Monday, October 18, 2010

COT Analysis

I have an idea for a new post on inflation and I will get to that tonight.  A reader asked a good question about using the COT to figure out the next move in the market plus had some good comments of his own.  As such, I decided to post his comment and my respsonse.  I would love to hear anyone else's view on this in the comment section.  This is a great topic and a subject of potential heated debate.

Anonymous said...

Could you give us your thoughts on the various COT analyses which seem to cover the internet when talking about silver. As I understand it when Lehman was taken over (and it may have been true of Bear Stearns short position as well, the Fed agreed to compensate for losses on the short. Now I have never read that this guarantee was limited in time or rescinded. Indeed much of JP Morgan's short position may still be Fed loss indemnified as it has persisted to this time.

There are three different types of analysis on the COT commercial positions and they basically tell two different stories.

There is the short analysis and there is the net short analysis. These tell us that the commercials are maintaining their shorts and are increasing to short in the face of long strength. As Gene Arensberg says the shorts are waiting in background to pounce and JPM according to Gene is now in grudge position with four million ounces on hand (yawn) from it's position as the SLC trustee waiting for the grudge match to bring the price down.

(Doesn't Gene know that banks always try and nick the security when they are in trustee position and the legal cases on this clutter up the Courts. In the UK they even invent new "terms" to disguise the process of putting a company into acceleration a cross default event under the bonds, the loan is "on demand" while they try to half inch the security with factoring leasing and other forms of lending that in a reasonable view consist of a disposal or the threat of disposal of a main part of the business etc. To suppose that JPM would resolutely stand by the SLV investors is no more or less likely than BAC would never violate the representations and warranties when selling an MBS. It displays a naivity that reeks of a lost age that probably may never have existed.)

The other analysis is that the commercials long position on the COT's this tells a different story altogether. Eric De Groot uses this and deduces that a new profile has emerged because it shows the commercials short covering into strength for the first time and going increasingly long, a change in trading pattern. There is a rationale explanations for why this could be happening. Firstly, JPM may not be wholly at risk on the short position and secondly the short position may be laid down by the investment committee as banks strategy and could be allocated to other capital reserves other than the trading desk.

If either of the two reasons given above are correct then Eric De Groot by concentrating on the long position may be looking at the actual trading desks position. The trading desk may to a small extent be betting against the house because the dealers get paid bonuses on the profits on their positions and they really couldn't give two stuffs what happens to the house.

I would be interested in you view of the two COT analysis rationale. If you have the time.

My view of the situation...

Thanks for your thoughts/comments. RE: your description of the UK court system: Charles Dickens presented a wonderful portrayal of the UK judicial process in "Bleakhouse."

In terms of your COT question. The true answer is that we don't know what the banks are capable of doing to try and create a typical COT liquidation stop-loss trigger. We just don't have access to the full data from the CME that insiders and banks have access to (i.e. I would want to see the true amount of physical gold sitting unemcumbered in the Comex dealer inventories at the Comex depositories and I would want to see a breakdown of the composition of the large spec category and the commercial category). As you can see, since the banks do have this info and we don't, it's a great example of the lack of free markets in this country.

Of course, Obama rode into office with one his promises being more transparency and honesty in Govt and true financial reform. He has delivered neither. In fact, if anything, the FinReform Bill actually gives the banks, in a round-a-bout way, a lot more power to hide, lie and cheat. Thanks Barack!

I have assumed a position of "neutrality" with respect to trying to use the COT as means of forecasting the next intermediate market move. It's one of those tools that is widely examined now (vs. 5 years ago) and certainly a lot of the predictive content gets priced into the market quickly now. So to say the net commercial short is near a record high and the o/i is near an all-time high and thus we should expect a big COT liquidation trigger is to take a simplistic view of how markets function.

I'm leaning toward the view (like De Groot's) that the physical market is too strong to allow the banks push around the price with paper like they have historically. And also the it is likely the character make-up of the large spec category is skewed more toward "stonger-handed" buyers vs. mosly technical "black box" players. But we don't know that for sure.  And anyone who thinks that latest reporting changes at the CME have made the situation more transparent with respect to what the COT really looks like is kidding themselves.

I'm not arrogant enough anymore to think that I know better than the market OR that I know better than those (i.e. the banks) with the access to the actual true info I would like to have.

As such, my partner and I have positioned the trading positions in our fund for the possibility that we will get a big manipulated COT liquidation but we also are set-up for the possibility that this current "overbought" condition might resolve itself with sideways move or even a slower continuation of the current move.

Hope that helps.


  1. I think perhaps the book your are thinking of is Great Expectations. As I recall from a long time ago this is a book based on a famous legal case over the trust security under a will. Same courts, same trust law. The case took slightly over a 100 years to resolve and the benefeciaries of the trust lost everything to the trustees in expenses.

  2. Bleak House.

    I have read most of Dickens' significant pieces of work, but Great Expectations is a hole in my literay CV with respect to CD.

  3. Hey Chico,

    Looks like I'm getting my dollar bounce(metals correction) to load up on more bullion.

    All gold comes to he who waits.
    Price-chasers are banker fodder.

    Do you need a spare buck in the interim Dave?

  4. Dude, i had SLW puts in my personal account and we had a big hedge in ZSL plus took a lot of profits in positions yesterday.

    Hell, I've been clear this whole time that the dollar is overdue for a decent bounce. Just using simple chart analysis tells me it could bounce up to 80. If it can't get that high the next downleg will be brutal.

    What's even more ominous is that Geithner has now reiterated twice that the U.S. supports and strong dollar. Make it thrice and I'll get short the dollar til my balls turn blue.

  5. And one more point - this China interest rate hike as the catalyst is total bullshit. The markets were all overdue for a correction. The Chinese 25 bp hike is meaningless in the larger context.