http://www.moneyweek.com/news-and-charts/economic-indicators/gold-indicators/10-gold-cot-00010

What traders can tell you about gold's next move

Indicator: commercial v non-commercial traders and gold

Updated 31 July 2012

One of the best guides to the short-term direction of gold is the Commitment of Traders (COT) Report. This shows the positions that traders are taking in New York’s Commodities Futures Exchange (the world’s largest exchange).

Gold dealers fall into two main groups, commercial and non-commercial. The latter splits further into small speculators and large traders. These account for most of the volumes in this category. Commercial dealers tend to be ‘short’ of the market, ie, they’re taking a view that gold will fall, as they often sell miners’ future gold production to guarantee the price these miners will receive. Large traders, meanwhile, tend to be ‘long’ of the market, ie, they are betting gold will rise.

History broadly shows that the commercial operators get it right, while the non-commercial brigade tends to pile in at the peak and unload at lows. In other words, the more heavily the large traders are betting on a rise, the closer the gold price is to a short-term top. And the less short the commercials are, the nearer gold is to a short-term low.

What’s the latest?

Commercial dealers are now started increasing their net positions (ie, going less short) while non-commercial traders have been cutting their holdings, so are becoming less long.

What does this mean for the gold price?

Source: Bloomberg

In the chart we track the net combined positions, in effect the balance between gold bulls and bears, for both commercial dealers (red) and non-commercial (blue). We’ve inverted the red line – in other words, the higher this rises, the smaller the net positions being run by commercial operators – to show how closely these match.

Further, on the chart we’ve advanced both the commercial and non-commercial positions by three weeks to indicate their predictive power for the gold price.

Both lines now starting to tick up indicates that the market is becoming more bullish on gold.