“Dear Friends,

As many of the readers of this site are aware, once a week the CFTC publishes a Commitment of Traders report which details the internal positioning of the various players that comprise the futures markets through Tuesday of the week which the report is issued.

Not that long ago, the CFTC, in response to numerous industry requests, issued a Disaggregated report which further breaks down the categories that we in the trade have come to know as the Commercials, the Large Speculators (predominantly Funds) and the Unreportables or the General Public.

The new report breaks out the Commercials as the Producer/Merchant/Processor/User category but instead of lumping in the Swap Dealers into that category or the Large Speculator Category as they did in the past, it provides a separate category for that group in addition to the category now classified as “Managed Money”. I have found this new report very useful as it gives us a much better picture of who is doing what in these futures markets.

The commodity markets of today are being driven primarily by two categories, Managed Money and Swap Dealers. Managed Money is pretty self explanatory – those are primarily hedge funds or fund like entities who serve clients that want speculative or investment exposure to commodities. Swap Dealers are a bit murkier. This group can be legitimately serving the needs of clients who want to offload risk in a risk management program but whose needs to do so are not best met by the standardized commodity futures contracts offered at the US futures exchanges. An example might be an airline which needs to offset the risk of rising jet fuel prices. There is no such contract offered at the Nymex. In times past such a company might have chosen to use the heating oil contract as a type of hedge instrument because its movements are generally related to the price of jet fuel but as you can surmise, there are vast differences between the two products. To fill this need the Swap Dealer has arisen which can offer a contract specifically covering Jet Fuel but which then needs to offset that risk themselves and so will come into the heating oil markets and employ those contracts as a hedge for their own risk exposure.

If things were that simple, it would make deciphering this new report a bit easier. The problem arises because these swap dealers also have clients that they represent who are speculators or because the swap dealer themselves might be speculating for their own interests. In other words, we can now see the positions of these swap dealers but we do not really know for whom they are acting. Transparency can only go so far.

In the last few years a new group of players have also come into the commodity futures markets known locally as the index funds. These are not the same as the hedge funds primarily because they are known as “long only” funds, in contrast to managed money which will go both long or short. What they do is to serve a group of clients who want exposure to commodities as an investment sector but who only want to buy commodities against an expectation of a falling US Dollar and a wave of inflation that results from excessive monetary easing. These funds will apportion their investment monies according to the weightings of the commodity basket selected by those who create and manage the benchmark commodity indices that they use to govern their futures holdings. The Goldman Sachs Commodity Index (GSCI), the DOW JONES/AIG Commodity Index and the Reuters Jefferies Commodity Index are among these various indices.

In a nutshell, what these index funds do is buy commodity futures across the board and then roll those positions from month to month as the front month futures contract expires. They are generally in the market on the long side as it is evident that those who want to allocate money to the commodity sector are doing so because they expect prices to rise over the long term. They do carry some short positions but generally those are small as could be expected. After all, if your clients want to own commodities because they think the price is going to rise, why would they be investing with a firm that is going to be short that sector? That is realm of the hedge funds who are in and out and both long and short depending on what they black boxes command these mindless dolts to do.

For CFTC classification purposes, a rather sizeable portion of this index fund community seems to be captured in the numbers that comprise the Swap Dealers category. I do not claim to be able to completely understand this but I do know from my analysis of these reports, especially by comparing the Supplemental COT report and this new Disaggregated Report, that the Swap Dealers category catches a large number of these index funds.

Regardless, if you look at the chart of the gold futures market, you will notice that since I started detailing this info beginning back in June 2006, these swap dealers have not once been net longs but have maintained a net short position even after all their short covering which was fairly extensive beginning when the credit crisis erupted in full force in the summer of 2008. This is quite odd when one does some further investigation into the commodity markets as a whole because there are very few exceptions, outside of the precious metals, where one can find the swap dealers on the short side of the market , particularly during periods of rising commodity prices.

Think about this – clients want to own commodities to protect against the decline of the US Dollar. They give money to firms that buy a basket of commodities for them. Gold is included in this basket as is crude oil, corn, wheat, soybeans, coffee, cotton, sugar, cattle, copper, etc. We could expect therefore when we do an analysis of a rising market to see both the Managed Money category and the Swap Dealer category to be on the net long side of the market against the Producer/User category. That is indeed the case with the large majority of the commodity markets. But it is NOT the case with the gold market. This is quite strange because any index fund that invests money for its clients is going to be long gold. It has to be in order to matching the weighting given to gold by the particular commodity index that is its benchmark.

For instance, if the weighting for gold in a commodity index is 5%, then for every $1 million of client money received, an index fund manager must buy $50,000 worth of gold contracts. Do the math and you can see that these giant index funds and their money flows into the commodity markets have pushed prices to levels commensurate with the kind of investment money that has piled into this sector. I did not detail it in this article with a chart, but copper for example has the Swap Dealers as NET LONGS by a SIX to ONE margin. Look at its price chart and you can see that it has gone vertical.

Corn is another example of where the Swap Dealers are overwhelming net long, alongside of the Managed Money category.

Yet when we come to gold not once in the last 3 ½ years has this category been net long, not once. I am at a loss to explain this quite frankly. Yes, there are Swap Dealers who are outright longs in the gold market, but they are dwarfed by those in that category that are shorts. Perhaps these gold Swap Dealers have long side exposure to gold elsewhere and are using the Comex gold market as a hedge against that position, something which would fit with their function of providing private contracts to clients to gain exposure to the gold market, but where do the index funds come in here? Are they being lumped in with the managed money section for the purposes of the gold report and if so, why, in contrast to what we see in nearly every other commodity market? Are some of these Swap Dealers also the same entities as are being labeled Producer/Merchant/Processor/User? If so, why?

I think it also useful to note here, even in silver, that other precious metals market in which shenanigans are occurring, the Swap Dealers are currently Net Shorts but not nearly to the extent that we see in gold. There in silver, Swap Dealers’ longs comprise 10.4% of the total open interest to their 5.4% of the total open interest on the long side in gold. Their shorts comprise 11.6% of the total open interest in silver compared to a whopping 19.5% of the total open interest in gold. Obviously a net difference of 1.2% in silver biased to the short side is dramatically different than a 14.1% difference biased to the short side in gold.

What all of this means is unclear to me at this point but I do think it is something worth noting. It further serves to underscore the murkiness that infests the Comex gold market and why even more transparency is required if investors are ever going to be able to have a level playing field when it comes to the US gold futures market. The CFTC needs to look even further into this market.

Recent discussion about potentially limiting position size in the precious metals market is useful but is not all that needs to be done. The problem with granting exemptions to position limits for hedgers is that it is quite possible that a Swap Dealer could be granted exemptions by claiming legitimate hedging needs to offload long side risk exposure, but who is then to say that the same outfit could not also be purely speculating for its own ends at the same time? Since this category by its nature is not easily defined, exactly how the CFTC can determine that the system is not being gamed with a speculative interest being granted position limits based on an incomplete or inaccurate description of the entirety of its activities is a challenge that must be addressed. Otherwise a shrewd operator can gain an unfair advantage over the rest of the speculative community that has to curb the ultimate number of positions that it can take on in a commodity market. Hedgers have no limits –speculators do, and therein lies the problem – should a speculator masquerade as a hedger and have access to a huge sum of money, who or what is to prevent them from sitting on a market? Just a thought….”- Dan Norcini, More at http://www.goldseek.com/email/lt/t_go.php?i=2166&e=MzM0MTg=&l=-http--www.jsmineset.com/">JSMineset.com