Gold’s young bull
market has totally stalled out in the past couple months. This
major loss of momentum following gold’s powerful surges in 2016’s
first half is really souring sentiment and vexing traders. They are
trying to figure out if gold’s recent consolidation drift is the
dawn of a new bearish trend or a healthy pause within an ongoing
bull. The likely answer comes from understanding what’s causing
gold’s high consolidation.
Back in
mid-December right after the Fed’s first rate hike in 9.5 years,
gold slumped to a miserable new 6.1-year secular low. That was
driven by heavy
gold-futures selling from speculators, who were utterly
convinced higher
rates are gold’s mortal nemesis. But with bearishness so
extraordinary and investors’ gold allocations so low, a mighty mean
reversion higher for gold was very likely in 2016 as I wrote
in late December.
Indeed that soon
came to pass. As the
grossly-distorted
stock markets artificially levitated by the Fed’s extreme
easings rolled over in January, investors started remembering the
wisdom of diversifying some of their portfolios into gold. As a
unique asset tending to move counter to stock markets, gold
remains the leading diversifier to mitigate downside risks in
stock-heavy portfolios. Gold was finally off to the races.
By early March
gold formally entered bull-market territory for the first time since
mid-2011, surging 20%+ off its deep secular lows. Gold’s enormous
16.1% gain in Q1’16 made for its best quarter in 30 years,
since Q3’86! Such a blistering pace of ascent wasn’t sustainable,
and gold started faltering in Q2’16. But heavy investment buying
was soon rekindled, starting with a colossal US-monthly-jobs miss in
early June.
Then in late June,
gold rocketed higher again after the surprise success of the British
people voting to overthrow the tyranny of those unelected,
unaccountable EU bureaucrats. But gold’s newfound post-Brexit
strength was short-lived, as it topped at $1365 in early July. In
just 6.7 months, gold had blasted an astounding 29.9% higher! So a
breather was certainly overdue, especially inside gold’s
summer doldrums.
Summer has always
been the weakest
time of the year seasonally for gold, as it’s devoid of the
outsized demand spikes driven by income-cycle and cultural factors
that gold enjoys much of the rest of the year. And indeed between
that early-July peak and the end of August, gold pulled back 4.1% to
$1308. This metal has been drifting in the mid-to-low $1300s for
over 9 weeks now, breeding mounting bearishness.
Until last Friday,
this summer’s unbelievable stock-market levitation to new record
highs offered some cover for gold’s lethargy. As recent years
proved in spades, gold investment demand wanes when the stock
markets apparently do nothing but rise indefinitely thanks to
endless central-bank easing. Why diversify into gold if stocks
seemingly never sell off materially? But that levitation finally
started to fracture.
A week ago the
flagship S&P 500 plummeted in a massive 2.5% single-day loss! That
was a stunning wake-up call to the legions of hyper-complacent stock
bulls. Yet there was no accompanying surge in gold investment
demand for prudent portfolio diversification. The world’s dominant
leading gold ETF, the American GLD SPDR Gold Shares, actually
suffered a major 1.1% draw that day stock markets rolled
over!
So what the heck
is going on with gold here? If not even the biggest stock-market
down day by far since that late-June Friday when the Brexit-vote
results became known could spark some life in gold, what will? The
longer gold remains stalled, the more investors’ and speculators’
concerns mount about the health of its young bull. Understanding
what’s been holding gold back is critical to gaming its next major
move.
Gold’s young bull
has stalled due to an interplay between investors’ gold demand,
speculators’ gold-futures trading, this summer’s lofty US stock
markets, and typical weak mid-year seasonals. Since this year’s
powerful gold bull has been driven almost exclusively by
investment buying, that’s the place to start. This chart looks
at GLD’s gold-bullion holdings overlaid on the gold price during the
past couple years.
As gold slumped to
last year’s major secular lows, its investment demand as evidenced
by builds and draws in GLD’s
physical gold
bullion held in trust for its shareholders waned dramatically.
