The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Scott Pluschau for ETF Digest

Updated at 4:30 pm

NEW YORK ( ETF Digest) -- I commented recently on silver, a short article touching on the price action and a Japanese Candlestick pattern here. This is a follow up, looking at a report from COT, the Commitments of Traders. Open interest in silver was 99,698 on this week's legacy COT report for October 11, 2011 released by the U.S. Commodity Futures Trading Commission. There is always one buyer on the long side and one seller on the short side for each contract of open interest.

I can't remember the last time the figure was below 100,000. This COT report now shows the commercials, also known as "big money," are net short 20,828 contracts. In a vacuum this may appear bearish.

Why is it important to follow the commercials? Not because they are the "smart money," but because they are the "informed money." Nobody should know more about their business than the insiders.

Commercials have a) the cash position to hedge, b) deep pockets and c) can stand for delivery, while a majority of speculators do not stand for delivery and trade with leverage.

There is not much else to consider about the COT report or its signals, if that last sentence is not understood. It is worth re-reading again.

In general, I believe the lower the open interest, the less public speculation, and it is the strongest-handed commercials that accumulate to the long side near market bottoms. On the other hand, typically when markets are making new highs, on increasing open interest, and high volume, it is a sign of rampant speculation.

It is important to look at what the commercials are doing in that scenario as well. The classic school of thought is that markets making new highs on an increase in volume are bullish. But if the commercials are building on their net short position, it is a sign that they are locking in a price that could be overvalued.

A pricing pattern breakdown afterward can lead to things getting really ugly really fast in that scenario, especially to those late to the game. Why? Because these speculators look to get out with "market orders" while they still can.

Bids get pulled, demand is gone and this leads to one-sided price action and margin calls -- I cringe to think about it. But that is a topic to expand on another day.

Let's take a look at the October 12, 2010 legacy COT report in silver. Silver had open interest of 153,970 contracts and the commercials were net short 61,504 contracts. In about one year, approximately 54,000 long positions and 54,000 short positions have been closed out, and the commercials have reduced their net short position by 40,000 contracts.

Does it seem like the speculators are leaving town?

In fact, going back the past seven years, around the middle of October for those years, silver open interest has had a low of 134,365 contracts (on October 10, 2006) to a high of 169,415 contracts (on October 11, 2005). Things are getting interesting, looking at the trend in the structure of the COT report in silver.

In a nutshell, the commercials are getting out of short positions while speculators have been liquidating their long positions. Commercials accumulating long positions in a quiet market has historically been a good sign of potential long-term gains.

In my opinion, it is very important to look at not only what the commercials are doing in regards to net changes in their position, but how that compares to the increase or decrease in open interest. The x-ray has three dimensional views when you include the COT analysis of the commercials, the open interest, along with the auction market profile.

Above is the latest chart on silver.

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Comments are welcome at Scott.Pluschau@ETFDigest.com

This commentary is that of the author and is not a recommendation and does not necessarily reflect the views of the ETF Digest or represent any guarantee as to its reliability or accuracy or reliability.
At the time of publication, Pluschau was long silver futures. This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.