Gold has lapsed
deeper into pariahdom this year, becoming the most-hated investment
class in all the markets. Traders are avoiding it like the plague,
utterly convinced gold is doomed to spiral lower perpetually. But
this wildly-bearish psychology is dead wrong. Financial markets are
forever cyclical, and gold is no exception to history?s ironclad
rule. The best time to be heavily long anything is when few others
are.
Gold?s universal
disdain today is the natural result of dismal price action. This
precious metal has not seen a new secular high since August 2011,
4.1 years ago. Between that latest bull-market peak and early
August 2015, gold fell 42.8% in a brutal secular bear market. With
the flagship S&P 500 stock index up 86.8% over that same span, it?s
easy to understand why many consider gold the worst
investment.
But gold wasn?t
always this way. The greatest mistake investors and speculators
make is extrapolating the present out into infinity. They succumb
to our innate human tendency to assume the status quo will persist
indefinitely. We all do this all the time in our normal lives.
When everything is going well, we get euphoric and think good times
will last forever. When nothing is working out, we despairingly see
a bleak future.
This
present-situation-lasting-perpetually outlook is obviously dead
wrong, as life moves in cycles. We will all see good times and bad
times, with neither extreme persisting for long. The financial
markets work the same way. Just when the vast majority of investors
and speculators are convinced that an old trend will be the new norm
forever, it reverses. The markets shift and massive
countertrend moves get underway.
Gold itself is a
fantastic example of this. Back in the early 2000s as the stock
markets soared, gold was considered dead. Investors despised it,
and central banks couldn?t dump it fast enough. As the mighty
secular stock-market bull peaked in March 2000, gold was around
$285. Everyone thought the stock markets were destined to rally
forever in a brave new technology-driven era, in which gold was
totally obsolete.
But just as the
market status quo seemed unassailable, it crumbled. Market extremes
are always the result of excessive greed or fear among traders. And
since these emotions are finite and inherently self-limiting,
they can?t last. Once everyone who bought stocks high had
already deployed their capital, no one else was left to buy. So the
astounding prevailing stock greed in the early 2000s burned itself
out.
Meanwhile gold was
racked by excessive fear and despair. Everyone who wanted to sell
it low had already done so, leaving no one left to sell. So gold?s
decades-old secular bear shifted to a powerful new secular bull.
Between April 2001 and August 2011, gold skyrocketed 638.2% higher
while the S&P 500 lost 1.9%! Gold was the world?s
best-performing asset class by far over an entire decade,
creating fortunes.
Like all markets,
gold flows and ebbs. It has great secular bull markets followed by
long secular bears. As any
multi-decade gold
chart reveals, gold is highly cyclical. It doesn?t move in one
direction forever any more than the stock markets do. And gold?s
innate cyclicality means it is way overdue for a massive trend
change out of the recent extreme lows and despair. Today?s
universal gold bearishness is dead wrong.
Investors and
speculators have witnessed gold weakness for so long that they have
forgotten what an anomaly it is. Back in August 2011 when gold?s
gargantuan secular bull crested, this metal was way overbought as I
warned at the peak.
Gold bullishness was ubiquitous, with greed off the charts. Even
major Wall Street firms including Goldman Sachs were publicly
forecasting a continuing rally for years to come.
But gold needed to
correct hard out of such euphoria, and it did. Over the next 9
months it lost 18.8%, a major correction taking gold to the cusp of
bear-market territory. After that gold stabilized, and actually
averaged $1669 in 2012 which was 6.1% above peak-year-2011?s $1573.
The gold market was working normally then, and building a strong
base for its next upleg. But then extreme central-bank
distortions derailed it.
Back in
mid-September 2012, the Federal Reserve launched its third
quantitative-easing campaign. The timing was highly irregular and
suspect, as a US presidential election was less than two months
away. Since 1900, the stock-market behavior in the Septembers and
Octobers leading into the November presidential elections
has predicted the
winner 26 out of 29 times, a truly stunning 90% success
rate!
