Gold and silver
are languishing near major lows, trudging through the barren
sentiment wasteland of the summer doldrums. The major factor behind
this weakness is extreme shorting by American futures speculators.
But their heavily-bearish bets are actually very bullish for both
precious metals. Not only do these traders as a herd always bet
wrong at price extremes, their shorts are guaranteed near-future
buying.
American futures
speculators? trading has utterly dominated gold and silver price
action in recent years. This single group of traders doesn?t
normally wield such outsized influence. But with Western investors
largely missing in action since early 2013, futures speculators have
gone unchallenged. Couple this with the extreme leverage inherent
in futures trading, and its stranglehold on gold and silver prices
is ironclad.
This vexing
anomaly started when the Federal Reserve?s
third
quantitative-easing campaign spun up to full speed in early
2013. Unlike QE1 and QE2, QE3 was open-ended with no
predetermined size or end date. The Fed deftly used this to its
advantage, working overtime to convince traders that it would ramp
up QE3 to arrest any material stock-market selloff. They came to
believe the Fed was backstopping stock
markets!
So traders were
quick to buy every minor selloff, forcing the stock markets
inexorably higher. Traders started to abandon everything else to
chase these extraordinary Fed-levitated stock markets. They forgot
about prudent portfolio diversification, and shunned alternative
investments led by gold. So it suffered its biggest quarterly
plunge in 93 years in Q2?13, as American stock traders
jettisoned GLD gold-ETF shares.
That
once-in-a-century hellstorm was so brutal that the vast majority of
Western investors have yet to return to gold. They remain
radically
underinvested in this essential portfolio diversifier, one of
very few assets that moves contrary to stock markets. And without
normal investment demand, American futures speculators have had free
reign to effectively hold precious-metals prices hostage to their
bearish psychology.
This epic
Fed-spawned anomaly has created a quandary for contrarian
commentators like me. The small fraction of investors and
speculators still interested in gold and silver these days want to
hear about fundamentals like Chinese and Indian demand, traditional
drivers. But in today?s unprecedented environment, all that
matters for price action beyond ETF capital flows is American
futures speculators? trading.
When they buy gold
and silver futures, the precious metals? prices rise. When they
sell, gold and silver fall. The correlation between recent years?
price action and American futures speculators? holdings is
incredibly high. While I can?t wait for this anomalous dominance to
fade again as investment demand finally normalizes, today it remains
the overwhelmingly-controlling driver of gold and silver price
action.
This is
crystal-clear when charted. American speculators? total positions
in long and short gold-futures contracts are published once a week
by the US government?s Commodity Futures Trading Commission in its
famous Commitments of Traders reports. And when gold and silver
prices are superimposed on this futures-holdings data, the results
are striking. All contrarians have to understand this stranglehold
on prices.
This chart may
look complex, but it?s quite simple. Humorously, a Polish
university professor in South Korea has been trying to get a
previous iteration of this chart accepted by Wikipedia as its ?busy
graph? example! All it shows is the daily gold price in blue
overlaid on the weekly CoT futures-positions data. American
speculators? total long positions in gold futures are shown in
green, and their total shorts in red.
Finally the yellow
series shows the total deviation of these holdings from their
average levels between 2009 to 2012. Those were the last normal
years before the Fed?s wildly-unprecedented QE3 campaign radically
distorted the global markets. But our focus today is on the
strong inverse correlation between the gold price and American
speculators? gold-futures short positions. They have become
gold?s entire story.
Whenever this
single dominant group of traders has significantly ramped their
leveraged downside bets on gold, this metal?s price has fallen. And
then as soon as these guys hit selling exhaustion and their shorting
peaks, gold bottoms. The light-red vertical bars above mark major
peaks in speculators? gold-futures short selling, and they closely
match gold?s major bottoms. The only reason it?s not exact
is data resolution.
American
speculators are actively trading gold futures every day the markets
are open, yet the CoT only reports their positions once a week. But
near major reversals in gold?s fortunes, futures trading becomes
fast and furious within CoT weeks. So the apparent precision
of gold-futures shorting in driving gold?s price action of recent
years is obscured. In this information age, the CFTC really ought
to release daily CoT reports.
The extreme
shorting of recent years began in early 2013 as the Fed ramped QE3
to full steam. While that particular once-in-a-century gold plummet
in Q2?13 was also driven by
extreme gold-ETF
selling by American stock traders, futures shorting played a
majority role. That quarter?s GLD liquidations soared to an epic
record 251.8 metric tons of gold! But even that colossal sum was
actually exceeded by futures dumping.
In that same
quarterly deluge of torrential gold selling, American speculators
liquidated 58.8k gold-futures long contracts while adding 76.9k
short contracts. Since each contract controls 100 troy ounces of
gold, this equates to 183.0t and 239.1t respectively. So the 422.1t
of gold supply spewed into the markets by futures speculators in
that climactic gold-selling quarter dwarfed the monster selling
pouring in via GLD!
