Gold’s
early-October plunge on futures speculators’ stop losses being run
has naturally left this metal mired in battered technicals and
bearish sentiment. But that sharp selloff has already accomplished
its rebalancing mission. The excessive gold-futures trading
positions that triggered that stop running have already reversed,
and the investors fueling gold’s bull are starting to buy again.
Gold is green lighting its next upleg.
Gold’s price
action in recent years has been overwhelmingly dominated by just
two groups of traders. Gold-futures speculators effectively
control gold’s short-term behavior, as futures’ extreme inherent
leverage gives their capital wildly-outsized influence. And
investors, specifically American stock investors buying and selling
shares in the flagship GLD SPDR Gold Shares gold ETF, have commanded
gold’s longer-term moves.
Plenty of
traditional gold investors don’t want to believe this, as it’s seen
as paper gold overpowering the real physical market. While the gold
futures that unfortunately rule gold pricing are definitely paper
gold, GLD truly isn’t. This critical ETF acts as a conduit
for the vast pools of American stock-market capital to flow into and
out of real
physical gold bullion. The interplay of gold-futures and GLD
trading drives gold.
This dominant pair
of primary drivers thoroughly explains everything that’s
happened to gold in recent years. That includes the brutal bear
market between 2013 to 2015, 2016’s young new bull, and even gold’s
early-October plunge. Speculators and investors who want to
multiply their capital in precious metals need to study gold-futures
and GLD-holdings action. Both are now green lighting gold’s next
major upleg.
While investors’
GLD-share buying is far more important to this gold bull’s ultimate
size and longevity, the best place to start is speculators’
gold-futures trading. It was these traders’ excessive upside bets
that spawned gold’s early-October plunge, and it will be their
buying that ignites and initially fuels this gold bull’s next surge
higher. Everything in gold-futures trading results from the
extreme leverage inherent in it.
Each gold-futures
contract controls 100 troy ounces of gold, which is worth $127,500
at $1275. Yet futures speculators are only required to deposit
$5400 of capital for each gold-futures contract they are trading.
That works out to extraordinary maximum leverage of 23.6x! For
comparison, the legal limit in the US stock markets has been just
2.0x since 1974. Gold futures’ leverage is an order of magnitude
greater.
At minimum margin,
fully-leveraged gold-futures speculators risk losing 100% of their
capital bet on a mere 4.2% adverse gold move! If gold moves more
than that against traders, their losses can quickly snowball beyond
100% as margin calls force them to contribute even more capital.
This extreme and unforgiving leverage inherent in gold futures
forces their traders to maintain an ultra-short-term focus.
Unlike investors
who own gold outright and have no problem weathering normal and
healthy mid-bull selloffs, gold-futures speculators can’t afford to
be wrong for long or they will be totally wiped out. The massive
risk their extreme leverage entails greatly amplifies both their
collective sentiment swings and trading action, leading to their
decisions having a wildly-disproportionate short-term impact on the
gold price.
This outsized
influence makes speculators’ total long and short positions in gold
futures one of the best short-term indicators for gold prices.
Their aggregate bets are published every Friday afternoon in the
CFTC’s famous Commitments of Traders reports, current to the
preceding Tuesday. And the latest CoT read before this essay was
published, last Friday’s, reveals that gold-futures selling risk
has radically abated.
The first chart
looks at the collective gold-futures holdings of speculators, both
large and small, from those weekly CoT reports. Their total long
positions, which are upside bets on gold, are shown in green. Their
shorts or downside bets on gold are rendered in red. Gold and some
key technicals are superimposed over the top. The latest CoT data
proved very bullish for gold, green lighting its next major
upleg to get underway.
To understand this
past week’s super-bullish gold-futures development, it’s necessary
to first get some context. Back in early July, total spec longs
surged to a staggering 440.4k contracts! Since every one controls
100 ounces of gold, that’s the equivalent of an enormous 1369.7
metric tons. That works out to almost a third of total
global gold demand in 2015, a freakishly-huge upside bet given
futures’ extreme leverage.
