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COT Propaganda Revisited – A Response to the Doubters

By: Dan Norcini

-- Posted Monday, 22 August 2005 | Digg This ArticleDigg It!

It appears that my recent essay entitled, “COT Propaganda” has stirred up quite a hornet’s nest among those who believe that COT in gold are invincible and that the poor specs haven’t a chance when the commercials are huffing and puffing.


I have attempted to respond to so many emails in person that it is threatening to take away what spare time I have left. Since trading is my primary business and not emailing, I deemed it best to do one more piece on this topic so as to silence those who continue to propagate the COT superiority myth as well as to answer the questions of those who have honest questions and are simply confused.


Some of the critics have suggested that the crude oil market is unrelated to gold and therefore I am comparing oranges to apples and that the comparison is not valid.


My response is quite simple and I will state it here once again before meeting my critics on the ground of their own choosing and demonstrating the truth of what I have asserted by using the gold market itself.


Here is the premise once again:


“NO ONE can state when an imbalance is too great until AFTER THE FACT.  Past references do not apply when a market enters a markup phase and especially when it enters an acceleration phase. Since no one knows exactly when that might occur, until it does, it is foolhardy to run at the first sign of a large number of commercial shorts in a market moving up.”


Many, many years of trading for a living have taught me this.


The crude oil market is just one example. Anyone using 1999 references to attempt to predict tops in the crude oil market in 2004 would have been utterly wrong. Same goes true for 2005 in crude.


This principle applies to any market including gold. Who is to say that by next year the open interest in the gold market cannot exceed 400,000 contracts with the trading funds holding a total long position far exceeding even this year’s totals? For that matter, let them marshal their arguments as to why open interest cannot exceed 500,000 contracts the following year or the year thereafter. What is the basis for such a claim by those who keep looking backward? Let them prove that it cannot occur and their reasons for such a bold claim and make us all their disciples. I stand ready to be converted.


In the meantime it is easily proved by using the gold market’s own history that past references do not apply when it comes to predicting exactly when a short term top will occur in gold based solely on the COT data.


To demonstrate my point let me take you back to the beginning of this generational bull market in gold with a chart of the year 2001.


Early that year, gold bottomed out of a multi decade bear market near the $255 level. The small specs moved over to the long side to stay in February of that year followed by the trading funds who made their appearance on that same side in May. The commercials off course became net short.


Now let’s observe the details in the chart


As the specs began building long positions, they drove the price of gold to a peak of $287.40 in May of 2001. Shortly thereafter, the fund net long (in blue) peaked at 43,236 while the small spec net long (yellow) reached 25,207 at the same time. Simultaneously, the commercial net short position (red) peaked at -68,443.


The result was the first market imbalance of the young bull market and gold reacted by dropping to 263.70 before resuming its uptrend – about $24 off its peak.



Now at this point, we had a reference which could then be used to attempt to predict the next top in gold – commercial net shorts approaching the -68,000 mark, while fund net longs approached the 43,000 net long mark. Small specs in the vicinity of 25,000 net long were also a factor to consider.


Now move forward on the chart and take a look at the next region that I have marked with some white ellipses. You can see that this took place in late September/early October of that same year. Gold had climbed back to $294, a run up of $30+ from the low point as once again the specs re-established new longs all the while the commercials increased their net short positions.


The commercial net short category this time (-67,122) was very close to the previous peak level (-68,443) where gold had experienced its first sizeable correction and as if right on cue, the market promptly proceeded to set back once again. However this time around the fund net long position ( 36,638) was slightly lower than at the last peak (43,326) the difference being that the small specs were more greatly extended at 31,951 compared to their previous peak at 25,207 back in May.


The end result was a $23 decline in prices – almost exactly the same magnitude of a decline that had occurred previously.


Now we have two reference points that are established with which to base estimates off of for COT analysis.


Let’s fast forward onto the next region I have highlighted which now takes us into the next year, 2002 and the month of February.


As you can observe, after bottoming in December at $271, gold went on to run $37 higher in the next two month’s time as once again the specs rebuilt their long positions. It is interesting to note here that for a short time, the funds had actually moved over to the net short side while the commercials had actually become net long. This did not last long however and soon after the familiar pattern re-emerged.


At the peak in February 2002, gold reached a price of $308 before another setback occurred once again. At that point, the fund net long position (36,333) was only 300 contracts shy of levels seen when the previous retracement took place in October while the commercial net short position (-62,223) was some 5,000 contracts off its previous peak near -67,000.


This setback was to be of $18.00 compared to the first two of $24 and then $23.


