Gold has rebounded
sharply higher in the past month, taking the early lead as 2017’s
best-performing asset class. Normally such a big gold surge would
require heavy gold-futures buying by speculators. But they’ve been
missing in action, barely moving any capital into gold yet. Their
collective bets on this metal remain very bearish. Since they are
such a strong contrarian indicator, that’s a very-bullish omen for
gold.
The sole mission
of speculation and investment, and thus all the endless research
that feeds into it, is to multiply wealth. Traders can’t
effectively buy low and sell high unless they understand what
drives the prices of their trades. For years now, gold has had
two overwhelmingly-dominant drivers. Their capital flows fully
explain the vast majority of all gold’s price action, and thus are
exceedingly important to study.
The first is the
world-leading GLD SPDR Gold Shares gold ETF. This acts as a conduit
for the vast pools of American stock-market capital to slosh into
and out of physical gold bullion. Differential supply and demand
for GLD shares relative to the underlying gold supply and demand is
directly shunted into gold itself. GLD’s physical-gold-bar
purchases and sales as its holdings grow and shrink greatly impact
gold prices.
Nothing has been
more important for gold over the past year than the American
stock-market capital that flowed into then out of it via GLD.
Speculators and investors can’t understand where gold has been or
where it’s likely heading without studying and closely watching
GLD’s gold-bullion holdings. Last week I wrote a
comprehensive
essay digging into this crucial GLD-and-gold relationship in
depth, check it out.
But American
speculators’ gold-futures trading often overpowers American
investors’ GLD-share trading in bulling the gold price around over
the short term. Futures speculators enjoy an outsized impact on
gold prices wildly disproportionate to the capital they wield for a
couple key reasons. First, the American gold-futures price is
gold’s de-facto world reference price. It is the
most-widely-followed and quoted gold read.
So when these
traders buy or sell aggressively and thus rapidly force gold
materially higher or lower, it has a big psychological impact on
everyone else in the gold world. Gold futures are the speculation
tail wagging the far-larger investment dog in gold. Investors
controlling vastly more capital than gold-futures speculators get
bullish or bearish, and change their trading behavior accordingly,
based on gold-futures action.
Second,
gold-futures traders enjoy a radically-inordinate influence on gold
thanks to the extreme leverage inherent in gold futures.
While investors buy gold outright or with at most 2x leverage
through GLD shares, gold-futures speculators often trade gold with
incredible 20x to 25x leverage! That means every dollar of capital
bet on gold futures can have 20x to 25x the price impact of another
dollar invested normally.
So futures
speculators’ collective buying and selling can really distort gold
prices over the short term, even though gold investment
demand will always ultimately prevail as gold’s primary driver.
There’s a critical interplay between GLD capital flows and
gold-futures action. Parallel buying or selling on both of these
fronts always drives gold higher or lower. Opposing buying and
selling tends to offset and cancel out.
Unlike
GLD-holdings data which is available daily, speculators’ collective
gold-futures trading activity is only published at a fuzzier weekly
resolution. Late every Friday afternoon the CFTC releases its
famous Commitments of Traders reports. These reveal what both
hedgers and speculators have been doing in gold futures current to
the preceding Tuesday. Watching them is essential to gaming gold
price action.
This first chart
looks at the aggregate gold-futures long and short positions held by
both large and small speculators, in contracts. Each gold-futures
contract controls 100 troy ounces of this metal. Total longs or
upside bets on gold are rendered in green, while total shorts or
downside bets are shown in red. The yellow line shows the deviation
of both these bets from normal years’ average levels between 2009 to
2012.
![](http://www.24hgold.com/24hpmdata/articles/img/Adam Hamilton-Gold Futures Looking Bullish-2017-01-20-001.gif)
Speculators’
gold-futures data may look complex, but it’s not difficult to
understand. Gold’s price over the past couple years or so is
superimposed in blue. Gold is strongly positively correlated
to speculators’ total gold-futures longs. Every significant gold
rally in recent years was partially driven by big gold-futures
buying as evidenced by spec longs surging. Until this past month’s
rally, which we will get to.
