Commitments Of Traders Report: Focusing On The Silver Trade (SLV, PSLV, AGQ, ZSL, DBS)

Scott Pluschau: I commented recently on Silver (NYSE:SLV), a two page article touching on the price action and a Japanese Candlestick pattern here. This is a follow up looking at the Commitments of Traders (COT) report.

Open interest in Silver was 99,698 on this week’s legacy COT report for October 11th, 2011 released by the U.S. Commodity Futures Trading Commission. There is always one buyer on the long side and one seller on the short side for each contract of open interest. I can’t remember the last time the figure was below 100,000. This COT report now shows the Commercials are net short 20,828 contracts.  In a vacuum this may appear bearish. Why is it important to follow the Commercials?  Not because they are the “smart money”, but because they are the “informed money”. Nobody should know more about their business than the insiders. Commercials have the cash position to Hedge, deep pockets, and can stand for delivery, while a majority of speculators do not stand for delivery and trade with leverage. There is not much else to consider about the COT report or its signals if that last sentence is not understood.  It is worth re-reading again.

In general I believe the lower the open interest, the less public speculation, and it is the strongest handed commercials that accumulate to the long side near market bottoms. On the other hand, typically when markets are making new highs, on increasing open interest, and high volume, it is a sign of rampant speculation. It is important to look at what the Commercials are doing in that scenario as well. The classic school of thought is that markets making new highs on an increase in volume are bullish. But if the Commercials are building on their net short position it is a sign that they are locking in a price that could be overvalued. A pricing pattern breakdown afterward can lead to things getting really ugly really fast in that scenario, especially to those late to the game. Why, because these speculators look to get out with “market orders” while they still can. Bids get pulled, demand is gone, and this leads to one sided price action and margin calls – I cringe to think about it.  But that is a topic to expand on another day.

Let’s take a look at last October 12th, 2010’s legacy COT report in Silver. Silver had open interest of 153,970 contracts and the Commercials were net short 61,504 contracts. In about one year, approximately 54,000 long positions and 54,000 short positions have been closed out, and the commercials have reduced their net short position by 40,000 contracts. Does it seem like the speculators are leaving town?  In fact going back the past seven years, around the middle of October for those years, Silver open interest has had a low of 134,365 contracts on October 10th, 2006 to a high of 169,415 contracts on October 11th, 2005. Things are getting interesting looking at the trend in the structure of the COT report in silver.

In my opinion, it is very important to look at not only what the Commercials are doing in regards to net changes in their position, but how it compares to the increase or decrease in open interest. The x-ray has three dimensional views when you include the COT analysis of the Commercial’s, the open interest, along with the auction market profile.

Here is the latest chart on Silver.

Related ETFs: Sprott Physical Silver Trust (NYSE:PSLV), ProShares Ultra Silver (NYSE:AGQ), PowerShares DB Silver (NYSE:DBS), ProShares UltraShort Silver (NYSE:ZSL), iShares Silver Trust (NYSE:SLV).

Comments are welcome at [email protected]

Written By Scott Pluschau From ETF Digest In full disclosure I am long Silver futures.

Scott was a financial advisor with Citi. His technical analysis report was recently featured by Dr. Marc Faber on the Nasdaq Composite Index in his June 1, 2011 Gloom Boom & Doom report. Scott earned his degree in Accounting and Taxation from Pace University. He lives in Long Island with his wife Ilona, daughter Olivia and new baby Henry.

ETF Digest writes a subscription newsletter focused on technical analysis of exchange-traded funds. ETF Digest was founded in 2001 and was among the very first to see the need for a publication that provided individual investors with information and advice on ETF investing.  Even if you’re not a fan of chart analysis, ETF Digest provides insight and commentary into which global markets are “working” and why.

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