A 66 Percent 'Smart' Money Trade

Elections have consequences, and one of the most surprising consequences of November's election has been the sharp increase in economic optimism. This can be seen in surveys of investors or business owners.

The general mood of the nation is captured by Gallup, which published a number of surveys. Their Economic Confidence Index shows some recent weakness, but is up sharply since the election.

economic-confidence

Digging deeper, we see that there is a sharp divide based on political affiliation but, on average, Americans seem happier today than they were in early November.

The same is true of small businesses, according to the National Federation of Independent Business (NFIB) Small Business Optimism Index.

small-business-optimism

NFIB notes that "the stunning improvements in the Index components that occurred after post-election were improved in December and confirmed in January." These improvements should lead to higher business spending and more jobs. If we see that, economic growth this year will begin to outperform 2016's.

Surveys are important, but economic growth will result only if spending follows the optimism. We should know by the middle of the year whether that's the case. I'll be watching economic data to see whether business and consumer spending rise enough to deliver the expected growth.

One advantage of being a trader instead of an economist is that we can get sentiment measures that show what investors are doing with their money instead of what they are saying they plan to do with their money. This is especially true in the futures markets.

In futures markets, the Commodity Futures Trading Commission (CFTC) issues a weekly report showing how many contracts various groups of traders own. The weekly report is known as the Commitment of Traders (COT) report. Traders are divided into three categories: Commercials are usually considered the smart money, hedge funds are included in the section reporting large speculators, and small speculators are individual traders.

Commercials are the producers and users of a commodity and are considered to be the smart money in a market because they know the fundamentals better than anyone else. Commercials will often be short a commodity in the futures market because they're hedging their positions. A miner produces gold so always has a long position in the mine, at refineries and in inventory. To hedge that position, they can sell gold short in the futures market.

The grey line in the chat shows a zero position for each group. Other groups are shown as colored lines, which are labeled. Notice that commercials are almost always short. Large speculators tend hold large long positions when prices peak and smaller positions when prices bottom.

gold-futures-stocks-aem

To make this data easier to understand, I convert the positions to an index that places the position into a range from 0 to 100. A reading of 100 indicates the group is holding its most bullish position over the time frame measured with a reading of 0 showing extreme bearishness. The timeframe used in the next chart is six months and as you see, commercials are more bullish now than they have been since the major bottom that occurred in late 2015.

gold-futures-stocks-aem

Commercials, the smart money in futures, are bullish on gold. We can trade alongside them using gold mining stocks.

The reason to invest in miners is that they're a leveraged trade on the price of gold. This is because production costs tend to remain relatively constant under normal market conditions, and increased market prices in gold can result in larger percentage gains in the profits of miners.

My favorite gold miner right now is Agnico Eagle Mines Limited (NYSE: AEM).

You can buy AEM shares outright to play the upside in gold, but that's not what I'm recommending in Income Trader, my premium newsletter. Instead, I'm suggesting readers sell puts on the shares and collect a 66% annualized "yield."

Giving away the exact trade wouldn't be fair to my subscribers. But if you're interested in learning more about selling puts, or even getting the exact details of my AEM trade, I put together a presentation you'll want to see. Click here to access it. 

[Market Outlook] Why I Can't Stop Talking About The 200-Day Moving Average
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Many investors hold strong opinions about the 200-day MA... but is it actually important?