Speculators’
collective upside bets on gold are also a powerful contrarian
indicator. Spec longs were high every time gold peaked in the
last couple years, including this past summer. As I warned back in
mid-July just after gold hit $1365, it faced a
record
gold-futures selling overhang due to specs’ excessive longs.
These hyper-leveraged traders were far too bullish, all-in on gold,
implying they would soon have to sell.
The higher spec
longs, the more bullish on gold these traders are. But that means
they have already deployed most of their available capital, with
limited firepower to push gold still higher once they’re all crowded
in. So gold rallies often peter out and then reverse once spec
longs get excessive. The worst time to get excited about gold is
when futures speculators are, since they are the most bullish
when gold is topping.
Conversely low
spec longs show when these traders are bearish. They don’t expect
much upside from gold so they’ve liquidated large fractions of their
leveraged long bets. That signals most of the gold-futures selling
has already happened, so gold is actually bottoming. Spec
longs were really low back in December 2015 when gold was carving a
major 6.1-year secular low. That birthed last year’s strong new
bull!
So the smart way
to game gold’s probable near-term price action is to do the
opposite of what the futures speculators as a herd are doing.
If they are betting big on higher gold prices as shown by excessive
longs, expect an imminent correction. If they are convinced gold is
heading lower as seen in low longs, expect a major rally to soon
erupt. Fading the futures-speculator mob is the surest way to win
in gold trading!
Speculators’
collective gold-futures short positions work similarly, but in the
other direction of course. In futures, traders can sell even if
they don’t own any contracts to sell. They effectively borrow them
from someone else, and then sell them. These debts must soon be
repaid, so speculators hope they can buy back the futures contracts
at lower prices to return them. They then pocket any
difference as profits.
In terms of
gold-price impact, there is zero difference between a speculator
selling long contracts they already own or short selling ones they
don’t. A sale is a sale, they are functionally identical. But
since speculators collectively hold fewer gold-futures shorts than
longs, shorting has a proportionally-smaller effect on prevailing
gold prices. But once again speculators bet wrong as a herd when
gold is ready to reverse.
Gold’s major
secular lows in 2015 were accompanied by record-high spec short
positions! Right when gold was bottoming ahead of major rallies,
these guys were holding the largest downside bets. Then as gold
subsequently topped, spec shorts had been bought and covered back
down to low levels. So gold is most bullish over the near term when
speculators are the most bearish as evidenced by excessive shorts.
Futures
speculators are always wrong at extremes, when gold has
either rallied or corrected too far for too long. High spec longs
and low spec shorts are a key warning sign of a major selloff
looming, just as I
warned last
summer. But low spec longs and high spec shorts signal the
opposite, that gold is on the verge of embarking on a major new
rally. This latter very-bullish situation is exactly what gold is
seeing today!
![](http://www.24hgold.com/24hpmdata/articles/img/Adam Hamilton-Gold Futures Looking Bullish-2017-01-20-002.gif)
This chart zooms
in to the past year or so, but let’s start on Election Day. That
night as Trump pulled into a surprise lead in the biggest
battleground state of Florida, gold futures rocketed 4.8% higher to
$1337! A Trump win was universally assumed to be bad for stock
markets and thus good for gold, which is the anti-stock trade
since it tends to move counter to stock markets. As stocks
rebounded, gold was sold hard.
This heavy
post-election gold selling was universal, coming from both investors
jettisoning GLD
shares and speculators dumping gold futures. With capital
rushing out of gold’s two primary drivers, it was just hammered. In
the 5 weeks between Election Day and the day after the Fed’s second
rate hike in 10.5 years in mid-December, gold plunged 11.5%! That
was part of a larger 17.3% major correction since early July’s peak.
