Hi Bujjai!

The COMEX publishes data on the net positions long and short for the metals. This information is presented in the Commitment of Traders report (COT), and the total of all open trading positions is known as the open interest. For every contract there is a buyer and seller, so they match up and offset each other. If a new short is opened, then a buyer for that contract must also appear. Sometimes the seller is a short, and sometimes its a vendor backed by real metal, but in either case a contract involves a unit of metal for delivery at a certain date at a certain price. The total number of contracts at all prices and delivery dates is your open interest. And if a long contract is liquidated before expiry, it is sold to close the position, and that can be bought out by a different long, in which case the open interest is unchanged, or it can be bought by a short that is also closing a position, and the net open interest will decline.

The reason this information is important is that it can shed light on the trading. If for example we see a big downside move in gold, and the open interest does not change much, then we can conclude that new shorts have appeared, since the downside move was accompanied by fresh selling, ie. new contracts were opened to offset those who were taking profis or selling out. If gold declines sharply and the open interest declines, then we may surmise that longs were liquidating, ie. selling their contracts and thus closing positions.

Historically large open interests suggest that the spec participation is getting top heavy and a correction may be close at hand. However, there many who believe that at some point the large offsetting short position will be in trouble since there is not enough physical bullion to meet a demand for delivery. If the specs do not close positions by selling in the market, and instead choose to take delivery, then its game over. This is why analysts make note of the COT report and infer what the sentiment of the market may be. IF the market is extremely bullish and the physical bullion supply is low, then we have a greater chance of a delivery failure and a major short squeeze.

cheers!

mike