Larry Williams: The Role of Hedgers In Commodity Markets

In 2007, Matt Caruso conducted an interview with popular trader and author Larry Williams, and there was a good point raised by Williams about the change in the mix of commodity participants now:

MC: After reading your book The Secrets of the Commitment of Traders Report, I understand that the position of commercial traders, the seasonality, and trend of a security are all important factors. Would you like to explain these tools?

LW: Yes, but first let me interject here – a great change that has taken place since that book was written and that is that we now have these basket commodity funds where they buy a bunch of commodities and hold them with the belief that the commodity will go higher. Jim Rogers started the whole idea I guess, but these index traders now account for about 25% of the market volume. When you’re looking at anything that has to do with COT (commitment of traders) positions, and I don’t know the answer yet because we haven’t had the data long enough, it’s not the same old game anymore since you have a huge number of perpetual longs, these index funds, and we’ve got to figure out what to do with these guys. Like I said, I don’t have the answer to that yet because I only have sixteen months of data with it.

The question remains, “How do we still use the data?” I think that what people need to understand, the biggest misnomer is just because the commercials are long doesn’t mean the market is going to rally. You have to understand that they don’t speculate in the market, they’re using the market to facilitate their business. They’re not taking positions in the market like you or I as speculators, they’re hedging their business by pre-selling their production, so you need to understand that their function in the marketplace is not the same as ours. They’ve been selling a lot in the grains now and it looks like the grains should come down – the reality is that a lot of guys are selling forward production because at these price levels they can produce a lot of crop; it’s priced to make money so they’ll sell it. It doesn’t mean they’re short the market – they just sold their future production. We really need to put their commercial position into phase with the trend of the market as well.

MC: So you would basically wait for a trend reversal before acting on the commercial short position.

LW: Yes, that’s really critical. They’re heavily short, but that doesn’t mean sell today – it means I want to focus in on that market. The ideal thing would be a big smack on the market and then some technical rally back where you look to take your position.

Williams was one of the first traders to examine the possibilities of using the Commitment of Traders Reports (COT) from the CFTC to spot trading opportunities. In the same interview he shares his view on using the data:

MC: This is very interesting. Do you plan on releasing an updated version of your COT report to include these new developments in the market?

LW: We don’t have enough data yet but I’m doing something for my subscribers in March about what I think we need to do. I think we need to create a true COT index so that it’ll ferret out all these index traders, option people and other data in there. We need to have a true COT index, a true open interest index, and a true large speculator index.

MC: So until these adjustments are made, do you still feel that there is still a lot of value in the numbers we get from the CFTC?

LW: Oh yeah! I also look at just the net position of the commercials. I put it into an index and I also look at their net position versus open interest. A classic example would be open interest is really peeling off in the marketplace. If you just look at the open interest you don’t know what that means. However, if you go inside that report and see the commercial long position is declining and the large speculator position is increasing rapidly we know that there are a lot of large trader longs coming in and they tend to be buyers of highs. So that would be a bearish scenario since open interest is down and without the large traders, open interest would be way down. If, on the other hand, you have open interest coming down and commercials are increasing their longs, that is very bullish because the only player in the markets on the long is the commercials. That’s how I like to look at the commercials in regards to open interest.

People can access the Commitment of Traders Reports here.