Gold’s two biggest
plunges in its miserable Q4’16, one of its worst quarters ever, were
fueled by heavy gold-futures selling by speculators. Since
such extreme leverage exists in this market, traders have to set
tight stop losses. If they are running 20x leverage, a mere 5%
adverse move in gold against their bets would wipe out 100% of their
capital risked! So even minor 1%ish gold moves are major for
futures traders.
In early October
as gold drifted towards $1300, it triggered a big mass of futures
stop losses set near that key psychological support. The resulting
mass stopping
quickly cascaded, as the more gold futures fell the more stops were
tripped unleashing even more selling. Another mass stopping
happened just two days after the election when another key gold
support zone at its 200-day moving average failed to hold.
These extreme
early-October and mid-November episodes of gold-futures selling
perfectly illustrate how disproportionate its impact can be.
Speculators dumped 43.4k and 45.6k contracts respectively in those
two key CoT weeks, unleashing the equivalents of 134.8 and 141.9
metric tons of gold. That is far too much selling for the gold
market to absorb in such short spans of time, which cratered the
gold price.
For perspective,
consider the latest global gold fundamental data available from the
World Gold Council current to Q3’16. That 9-month year-to-date span
saw massive
gold-investment demand, huge by recent years’ standards. Yet it
still only averaged 35.6t per week. So whenever gold-futures
speculators get spooked or forced into dumping 100t+ in single-week
spans, gold is certainly going to get kicked in the teeth.
The resulting
sharp drops really crush gold psychology, leaving investors and
speculators alike much more bearish and pessimistic. They start to
extrapolate that trend, expecting gold to keep falling farther. So
they buy less or sell more, and gold’s futures-driven selloff soon
becomes self-feeding. It is amazing how much gold futures
impact overall gold sentiment, these speculators’ influence is
wildly disproportional.
That extreme
post-election selling initiated by speculators’ gold-futures stops
being run finally ran its course by the day after the Fed hiked
rates again last month. Futures speculators have long feared Fed
rate hikes’ impact on gold, which is supremely irrational. During
the exact spans of all 11 previous Fed-rate-hike cycles since 1971,
gold rallied an average of 26.9% higher! They have
proven very
bullish for gold.
By the time gold
finally bottomed last month, its correction had ballooned to 17.3%.
That is huge, but still shy of 20%+ new bear territory. In addition
to heavy differential GLD-share selling, the other primary driver
was heavy gold-futures selling by the speculators. Over that entire
correction span since early July, they had liquidated an astounding
174.0k long contracts while adding 32.2k short ones, serious
selling.
That equates to
641.3 tonnes of gold, or nearly half of the 1389.2t of global
gold investment demand in the first 9 months of 2016! Speculators
had unwound fully 69.8% of all the long positions they had added to
help drive gold’s new 29.9% bull market between mid-December 2015
and early July. All this extreme selling along with GLD’s blasted
gold so low that it erased a staggering 75.4% of its bull’s
progress.
With speculators
fleeing gold futures at a magnitude that defies belief, they had to
be exhausting their selling as I
wrote in
mid-December. These traders only have so many contracts they
can sell, so the more they’ve sold the less selling is still to
come. And soon after gold’s 10.6-month low in mid-December, these
gold-futures spec long positions had collapsed back down to 255.7k
contracts. That was a 10.4-month low.
American
speculators hadn’t held fewer gold-futures longs since way back in
mid-February before gold had even entered new-bull-market territory
yet at a 20%+ gain. So with the great majority of the entire young
bull market’s gold-futures long buying already unwound, spec longs
are very low today. That is a super-bullish omen just like it was
at past major gold lows. These traders have
vast firepower to buy back in!
A week after that
recent longs low, spec shorts surged to 138.6k contracts. That was
also the highest level seen since early February, and way above last
year’s 95k-contract support line. While there was some modest
covering in the latest CoT report available before this essay was
published, shorts are still relatively high. That means speculators
have to buy lots of gold futures to cover and offset their
shorts.
