Friday’s unemployment report, specifically the dovish non-farm payrolls number, created quite the knee-jerk reaction among all inflation sensitive commodity products. This morning, we’ll revisit the silver market and determine what to do about the short position we established here on May 2nd near the high.
First, the background, we track the relative behavior between the commercial and large speculator categories of the Commodity Futures Trading Commission’s weekly Commitments of Traders report. We parse out the data between the speculators and the miners and refiners in an attempt to separate speculative activity from the fundamental price discovery process that naturally occurs between the miners and refiners representing supply and demand, respectively. One of the big reasons for the initiation of our short position was the fact the bias between these two participants had grown to record levels.
Fundamentally, we believe that the commercial traders ultimately determine value in the market, while the speculators provide the run-ups and declines that provide over and under-valued situations. We use these moves to initiate our swing trades. Therefore, the large speculator record net long position in what has been a downward trending market was a very clear signal that the rally was due to fail. Furthermore, referring back to our May 2nd piece here at TraderPlanet, “Commercial traders are net short more than 85,000 contracts. This has happened only three other times. (10/1994, 4/2004, 12/2005). Each of these cases brought a major reversal, cancelling out all of the gains from the previous rally within one month.”
All of the above was also happening concurrently with significant commercial trader behavior in the interest rate sector, which has been building the case for a steepening yield curve in line with the Federal Open Market Committee’s stated intentions of raising rates, once again at this month’s meeting. A steepening yield curve led by a hawkish FOMC would mitigate domestic inflationary risks and strengthen the U.S. Dollar, both of which weaken the supporting argument for owning silver futures.
Based on recent commercial purchases as they’ve begun to cover their short position under $16.25 per ounce. This buying has nudged commercial momentum into positive territory. When we combine positive commercial momentum with a bounce in our momentum trigger from oversold levels, we get a COT Buy Signal. While we expect the next few days to be a choppy trade in the metals markets, it’s quite possible that Friday’s numbers have taken some of the starch out of the FOMC’s eagerness to raise rates again.
However, and I’ll close with this, I think the Fed needs to raise rates one more time and, I think they’ll do it before we get into the fall election season. That leaves June 15th or July 27th as the only opportunities. Based on history, we’ll watch the commercial trader position closely to determine if they’re taking short profits on their cash hedges or, if refiners are beginning to worry about chasing prices higher in an inflationary environment.
For more information on our approach to value based, swing trading in the commodity markets, please visit COTSognals.com.
