After surging dramatically in the last couple months, gold’s selloff
risk is high. Massive recent buying not only catapulted gold deep
into extremely-overbought territory, it exhausted gold-futures
speculators’ likely capital firepower for buying. Couple that with
October’s normal seasonal pullback, an oversold US dollar, and
excessively-dovish Fed-rate-cut expectations, and gold is staring
down a large pullback if not a correction.
Market trends are rarely linear for long, they naturally flow and
ebb. Prices surge in bull-market uplegs, generating increasing
popular greed. That soon sucks in all available near-term buyers,
stalling upside progress. Then selling flares, forcing prices back
down and rebalancing sentiment. Even the strongest uplegs are
punctuated affairs, advancing two steps forward before stumbling one
step back. Gold is no exception.
Over
this past year gold has blasted higher in a monster upleg,
soaring 46.8% at best over 11.7 months into late September!
This remarkable rally has proven one of gold’s biggest and longest
uplegs in decades. Bull uplegs are born after corrections or bear
markets, 10%+ and 20%+ declines respectively. Uplegs remain alive
as long as their periodic selloffs are sub-10% pullbacks, since
larger corrections reset uplegs.
This
current unusually-large gold upleg really accelerated since late
July, surging 13.1% in 2.1 months. That compressed nearly 3/8ths of
this upleg’s entire gains into less than 1/5th of its lifespan! The
Fed launching a new rate-cut cycle was the main driver, first on
hopes of the FOMC birthing it with a crisis-level 50-basis-point cut
and later when that actually came to pass. That blasted gold to 13
nominal record
closes!
The
faster any upleg rallies and the higher it shoots, the greater the
odds a material selloff is imminent. Ironically that’s when most
traders least expect one, as bullishness soars with herd greed. The
longer and stronger any upleg runs, the more traders assume it will
continue indefinitely. So they rush to chase those mounting gains
when they should be wary, biding their time and waiting for
inevitable selling to buy lower.
Overboughtness indicators measure how fast prices have surged,
revealing when they get so stretched technically they are highly
likely to mean revert lower soon. One simple gold-overboughtness
construct divides gold’s closing price by its trailing 200-day
moving average. Charted over time, this
Relative Gold
indicator tends to carve horizontal trading ranges. Gold just
leapt back into extremely-overbought
territory!
This
chart effectively takes gold’s 200dma and flattens it to horizontal
at 1.0x. The Relativity multiples oscillate around that, rendering
the size and speed of gold moves in constant-percentage terms. In
late September gold blasted up so far so fast that rGold stretched
way up to 1.173x. Such rarefied levels are very unusual, and
historically big-and-sharp selloffs usually immediately follow
extreme overboughtness.
Over
the past quarter-century since early 1999 encompassing the entire
modern gold era, rGold levels over 1.173x have only been seen on
3.7% of all trading days. They are way rarer in gold’s current
secular-bull phase which was born in mid-December 2015. Over the
decade or so since, only 30 out of 2,211 trading days have seen
1.173x+ rGold levels making for 1.4%. Gold doesn’t get this
overbought very often.
Yet
the last time it happened wasn’t long ago in mid-April, when gold
rocketed to 1.188x its 200dma on heavy buying from Chinese investors
and central banks. Gold emerged from that one pretty unscathed,
merely suffering a 4.0% pullback into late April followed by a
second 5.7% one into early June. If foreign gold demand remains
strong or American stock investors return, we could get lucky again
this time around.
But
before gold’s blistering spring surge, the last time such extreme
overboughtness was seen was fully 3.7 years earlier in August 2020.
That month gold’s last 40%+ monster upleg crested, after emerging
from March’s pandemic-lockdown stock panic. Gold had rocketed 40.0%
higher in just 4.6 months, a scorchingly-fast run. That actually
left gold extraordinarily-overbought, peaking at an epic
1.260x its 200dma!
While gold can get more overbought than recently, such extremes are
crazy-rare. Gold only exceeded 1.25x its 200dma on 0.8% of all
trading days since early 1999, and only that single trading day
over this past decade for 0.0%! And the reckoning after soaring too
far too fast wasn’t pretty. Over the next 7.0 months into early
March 2021, gold suffered a major 18.5% correction! Extreme
overboughtness is very risky.
Yet
if gold’s only problem today was stretching 17%+ above its 200dma in
late September, I wouldn’t have bothered with this essay. As April
2024’s extreme-overboughtness episode showed, they can also be
resolved with high consolidations. Rather than selling off hard to
rebalance greedy sentiment and overextended technicals, gold drifts
sideways to lower gradually bleeding them off. That could
happen again.
