Open Interest Patterns
Dan NorciniI have been very quiet the last few weeks as there has not been much to write about in regards to gold since it has been the same old drill as we are all too accustomed to.
However, with the release of this week's Commitments of Data report, I believe there are a few things finally worth mentioning. Judging from the emails I receive, a goodly portion of the gold community has given up the ghost and many of those that remain are badly demoralized. Perhaps this essay will be an encouragement to some.
The total open interest in gold has dropped nearly 100,000 contracts since its peak made on 11-22-2004 where it reached 370,786. As of this week's release of the COT data, we are now at 275,630. That is a pretty significant reduction no matter how one measures it.
The past two week's worth of COT data indicates that the trading funds have been moving off of the long side of the gold market and gradually shifting over to the short side. In this 2 week time period they have added nearly 11,000 new shorts while liquidating approximately 32,600 longs. This event is the culmination of a process that has resulted in a sharp drop in the NET LONG fund position from its peak of 138,632 made the last week in November 2004 to its current reading of a mere 29,566 contracts. That is a drastic reduction of some 78.7% and brings the NET FUND long position to the lowest level it has been at since June 2004 when the front month contract closed at 388.10.
One might say that we have experienced one helluva massive Drano job (think flush).
Further analyzing this information using a method I employ in my analysis of various commodities yields what I consider something important enough to mention to the gold community.
Shown below is a chart which graphically depicts the FUND NET LONG position in terms of a percentage of the total open interest. The reason I employ this particular method that I have developed for my own personal trading use is that it functions irrespective of the total open interest levels.
As most of you know who have read my essays in the past, one of my pet peeves is with the so-called "gold-advisors" who have some sort of perverse delight in arbitrarily picking tops in the gold market based on what they consider "excessive" levels of open interest or fund long positions. As I have stated so often - no one can properly judge when there is an excess of speculative positions on one side or the other of a market since we have no idea what number is "excessive" until after the fact. Markets can run much farther and longer than most anyone believes is possible. If anyone doubts the truth of this statement, I would suggest they pull up a chart of the Nasdaq from 1994-2000! Nuff said!
Anyway, this method of analysis allows me to disregard the actual open interest totals and focus more on the breakdowns by category. By looking at the chart above one can see that over the last two years, there have only been a few occasions in which the fund net longs as a percentage of total open interest has dropped below 15%. In all but two cases it has coincided with a very near bottom in the gold market. Succinctly stated, we are at this level now. Some of the technical indicators have turned up on gold which is a nice confirmation but not all are in agreement at this point. A close above $430 basis February would be most constructive. Traders need to be nimble.
As I see it, gold would have to shift from a bull market to a bear market in order for this particular signal to be rendered invalid. I do not believe that is going to happen.
I want to also mention here that this is not to be used as a stand alone indicator, a type of Holy Grail which will enable one to pick bottoms in markets. That is reckless and dangerous as you can see that the method is not foolproof. No indicator is. Back in the beginning of 2003, gold dropped from near $380 to $320, a severe shakeout that knocked it back some $60 and the signal would have been way too early. Ditto for early July of last year.
Still, that does not negate from its usefulness. As such, it is one more tool in the arsenal which can signal the astute trader to watch his or her technical indicators for signs of a market reversal.
A cautionary note is in order here - please be aware that we have an upcoming G7 Summit next month in February. With their backs up against the wall, there is no telling what sort of mischief the monetary authorities may attempt to concoct coming out of that meeting. The currency markets will be on edge and quite jumpy until we get the communiqué issued by the illustrious ones who are legends if only in their own minds. Gold will of course be watching as well.
January 23, 2005
Dan is a professional off-the-floor commodity trader residing in Texas and can be reached at email@example.com with comments.
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