Our gold-futures
CoT data goes back to early 1999, and specs’ extraordinary massing
of longs in early July was easily the highest seen in that 17.5-year
span and almost certainly an all-time record. These elite
traders had gotten caught up in gold’s powerful post-Brexit-vote
summer rally, which ran counter to its
normal seasonal
weakness. Their collective longs ballooned to records as they
expected gold to keep surging.
Futures
speculators as a herd make the same dangerous mistake as the vast
majority of other traders, assuming already-mature trends can
be extrapolated out into the indefinite future. They are the most
bullish as evidenced by the highest long-side bets when gold hits
major interim highs after strong rallies. Being bullish when
everyone else is near greed-drenched toppings is exactly the wrong
time to be way long.
So when gold
starts moving against speculators’ hyper-leveraged gold-futures
bets, they are forced to sell rapidly to avoid full-on
annihilation. The maximum leverage in gold futures usually runs
between 20x to 25x as maintenance-margin requirements are
periodically adjusted by the futures exchanges. At 20x and 25x, a
mere 1% drop in gold multiplies to scary 20% and 25% losses. At 2%,
they hit 40% and 50%!
So when futures
speculators are excessively long and gold moves against them, they
have no choice but to exit fast. And this selling quickly
cascades, exacerbating the resulting futures-driven gold
selloff. The more long contracts speculators sell to get their
capital out of harm’s way, the faster gold falls. And that triggers
still more selling by other speculators, aggravating the downside in
a powerful vicious circle.
The serious
near-term downside risk specs’ record gold-futures longs presented
to gold were very clear back in early July. In my first essay after
gold soared to its $1365 bull-to-date peak back then, I warned in
depth about
gold’s record selling overhang. As long as futures speculators
are excessively long, the odds favor even minor gold selloffs
snowballing into something serious as these traders rush for the
exits.
Gold-futures long
extremes are usually short-lived, lasting a week or two before the
cascading selling necessary to reverse them kicks in. Yet
incredibly, gold-futures speculators were so bullish on gold that
they ignored many things including surging Fed-rate-hike odds to
maintain those high positions for a wildly-unprecedented 12 more
CoT weeks! Spec longs defiantly stayed above 400k contracts for
10 of those.
That’s why gold
consolidated high after early July’s bull peak instead of correcting
like normal after a major bull-market upleg. Without gold-futures
speculators liquidating their longs en masse, there was no material
selling pressure on gold. After spec longs stayed near record highs
for an entire quarter in the weak summer season despite
mounting hawkish Fed expectations, they were actually starting to
look sustainable.
While I warned
about specs’ near-record selling overhang for weeks on end in our
newsletters, after 13 consecutive weeks of them I was guilty of
getting complacent too. But the necessary selling to reverse these
excessive longs still finally arrived amazingly late in early
October. As gold started to drift under its $1308 late-August
pullback low for the first time on October 4th, gold-futures stop
losses started to trigger.
In a realm as
hyper-leveraged as gold-futures trading, maintaining automatic
stop-loss orders on trades is essential for survival. Gold
can move 2% fast, wiping out fully half of traders’ capital if they
bet wrong in gold futures. Futures stop losses started triggering
at $1305 that day, exacerbating the selling which soon forced gold
under major $1300 support. That tripped many more stop losses,
leading to a mass liquidation.
Cascading
gold-futures selling quickly blasted gold down 3.3% on Tuesday
October 4th, hammering it to a deep new pullback low of $1270. It’s
critical to understand exactly what happened that day, so I wrote an
entire essay on
gold futures’ stops being run that week. But unfortunately
despite that extreme down day that looked and felt like a climaxing
capitulation, specs’ gold-futures longs remained far too high
after it.
They were still
way up at 379.1k contracts, which was still the 20th highest
witnessed out of the 928 CoT weeks since early 1999. While specs
had liquidated an enormous 33.0k gold-futures long contracts to
drive that big down day, their longs still remained so high that
they kept that vexing near-record futures-selling overhang largely
intact. That implied the selling wasn’t over, and indeed gold was
soon pushed even lower.