The very day that gold bottomed in mid-December immediately after
the Fed’s first rate hike in nearly a decade, GLD’s holdings hit
their lowest level in 7.3 years! American stock investors
had abandoned gold, leaving it for dead.
But this dire
trend soon reversed right out of the gates in early 2016. Thanks to
a sharp stock-market selloff, which would snowball to the
biggest in 4.4 years for the benchmark S&P 500, investors finally
started returning to gold. They began aggressively adding gold
exposure via GLD shares, which is the quickest, easiest, and
cheapest way by far for mutual funds and hedge funds to buy gold.
GLD demand just skyrocketed.
GLD is a tracking
ETF, it’s designed to mirror the price of gold. But GLD-share
supply and demand is totally independent from gold’s own
supply and demand. Thus GLD-share prices always threaten to
decouple from gold prices. There’s only one way to neutralize this
inherent conflict. Excess GLD-share supply or demand has to be
directly shunted into underlying physical gold bullion itself,
to equalize any pressures.
So when American
stock investors buy GLD shares faster than gold itself is being
bought, their prices will soon break away from gold’s to the
upside. GLD’s managers have to intervene to maintain tracking. So
they issue enough new GLD shares to supply and offset the excess
demand, keeping GLD’s price in line with gold’s. Then they
immediately deploy the capital raised from these share sales by
buying gold bars.
GLD necessarily
acts as a direct conduit between the vast pools of
stock-market capital and the global physical gold market. So daily
builds in GLD’s holdings showing this ETF is buying gold bullion
reveal stock-market capital flowing into gold. Heading into
February, differential GLD-share demand from big American stock
investors, overwhelmingly funds, exploded higher as the stock
markets kept tanking.
Take careful note
of the timing. In January, GLD’s holdings grew by 4.2% or 26.9
metric tons. But in February they rocketed 16.1% higher in a
gigantic 108.0t build! This is a critical lesson for today. Last
Friday’s sharp S&P 500 selloff was merely the beginning of stock
markets rolling over. Selling pressure has to be sustained,
becoming a trend, before stock investors’ complacency crumbles so
they once again seek gold.
So far in this
latest stock-levitation rollover, we’ve only seen 2 major S&P 500
down days. Last Friday’s 2.5% and this past Tuesday’s 1.5%. While
no doubt steep in light of recent months’ record-low volatility,
that’s not enough selling to convince stock investors the prevailing
trend has decayed to down. We will probably need a couple weeks of
selling before they get worried enough to start re-diversifying into
gold again.
Back in the first
10 trading days of January, the S&P 500 saw no fewer than 6 major
down days! They included daily drops of 1.5%, 1.3%, 2.4%, 1.1%,
2.5%, and 2.2%. Gold investment demand didn’t pick up dramatically
until stock investors were really getting spooked by an ongoing
hammering. The differential demand for GLD shares forcing
holdings builds that drive up global gold prices didn’t come until
after that.
So a couple days
of material stock-market selling so far in September probably hasn’t
been enough yet to shift stock-investor psychology away from this
summer’s hyper-complacency. If the stock markets keep grinding
lower on balance as they certainly ought to after such an extreme
Fed-conjured levitation to new record highs, gold will inevitably
catch another major investment bid sooner or later here. Be
patient.
And the importance
of GLD-share buying by American funds for this gold bull cannot be
overstated, it is staggering. In Q1’16, gold surged 16.1% higher on
a 27.5% or 176.9t build in GLD’s holdings. The best research
available on gold’s actual underlying physical supply and demand
comes from the venerable World Gold Council, in its indispensable
Gold Demand Trends reports that are published once a quarter.
Back in May the
WGC released its Q1’16 GDT. It reported that global gold demand
climbed 20.5% year-over-year, or a 219.4t gain. Incredibly, that
first-quarter 176.9t build in GLD’s holdings alone accounted for a
staggering 80.6% of the total worldwide growth in gold
demand! That compares to traditional bar-and-coin demand only
rising a trivial 1.7t YoY. GLD gold-bullion buying was the whole
story of Q1’16.