If the Fed hadn?t
acted right then to goose stock markets, they would have fallen
leading into that critical 2012 presidential election. In fully 10
of the 12 times when the stock markets fell in September and October
leading into an election, the incumbent party lost. The sharp
post-QE3-announcement gains pushed stocks to a final-two-month
rally. In 16 out of the 17 times that happened, the incumbent party
won.
The Fed is usually
very careful not to act leading into an election, because it doesn?t
want to be seen as political which leads to all kinds of fury from
Congress. But Republican lawmakers had been highly critical of the
Fed?s enormous previous quantitative-easing debt-monetization
campaigns, and a new Republican president would have made the Fed?s
existence a nightmare. So it acted to sway an election!
QE3?s timing
wasn?t the only odd thing, so was its methodology. QE1 and QE2 both
had predetermined sizes and end dates when they were initially
announced. But the radically-unprecedented QE3 was totally
open-ended. The Fed intentionally never disclosed how big it
intended QE3 to be and how long it intended QE3 to run. Just 3
months after its birth, QE3?s monthly purchases were more than
doubled in December 2012.
Stock traders
absolutely love central-bank easing, since the deluge of
freshly-conjured money works to buoy stock prices. And since QE3
was open-ended, its psychological impact on the stock markets was
far greater than the previous QEs?. Whenever the stock markets,
which were already overvalued and overextended at QE3?s launch,
threatened to sell off, Fed officials raced to the microphones to
jawbone.
They were
constantly alluding to the fact that they stood ready to ramp QE3 if
necessary. Stock traders took this as the Fed intended, assuming
the US central bank was effectively backstopping the US stock
markets! Every dip was quickly bought on the ever-present promise
of more Fed QE, spawning a truly extraordinary and unprecedented
stock-market
levitation. The QE3 era saw stocks do nothing but rally.
And thus began
gold?s horrendous death march through the sentiment desert. Gold
has always been and always will be an alternative investment. It is
one of only a handful of assets that generally move counter to
the stock markets. So gold investment demand is strong when
stock markets are weakening or flat. With stock markets endlessly
surging thanks to the Fed, gold investment demand cratered in 2013.
Professional money
management is a fiercely-competitive industry, where investors
always seek out the best returns. So the fund industry poured its
clients? capital into the Fed-goosed stock markets, driving them
even higher. The strong stock-market gains were very attractive,
seducing capital out of all other markets including gold. So
this precious metal utterly collapsed in the first half of 2013 as
investors fled.
This extreme
selling was concentrated in the flagship GLD SPDR Gold Shares ETF,
the premier way for stock traders to get gold portfolio exposure.
When they buy GLD shares faster than gold is rallying, this ETF
shunts that excess capital directly into physical gold bullion held
in trust for its shareholders. GLD?s holdings peaked at 1353.3
metric tons just two days before QE3 was expanded back in
December 2012.
With the Fed
effectively backstopping stock markets, the S&P 500 levitated 12.6%
in the first half of 2013. So stock traders sold their GLD shares
to chase these big gains, plowing their capital back into general
stocks. During that 6-month span, GLD?s holdings collapsed a
radically-unprecedented 28.2%. Extreme differential selling of GLD
shares forced this ETF to jettison 381.3t of gold bullion into the
markets!
Such a deluge of
marginal gold supply unleashed in such a short period of time was
far too much for normal investment demand to absorb. That GLD
selling alone equated to 63.6t per month. According to the World
Gold Council, during 2012 which was the last normal year for gold,
global investment demand averaged 135.5t per month. So the extreme
GLD liquidations alone offset nearly half of normal-year
demand!
These epic supply
headwinds from investment selling caused gold to collapse 26.4% in
the first half of 2013. Fully 5/6ths of this gold selling hit in
2013?s second quarter, where gold plummeted 22.8% to its worst
quarterly loss in an astounding 93 years! A
once-in-a-century superstorm of selling spawned by a central bank
gone rogue is not a normal or sustainable market event. Everything
subsequent is a huge anomaly.
