This title might confuse some readers. After all, we promote precious metals, right? And we’re long-term bulls, right?

These are both correct. However, our first interest is to help the investor. A lot of gold-bugs out there can’t think beyond the “precious metals will go up forever” mantra. And, while we agree from a macro perspective, the fact remains that nothing goes straight up. There are ebbs and flows.

With this in mind, we’ve counseled caution this past week as we approached the announcement from Jackson Hole. Too many commentators were calling for QE3 at a time when it just wasn’t logical. And we continue to see many jumping on the precious metals bandwagon, calling for imminent new highs.

While this is possible, as we pointed out last week, there are reasons to believe that there will be a valley before the next mountain. And today, even as metals continue to rise in eastern markets, I was treated to some excellent analysis on a private forum from Colchure. His observations are enough to make us take note and consider carefully our next move.

In a nutshell, the actions of managed money and commercial interests are showing topping signs. In fact, some of them are at highs not seen since metals dropped so hard last February. In the following quote I’ll attempt to distill the article down to a more narrow focus. However, due to the excellent detail, while long, the quote is priceless.

Historical COT data shows that when managed money gets very long, large corrections are usually near. Likewise when the commercials are getting aggressively short, the same applies. Therefore the shift in trader positions was suggesting that a correction was looming.

Technical indicators are now at breaking point, resistances have been smashed and most importantly traders are getting incredibly bullish… the strange thing about PM’s (especially silver) is it’s near mystical ability to sweep traders along with its extremity. We see this time and time again- traders begin to short silver, it then makes a huge move against them, and then those who get caught feel annoyed and start to completely change their view to the long side. Then of course silver drops like a lead balloon.

Managed money [is] reducing their short positions even more aggressively and adding longs and commercials [are] grabbing as many shorts as they can find.

Commercials increased their short positioning from 32k to 38k contracts net short- this is their largest short position since Feb 28 2012 (the leap year massacre as i call it) Managed money reduced their short hedge by a massive 46% and added 46% to their longs. (since July 21st Managed Money has covered 71% of their short hedge!) This short covering is no doubt the reason behind the price behavior of the white metal. Surprise, surprise, Managed Money now has its highest long position since Feb 28 2012- the day before silver plummeted 4.7% in a day.

The write goes on to express that this data is not conclusive. The only sure thing about the future is that it will one day be history. However, history has a habit of rhyming. It doesn’t have to happen that way. But probability mounts toward certain results as the data mounts. With this in mind, Colchure offered the following concluding statements.

The COT data is showing the same action it always shows before major corrections in the PM’s. This is no guarantee of a correction tomorrow, but it is food for thought. From my point of view one has to weigh up the risk reward here. Yes, PM’s could go parabolic (they have done before despite equally extreme technicals) but there is mounting evidence that they are overextended and that the traders who usually make all the real dough (the commercials) are not buying this spike for a second. Two months ago the commercials were signaling that they did not see much more downside in the metals- i wrote at the time that although it may take time the likely direction was therefore up. This eventually has come to pass. Now they are saying the opposite- and if you add this to the technicals, the over bullish sentiment and the fact that QE has not even been announced let alone implemented, you have to wonder how much legs this rally has left. 

Note that Colchure is looking at things from a trader’s perspective. He books profits based on market movements. With this in mind, he desires to buy and sell short-term based on market movements.

However, for those of us looking to buy and hold, as discussed last week, perhaps this offers us an opportunity to consider our next entry. Will metals skyrocket from here? Or, will we see a healthy correction that coils the springs for a much larger surge? If it’s the former, we’d do good to buy now. If the latter we’d do well to wait a few weeks to see what happens. Regardless, we still expect to approach, or even surpass, all-time highs before the end of the year.

For your prosperity,

J. Keith Johnson
The Gold Informant