2016’s new gold
bull exists solely because large American stock investors
decided to flood back into gold via GLD shares after neglecting
reasonable portfolio allocations to it for years. Gold rocketed up
in the first quarter not because small investors were buying bars
and coins, but because big ones were buying ETF shares. This gold
bull’s incredible dominance by GLD-share buying actually intensified
in Q2’16!
In August the WGC
released its Q2’16 GDT report, revealing worldwide gold demand
surged up another 15.4% or 139.8t YoY. GLD’s Q2’16 holdings build
alone of 130.8t accounts for a whopping 93.6% of this total
global increase in gold demand! Again world bar-and-coin demand was
dead flat, up a trivial 2.5t in the second quarter. Gold’s entire
new bull market has been overwhelmingly
driven by differential GLD buying!
Now odds are this
anomalous GLD-dominating trend won’t persist. As this gold bull
lasts longer and marches higher, traditional demand for jewelry in
Asia and bars and coins in the West will start growing and
flourishing again. ETF buying commandingly led by GLD will hand off
the gold-buying baton to other investors. But for now, this entire
gold bull is built on the back of GLD. And that’s why gold
has stalled.
Differential
GLD-share demand has totally evaporated in this almost-over
third quarter. As of the data cutoff for this essay on Wednesday,
GLD’s holdings had actually fallen 1.5% or 14.6t so far in
Q3’16! This modest GLD draw, or more accurately the lack of big
ongoing GLD builds, is why gold is dead flat quarter-to-date.
Without large American stock investors buying GLD, the entire
impetus of gold’s bull has vanished.
There are a few
reasons. Differential GLD-share demand was extremely strong after
that Brexit vote in late June into early July. Early in quarters is
when hedge funds often position capital for those entire quarters.
That big fund buying wasn’t sustainable, and soon petered out. That
was exacerbated by both the market summer and the shocking
resumption of the stock-market levitation back up to new record
highs.
All throughout the
markets there is a big summer lull as traders’ attention naturally
shifts to vacations and leisure. Kids are out of school, the sun is
warm and welcoming, so the majority of traders including big fund
managers leisurely drift through summer. They loosely watch the
markets, but don’t often make major allocation decisions unless
forced to. That’s one reason gold has always languished in summer
doldrums.
On top of that,
the US stock markets surged to new record highs again soon
after that pro-Brexit vote that was long-prophesied to spell doom.
Gold topped on July 8th, and the very next trading day the S&P 500
edged up to its first new record high in 13.7 months. The
failing stock
bull was suddenly alive and well again despite the feared Brexit
coming to pass. The day after that GLD suffered a major 1.6% draw.
Over two weeks in
mid-July, the S&P 500 climbed to new all-time highs in 7 out of 10
trading days! That kind of thing breeds epic complacency,
rekindling the stocks-can-rally-forever myth of recent years fed by
extreme central-bank easings and jawboning. So with stocks back in
vogue in a major way, the allure of counter-moving gold for
portfolio diversification evaporated. Just like it had during the
past couple years.
Now I fully expect
this love-stocks-hate-gold trend to reverse again just like it did
back in January. But we first need to see the stock markets sell
off for long enough to worry investors that their trend is once
again lower. The sharp S&P 500 drops over this past week are a
great start, but odds are we’ll need to see a couple weeks of lower
stock markets before investors start actively diversifying
portfolios into gold again.
They remain
radically underinvested. GLD is the best proxy by far for
stock-market capital invested in gold. Back in late August, its
total physical gold-bullion holdings held in trust for its
shareholders were worth $40.3b. Meanwhile the collective market
capitalization of all 500 elite S&P 500 stocks was way up at
$20,063.4b. So gold investment represented just 0.2% of
stock investors’ portfolios by this particular metric!
