Gold Speculation and the Comex
by Ben Traynor,
BullionVault
Thursday, 2 May 2013
What exactly does ‘speculative net long’ mean…?
EVERY FRIDAY, the Commodity Futures Trading Commission publishes data that enable analysts to ‘take the pulse’ of various commodity markets.
The
Commitments of Traders (CoT)
report gives the aggregate positions held by traders from the previous
Tuesday, including the number of long contracts (that stand to benefit
if prices rise) and short contracts (that benefit if they fall).
Included in the CoT is positioning in gold and silver futures and options on the New York
Comex.
A futures contract is a standardized agreement to buy or sell a
particular commodity at a particular date in the future. On the Comex,
each gold futures contract is for 100 troy ounces, while each silver
contract is an agreement to buy or sell 5,000 ounces. A Comex option
meanwhile gives its owner the right, but not the obligation, to buy or
sell a futures contract.
The CoT breaks traders down into four categories:
- Producer/Merchant/Processor/User
- Swap Dealers
- Managed Money
- Other Reportables
Other smaller traders are also accounted for separately as ‘Nonreportables’.
This CFTC document gives
brief descriptions for the four categories above. In essence, the
first, Producer/Merchant etc., is anyone who is in the relevant industry
commercially and using the futures market to hedge the price of their
inputs or outputs (e.g. mining companies, refiners, jewelry
manufacturers in the case of gold).
A Swap Dealer (usually a division of a major bank, see
here for a list) may be dealing in
swaps with
speculative counterparties or with industry clients looking to hedge;
the swap dealer may then be using the futures market to hedge their own
book.
Managed Money, as the name suggests, includes hedge funds and the
like, while Other Reportables are traders large enough to report their
positions but who are judged not to fit into any of the other three
categories.
One closely-watched metric from the weekly CoT is the so-called
speculative net long, which is calculated by taking the total number of
open long contracts held by ‘speculators’ (we’ll get to who they are in a
moment) and subtracting the number of open short contracts.
The spec net long is viewed by many as a useful gauge of how bullish
or bearish the market is. If the spec net long goes up, the implication
is that speculators are growing more bullish. If it goes down, they’re
getting less so.
There is, however, a problem with the spec net long. There doesn’t
seem to be agreement on what exactly it is. Different analysts calculate
it differently, depending on who they class as speculators and the
types of contracts they look at.
Who are the speculators?
Until September 2009, the CoT used to break large traders down into
two main camps: commercial and noncommercial (there was, as now, also a
Nonreportables category to account for smaller players).
Commercials comprised the first two categories mentioned above,
Producer/Merchant etc. and Swap Dealers. The noncommercials were
regarded as speculative money, and hence it was their positioning that
was used to calculate the spec net long.
Since September 2009, when the CFTC started publishing its
disaggregated CoT, the picture has become more nuanced. Many analysts
still lump Managed Money and Other Reportables together as the
noncommercial, speculative end of the market. An example is Japanese
trading house Mitsui, whose weekly report quotes the net long in broken
down in terms of ‘Large Specs’ (i.e. Managed Money and Other reportable
together) and ‘Small Specs’ (the Nonreportables), in terms of futures
only, options, and the futures and options combined.
South Africa’s Standard Bank also lumps both types of noncommercial
player together, calculating a net long figure based on the aggregate
futures and options positioning of Managed Money and Other Reportables
together.
Others analysts prefer to look at Managed Money in isolation, viewing
it as a purer measure of speculative sentiment. One example is
Commerzbank, whose research notes quote the spec net long in terms of
futures contracts held by Managed Money. Brokerage INTL FCStone also
looks just at the managed Money category, but it differs from
Commerzbank in that it uses futures and options combined to calculate
the figures it quotes as the spec net long.
Which classifications of traders you count as speculative can make a
difference. As an illustration, here’s what happened in the week ended
Tuesday 16 April, a week in which gold saw its steepest price drop in
three decades:
Managed Money responded to the price drop by cutting aggregate short
positions and increasing long ones. Other Reportables did the exact
opposite (as did Nonreportables). And this was far from the only week
when the two camps of traders moved in different directions. It seems
the positioning decisions of Managed Money and Other Reportables are
driven by different factors.
There is no right or wrong answer when it comes to who to include as
‘speculative’ traders. In many cases it is a judgment call, not an
immutable fact. The regulator makes a judgment call on which
classification should apply to a given trader, while analysts make
judgment calls on which classifications to view as ‘speculative’.