By the time the
dust settled in mid-2013, American speculators had ballooned their
total gold-futures shorts to an astounding 178.9k contracts! That
was the highest level witnessed since at least 1999, the extent of
our historical CoT data. And it was very likely an all-time
record. Gold bottomed right as these traders? bearish downside bets
in this metal peaked. And then a massive short-covering rally
ensued.
Shorting anything
in the futures markets is extraordinarily risky due to their
inherent extreme leverage. In the stock markets, leverage has been
legally limited to 2 to 1 since 1974. The Fed instituted that 50%
margin rule in response to a near-panic in the US stock markets, and
it?s never been changed. But in the futures world, normal limits
don?t apply. These speculators can run leverage that is quite
frankly crazy.
This week with
gold trading near $1175, the minimum maintenance margin required to
hold a single gold-futures contract is just $3750. But each
contract controls 100 ounces of gold worth $117,500. That means
futures speculators can run leverage up to an absurd 31.3x!
31 to 1 is enormous beyond belief, giving the capital these traders
risk a radically-disproportionate and totally unfair impact
on the gold price.
Every single
dollar bet on gold futures by American speculators has the same
impact as up to $31 in the underlying physical gold market or up to
$15 in the gold ETFs! So it?s no wonder futures trading has utterly
dominated gold in recent years, especially with Western investors
largely abandoning alternative investments. But such extreme
leverage leaves little margin for error, as losses can mount at
dizzying speeds.
When the gold
price moves against a fully-leveraged futures speculator?s bet,
their entire capital risked can literally be wiped out within
days. At 31.3x, a mere 3.2% adverse move in gold would devour
100% of the money bet on that contract. And a total loss isn?t even
the worst of it. If traders can?t exit their trades quick enough,
they are subject to margin calls requiring them to immediately
deploy even more capital.
So once short
covering gets underway, this process quickly feeds on itself
and accelerates. In futures markets, the only way to close a short
contract is to buy a long contract to offset it. And the upside
price impact of buying longs to close shorts or buying new longs is
identical. So the more speculators who rush to cover their shorts,
the faster gold?s price rallies. The quicker it surges, the more it
forces others to cover too.
Thus American
futures speculators? short covering fuels sharp rallies in gold.
After growing their shorts to record highs in mid-2013, this
perpetually-wrong-at-price-extremes group of traders covered
95.3k contracts in 16 weeks. That was the equivalent of 296.4t of
buying, and it catapulted the gold price 18.2% higher in less than 9
weeks leading into the autumn of 2013. Extreme gold-futures shorts
are very bullish!
But with investors
still missing in action in late 2013 as the US stock markets
continued levitating, American futures speculators couldn?t resist
returning to their bearish ways. They effectively borrowed and sold
gold futures aggressively, catapulting their total downside bets
back up to 150.0k contracts. That turned out to be a
super-important level, defining major overhead resistance for
gold-futures shorts.
But selling
exhaustion was reached even as gold plumbed new lows below
mid-2013?s. And once the futures speculators are done selling gold,
it quickly surges higher since that fierce supply headwind
vanishes. So they bought to cover 72.3k contracts over 15 weeks
leading into early 2014, which helped propel gold 16.2% higher in
about 11 weeks. Are you starting to see the pattern here? It?s
very relevant today.
Covering short
positions is not optional for futures speculators. They borrowed
gold futures that they did not own, sold them, and are legally
obligated to soon repurchase these gold futures to repay these
debts. So extreme gold-futures shorts held by speculators is
guaranteed near-future buying for the gold market. Self-feeding
short covering all alone is actually all that?s necessary to rapidly
catapult gold higher.
This trend
continued last year, with this group of traders waxing super-bearish
and ramping their shorts. But they soon hit selling exhaustion,
reaching their limits for making hyper-risky downside bets against a
deeply-out-of-favor asset that refuses to tumble significantly
lower. So they soon rush to cover and the resulting
gold-futures buying rapidly pushes the metal higher again. These
sentiment-driven cycles are common.
Even in this
grossly-distorted QE3 era thanks to this uber-dovish inflationist
Fed, speculators? total gold-futures shorts have carved a
very-definite trading range. Their zeal for shorting gold futures
dwindles whenever their total short contracts near 150k, regardless
of gold?s price level. And then they soon scramble to cover, buying
enough long contracts to push shorts back down near their 75k lower
support level.
Provocatively in
the latest CoT week?s data available before this essay was
published, speculators? total gold-futures shorts ballooned to
148.3k contracts. That is right at the 150k resistance that has
proven so bullish in recent years! This implies major short
covering is coming soon. And once this process gets started, it
rarely stops until these traders? total short holdings are driven
back down to their 75k support.
That will require
an incredible 73.3k contracts of short covering alone, the
equivalent of 228.1t of gold buying! And a range of catalysts could
spark it anytime. With gold?s seasonals bottoming right now, we are
on the verge of this metal?s
major seasonal
rallies driven by various demand surges in late summer, autumn,
and winter. Seasonal tendencies shifting from very weak to very
strong alone could spark short covering.