That’s absurdly
low, practically nonexistent. For millennia, the world’s smartest
and most-successful investors have advocated having at least 5%
of every portfolio invested in gold. And while that
bare-minimum goal is likely far too lofty for American stock
investors brainwashed into believing gold has no use in the modern
world economy, their gold holdings are still very low even by
their own recent standards.
The last normal
years before this latest
artificial
stock-market levitation driven by the Fed’s open-ended QE3
campaign ran from 2009 to 2012. During that span, the ratio of the
value of GLD’s holdings relative to the total market cap of all S&P
500 components
averaged 0.475%. So American stock investors are woefully
underinvested in gold today even by their own pathetic precedent,
running at just 3/7ths normal levels.
This ongoing
radical gold underinvestment despite this year’s huge GLD holdings
build is glaringly obvious in this chart. It divides the total
value of GLD’s holdings by the collective market capitalization of
the S&P 500, or SPX. American stock investors’ investment-capital
inflows into gold are only beginning, with the lion’s share
yet to come when this artificially-extended stock bull inevitably
rolls over into a
new bear.
In late August,
American stock investors had only 0.198% of their portfolios
allocated to gold per this GLD/SPX ratio! That’s really low
relative to their own precedent after GLD’s early-adoption years,
which averaged 2.4x higher in that post-panic pre-QE3
normal-year span between 2009 to 2012. So they have vast GLD buying
still left to do even from here merely to mean revert and normalize
their gold exposure.
This young gold
bull’s overwhelmingly-dominant driver, heavy differential GLD-share
demand from large American stock investors, is far from over. Once
normal stock-market cycles driven by valuations again
overpower central banks’ false assertion that they’ve been
eradicated, gold investment demand will come roaring back. And that
will ignite and fuel gold’s next major upleg, likely again led by
GLD inflows.
While GLD isn’t
the whole story of gold’s young new bull, it’s certainly the vast
majority. The remainder has been driven by gold-futures trading
by American speculators. As I warned back in mid-July, these guys
added new long-side bets so aggressively last summer that they
soared to all-time records. That made for a
record
gold-futures selling overhang that has really dogged gold in
recent months, truncating any rallies.
With speculators’
hyper-leveraged gold-futures longs remaining at near-record levels
ever since then, this elite group of traders hasn’t had sufficient
dry powder to bid gold higher. This too has contributed to the
stalling gold prices in recent months. But digging into what’s
going on in gold futures in depth would require another whole
essay. While important, the gold-futures developments take a back
seat to GLD buying.
Gold stalled out
in this third quarter because large American stock investors halted
their diversification into gold via GLD shares. The miraculous
resurgence of the long-in-the-tooth stock bull to a streak of new
records this summer despite the Brexit vote’s success rekindled
recent years’ love affair with stocks. But when these lofty
overvalued stock markets unavoidably roll over, gold investment
demand will soar again.
Investors can
certainly play gold’s coming next upleg with GLD shares or physical
gold coins. Gold is essential for all portfolios, as its tendency
to move counter to stock markets provides a critical hedge for the
rest of portfolios. But once that foundation is in place, gold’s
gains will be dwarfed by those of the elite gold miners’ stocks.
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many times gold’s own.
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The bottom line is
gold’s young new bull market has stalled because American stock
investors ceased aggressively buying GLD shares in the third
quarter. The stunning new stock-market record highs soon after the
long-feared Brexit vote this summer shifted attention away from gold
back to stocks. Investment demand for gold wanes when stocks
apparently do nothing but rally indefinitely, as recent years proved
in spades.
But as these
lofty, overvalued, central-bank-goosed stock markets inevitably roll
over, American stock investors will once again look to
counter-trending gold for prudent portfolio diversification. It was
their heavy differential buying of GLD shares that catapulted gold
sharply higher in the first half of 2016, so their return to gold
buying will also ignite and fuel gold’s next major upleg. Get
deployed now, before it arrives.
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