If this is all we had to go on, we could feel pretty comfortable in asserting that anytime that commercial net short position exceeded the -62,000 level and particularly was closer to -67,000 while the fund net long position was at 36,000 or above, gold was primed for a top. Guess what – that was a pretty good analysis as history bore it out. However, and here’s the kicker and where I will prove my premise – this analysis became obsolete before the year 2002 was out!


Take a look at the chart again.



After bottoming in March at 289.90, the funds and small specs along came back into the market driving prices to $312.20 five weeks later in late April.


You can see that by focusing on the white rectangular areas. Notice carefully, the fund net long position was at levels that exceeded anything we had seen at any time since the young bull market began in early 2001. It had climbed to 46,607 net longs which eclipsed the peak going back to May 2001.


What is particularly interesting is that twice in 2001, whenever the fund net long position had reached a level near 36,000 contracts, the market had found a near term top. Here it was fully 10,000 higher than those levels.


Furthermore, look closely at the size of the commercial net short position. It had skyrocketed to a huge -82,381 absolutely dwarfing the levels at which previous reaction setbacks had occurred, from -62,000 to -68,000, or some 14,000 more net short positions than the highest point to date.


I can still remember “experts” crying the sky was falling in gold because the COT data had revealed this massive buildup of spec longs as over against the “invincible, always-on-the-right-side-of-the-market” commercials. “We are in record territory”, they cried. “Get ready for a massive correction” they warned.


The only problem for them was that no one bothered informing the gold market that is was duty bound to obey their mere beck and call of its master prophets.


Look at what gold did even with this “record” imbalance facing the market. It promptly proceeded to head straight up another $18 before it topped at $330.00 fully FIVE WEEKS LATER in early June. So much for the prophets!


Do you realize how much money any spec lost by running at their warnings without allowing the market to tell them when it would deal with the imbalance? That is “only” another $1800/contract that they foolishly left on the table!


By the time prices did actually reach a short term peak, the commercial net short position had reached a whopping -88,640 net short positions, a full 20,000 more than the record peak to date in the young bull market.


The fund net long position remained pretty much where it was at the June peak but the difference was that the small spec buying had taken the market the next $18 as they increased their net longs to a record 46,109 before prices peaked.


Why this time around did the previous year’s statistics prove to be so inaccurate and useless?


The answer lies in the open interest totals chart below.


Observe that the graph denoting the open interest totals reflects a market in which participation is slowly, but steadily increasing as the bull market in gold unfolds.


I have provided the total open interest at each point where a price reaction occurred for your convenience. What is particularly noteworthy is that in April 0f 2002, when the spec net long position and commercial net short position had eclipsed anything of record at this point in the up-move, open interest was 15,000 contracts greater than the first price reaction peak which occurred all the way back in May-June 2001. By the time the market actually did experience a pullback of size, it has run another 16,000 contracts more to 195,906. By that time, any inference to past numerical levels was useless as we were at new heights in the open interest category.



Let’s go back to the COT chart once again and take a look at the next point of interest. This time I have gone back to using the white ellipses. The month we are interested in is September 2002.



Prices had climbed back up from the dip below $300 which took place in August that year. Indeed, this last price reaction was pretty hefty as the market came back nearly $32 before the speculator selling was finished. The run back up from August into September was good for $27 before once again the COT levels had reached the same general area where the previous reaction had occurred.


The small specs were about at the same level of commitment as well as the trading funds which were a tad less exposed at 42,702 net longs as over against their record high to date of 46,607. The commercials were also very close to the same level that had preceded a sell off having rebuilt their net short position to -88,391, a bit less than the -88,643 previous peak.


This time the market did setback as it did not like the imbalance and the drop in prices was good for about a $16 retreat. This was enough nonetheless to make those who had used the previous June’s levels to give their regular warnings look pretty clever.


This is where the fun really starts and the point I am attempting to drive home should begin to set in. Let’s look at the COT chart again and move further along to the right.


Zoom in on the December 2002 white rectangles.



By this time, gold had climbed back up from 309.80 and reached 333.20 completely erasing the price setback from the previous months and establishing a new high in the process. The week of December 13, when this occurred, saw the fund net long position now at 51,359 as against the previous peak of 46,607 while the commercial net short category had also moved once again into new territory coming in at -90,824 compared to its previous peak of -88,643.