The next CoT
report following the 4th’s was the 11th’s that came out last Friday
afternoon, the newest CoT before this essay was published. And it
proved astonishing! Gold only retreated 1.3% during that
latest CoT week ending the 11th, less than a third of the 4.3%
plunge of the previous CoT week. Thus there was no reason to expect
to see speculators’ gold-futures long liquidation continue at any
serious scale.
Yet incredibly
despite gold’s relatively-mild drift lower, these traders liquidated
fully another 42.0k long contracts! That was immense, actually the
8th-largest spec long dumping witnessed in those 928 CoT weeks since
early 1999. The only larger single-CoT-week long liquidation in
recent years was a 49.5k one in late May 2016. And that
capitulatory selling frenzy by futures speculators heralded a
major gold bottom.
Last CoT week’s
epic long liquidation hammered specs’ total gold-futures longs back
down to 337.1k contracts. That’s right under the 340k-contract
major support zone this young new gold bull has enjoyed since
April. So the record and near-record gold-futures selling overhang
that has kept a lid on gold since early July has essentially
fully reversed! It is no longer a threat, as speculators now
have firepower to buy.
These elite
traders now have room to buy over 103k gold-futures contracts just
to push their collective bets back up near early July’s levels!
That’s the equivalent of 321.3t of gold. The entire 29.9% gold bull
so far between mid-December and early July was partially driven by
futures specs buying 249.2k long contracts while covering 82.8k
short ones. So now having room for 103k contracts of long buying is
very bullish.
But it gets even
better. Specs also added 8.0k short contracts last CoT week, taking
their total to 115.9k. That’s the highest since gold was bottoming
in late May just before its sharp summer upleg. Support
levels of spec gold-futures shorts have been running around 95k
contracts in this young bull. So gold is also poised to enjoy
another 21k contracts of futures buying on short covering as it
inevitably starts rallying again.
So in just the
last two CoT weeks, speculators’ collective gold-futures positions
have swung from a near-record selling overhang of longs and
relatively-low shorts to about 125k contracts of near-term buying
potential! Gold’s bull-market uplegs are almost always
initially sparked by spec futures short covering, which has the same
upside impact on gold’s price as new long buying. Then long buying
accelerates the upleg.
The fact gold is
now seeing its most-bullish gold-futures setup since late May
just ahead of its last upleg is super-bullish. Futures are now
green lighting gold’s next major upleg. Technicals back this too,
with gold holding near its 200-day moving average since its
early-October plunge. 200dmas are always the strongest support
zones within ongoing bull markets, with stellar probabilities of
stopping selloffs cold.
With gold-futures
speculators’ collective bets no longer excessively bullish and
holding back gold, that paves the way for major investment buying
to resume. It is these investment-capital inflows, through that
leading GLD gold ETF in particular, that have been responsible for
the great majority of gold’s new bull market this year. GLD acts as
a direct conduit for stock-market capital to buy real physical gold
bullion.
GLD’s mission is
to track the gold price, but its shares have their own unique supply
and demand that is totally independent from gold’s. So when
American stock investors buy GLD shares at faster paces than gold
itself is being bought, they will soon decouple to the upside. The
only way GLD can keep on mirroring gold is if that excess
differential buying pressure is equalized directly into the
underlying gold market.
So when GLD-share
demand exceeds gold’s, this ETF’s managers are forced to issue new
GLD shares to offset this excess demand. Then the resulting
proceeds are immediately used to buy physical gold bullion that is
held in trust for GLD’s shareholders. Thus GLD’s holdings, which
are published daily, reveal whether stock-market capital is
flowing into or out of gold. They too are green lighting gold’s
next upleg.
Without 2016’s
massive buying of GLD shares by investors, there’d literally be
no gold bull. And that is not hyperbole or exaggeration at
all. Gold soared 16.1% in Q1’16 and 7.4% in Q2’16 almost
exclusively because GLD’s holdings skyrocketed 27.5% and 16.0% on
heavy stock-market-capital inflows into this ETF’s shares. The
World Gold Council’s global fundamental gold supply-and-demand data
proves this.
