Wednesday, December 04, 2013

Rare Signal – Producer Merchants Net Long Gold Futures

HOUSTON – What are we to make of the fact that the largest, best funded and probably the best informed traders of COMEX gold futures on the planet have become net long gold futures, according to data released Monday by the Commodity Futures Trading Commission (CFTC)? 

Net long means that these veteran traders, called by the CFTC “Producers, Merchants, Processors and Users,” now have more contracts which benefit from higher gold prices than lower prices.  That’s very highly unusual.  Indeed this class of traders is dominated by actors who are hedging price risk of their own physical or financial exposure to precious metal, so they are usually more short than long futures.  Much more so. 

Before we go any further, here’s the graph of the “Producer Merchant’s” net positioning since 2008 as reported by the CFTC.  The graph shows just how rare it is to see the Producer Merchants net long. This is the first time in the history of the disaggregated COT reports with data back to 2006. 


20131204 PM Net Gold

Source:  CFTC for COT, Cash Market for gold, GGR.  To quantify the chart, as of November 26 the Producer Merchants reported 5,910 contracts net long with gold then $1242.


Take a good long look at that chart covering five years of data.  Notice, please, that if we were to assume an average position for the Producer Merchants, it would fall somewhere in the -160,000 contract region, give or take (and that’s without running a scan on it).   That means that “normal” for this group of industry gold traders is to have about 160,000 contracts net short, mostly hedging their positions in other markets. 

This category of traders includes producers and miners, refiners, large jewelers, large bullion merchants and, perhaps most importantly, it also includes the large bullion banks those gold industry titans end up trading through on the COMEX bourse. (The ones that do not have their own connections here and in London.  The ones who prefer to have a banker manage their hedging, for example, which is more common than people think.)

We could use a bunch of complicated jargon to make the setup sound vastly more complex than it is, but instead let’s fall back to the simple:  These guys are supposed to be net short because they are the Big Hedgers of the futures world. What we see as a usually net short position is actually the hedge part of a binary trade. Something has been bought or sold somewhere else and the hedge (usually, but not always a short) is a simple offset to lock in the spread already booked.  At any given time the hundreds of traders who potentially fall into this category are winnowed down and funneled into about 40 or 50 actual reporting traders who take one side of a COMEX contract (usually from a speculator) to offset or cancel out any adverse price movement until the hedge is no longer needed… In theory.

There’s more but for our purposes what is important is that it is rare for the collective positioning for the Big Hedgers to fall below, looking at the chart above for reference, say 140,000 contracts net hedged.  That's just the normal "PM action" or depth in the market, for lack of a better description. The only other time that has happened (fallen below 140,000 net short for any length of time) in the past five years was during the harsh correction for gold in 2008. During that event gold retreated to near $700 from over $1000 and the Producer Merchants reduced their hedges then to as little as 27,386 contracts on September 16 of 2008, with gold then $779. 

Gold staged a recovery thereafter and the Producer Merchant’s net hedge position worked its way back up the normal zone along with it.  By February, 2009, (5 months later) it had recovered to over 140,000 contracts net short – to, call it the "comfort zone." 

To recap:  In 2008 gold corrected harshly and the Producer Merchant net short position plunged to only 27,386 contracts.  This time gold has corrected quite a bit more. So much so that the Producer Merchant commercial traders have not only reduced their net short position – they have actually become net long.  Hello!  In 2008 the hedge position fell but it never got to where the gold trade itself was actually hedging for higher prices. 

It is, or rather they are now, and that’s the Big Story.  The people who ought to know the value of an ounce or kilo or tonne of gold; The people in the gold trade, the merchants, the producers, the refiners and the bullion banks they end up trading quite a bit through have, for the first time since the disaggregated COT report data begins in 2006, … have more contracts that benefit if gold prices rise than if prices fall. 

Amazing.  “How about that, Martha!  Even the bullion banks think that gold has sold off too far!”   

In the simplest of simple terms with gold near $1242 the largest, best funded and presumably the best informed traders of gold futures on the planet are hedging their positions more for higher gold prices than lower.  You sure don’t see that every day. 

They are positioning as though they believe that gold has been grossly oversold – as though they believe that gold belongs at a higher handle than the $1240s.  We know because we can read a graph and see right there on the graph where the Producer Merchants were comfortable hedging with gold at prices from $700 to $1900. (Anyone can see the zone if looking for it.)

Here's the graph again for convenience:

20131204 PM Net Gold

And since we can read a graph we can also see that in about April of this year, as gold shattered the $1500 former technical support, the collective hedges for the Producer Merchants began to fall harshly again, like they did in 2008. (On the graph as the blue line is rising the net hedge position is falling.)  Something had changed again, in May, June and July… the net hedge position became smaller and smaller still. 

And just this past week, with little fanfare or notice, the Big Hedgers actually became NET LONG gold futures for the first time in DCOT history! 

I suppose it should not be all that surprising when we consider that the CFTC Bank Participation Report, which we also track here, has shown the four reporting U.S. banks being net long gold futures since June, as shown in the graph below. 

20131204 US Banks Net Gold

Source: CFTC for Bank Participation, Cash Market for gold, GGR.  Please note:  The graph is designed to capture a “normal” net short position of the U.S. bullion banks, so a negative figure is actually a net long position.     

The large U.S. bullion banks have been net long gold futures since June. Now the entire Producer Merchant class of traders is collectively net long gold futures. Incidentally a new Bank Participation Report is due out Friday for Tuesday positioning.    

So what do we make of the facts above?  Something has changed in the view of the largest traders of gold futures.  Gold has been sold down long enough and far enough that the gold trade itself suspects it has little in the way of downside left.  Are they right? (They certainly were in 2008.)

And, is gold about to work its way back up to a point where the Producer Merchant net hedge position can return to where it seems “comfortable?” – Back to the range of between 140,000 and about 200,000 contracts net short? 

If so, both gold and the Producer Merchant net hedge position have a lot of chart real estate to cover.  The charts above strongly suggest that the gold trade is expecting such a reversal too.  The question is not if, but when. 

Bottom line:  We know there is a huge momentum-driven spec short position on at the moment.  With some pretty inflated egos pushing it, talking their book as best they can. We have already reported on it. But man alive, would you really want to be short into the situation showing above -  where it is clear that the Producer Merchants, the biggest of the Big Boys - the guys with their own round spheres on the line every single day believe the path of least resistance is higher for gold? 

I mean, really?   You want to short gold into the chart above showing the Producer Merchants net long for the first time in DCOT history?  And if so, do you wonder how fast you can get flat in a rout?  ...  Just asking.  

I haven't mentioned it, but keep an eye on silver and the miners just ahead.  Especially following the non-farm payroll figures on Friday.  Believe it or not silver outperforming gold and late strength in the day for gold and the miners are all signals the spec shorts are cutting and running.  Watch for it.   

That is all except to say I will be exceptionally scarce between now and the New Year.  Carry on. 


The Original
Vulture Speculator

Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

"I've been a huge fan of Gene and his amazing work for years..."

Brien Lundin, CEO, Jefferson Financial, Host of the annual New Orleans Investment Conference and Publisher of Gold Newsletter

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