Once again the prophets were issuing their warnings: ‘New Fund Net Long Record”, “Commercials setting up the Specs for a takedown”, “Specs – Flee in terror – you’re masters command you”. Note, that the last time the prophets had called for a reaction when commitments were at reaction inducing levels, a mere 2 ½ months earlier, they had indeed looked like veritable wizards. No doubt that call had served to further establish their soothsaying abilities. Probably was even good for some new subscriptions to their crystal ball newsletters. Once again however, the gold market completely ignored them.


Gold ran all the way to $388.90, a gain of some further $55 in the face of the largest spec/commercial imbalance that had yet been seen in this bull move. That my dear friend is an astounding $5,500/contract which would have made anyone who hitched his wagon to it some pretty good returns. Meanwhile – back at gloom and doom city – the prophets were attempting to explain to their disciples why they had failed to correctly foretell such a monumentous event.


When the market did finally peak and decided to address the imbalance, the fund net long position was at 66,814 compared to the previous highest level of 46,607 before a reaction or a whopping 20,000 more net long positions.


The details surrounding the commercial camp are no less stunning. They managed to amass an incredible -126,507 net short positions which absolutely dwarfed the previous peak level of -88,643 which preceded a price setback. That is 38,000 more net shorts they were carrying.


What was the open interest at this time? Answer – see below. It had mushroomed to 234,148 – again – a new record level in the ongoing bull market.



I hope by now, that the reader can see the point I am making and why I continue to assert my main premise which I once again repeat:


“NO ONE can state when an imbalance is too great until AFTER THE FACT.  Past references do not apply when a market enters a markup phase and especially when it enters an acceleration phase. Since no one knows exactly when that might occur, until it does, it is foolhardy to run at the first sign of a large number of commercial shorts in a market moving up.”


What is remarkable about this is that gold has yet to enter anywhere near its acceleration phase.


I have responded to numerous people with questions about this subject and comments about the various “prophetic top callers” and told them that before this gold bull is over, we will see these prophets warning of imminent collapse in the gold price due to what they consider “excessive” spec/commercial imbalances. They will do so and the following day, the gold price will jump some $40-$50 and never look back leaving them to look like utter fools and robbing anyone who listens to them of untold profits as they ruefully watch the market soar with them on the sidelines.


As my good friend Jim Sinclair has attempted to teach – all that is necessary to protect yourself from both these prophets and from these market imbalances which do certainly become unwieldy and unsustainable at times, is to use a simple trend line. Those are always correct and never need to apologize to their subscribers. Let the market tell you when IT THINKS the imbalance is too great and not some wanna-be soothsayer or crystal ball gazer looking for a reputation.


People frequently write asking me what then is the proper way to use the COT data. My response is to be alert to these build up in the spec/commercial imbalance but to NEVER, UNDER ANY CIRCUMSTANCES, close out a winning position because some one of these “prophets” says that the imbalance is too great and the market is due for a setback. How do they know what is “too great”? Does the sum total of all human wisdom reside in them to the exclusion of the rest of the market? That is the best way I know to take a large sized trading account and turn it into a small sized trading account. Rather instead, simply tighten up your stops if you use those or watch your trendlines closely. The market will either take you out or the trendline will tell you when to get out. Isn’t that easy? In the meantime, if the market continues catapulting higher, simply sit back and enjoy the ride!


I want to provide a few more charts for further demonstration purposes and to provide a panoramic overview and then close.


I have had to pull back a bit on the chart’s view to allow you to see the larger move unfolding and in the process of so doing the numbers might appear to be a bit bunched up and perhaps difficult to read. If so, I apologize for that but it is the only way I can give what is perhaps a classic picture of the principle I am stating.




Notice that as the bull market in gold unfolds, the imbalances are growing larger and larger each time before prices set back some all the while open interest continues heading upward. This is actually a picture-perfect long-term, sustainable bull market – specs on the long side driving prices higher while commercials sell and are on the short side. It is the same picture you will see in ANY COMMODITY MARKET experiencing a bull move upward. You simply cannot find any bull market in any commodity, anywhere  which presents a graph otherwise. Period!


Do you see how the COT data appears to be conical in shape with the right side opening larger and larger as the gold price moves steadily higher and higher all the while open interest continues to grow larger and larger? Look at how past levels of spec/commercial imbalances that once precipitated price reactions are absolutely OBLITERATED as price moves relentlessly higher.


To borrow a phrase from the old Bachmann, Turner Overdrive song – “Baby, you ain’t seen nothin yet!”