Per the WGC’s
definitive research, worldwide gold demand surged 20.5% or 219.4t
year-over-year in Q1’16. GLD’s gargantuan 176.9t holdings build
alone in Q1’16 accounted for a whopping 80.6% of that total
global growth in gold demand! GLD’s incredible dominance over gold
grew even more complete in Q2’16, where world gold demand climbed
another 15.4% or 139.8t YoY. GLD’s Q2’16 build was 130.8t.
Thus differential
GLD-share buying by American stock investors was responsible for
a staggering 93.6% of the total global increase in gold demand
in Q2’16! So truly without American stock investors buying GLD
shares faster than gold was being bought, gold’s bull would’ve never
been born. The fundamental reason it stalled in Q3’16 is GLD’s
holdings actually fell 0.2% or 2.1t as stock investors’ capital
inflows ceased.
I wrote a whole
essay on this
GLD-driven gold-bull stalling in mid-September if you’d like
more detail. In a nutshell, record stock-market levels retarded
gold investment demand. As stock markets soared to new record highs
after their sharp post-Brexit-vote selloff, investors’ desire to own
gold waned. Since it tends to move counter to stock markets,
gold demand for prudent portfolio diversification temporarily
evaporated.
On October 4th as
gold plunged, I knew cascading gold-futures selling had to be the
culprit as I wrote to our newsletter subscribers that very
afternoon. But my biggest fear that day was such intense futures
selling would scare investors into joining in. If they started
fleeing, gold’s bull would face serious risks of being snuffed out.
So it was a big relief to see GLD’s holdings dead flat on the 4th
and the next couple trading days.
Instead of
spooking investors, the sharply-lower gold prices from that
gold-futures stop running actually encouraged them to buy!
GLD’s holdings surged by 1.2% just a few trading days after that
plunge on the 7th. American stock investors were buying more gold
via GLD shares than the futures speculators were dumping. That
trend wonderfully continued this week, with more GLD builds despite
gold lingering near lows.
Thus so far in
young Q4’16, GLD’s holdings have already climbed 2.0% or 19.3t
despite the sentiment damage wreaked in early October. Amazingly
this big early-Q4 GLD build is right on pace with Q1’16’s 19.7t by
this point, which proved a monster quarter of differential GLD
buying catapulting gold higher. And Q4’16’s quarter-to-date
19.3t build is vastly superior to Q2’16’s 14.3t draw by this point
in that quarter.
So American stock
investors’ differential GLD-share buying, the
overwhelmingly-dominant force behind this year’s young new gold
bull, is resuming at a major scale! This has also green lighted
gold’s next major upleg, which is likely already underway. As
today’s fake Fed-levitated
wildly-overvalued
US stock markets inevitably weaken, and gold enters its
strongest time of
the year seasonally, investors are buying again.
Thus the forces
that drove gold’s high consolidation in Q3’16 followed by
early-October’s plunge have already reversed. Speculators’
vexing near-record gold-futures selling overhang has finally just
been eradicated, leaving them positioned to be aggressive buyers
again. And investors’ mid-year break from gold buying that stalled
out this young bull appears to be over, as the critical GLD builds
are resuming.
Gold’s next upleg
can certainly be played with GLD, but this ETF will merely pace
gold’s coming gains at best. Meanwhile the
stocks of the
elite gold miners will really amplify gold’s upside due to their
great inherent
profits leverage to gold. And as I discussed in depth last
week, the gold
stocks are screaming buys today with gold’s bull entering its
next major upleg. The window to get deployed at relatively-low
prices is closing.
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The bottom line is
gold’s overwhelmingly-dominant primary drivers are both green
lighting a major new bull-market upleg. Futures speculators’
excessive longs have been liquidated back down to bull-market
support, while their shorts surged near bull-market resistance.
That leaves these key traders with great buying firepower for the
first time since late May, just before gold’s last major bull-market
upleg got underway.
Meanwhile American
stock investors have started heavily buying GLD shares again,
fueling this ETF’s big early-quarter holdings build equaling Q1’16’s
massive jump that ignited gold’s young new bull. If this resumption
of investment-capital inflows into gold persists, they will again
drive its next major upleg. Contrarian speculators and investors
can still buy in relatively low before the rest of traders figure
this out. |