Commodities Cautiously Optimistic

by Alex Roslin
Kitco.com
Tuesday, July 15, 2008

While stocks continue to suffer their bloodbath, precious metals bulls have cleaned up in recent weeks. Gold and silver have marched back close to their March highs, while copper briefly poked to a new high in July. Is this the launch pad for a new run-up in bullion prices? Will gold stay above $1,000 this time?

Trader positioning as reported in the weekly Commitments of Traders reports is a little mixed at this point, but my read is that it has been suggesting more U.S. dollar weakness, which would translate into higher commodity prices. Here are some highlights from the recent data, as reported by the U.S. Commodity Futures Trading Commission:

• The "smart money" commercial traders in U.S. dollar index futures sat at a bearish extreme in their positioning during all four weeks of June. They were more net short than any time since Oct. 2006 as a percentage of the total open interest. Recall that this was just as the greenback broke down from a half-year trading range between 83 and 87 and started the plunge to unprecedented lows. (On Monday the index was below 72.) In fact, the commercial traders haven’t been this negatory since May 2004 in relative terms (in comparison to their historic positioning). In mid-June, they were more than three standard deviations below the moving average I use for my U.S. dollar trading setup. By the latest COT report for the week of July 7, the commercials had backed off a little and were 1.4 standard deviations below the average, but in absolute terms they are still at the levels seen in the fall of 2006.
  
  
• There is a strange divergence between my silver and gold data. In silver, the commercial traders have really hit the brakes, increasing their net short position to a one-year high. In fact, they haven’t been this bearish in relation to past data since Dec. 2006. Meanwhile, the large speculators in gold, whom I trade alongside, are blithely bullish—more than one standard deviation above the moving average for this setup.
  
  
• So how to make sense of these conflicting signals? I've been trading with a new rule for a few months that helps me figure out what to do. I saw that I’ve got six highly correlated commodities setups. I take a trade only when the signal agrees with the majority of these setups. As an example, right now, four of the setups are bullish (gold, copper, platinum and crude oil), while two are bearish (silver and heating oil). This means when my silver setup went to bearish on July 7, I ignored it and happily held onto my gold long position. It is, however, possible that the short signal of the silver setup—and the fact that there are two bearish holdouts among the six setups—means some short-term volatility is in store for commodities.
  
  
• This cautionary note is further amplified by the fact that my copper setup is turning bearish for the open of July 28. Note that the copper setup works with an eight-week trade delay, so this signal actually took place with the May 27 COT report. Since then, the setup has gone back to bullish, with a long trade due for Aug. 25.