Watching the flows in commodities

the traditional way of looking at flow indicators in commodity futures markets has been through the commitment of traders. The net positions for non-commercial and commercial traders are used as an indicator of market extremes and what is having with smart money. Small speculators are viewed as a counter-indicator. They generally lose money. Hedgers are viewed as smart traders and the large speculators are viewed as momentum traders whose positions peak at market tops and bottoms. The actual forecasting ability of the commitment of traders (COT) is suspect. For every extreme that is indicated with COT there are just as many periods of failure. The data has been looked at as percentiles, as a function of open interest, and as outright size. There is no true method for looking at the data.

Now, there is a new focus on ETF flows as a new indicator of market momentum and direction. The flow data especially for gold has matched the increase in prices over the last few years. Part of this flow has been catch-up for a new product, so it has been hard to determine forecasting skill. Still, we think the flows in ETF will become an increasingly important tool even if it reinforces price momentum.

We have noticed a new research product form JP Morgan called the commodity investment flow indicator which may be useful for watching what is happening in the commodity ETF market. Their recent research piece from January 10 offers some useful insights.

Open interest in a set of 43 commodity futures markets has surpassed the 2008 peak in the market. More participants are active in the commodity markets.

The changes in market cap for long-side and short-side commodity exchange traded products (ETP's) is starting to express differences in opinions about the movement in commodities. Precious metals have exploded in the last year but we are starting to see a slowdown in growth that is consistent with the more range-bound price behavior. Energy exposures have come down with the decline in natural gas prices and the more range-bound oil behavior. Agricultural and industrial metals demand has not seen the same growth. The short-side for many of these commodity products have also seen explosive growth. In fact, there has been more growth in the short-side products in the agricultural ETP products than from the long-side albeit from a much smaller base.

The ETP flows may become the new commitment of traders report over the next few years. It certainly should be used as an adjunct to the commitment reports.