Palladium is the best long-term commodity trade that traders ignore.

It’s an important component in catalytic converters, a part of a car’s exhaust system that controls emissions used in gas-powered and hybrid vehicles.

According to the BBC, this use should keep demand for palladium high as governments around the world, “notably China, are tightening regulations as they attempt to tackle air pollution from petrol vehicles.”

Also, “as a secondary product of platinum and nickel extraction, miners have less flexibility to increase palladium output in response to rising prices.”

The chart below shows that the smart money is now buying palladium.

Palladium Futures’ Past

Palladium Futures Offer Short- and Long-Term Gains

In futures markets, traders buy contracts or “go long” when they expect prices to rise. When a decline is expected, they sell contracts, creating a short position.

Traders in stocks can also take short positions but rarely do so because shorting is expensive. In futures, going short is common because the costs are the same as a long position.

The indicator at the bottom of the chart shows whether important groups of traders are long or short in the market. This indicator is based on an obscure report issued by the Commodity Futures Trading Commission. The Commitment of Traders report tells us who is buying gold, soybeans and other commodities like palladium.

Analysts call one group “smart money.” This group expects to be right about major trends more often than not. In the report, this group is called commercials.

For palladium, commercials include miners and automakers who use palladium. Buying and selling futures allows these groups to reduce, or in theory, eliminate risks from changes in the metal’s price. Groups in the COT report are either net long or net short, and the dashed line in the chart shows the division between long and short. Now, commercials, the green line are long palladium contracts for the first time since last summer.

Because commercials are smart money, analysts expect prices to rise when commercials are long. Adding to this likelihood is the fact that individual investors, the red line in the chart, are net short. Individual investors are often wrong in futures markets.

We know palladium offers long-term potential. COT tells us it also offers short-term potential.

Michael Carr is a Chartered Market Technician for Banyan Hill Publishing and the Editor of One Trade, Peak Velocity Trader and  Precision Profits. He teaches technical analysis and quantitative technical analysis at the New York Institute of Finance. Mr. Carr is also the former editor of the CMT Association newsletter, Technically Speaking.

Follow him on Twitter @MichaelCarrGuru.