Gold
is faring quite well today technically, though you sure wouldn’t
know it from the rampant bearish sentiment. Gold’s price is in a
strong uptrend over a year old, high in both its current upleg and
young bull market. Gold isn’t far from breaking out to its best
levels since September 2013, a really big deal. The stock markets
even finally sold off after years of unnatural calm. Yet traders
are still down on gold.
Across all markets price action drives psychology. When
something’s price is rising, traders get excited and bullish on it.
So they increasingly buy to ride that upside momentum, amplifying
it. Of course the opposite is true when a price is falling, which
breeds bearishness and capital flight. Given gold’s great technical
picture today, investors and speculators alike should be growing
enthusiastic about its upside potential.
But
they really aren’t, which is certainly curious. Gold’s current
upleg was born right before the Fed’s last rate hike in
mid-December. Everyone thinks Fed rate hikes are very bearish for
gold, but
history proves the opposite as I argued near gold’s recent
interim lows. In the 2.4 months since, gold has rallied 6.6% as of
the middle of this week. That trounces the leading benchmark S&P
500 stock index’s mere 1.6%.
Gold’s rate of ascent since mid-December annualizes out to a 33%
pace, which is pretty darned exciting! Yet gold’s two primary
sentiment proxies, silver and the stocks of gold miners, show
enthusiasm for gold is nonexistent. Over that same
current-gold-upleg span, silver is only up 5.0% while the HUI
gold-stock index clocked in with a dismal 1.8% gain. Normally
silver and the gold stocks leverage gold upside
by 2x to 3x!
As I
discussed about a month ago, gold is on the verge of
a major breakout
that would greatly shift psychology back to bullish. Gold’s
bull-to-date peak was carved in early-July 2016 at a $1365 close.
For a variety of reasons gold stalled at best since. Just a month
ago gold surged to $1358 though, and only a week ago it hit $1353.
It wouldn’t take much of a rally to boost gold to new bull-market
highs to catch the limelight.
Generally upside breakouts have to be decisive to really
attract traders’ attention. I define that as 1% beyond the old
level, so $1379 in gold’s bull-high case. That’s only a handful of
good up days away, not far at all. And that’s close to $1383, which
is gold’s best level in a whopping 4.5 years. Start pushing $1400
again, and even oblivious traders who’ve long forgotten about gold
will realize something big is changing.
On
top of these key technical upside-breakout levels so close, the
sharp
stock-market selloff is fantastic news for gold investment
demand. The S&P 500 plunged 10.2% in just 9 trading days! That
ended an all-time-record 405-trading-day span without a mere 5%
pullback, and is the first stock-market correction in 2.0 years.
Stock selloffs are
very bullish for
gold, as investors remember the wisdom of diversifying
portfolios.
So
gold’s popularity should really be mounting now given its strong
price action. Yet that certainly hasn’t happened yet, gold’s
sentiment is really curious. The prevailing psychology remains
quite bearish, which feels much more like a major bottoming. The
fear, anxiety, and apathy somehow still plaguing gold is the polar
opposite of the greed and excitement near major highs. Gold is
still overlooked, ignored, and shunned.
This
weird sentiment anomaly totally disconnected from technical
realities can and will turn fast, likely as gold decisively breaks
out to new bull highs. That could happen anytime in the coming
weeks or maybe months, it is nearing. But for now, it’s useful to
understand why gold oddly remains so out of favor. The answer lies
in the psychology of gold’s two primary driving forces, futures
speculators and stock investors.
Gold-futures speculators exert inordinate influence on daily gold
price action. This is primarily due to the extreme leverage
inherent in futures trading. This week a single gold-futures
contract that controls 100 ounces of gold has a maintenance-margin
requirement of just $3500. That’s all the capital traders need to
buy or sell a contract. But at this Wednesday’s $1323 gold, each
contract controls gold worth $132,300.
That
equates to extreme maximum leverage of 37.8x, death-defyingly high!
For comparison, the legal limit in stock markets for decades has
been 2.0x. At 35x leverage, each dollar speculators deploy in gold
futures has 35x the gold-price impact of another dollar used
to invest in gold outright. Such ridiculous leverage allows futures
speculators to collectively punch far above their weights,
dominating gold-price action.
As
if that’s not unfair enough to normal investors, gold futures’
extreme leverage necessitates an ultra-short-term focus.