With speculators
very bearish on gold today as evidenced by low longs and high
shorts, you couldn’t ask for a more-bullish gold setup. Just as
in the past, gold tends to bottom right as these influential traders
are reaching selling exhaustion. That leaves nothing but buyers, so
gold soon starts rallying in major new uplegs. Indeed one has
already begun, despite futures speculators not doing any significant
buying yet.
Major gold uplegs
are usually born when speculators buy gold futures to cover their
short positions. As they are legally obligated to pay back those
borrowed contracts, and have to buy to protect their capital when
gold rallies, short covering is involuntary. Speculators do it
regardless of how they feel about the gold outlook. But that very
short covering drives gold higher and starts to erode bearish
bottoming psychology.
So the much-larger
contingent of gold-futures speculators on the long side soon start
buying as gold’s short-covering-fueled rally convinces them it is
reversing higher. That starts to turn sentiment bullish again, with
buying begetting buying. Eventually that long-side buying drives
gold high enough for long enough to get investors, with their
vastly-larger pools of capital, interested in starting to buy gold
again.
While we saw
modest spec short covering of 6.4k contracts as of January 10th, the
last CoT data before this essay was published, there has been no
material long buying yet. Since that 255.7k-contract trough of
spec longs a couple CoT weeks ago, speculators have only added 2.4k
contracts. That’s practically a rounding error. Seeing gold blast
7.7% higher in just a month with no real gold-futures buying is
remarkable!
And there
hasn’t been any
differential GLD-share buying either. Gold’s initial rebound out of
its deep post-election lows apparently came from Asia. There
have been plenty of days in recent weeks where gold rallied
significantly overnight when American traders were sleeping. That
global gold demand that is pushing up prices without any help from
gold’s dominant couple drivers is going to ignite big buying.
Sooner or later
gold will have rallied enough to convince both American gold-ETF
investors and gold-futures speculators to return. And with specs’
longs so low and shorts so high, they are going to buy with a
vengeance to mean revert their excessively-bearish bets back up to
more-normal levels. In addition to higher gold prices, there are a
couple more key catalysts that will soon spark big gold-futures
buying.
Gold-futures
traders are highly sensitive to the US dollar, since gold is
ultimately the universal world currency. So as today’s
wildly-overcrowded long-US-dollar trade
inevitably
reverses, speculators are going to flood back into gold
futures. They will also aggressively buy when the overvalued US
stock markets sell off and roll over into their
long-overdue bear
market, which will lower perceived Fed-rate-hike odds.
With speculators
way too bearish today as their low longs and high shorts prove,
there’s heavy gold-futures buying coming. It will catapult
gold sharply higher in the coming months, as always happens soon
after these guys as a herd get too pessimistic. Some combination of
higher gold prices, a lower US dollar and/or stock markets, and
less-hawkish Fedspeak is going to soon kindle serious gold-futures
capital inflows.
This coming major
new upleg in this young gold bull can certainly be played with GLD
or call options on it. But the gains in the gold miners’ stocks
will dwarf the gains in gold, since their profits growth
greatly leverages
gold’s upside. As I
discussed in
depth a couple weeks ago, we’re already seeing that. Over that
recent single-month span where gold rallied 7.7%, the leading
gold-stock index already surged 25.3% higher!
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The bottom line is
the gold-futures setup today is exceptionally bullish. Speculators
grew excessively bearish in the wake of the election, dumping a
colossal amount of long contracts while adding plenty of shorts.
This huge liquidation left their longs low and shorts high, a strong
contrarian indicator that has always signaled major reversals higher
in gold. These elite traders as a herd are always wrong at
extremes.
So big spec
gold-futures buying is coming soon, which will help catapult gold
sharply higher again just like it did a year ago. It is already
starting with initial short covering, but will soon expand into
far-larger long buying as gold continues powering higher. After
selling their longs to such low levels, these influential traders
will need to buy big for months on end to restore normal positions.
That’s great news for gold! |