COT Stats For Gold Suggest Caution Is Warranted

08/26/10 08:35:57 AM

by Donald W. Pendergast, Jr.

After a nearly 10-year bull run, does gold have enough steam left to make yet another nominal high?

Security: GC, GLD
Position: N/A

Any commodity that can quintuple in price in less than a decade must have something very good going for it. Gold has already accomplished that feat after languishing for the better part of two decades prior to the late 2000 launch of this most recent runup. However, when gold is viewed through the lens of CFTC Commitment of Traders (COT) data, we can often be warned of the potential for a sharp selloff, and with very high reliability. Right now could be one of those warning signs, all of the bullish froth on TV and the Internet notwithstanding. Here's a look at the current COT net positions layout in this highly emotional market.

FIGURE 1: GC, WEEKLY. Gold market COT data isn't a "silver bullet," but it is still an essential tool for serious commodity market traders and investors, particularly for the precious metals markets. Existing long gold positions should be protected with a close stop; new positions should only be added on a successful breakout and retest of the June 2010 high at $1,268.80.

Graphic provided by: TradeStation.

I'm not about to tell you that this market can go so high and no higher, but what I will tell you is that when the spreads between large speculator and commercial net futures positions in COMEX gold widen toward historical extremes (see all of the red bidirectional arrows on the lower plot of Figure 1), it often serves as a very reliable warning that a corrective move lower is about to commence.

Further, when we also see the price of gold moving higher even as large speculator net futures positions begin to decline, that is often an even stronger warning that some sort of a trend reversal is likely to manifest -- and soon. In addition, when we see the commercial net futures position go into bullish divergence mode (as in the two large vertical boxes on the chart for all of the major large spec and commercial divergences) at the same time as the previous action is taking place, we have an extremely accurate early warning system in place, alerting us to be more cautious if we're holding substantial long futures or physical gold positions and also giving short-sellers an early heads-up to be on the lookout for suitable shorting setups in the near future.

We are on the brink of entering the most bullish seasonal cycle of the year for gold, and the minor run higher from the recent July lows of $1,157.90 is getting the attention of gold bugs everywhere. However, if they aren't monitoring the COT situation in gold, then they're not getting the big picture. So, here's a suggestion if you are a confirmed gold bug, one who is firmly embracing the idea of a sizable rally and blast into the $1,300+ zone this autumn. The word of wisdom is this:

1. If you're long gold futures right now, consider running a closer stop and/or consider taking some positions off for a profit, if at all possible.

2. If you're not in gold (futures or physical metal) at the moment, do yourself a big favor and simply wait for a successful breakout and retest of the June 2010 high of $1,268.80 before going long this market again.

If this market decides to follow through on these COT warnings, aggressively pulling back despite popular opinion to the contrary, the wave of selling that could ensue could be memorable. Play it safe and wait for gold to tip its hand before deciding to put on any new long positions right now. It could be some of the best trading advice you'll get, all thanks to the invaluable information that the COT reports graciously provide traders and investors with every week.

One day gold will finally end its bull run, and you want to have plenty of advance warning before the major players in this market start to move record numbers of contracts. Because when this happens, it might precipitate one of the biggest moves since Jed Clampett loaded up the truck and moved to Beverly. Hills, that is.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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COT Stats For Gold Suggest Caution Is Warranted

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