An important point to stress is that it is the trader that is
assigned a classification by the CFTC, not trades themselves. This means
that an entity classified as ‘speculative’ (Managed Money and, for some
analysts, Other Reportable) may still hold positions that are not
speculative in motive (e.g. hedging a swap position) and vice versa. Yet
those positions will be counted towards the grand total of such
positions held by speculators.
What contracts should be considered?
For each commodity market the CFTC publishes two versions of the CoT
each Friday. One is based only on positioning in futures contracts while
the other also includes options. Most weeks, both reports tell a
similar story in terms of changes in the spec net long. But this is not
always so.
The table below shows how the spec net long changed in the week ended
April 16 2013, according to four different ways of calculating it:
By the end of Tuesday 16 April gold was down more than 10% from a
week earlier. As you can see from the table, this price drop was met by
a large increase in the futures only net long position of Managed
Money, whose futures and options net long also increased, though less
dramatically.
If you include Other Reportables, however, then for the week in
question it makes a difference whether or not you include options. On a
futures only basis the net long of all noncommercials went up, but if
you include options it fell. Why?
Our guess is that this is in part explained by what’s known as
delta-weighting. When calculating traders’ positions for its weekly
report, the CFTC weights long and short option positions according to
what’s known as the ‘delta’, the sensitivity of the option’s price to
movements in the underlying, in this case the price of a gold futures
contract. So if a $1 move in the price of the futures contract results
in a $0.50 move in the price of the option, the option is said to have a
delta factor of 0.5.
Let’s say a trader holds 100 identical call options (the right to buy
at a given strike price). He is considered to be long since he stands
to benefit from a rising price in the underlying. The CFTC converts the
trader’s option position into a futures contract equivalent by
multiplying the number of contracts by the delta factor. If the option
has a delta of 0.5 then the trader’s option position appears in the
futures and options CoT report as a long position of 50 futures
contracts.
By April 16, with gold having fallen so hard, many of the long
options held a week earlier were now well out of the money. Those that
had not been closed out will have seen their deltas fall dramatically. A
call option to buy at $1800 an ounce isn’t worth much once gold’s
fallen below $1350 – and it doesn’t get much more valuable even if gold
climbs $50 or $100 from there.
The same dynamic works the other way with short positions – any well
out-of-the-money puts on Tuesday April 9 that were still open a week
later will have seen their deltas rise.
This, we suspect, goes some way to explaining why the changes in
futures and options spec net long cited above tell a different story
from the futures only. On Tuesday 16 April, the biggest open interest
for May call options was at the $1650 strike price, at 12,261 contracts.
Yet these calls would have been given a lower weighting in the CoT for
that day than they had been a week earlier.
Of course, market-driven changes to delta weighting are not the whole
story – no doubt a lot of long option positions were closed and short
ones opened when the price started to fall. This aspect of the CoT is
however worth bearing in mind when analyzing the numbers, especially at
times when the price has moved a long way.
Why are traders long or short?
When trying to make sense of Comex positioning, the fundamental
question is why traders are long or short. Are they hedging a commercial
activity? A position in another market? Or are they taking an
out-and-out speculative bet on price direction?
The CoT does not provide enough information to answer these questions
definitively. Classifying traders according to their typical trading
activity, as the CFTC does, allows us to inferences, but always bear in
mind that even professional analysts don’t agree on who should be
regarded as a speculator. Remember also that just because a trader may
be classed in a ‘speculative’ category does not mean all their trading
should be considered as such.
As we have seen, it can make a significant difference who you regard
as a speculator, as well as the types of contracts you take into
consideration. These decisions are judgment calls. Often it makes little
difference to the overall story whether you look at futures only or
futures and options, or whether or not you split out Managed Money. But
occasionally it does – and as we saw in April 2013 this can be at times
when sharp price moves have already created a confusing picture.
Ben Traynor
BullionVault
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Editor of
Gold News, the analysis and investment research site from world-leading gold ownership service
BullionVault,
Ben Traynor was formerly editor of the
Fleet Street Letter,
the UK’s longest-running investment letter. A Cambridge economics
graduate, he is a professional writer and editor with a specialist
interest in monetary economics. Producer of BullionVault’s informative
videos on
YouTube he can also be found on
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(c)
BullionVault 2013
Please Note: This article is to inform your thinking, not lead
it. Only you can decide the best place for your money, and any decision
you make will put your money at risk. Information or data included here
may have already been overtaken by events – and must be verified
elsewhere – should you choose to act on it.
