Commodities Insights – The US Government Provides Inside Information in the Commodity Markets
The U.S. government publishes a weekly report called “Commitments of traders” or “COT” which provides a very unique view of the futures and options market from the inside looking out.
The Commodity Futures Trading Commission (”CFTC”) is the U.S. government agency responsible with policing and regulating trading on U.S. futures and options markets. The agency keeps track of all trading activity that takes place in these markets. The CFTC’s power and authority to oversee all trading activity gives it unique access to inside information in regards to the identities of market participants and their positions. This information in the hands of futures and options traders can be extremely powerful. Many people believe this information is heavily guarded and kept out of reach to individual traders, and in most countries that is indeed the case, but not in the U.S.
The CFTC is mandated to keep the marketplace fair for all participants, big and small, and to prevent price manipulation from taking place. To achieve this, the CFTC releases certain information to the public on a weekly basis. This information is contained in the Commitments of traders (”COT”) report. The COT contains a summary of all positions held by the largest market participants. Making this data public helps to provide market transparency and gives the public a certain ability to police the markets as well. In addition to that however, it also gives traders access to a powerful tool. It helps to level the playing field between large and small speculators, though that may not be the intended effect. Having access to weekly changes in positions held by large commercial producers, processors, and users of the world’s commodities provides the little traders with a wealth of information that can never be obtained through any price indicators!
The weekly COT data provides individual traders with inside information regarding changes in hedging activities by commercial producers as well as speculative activity by the world’s largest money managers and swap dealers. The CFTC releases all of this information to the public weekly via the Commitments of Traders (”COT”) report.
It still amazes me how few people actually know about this report. And of those who know about it, few really understand the information and know how to put it to use. I’ve spent the last fifteen years studying this data and building entire trading strategies around this information. Recently (2009) the CFTC has begun to improve the report and is now even breaking down positions further in an effort to provide greater clarity into the individual market participants.
I am thrilled that that the U.S. government provides this wonderful service (no other government in the free world provides such a service) and yet I am also still puzzled how few people know the report exists. If you are trading futures, an examination of this report is like turning on the lights in a dark room! The positions are all revealed. The report provides a detailed breakdown of all positions and discloses which market participants (by category) are holding the positions. Amazing!
In 2006 the CFTC began a pilot to provide greater clarity of the commercial category, which had begun to change due to new trading practices (pension funds and swap dealer activity). To address these changes the CFTC began releasing a supplemental report called “CIT” or commodity index trader report in twelve agricultural markets. The CIT report discloses the positions of commercial producers and commercial consumers on a weekly basis. These large commercial institutions utilize the futures market to hedge their cash exposure in the underlying physical markets. For example, an energy consumer (e.g. airliner) may use the futures markets as a form of insurance; to lock in the price they pay for their energy consumption in the future. This is called “hedging” and it reduces a business’s risk to future market fluctuations.
An airline which consumes jet fuel can use the futures market to lock in the price they pay for their fuel over the next five years. This hedges their exposure to the risk of sharply higher prices in the next five years. If an unforeseen event were to occur which causes fuel prices to sky-rocket, the company would not have to worry as they would have their price secured for a predetermined period (in this example five years). These commercial consumers and producers are widely considered to be the most knowledgeable group of traders in the futures markets.
The Trading Groups in the COT Report
The commercial entities typically know more about the true supply and demand than any other trading group. There are two other categories of traders in the markets and their positions are also disclosed in the COT report. These are Large trader (managed money) positions and small speculators. The large traders are usually funds, such as a hedge fund, which typically use price indicators such as trend following techniques combined with fundamental information. What is interesting here is that most of the fundamental information that gets reported to the government (such as crop reports) all comes from the commercial traders. Thus, that’s why the commercials are widely considered to be the most “knowledgeable” group in the markets.
That said however, there are some things that are unknown to all market participants. For example, no one can know for sure what the weather will do a year from now. In addition, while we can certainly track the geopolitical tensions, there is no way to know for certain what any person or group may be planning to do. Thus, no matter how much information a person has access to, there will always be a degree of uncertainty. Professional traders do everything possible to reduce the element of uncertainty, but it can never be eliminated entirely.
The COT report is the kind of information you’d be happy to receive once in a lifetime, yet few people are aware that the U.S. government actually publishes this information on a weekly basis.
This information has provided the public with a ‘heads up’ to massive movement in and out of various futures markets, including the U.S. stock market. Consider the Nasdaq stock index at the height of the internet bubble at the turn of the last century. When the Nasdaq was trading around 5000 (its all-time high at the time) the COT report showed the commercial traders were actually selling off all of their long positions in the futures market and in a little over a weeks’ time had accumulated a record size short position in Nasdaq futures!
This article is an excerpt from the free e-book Slipstream Wealth. Read the full chapter in the free e-book Slipstream Wealth downloadable at SlipStreamWealth.com
By: Floyd Upperman