In the world of commodities trading, it’s usually best to follow the smart money.
Commercial traders are the smart money. They’re the banks, institutions, and merchants that have a vested interest in the underlying price of the commodity. Commercial traders are active in the futures markets where they trade contracts in an effort to hedge their risks and/or lock in a favorable price for the commodity.
Commercial traders are called the “smart money” because at major turning points, these traders are always right.
Speculators, on the other hand, are called the “dumb money.” Speculators almost always get it wrong. They tend to hold record-sized long positions just as the price of an asset peaks and starts to decline. And, they tend to hold record short positions right as prices bottom and start to rally.
For the past couple of months, though, the world has been flipped upside down – especially in the gold market.
At the end of May, speculators had amassed the largest short position in gold since the price of the metal bottomed in December 2015. Commercial traders were holding their smallest short position of the year.
Since then, gold has fallen more than $100 per ounce. Speculators are making money on their downside bets.
And the smart money? Well… the smart money looks stupid.
I suspect that’s temporary.
I’ve traded gold and gold stocks for more than 35 years. I haven’t made money on every trade in the sector. But I can tell you, without any hesitation, that I have made far more money trading gold stocks than trading any other sector in the market. And, much of those profits have come from following the smart money – and being patient enough for those trades to work out.
For example, back in December of 2015 I amassed my largest gold stock position ever. The commercial traders had the smallest net short position I’d ever seen – just 7,000 futures contracts. I viewed that as incredibly bullish. So, I bought every gold stock I could get my hands on.
Two weeks later, I was dying.
Most of the gold stocks had drifted lower. Many were trading at multi-year lows. Subscribers were sending me nasty emails. Folks were harassing me on Twitter. It was a ridiculously tough time.
The VanEck Vectors Gold Miners Fund (GDX) was trading at a multi-year low of $13.50 when I recommended it to subscribers in mid-December, 2015. Three weeks later GDX was trading for $12.20.
But, here’s the thing…
By early-March, GDX was trading for $20 per share. It broke above $30 per share by July.
For its part, the price of gold rallied from $1,050 per ounce in mid-December to $1,300 by March. It was $1,375 by early-July.
In other words… the smart money was right. The smart money didn’t time the gold market bottom perfectly. But, it timed it close enough that patient traders could have made a lot of money following their lead.
That’s the situation we have today.
The CFTC Commitments of Traders report (COT) released last Friday – which showed positions as of Tuesday, August 7 – showed the “smart money” net-short gold position was down to just 22,000 contracts. That’s the smallest short exposure since December of 2015.
Keep in mind, the commercial short position in gold is almost always a positive number – meaning that commercial traders are usually short the metal. That makes sense, since most commercial short positions are hedges against future declines in price.
But when commercial traders expect the price of gold to increase, the COT short interest often drops to less than 100,000 contracts. A position of less than 50,000 short futures contracts almost always leads to short-term rallies in the price of gold. So, the current reading of 22,000 net-short contracts has to be seen as bullish.
Yet, gold has continued to fall this week.
I think that’s temporary. I think it’s a buying opportunity. And I think gold will be sharply higher two or three months from now than where it is today.
In other words, I think the smart money will be proven correct once again.
Best regards and good trading,
Today in the mailbag, readers reflect on Tuesday’s Minute, “’I’m Benito’”…
Dear Jeff, Thanks so much for sharing this wonderful experience. It so perfectly shows your human side. You have reached that age when one realizes that it is faith, family, and friends that make us truly happy. Money is merely a tool to make us comfortable, not the goal of life.
Loved it. You can make the trip to Fabbriche di Vallico, step away from the financial whirlwind, and appreciate the personal impact and value in relationship. I’d like to go there.
Jeff, greatly enjoyed your note to us about going to Italy. You have your priorities in the right place – i.e., sons’ BB games, taking your father-in-law to Italy. It was touching to read about it.
You’re there when I need you. Seems to me that you knock yourself out to look out for our interests. I prefer to do business with people who have your values. One thing though: You MUST quit throwing your dirty socks under the couch!
And a candid response to Jeff’s bullishness on gold…
Crazy is not the word to call you. You are The WISEMAN. I am following you.
Thank you, as always, for your kind and thoughtful feedback. Keep it coming – along with any trading questions or comments – right here.
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