Unfortunately gold faces a much-bigger challenge than extreme
overboughtness. Gold’s powerful surge over the last couple months
was largely driven by massive gold-futures buying.
Speculators in that realm punch way above their weights in bullying
around gold prices, due to the extreme leverage inherent in it.
Each contract controls 100 ounces of gold, worth $265k at $2,650.
But margin requirements are super-low.
Absurdly these traders are only required to keep $11k cash margins
in their accounts for each gold-futures contract they trade. That
makes for extreme maximum leverage to gold of 24.1x! Way up there
every dollar deployed in gold futures has 24x the price impact on
gold as a dollar invested outright. But the risks are insane,
as a mere 4.2% gold move against specs’ positions wipes out 100% of
their capital bet.
This
next chart is far scarier than the last, looking at speculators’
overall gold-futures positioning in recent years. That data is only
published weekly in the famous Commitments of Traders reports,
current to Tuesday closes but not released until late Fridays. So
the latest-available CoT data before this essay was published was as
of September 24th. Gold surged to its latest nominal record of
$2,662 that day.
Total spec longs are rendered in green, and total spec shorts in
red. The former are proportionally more important for gold’s
near-term price direction, as longs outnumbered shorts by an average
of 3.5x over the last 52 CoT weeks. These hyper-leveraged
speculators have thrown so all-in-bullish on gold that their longs
are now in far-more-extreme territory than gold
overboughtness, which is ominously-bearish for gold.
A
major driver of gold’s monster 46.8% upleg since early October 2023
was speculators buying gold futures, sometimes aggressively. During
that span specs added 167.4k long contracts, while their
shorts fell by 60.4k. That huge 227.7k of combined buying has
exhausted these traders’ likely capital firepower for buying. This
is evident in the secular trading ranges of both spec longs and
shorts, drawn in this chart.
Recent years’ support for total spec shorts has run around 95k
contracts. Yet they recently fell well under that, to just 61.8k in
late June 2024 which was a deep 4.1-year low! They did recover to
101.3k by this latest CoT report, but that was still just over
secular support. This implies speculators aren’t likely to do much
more short-covering buying. On the contrary, they have huge room
to ramp selling slamming gold lower.
The
scariest thing for gold heading into Halloween is way-more-important
spec longs, which are super-high at 441.0k contracts. That’s their
loftiest levels witnessed in 4.6 years, extreme rarefied territory
well above their own 415k resistance! But the kicker is even
worse. Out of all 1,343 CoT weeks since early 1999, this
latest-reported one ranks as the 5th-highest spec longs on
record! That’s extreme top 0.4%!
The
only time total spec longs have ever been higher was between late
December 2019 to late February 2020. During that anomalous span,
fully 7 of the top-10 CoT weeks were hit including the all-time
spec-longs record of 473.2k in mid-February. Back at the time I
warned how dangerous
gold’s peculiar
surge was that exhausted specs’ buying firepower. Indeed in
mid-March gold plummeted 12.1% in just 8
trading days!
That
brutal collapse was fueled by enormous mean-reversion
gold-futures long dumping over several CoT weeks. Granted that
happened during the pandemic-lockdown stock panic, when the US
dollar soared on enormous safe-haven buying. Yet the principle
still stands. When total spec longs grow excessive relative to
their own history, massive selling soon erupts to normalize those
bets. That needs to happen again soon.
Futures trading is very different from most trading. When
speculators add longs or shorts, they become legally-obligated to
close out those positions by doing the opposite. Over the
last seven CoT weeks alone, these traders added 91.7k long
contracts! That hyper-leveraged buying was the primary driver of
gold’s recent record-breaking surge. But now these guys have 92k
new longs they need to unwind by selling.
If
that 92k contracts of long buying catapulted gold from $2,388 to
$2,662, the coming proportional gold-futures selling could force
gold similarly lower. That was about $275 up, and a comparable $275
down would make for a 10.3% correction. Seeing sub-$2,400 gold soon
wouldn’t be seriously damaging technically, but would wreak havoc on
sentiment. The recent popular greed would fast give way to
widespread fear.
Ultimately such mid-upleg selloffs are healthy, extending uplegs’
longevity and ultimate magnitude. They bleed off excess greed
before it becomes upleg-threatening. Gold’s bull market is very
much alive and well, so gold’s longer-term outlook remains really
bullish following a necessary short-term pullback or correction.
And there are a couple more factors arguing big mean-reversion
gold-futures selling is imminent.