Can you see just by observing these charts, which only goes through 2004 and thus provide a three year panoramic view, that any attempts at using raw totals from previous years to categorically state that the spec/commercial imbalance is too large are completely and utterly useless and self-defeating? How anyone can view these charts and maintain that they know when such an imbalance is too large and can tell their disciples when to flee and maintain the LEAST BIT of credibility is beyond my comprehension. I have seen a lot of things in my trading career but the current near Pavlovian response in the gold community as these imbalances occur is simply mind-boggling. COT simply laughs at this gold community whose advisors do their bidding for them.


That is why I feel so deeply that this MYTH of commercial superiority needs a stake through its heart. Simply put – the commercials are winning some battles in the gold market but they are in the process of LOSING THE WAR. My good friend Bill Murphy never gets tired of repeating this and Bill is exactly right and has been since this bull market began. It just keeps going higher and higher in spite of the COT.


The MYTH is simply not true and the reason why it exists is that it has taken on a life of its own through near constant repetition by those who cannot see the forest for the trees having an acute and methinks, terminal case, of shortsightedness.


Yes, sometimes the “prophets” can get it right and pick a short term top. At other times, they look like hapless buffoons tripping over their own wild predictions. That is why so many times you will see caveats and disclaimers and this condition and that condition usually attached to their predictions.


Here’s the most frequent: “We remain long term bullish but are short term bearish”. I love that one! Translation – if the market heads up for some reason and defies my command for it to sell off now that I have issued my prediction – then I am right after all. If it sells off, then I am right after all as well. Heads, I win – Tails, you lose – Chump. Now please keep those checks and subscription renewals coming my way to put food on my table since I sure as hell can’t trade my way to support myself”.


The simple truth is that they haven’t a clue as to what they are talking about as they blindly look in the past for some sort of guide to the present.


Unfortunately for them, markets are not static things but are rather living, breathing, dynamic organisms that grow and change as the supply/demand conditions underlying them change and as market psychology and trader sentiment ebbs and flows.


As we wind this essay down, let’s look at the most current charts that include the very beginnings of our golden bull all the way through this past week.





Can you still see the conical appearance on the COT data chart? Observe how the fund net long position continues to increase exceeding previous peak levels, just as it has every single year since this market bottomed in 2001? They want to be long gold – and why not since the fundamentals favoring a bullish view on gold could not be much better. Do you see how the commercial net short position continues to increase as well with the passing of each year? And yet, for all that, gold continues to power steadily upward and onward and open interest continues heading north.


As a matter of fact, we are still currently far below the peak open interest level which occurred in November 2004 when it hit just shy of 365,000.


It is interesting to note that the small spec category has not significantly increased their net long positions having yet to exceed the 53,000 level peak since April of 2004. Regardless of what some are saying, the general public has yet to discover gold in a large way – they are still enamored with their darling tech stocks.


This is the reason I have absolutely no hesitation in making the assertion once again that before this generational bull market in gold is finished, we will witness open interest soaring to unheard of heights and spec/commercial imbalances that were at one time unthinkable in the minds of so many.


In the meantime, traders protect yourself from the “trade-everything-all-the-time” crowd and the wanna-be prophets by using those trend lines. Do not abuse margin and remember that leverage is a great servant but a ruthless master so do not overtrade your account and keep your position size within rational bounds. Just because you have enough money in your account to put on 5 gold contracts or 10 or 20 or whatever the number is, that does not mean that you should. What are you going to do when these inevitable setbacks occur? Sell some of your position into strength and let the market and your own risk tolerance tell you what to do with the rest. Do this, ignore the “advisors” and “prophets”, and you will do fine.


I will leave it up to the readers of this as to whether I have sufficiently proved my premise that I began with. I believe I have as the data and the charts support my contention.


Let me leave you with that premise one last time:


“NO ONE can state when an imbalance is too great until AFTER THE FACT.  Past references do not apply when a market enters a markup phase and especially when it enters an acceleration phase. Since no one knows exactly when that might occur, until it does, it is foolhardy to run at the first sign of a large number of commercial shorts in a market moving up.”


Quod est Demonstratum


Dan Norcini

August 21, 2005


Dan is a professional off-the-floor commodity trader residing in Texas and can be reached at with comments. Those who wish to hurl fireballs may feel free to do so but do not expect an answer from me if you wish to be uncivilized. Also, I choose to ignore comments sent to me by others that they collect from the chat rooms vilifying my views as those do not affect the balance in my trading accounts in the least bit. Since I am not peddling a subscription of any sort or any fee-based newsletter, but make my living IN the market instead off OFF of the market, I devote my time to research and analysis of the same and not in useless exchanges with those who simply love to carp and remain willfully blind.

-- Posted Monday, 22 August 2005 | Digg This Article


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