Again at 35x leverage, a mere 2.9% adverse price move in gold would
wipe out 100% of the capital speculators risked! So these guys are
forced to think in terms of minutes, hours, days, or sometimes weeks
for their trading time horizons. The months and years of investors
may as well be eternities.
That
incredibly-myopic view on gold creates all kinds of problems because
data is far too sparse to justify ultra-short-term trading. The
best fundamental data available on gold is only published once
each quarter by the World Gold Council. Some other localized
peripheral data is released monthly. So with insane leverage
compressing down speculators’ gold outlooks into days or less, they
have nothing to trade on.
Instead of backing way off on their leverage and taking rational
longer-term trading spans, they fabricate their own gold-trading
cues. The two they’ve collectively decided on are the price action
in competing US Dollar Index futures and the closely-related
Fed-rate-hike outlook. Developments there motivating gold-futures
speculators to act are half of the explanation surrounding gold’s
curious sentiment these days.
Nearly a month ago futures speculators bid gold up to $1358. They
were watching USDX futures, as that leading US dollar benchmark was
grinding inexorably lower. On February’s first trading day, the
USDX slumped to a major 3.1-year secular low. That weak dollar is
what drove gold tantalizingly close to a major bull-market
breakout. But futures speculators were perplexed if not angry this
was actually happening.
These elite traders hold tight to certain core beliefs with tenacity
that puts religious zealots to shame. The main one is that Fed rate
hikes are bullish for the US dollar and therefore bearish for gold.
The idea is simple, higher rates boost dollar yields making it
relatively more attractive than other currencies. So foreign
investors rush to buy, bidding the dollar higher. Futures
speculators know this is how the world works.
That
logic appears sound, but what if their deeply-held thesis simply
isn’t true? The Fed’s current rate-hike cycle began in December
2015 after 9.5 years with no rate increases, and 7.0 continuous
years of a zero-interest-rate policy. The 5 hikes since coming
off a near-zero base should’ve been wildly bullish for the USDX,
right? Futures speculators bet heavily long the dollar and short
gold heading into that initial hike.
Yet
since the day before the Fed started its current rate-hike cycle,
the USDX is down 8.3% and gold is up 24.7% as of the middle of this
week! Clearly Fed rate hikes aren’t as bullish for the US dollar or
as bearish for gold as futures speculators thought. You’d think
they’d be smart enough to form their trading strategies based on
hard data instead of mere conceptual arguments. But they
steadfastly refuse to budge.
Gold
started to sell off on Friday February 2nd in the wake of the latest
monthly jobs report. It saw wage growth climb at its fastest annual
pace since June 2009, stoking inflation fears. Higher inflation
implies the Fed will have to hike rates faster. So the
oversold USDX surged 0.7% higher that day, making for its biggest up
day since late October. Gold-futures speculators saw that and fled,
hammering gold 1.4% lower.
The
S&P 500 happened to plunge 2.1% that day on those same inflation
fears, its own worst down day since early September 2016 before
Trump won the election kicking off the extreme taxphoria rally.
That sharp stock-market drop shattering the unnatural calm was the
dominant news that day. That led investors to assume gold fell
because the stock markets sold off, but the real reason was that big
dollar bounce.
That’s happened before. Back in late 2008 during that first stock
panic in a century the USDX rocketed 22.6% higher in just 4.2
months, its biggest and fastest rally ever! That was in response to
safe-haven buying as the S&P 500 plummeted 38.1% in that
short span. But that epic dollar strength hammered gold a
proportional 23.7% lower. Investors wrongly figured weak stock
markets hurt gold, but it was the hot dollar.
When
stock markets fall sharply, cash suddenly becomes much more
attractive than stocks. So dollar demand surges as stocks plunge.
Gold-futures speculators see that and dump gold, driving it lower.
This dynamic fully explains gold’s weakness in recent weeks. Every
single gold down day was the direct result of a parallel USDX
rally! That was true in early-February’s S&P 500 selloff and then
again this week.
Since the dollar’s action and the Fed-rate-hike outlook is the
extent of gold-futures speculators’ entire trading worldview,
they’ve been really bearish on gold as the dollar bounced twice this
month. Thus they have greatly pared their long gold-futures
positions. This chart superimposes gold over the total gold-futures
long and short contracts held by speculators, published weekly in
the Commitments of Traders reports.