Speculators’ extreme leverage forces their gold-futures-trading time
horizons to be ultra-myopic, days or maybe weeks. These traders
look to the US dollar’s fortunes for their primary trading cues,
doing the opposite. The benchmark US Dollar Index fell considerably
during gold’s recent 13.1% surge since late July, down 3.7%. That
has left the USDX pretty-oversold, increasingly due for a bigger
bear-market rally.
The
dollar in turn is often driven by traders’ expectations for the
Fed’s interest-rate trajectory. That recent 50bp rate cut in
mid-September to kick off a new cutting cycle was a surprise. That
morning Bloomberg published a survey of Wall Street economists, with
only 9 of 113 predicting the FOMC would go a crisis-level 50bp
instead of the usual 25bp! That helped force the USDX to a
14.2-month low, which was quite oversold.
At
that FOMC meeting, top Fed officials predicted another 50bp of
additional cuts across 2024’s pair of remaining FOMC meetings. But
as of mid-week, federal-funds futures were implying traders
expecting fully 75bp of more cuts by the end of this year!
That would require dismal major economic data, which isn’t likely.
So sooner or later traders’ rate expectations have to be reined in
to align with top Fed officials’.
October will likely see some key economic data on jobs or inflation
print better than anticipated, slicing expected Fed rate cuts back
to 25bp at each of the next two FOMC meetings. That will force the
USDX higher on dollar-denominated yields not falling as fast as
currently feared. And a sharp dollar bear rally is likely to spark
big gold-futures selling, which will almost certainly snowball from
these extreme spec-long levels.
The
second factor arguing for the timing of gold’s overdue
mean-reversion selloff coming sooner rather than later is
seasonals. For decades gold has tended to suffer a seasonal selloff
from late September to late October. That happens between
gold’s autumn
rally and winter rally, with the latter proving gold’s strongest
seasonal rally by far. These brief seasonal headwinds may be
sufficient to push selling over the edge.
But
despite gold’s short-term selloff risks, its longer-term outlook
remains really-bullish. Chinese investors and central banks are
still big buyers by most accounts, and Indian demand is surging for
this year’s key wedding season. Most importantly of all, American
stock investors have
barely even
started chasing this monster gold upleg yet! Distracted by the
AI stock bubble stealing the limelight, they’ve ignored gold.
Gold’s last two monster uplegs both crested in 2020 at 42.7% and
40.0% gains. Those were largely fueled by huge differential buying
of gold-ETF shares by American stock investors. During those spans,
GLD+IAU gold-bullion holdings rocketed up 30.4% or 314.2 metric tons
and 35.3% or 460.5t! Yet utterly astoundingly during gold’s current
46.8% monster upleg, GLD+IAU holdings
somehow fell 2.4% or 30.1t!
Such
an anomaly is unprecedented in this modern gold-ETF era, and can’t
last. Sooner or later gold will have rallied high enough for long
enough to attract back American stock investors and their vast pools
of capital. Their coming buying will supercharge gold,
driving its prices much higher. So this overdue selloff from
extreme overboughtness on excessively-bullish spec gold-futures
positioning is a short-term speed bump.
These inevitable periodic retreats should be embraced, offering the
best buy-lower opportunities seen in ongoing uplegs and bulls.
That’s especially true in gold miners’ stocks, which tend to amplify
their metal’s material price trends by 2x to 3x. The
gold stocks are
forging higher, on the verge of reporting their best quarterly
results ever! Their record profits and huge earnings growth
are unparalleled in all the stock markets.
Even
though gold stocks remain way undervalued relative to prevailing
gold levels, even though they have really lagged gold’s monster
upleg, they will still get sucked into any gold pullback or
correction. They will almost certainly leverage gold’s downside,
although not as much as if they had fully amplified this huge
upleg. Actively trading gold stocks as gold flows and ebbs has
proven quite lucrative for decades.
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The
bottom line is gold’s selloff risk is high. Surrounding the Fed’s
outsized rate cut, gold recently blasted up to extremely-overbought
levels. Those big-and-fast gold gains were mostly fueled by massive
gold-futures buying. Speculators flooding in catapulted their
overall positioning to exceedingly-rare extremes. Total spec longs
have only seen a handful of higher weeks ever, immediately preceding
sharp gold selloffs.
Excessive spec longs have to soon be unwound by proportional
selling, which cascades hammering gold lower. The timing of this
inevitable mean-reversion gold-futures dumping is likely imminent.
The US dollar is quite oversold and due to bounce on moderating
Fed-rate-cut expectations, and gold has weak October seasonals.
Gold’s healthy selloff will prove an excellent opportunity to add
great gold stocks cheaper. |