Plenty of other
potential gold-buying catalysts exist too. The lofty Fed-inflated
US stock markets are on the verge of rolling over decisively as the
threat of imminent
rate hikes looms. The
euphoric US
dollar that has kept a lid on gold investment demand is
weakening. The Greece nightmare could hammer the European stock
markets anytime, and the
popular
speculative mania in the Chinese stock markets is failing.
Regardless of the
triggering catalyst, with speculators? gold-futures shorts so
extreme today serious short covering is imminent. And that is going
to propel gold dramatically higher. In the 3 prior times these
traders? total gold-futures shorts challenged or exceeded 150k
contracts in recent years, gold powered higher an average of 16.2%
in just 10 weeks! And that was even with the stock markets still
levitating.
Apply this
merely-average gold-short-covering rally to this metal?s price as of
its latest CoT report, and we would be looking at $1375 gold
by its next major
seasonal peak in early October! And that is so much higher than
today?s dismal levels that it will probably even motivate Western
investors to start returning. I suspect that process has already
begun, as gold-futures shorting is losing its efficacy in battering
gold lower.
Despite
speculators? downside gold-futures bets nearing 150k resistance
twice this year, extreme levels by any measure, gold has not fallen
significantly this quarter. When taking on such hyper-dangerous
leverage, speculators need to quickly see profits on their trades.
Their increasing inability to force gold lower is going to make them
nervous, as they have to start wondering if super-cheap gold
warrants selling low.
And contrary to
the totally-false popular belief today, the Fed?s coming rate hikes
are no threat for gold. Yes gold yields nothing, but
rising-rate environments are very damaging to stocks and bonds. So
when the Fed hikes rates, investors tend to flock back to
alternative investments led by gold. Since this hard historical
truth is absolutely essential for contrarians to understand, I?ve
written important
essays exploring it.
During the Fed?s
last rate-hike cycle from June 2004 to June 2006, it more than
quintupled its Federal Funds Rate to 5.25%. Yet over the exact
span of those rate hikes, gold blasted 50% higher! A similar gain
from this week?s levels would catapult gold well over $1750. And
that?s not farfetched. In all of 2012 before the Fed?s gross QE3
distortions began, gold averaged about $1675. It will certainly
mean revert back up.
And the last time
the Fed was forced to seriously hike rates to atone for excessive
easing was in the 1970s. It raised its FFR from 3.5% in early 1971
to an astounding 20.0% by early 1980! Yet gold didn?t collapse as
yields soared as naive analysts argue today, it skyrocketed an epic
24.3x higher on surging Western investment demand! Rate
hikes are very bullish for gold since they are so damaging to
lofty stock markets.
Provocatively the
situation in American speculators? downside bets on silver is
even more extreme than gold?s! While
silver is driven
by gold, it too is on the verge of a major frenzy of short
covering. This next chart reveals the same CoT data for silver, and
it is dazzlingly bullish. So when the inevitable next gold-futures
short-covering spree gets underway, this same fast-buying phenomenon
will also ignite in silver.
According to the
latest CoT data, American speculators? silver-futures shorts have
soared way back up to 66.4k contracts. That is nosebleed high, not
far below their all-time record peak of 70.0k contracts back in
early November 2014. Incredibly in the last two CoT weeks alone,
this group of traders grew so bearish that they ramped their
silver-futures shorts by a breathtaking 132% or 37.7k contracts!
Talk about extreme selling.
Yet silver
barely budged, which is a big warning sign to these futures
speculators that their leveraged downside bets are far riskier than
they thought. In order to return their current extreme shorts back
down to support near 27k contracts, they are going to have to buy to
cover around 39.4k contracts. Since each contract controls 5000
troy ounces of silver, that is the equivalent of a staggering 196.8m
ounces of buying!
So once gold
starts moving decisively higher on short covering, the speculators
heavily short silver will be forced to cover too. Since the extreme
shorting in both precious metals represents legally-mandated
guaranteed near-future buying, the coming months ought to see
major rallies in this deeply-out-of-favor sector. Contrarian
traders smart, courageous, and foresighted enough to buy ahead of
the crowd will reap big gains.
The coming
short-covering-fueled gold and silver rallies can be played in the
metals themselves or their leading ETFs. These are of course the
GLD SPDR Gold Shares and the SLV iShares Silver Trust. But these
precious-metals gains should be really amplified by the
left-for-dead stocks of their best miners and explorers. No other
sector in all the stock markets has
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The bottom line is
American speculators? short selling in gold and silver futures has
reached extremes in recent weeks. This single group of traders
commands a wildly-disproportionate impact on prices due to the
absence of investors and outsized leverage inherent in futures
trading. But extreme shorting is a very bullish indicator, as
offsetting long futures contracts must soon be bought to cover these
excessive shorts.
Even in the recent
years grossly distorted by the Fed, major short-covering rallies
have erupted in the precious metals from speculators? same extreme
short levels as today?s. Taking up to several months to unfold,
these short-covering frenzies lead to double-digit-percentage gains
in gold and silver prices. And there?s a great chance these coming
rallies will grow much bigger as the stock markets start rolling
over.
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