COMEX Producer/Merchants in Gold, View from 30,000 Feet an Eye Opener

HOUSTON – One of our longtime members, who, because of the firm he works for (as a senior officer), has to remain anonymous, checked in to make an observation about the large trader positioning and we thought it worthy of sharing with the entire readership. 

Our friend … let’s call him “Mike” … writes:  “Gene, what do you think about bringing back your “view-from-30,000-feet” section for the COT?  I used to cut and paste it to my monitors to keep me focused on your long term expectation.  That was one of the most valuable segments of the old Resource Investor Crew email service.  I still miss it. … If I had to guess it would be the lack of producer merchants net shorts giving the COT a long term long  bias. … How did I do?  Hope you are feeling better.  … (Mike) 

Not bad, “Mike,” not bad at all.  Let’s do take a view from 30,000 feet.   That’s where we focus on what is OUT OF KILTER or ABNORMAL and really nothing else in the large trader positioning on the theory that when things are out of kilter they will almost certainly return to form in a predictable, but not necessarily imminent fashion. 

Recall that we are limited to using just one, and rarely two of our eight most important tracking graphs for the COT for gold futures – on the theory that when something becomes out of whack the forces drawing it back “into whack,” so to speak, are somewhat stronger than normal.  And so on…    

What do we see this week?  That’s easy.  Look at the Producer/Merchant graph.  I think it is the most important graph for this exercise at this time. 

There is nothing magic about what we are looking at.  As of right now the Producer/Merchants – which is just about everyone in the gold trade who holds more than a few hundred ounces of gold or a few thousand ounces of silver inventory, putting on hedges to protect deals in transit, deals sold, but not yet delivered, metal ordered but not received, metal in inventory, metal managed for others or leased to or for others, metal being minted into ingots, rounds, medals, and on and on and on…  This category includes all kinds of private bullion dealerships, jewelry manufacturers, refiners … (think of any place that holds or manages inventory) … oh, and it also includes the bullion-trading banks that all these independent traders end up trading through – either out of necessity, convenience or what have you.  That’s why we also call the Producer/Merchant commercial traders “the Gold Trade itself.”  If you are in the bullion business and you want to stay in business you hedge your long exposure over a certain risk level.  The least expensive way to do that is with options or futures.

So what is the observation for this category from 30,000 feet? 

Isn’t it obvious?   Look where the blue line resides today compared to where it spent almost all of 2008 to 2012! 

Fact:  The Gold Trade is NOT VERY motivated to put on hedges with gold below $1500.

Instead of an average, say 175,000 net hedges, which is what the average was, more or less as gold was in a long term uptrend, making new highs and in demand in western markets … witness now the much, much lower number of net hedges currently (closer to 50,000 lots, which is not much for an entire bullion industry).  The Producer/Merchants lack of hedging showed essentially beginning in April of 2013 (the Goldman Smash of gold then, where gold broke below $1500 for the first time since 2011). 

Fact:  When gold fell below $1500 the gold trade lost a good deal of the incentive to hedge – so says the graph. 

More importantly, since then the Gold Trade has not really changed its mind in that regard – so says the graph.  Ergo, from 30,000 feet we see a chart of the blue line that “wants” to return to whence it came (lower in this chart, which is a higher number of hedges).  The only unanswered question is when gold will advance in price to the point where the Gold Trade will send the blue line back down to complete the trip. 

Always remember – inevitable does not necessarily equate to imminent.  It’s just inevitable. 

Fact:  For a brief period in November and December of 2013 the Producer/Merchants actually became net long gold futures, an extremely rare event. 

Gold was in the process of double bottoming then, trading with a $1200 handle, and double bottoming at $1181 on the last trading day of 2013.  // Why is that significant exactly?  Because the Producer/Merchants primarily use futures to hedge, not speculate.  They use futures to protect a profit already assumed, not to generate a new trade.  The combined or collective number of hedges shown on the COMEX by Producer/Merchants is a decent proxy for (mostly) western dealer/processor/refiner/user expectations or fear that gold could fall significantly in price. 

The lack of net hedging reveals that the people who trade gold every day to the public and institutions all over the world no longer fear a precipitous gold plunge.  To the contrary.  It reveals that the gold trade expects gold to return to higher prices – to the point where they were actually net hedged long gold with a $1200 handle in December.   It is this lack of hedging and the fact that it has persisted for so long now that makes this chart so out of whack. 

WHEN GOLD RETESTED $1181 THE PEOPLE WHO OUGHT TO HAVE A HANDLE ON WHAT THE GOLD PRICE WILL DO WERE SO UNCONCERNED THAT GOLD WOULD FALL FURTHER THEY ACTUALLY REVERSE HEDGED!  THE RAREST OF RARE EVENTS FOR PRODUCER/MERCHANTS.  THAT SCREAMED TO US ALL THAT THEY THOUGHT GOLD WOULD RECOVER AND GO HIGHER RIGHT QUICK. (Which of course it did.)     

The view from 30,000 feet shows us all that the people in the gold trade are currently positioned as though they do not believe that gold has any significant downside. 

Are they right? 

That is all. 

Thanks Mike.  Don’t be a stranger.