With gold brutally
hammered in 2013?s first half, American futures speculators rushed
into the fray. Of course futures trading is a hyper-leveraged
zero-sum game, vastly different from stock trading. Due to this
very nature of futures, speculators have no choice but to try and
follow trends. So they hopped on the epic-gold-liquidation
bandwagon, selling long positions and adding short ones. This
amplified gold?s drop.
This chart looks
at the total positions in long and short gold-futures contracts held
by American futures speculators during the Fed?s extreme QE3
anomaly. The Commodity Futures Trading Commission?s famous
Commitments of Traders reports disclose gold-futures speculators?
collective bets once a week. And after the extreme GLD-share
exodus, they are the other key driver of gold?s anomalous QE3-era
price action.
As gold plunged in
the first half of 2013 as the Fed?s incessant jawboning about
expanding QE3 led to incredible stock-market distortions, American
speculators sold gold futures aggressively. They dumped 66.2k
long-side contracts while adding 99.6k short-side ones in those
fateful 6 months. And with every gold-futures contract controlling
100 ounces of the metal, this unleashed a jaw-dropping amount of
gold.
We are talking
about the equivalent of another 515.9t of gold sold through the
futures markets, a monthly rate of 86.0t! That alone would have
offset nearly 2/3rds of the normal monthly gold investment demand in
2012. With this extreme gold-futures selling by speculators on top
of that massive GLD-share dump, it?s no wonder gold fell off a cliff
in the initial 6 months of full-strength QE3. The gold selling was
epic!
Gold?s entire
hyper-bearish psychological environment today remains the product of
that superstorm of selling in the first half of 2013. Such an
extreme event left such a traumatic imprint on investors and
speculators alike that they now assume gold is doomed to spiral
lower forever. But in financial markets which are forever
cyclical, sentiment based on a perpetual extrapolation of
present conditions is dead wrong.
You don?t have to
take my word for it either, the hard data proves the first 6 months
of 2013 have not become the new norm. While the GLD liquidation
since has been ongoing as stock traders continued to exit gold, it
has slowed dramatically since the middle of 2013. The average
monthly liquidation rate of GLD?s holdings has collapsed from 63.6t
in the first 6 months of 2013 to just 10.9t since. That?s a 5/6th
reduction!
And the extreme
gold-futures selling by speculators has actually reversed.
It plummeted from that 86.0t-per-month average in the first half of
2013 to buying of 1.2t per month since! Both the extreme
GLD-share and gold-futures selling were already largely exhausted by
the middle of 2013. That?s why gold didn?t keep on plunging since,
but has only been gradually grinding lower. And this trend is
way overdue to reverse.
While gold
psychology has been overwhelmingly bearish since that extreme
Fed-fueled anomaly in the first half of 2013, it took a sharp turn
for the worse just a couple months ago. In late July, gold plunged
in an extreme
gold-futures shorting attack exquisitely timed to wreak the
maximum havoc on gold prices and long gold-futures stop losses. If
you aren?t familiar with that event, it is exceedingly important to
understand.
Late on a Sunday
night
when the vast majority of American traders weren?t paying attention,
a stunning blitz of gold-futures short selling was unleashed. 24k
contracts were shorted in one minute, forcing gold to its
recent dismal new lows. But the exciting and bullish thing about
this is all futures short selling has to soon be fully reversed.
Speculators have to buy long contracts to offset and cover their
short ones.
In early August
just after that brazen shorting attack, American speculators?
gold-futures shorts soared to an all-time record high of 202.3k
contracts. That is extreme beyond belief! In 2009 to 2012, the
last normal years before the Fed?s epic QE3 market distortions,
speculators? gold-futures shorts averaged just 65.4k contracts. And
major support for these positions visited multiple times in the
subsequent QE3 era is 75k.
There is zero
doubt that speculators will cover their massive short bets back down
to 75k, that is a total certainty. And per the latest Commitments
of Traders report before this essay was published, American
speculators? total gold-futures shorts were back up to 173.9k
contracts. This remains incredibly high. In the 141 CoT weeks
since early 2013, only 9 saw higher speculator shorting. Today?s
levels are unsustainable.
