIRELY by trading like we real traders do. After all, if you are that good then you should be able to make a tidy sum trading. What do you need a paid newsletter service for? Try making a living IN the market instead of living OFF the market. Let's see how good you really are.
Keep in mind folks that for the gold cartel to make any money at all they must find sellers that they can buy back their short gold positions from. If the gold community would learn to sell the trading portion of their gold position into strength at appropriate levels while retaining whatever portion they have designated as their core they could then sit tight and watch the cartel being forced into bidding the market back up as they attempt to cover their losing shorts. Think what would happen to the gold cartel if the thousands of gold traders followed this trading discipline. We would eat the cartel for lunch and be rid of them for good. Instead of selling in panic, we would be looking to buy right alongside of them as the market moved down. How can that take place if so many in the gold community are busy attempting to run through the same tiny exit at the same time? Shame on those of you who continue to pay these gold advisors good money to work against your own best interests in gold.
Something to consider.
Dan Norcini
October 12, 2004
Dan is a professional off-the-floor commodity trader residing in Texas and can be reached at dnorcini@earthlink.net with comments.
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