CoT
data is released late each Friday afternoon current to the preceding
Tuesday close. So the latest-available data on speculators’
collective gold-futures trading when this essay was published is as
of February 13th. In just the 3 CoT weeks since gold hit $1358,
these guys dumped a massive 59.8k long contracts! That’s equivalent
to 185.9 metric tons of gold, a huge amount. No wonder gold
couldn’t rally during that.
But
interestingly all that frenzied gold-futures long selling on modest
US-dollar strength drove specs’ total longs back down to their
gold-bull support line rendered above in green. Other than a
brief break below leading into the Fed’s last rate hike, strong
buying has soon followed earlier support approaches. That has
fueled sharp gold rallies once spec longs hit support. That will
likely prove true again in coming weeks.
Despite the extreme leverage they wield, gold-futures speculators’
capital is finite. They only have so much they can deploy on both
the long and way-smaller short sides of the trade. So looking at
where specs’ total longs and shorts are relative to their own
past-year trading ranges offers an excellent approximation of how
much buying or selling firepower these guys have left. That
greatly affects gold’s outlook.
As
of last Tuesday the 13th, their total longs were only running 35% up
into their past-year trading range. That means these elite traders
still had room to do nearly 2/3rds of their likely near-term
buying! That’s very bullish. The short side was far-less bullish,
with speculators’ total gold-futures shorting running just 14% up
into their past-year trading range. That means 6/7ths of likely
short-covering buying was already done.
The
gold-price impact of buying new long contracts or buying to cover
existing shorts is identical. If these total long and short trading
ranges are combined, speculators’ effective total upside bets on
gold were at 55%. That implies 45% of probable near-term buying
remains! That’s exceptionally bullish with gold still up near
major breakout highs. Normally near highs 80% to 90% of buying
power has already been expended.
So
once the USDX inevitably turns lower again, there’s lots of room for
speculators to buy gold futures and push gold higher. The dollar
weakness will likely reemerge on ballooning US deficits and
debt. The Republican lawmakers are keeping the extreme
out-of-control
government spending of the Obama era intact, while
simultaneously cutting taxes. Rising rates are also catapulting US
interest expenses much higher.
And
more Fed rate hikes aren’t likely to ride to the dollar’s rescue.
The USDX entered the last Fed-rate-hike cycle between June 2004 to
June 2006 relatively low, perfect conditions for a rally. Then the
FOMC hiked 17 times in a row, more than quintupling its
federal-funds rate to 5.25%. Yet the USDX still slipped 3.8% over
that exact span, while gold powered 49.6% higher! Fed rate
hikes haven’t proven great for the dollar.
The
second driving force behind gold’s curious sentiment is little
investor interest. Investors control vastly more capital than
futures speculators. So when investment capital is moving into or
out of gold in any significant way, it overpowers and drowns out all
the daily gold-futures noise. Stock selloffs greatly boost gold
investment demand, but not immediately. Investors first get
distracted by the dollar-driven futures action.
The
S&P 500 plunged 8.5% in just 5 trading day ending February 8th, a
precipitous tumble. Yet instead of surging on that stock weakness,
gold dropped 2.4%. Investors assume that was in sympathy with the
stock markets. But it was really the result of the USDX surging a
similar 2.0% over that span on safe-haven buying. The dollar
surging on heavy demand in the hearts of stock-market selloffs
delays gold’s reaction.
So
investors weren’t yet flocking back to gold earlier this month. The
world’s dominant gold ETF publishes its physical-gold-bullion
holdings held in trust for shareholders daily. The GLD SPDR Gold
Shares showed no holdings builds as stock markets recently plunged,
indicating stock-market capital wasn’t yet flowing into gold. There
were actually sizable draws over that span as stock investors dumped
GLD shares.
When
stock markets fall sharply, investors freak out. Fear flares so
fast that people have to act instead of think. So they sell
everything they can to raise cash, including gold. Weaker gold
prices driven by futures selling in response to the surging USDX
exacerbate any gold selling. In the heat of the moment investors
think gold gets sucked into stock-market selloffs, that it really
doesn’t move counter to stocks.
But
once the biggest-fear days in stock-market selloffs pass, investors
come to realize they are taking on too much risk with their
stock-dominated portfolios. So they start rebuilding
depleted gold
positions in the wake of major stock-market selloffs. We’re
indeed already seeing modest GLD builds return over the past week or
so. And this same dynamic was actually what birthed today’s gold
bull back in early 2016.
Heading into that first Fed rate hike in 9.5 years in December 2015,
gold slumped to a brutal 6.1-year secular low. Because futures
speculators are totally convinced Fed rate hikes are kryptonite for
gold, history be damned. The S&P 500 had gone a near-record 3.6
years without a single 10%+ correction, so complacency was extreme.
Investors believed stocks did nothing but rally, so they could hold
them forever.
Finally back-to-back S&P 500 corrections arrived in mid-2015 into
early 2016. This benchmark stock index fell 12.4% in 3.2 months,
bounced most of the way back, and then dropped another 13.3% over
3.3 months into mid-February 2016. That first SPX correction only
spurred limited gold investment buying. Stock investors weren’t
very worried the lofty stock markets would head much lower again, so
they procrastinated.
Yet
after that second correction arrived shortly after, differential
GLD-share demand exploded! Investors
flocked back to
gold to prudently diversify their stock-heavy portfolios. That
heavy investment buying catapulted gold 29.9% higher in just 6.7
months, birthing today’s bull market. Gold kept rallying rather
relentlessly until the stock markets finally made new highs
which totally dispelled weaker-stock worries.
The
same thing happened during and after 2008’s epic stock panic. Gold
was hammered by the skyrocketing USDX during that extreme
stock-market selloff. But in the following months gold investment
demand blasted higher as investors realized they needed
counter-moving gold allocations in their portfolios. That heavy
gold investment demand
persisted for
years after the stock panic, driving gold to record highs.
History has shown over and over that gold investment demand is weak
when stock markets are high and euphoric. Why buy gold when stocks
apparently do nothing but rally indefinitely? But once corrections
or new bear markets emerge to rebalance sentiment and knock back
overvalued, overbought stocks, gold soon returns to favor. That
doesn’t happen instantly, as safe-haven dollar buying temporarily
forces gold lower.
But
after major selloffs when investors start to realize that stock
markets can fall too, they start thinking about gold again.
It’s the ultimate portfolio diversifier. That post-selloff
gold-investment process is very gradual, it takes months or years to
rebuild significant gold positions relative to stock portfolios.
Odds are a similar outcome will play out again following this latest
sharp S&P 500 selloff, which
likely isn’t over
yet.
Given the radical
gold underinvestment following this
extreme stock
bull, investors will likely have to do big gold buying for years
to reestablish normal portfolio allocations. That will continue to
fuel this young gold bull born in late 2015 in the previous
stock-market correction. At best gold was only up 29.9% so far as
of mid-2016, nothing yet. The last gold bull powered 638.2% higher
over 10.4 years ending August 2011!
While investors can ride gold’s ongoing bull in GLD shares, far
better gains will be won in the
stocks of its
leading miners. They tend to amplify underlying gold gains by
2x to 3x due to their profits leverage to gold. With gold so out of
favor, the gold stocks are
deeply
undervalued today. That gives them huge upside as gold mean
reverts higher, dwarfing everything else in all the stock markets.
Fortunes will be won.
At Zeal we’ve
literally spent tens of thousands of hours researching
individual gold stocks and markets, so we can better decide what to
trade and when. As of the end of Q4, this has resulted in 983 stock
trades recommended in real-time to our newsletter subscribers since
2001. Fighting the crowd to buy low and sell high is very
profitable, as all these trades averaged stellar annualized realized
gains of +20.2%!
The key to this
success is staying informed and being contrarian. That means
buying low before others figure it out, before undervalued gold
stocks soar much higher. An easy way to keep abreast is through our
acclaimed weekly
and monthly
newsletters. They draw on my vast experience, knowledge, wisdom,
and ongoing research to explain what’s going on in the markets, why,
and how to trade them with specific stocks. For only $12 per issue,
you can learn to think, trade, and thrive like contrarians.
Subscribe today,
and get deployed in the great gold and silver stocks in our full
trading books!
The
bottom line is gold’s curious sentiment today results from an
interplay of factors. Safe-haven dollar buying erupted as usual
during the stock markets’ first real selloff in a couple years.
That led the gold-futures speculators to sell aggressively, driving
gold lower. Investors saw gold falling with stocks and wrongly
assumed stock selloffs aren’t bullish for gold. And their
confidence in stocks remains very high.
But
as stocks head lower again after their post-correction bounce,
psychology will really shift. Investors will increasingly worry
that stock weakness could persist for some time. They will remember
gold is the ultimate portfolio diversifier, and start shifting
capital back into it. The resulting investment buying will persist
for months or even years, drowning out whatever the hyper-leveraged
gold-futures speculators are up to. |