In order to buy
down their massive short-side bets back to recent years? strong
75k-contract support, speculators need to purchase an incredible
98.9k contracts! That?s the equivalent of 307.5t of gold. And as
the chart above shows, short covering rallies tend to rapidly unfold
over a couple months or so. With gold futures so hyper-leveraged,
speculators have to be quick to cover or face catastrophic losses as
gold rallies.
So once a small
fraction of speculators buy to cover, the rest are forced to
follow. And that would create marginal new gold investment demand
on the order of 153.7t per month for a couple months! According to
the World Gold Council, global investment demand in the first half
of 2015 averaged just 75.7t per month. So speculators? gold-futures
short covering alone has the potential to temporarily triple
investment demand!
And believe me,
that happening in today?s lopsided sentiment environment where gold
is loathed will lead to this metal soaring. Major new uplegs are
almost always sparked by futures short covering, as these
speculators are the only ones legally and contractually forced to
buy low. And once they get the rally ball rolling, the
bandwagon speculators and investors hop on to ride the momentum and
accelerate the gains.
Between 2009 and
2012, American futures speculators had average long positions in
gold of 288.5k contracts. Merely mean reverting back up to those
levels would require another 81.7k contracts of buying, equivalent
to another 254.0t of gold demand. A conservative estimate
for this mean reversion is 6 months or so, adding another 42.3t of
gold demand per month. See how that buying will really add up?
But the speculator
buying, no matter how large coming out of such extreme short highs
and long lows, is just the pre-game show. Gold?s real upleg
requires investors to return, which they are overdue to do in
a major way. As the trivial value of GLD?s bullion holdings
relative to the overall stock market?s market capitalization proves,
investors are
radically underinvested in gold today. They will start
returning as gold rallies.
Gold?s
hyper-bearish psychology is dead wrong due to this causal
chain of self-feeding buying being on the verge of being ignited.
First gold-futures speculators are forced to cover, which will drive
gold sharply higher. Then the long-side futures speculators will
jump on to ride the momentum, further accelerating gold?s gains.
And once gold rallies far enough to capture investors? attention,
they?ll take the baton.
With everyone
despising gold right now and convinced it is dead, near-record
speculator gold-futures shorts wound like a coiled spring, and the
stock markets
decisively rolling over which will rekindle gold investment
demand for prudent portfolio diversification, only a fool would not
want to be heavily long gold! History proves the great majority of
traders are the most bearish right as major bottoms are being
carved.
And contrary to
the bearish boogeyman, the upcoming Fed-rate-hike cycle is no
threat to gold. I recently did
a comprehensive
study on how gold performed in every Fed-rate-hike cycle since
1971. Gold not only rallied in 6 of these 11 cycles, but did so
dramatically with an average gain of 61.0% in the exact
Fed-rate-hike-cycle spans! Gold surged 49.6% in the Fed?s last
rate-hike cycle between June 2004 to June 2006.
This was despite
the Fed more than quintupling its federal-funds rate from
1.00% to 5.25% through 17 separate hikes! And in the other 5
Fed-rate-hike cycles where gold lost ground, every one of them
started with gold near major multi-year highs. Today gold is
just off that gold-futures-shorting-attack-driven 5.5-year secular
low. So the coming Fed-rate-hike cycle is likely to prove
exceedingly bullish for it.
How can that be?
Gold yields nothing, so higher rates should slaughter it right?
Wrong, history proves. Higher rates are very damaging for stocks
and bonds, and when stock markets weaken gold investment demand
surges since gold prices generally move contrary to stock markets.
Fed-rate-hike cycles work to rekindle demand for alternative
investments since they wreak so darned much havoc on mainstream
ones.
So the prudent bet
for investors and speculators to make today is to fight the crowd
and be heavily long gold and the derivative plays that rally with
it, silver and the precious-metals mining stocks. Physical gold and
the GLD ETF are great places to park capital, but the coming gains
in the radically-undervalued and left-for-dead gold-mining stocks
will dwarf gold?s. This sector is trading at
fundamentally-absurd price levels!
And that?s why you
need us at Zeal. We?ve long specialized in this obscure contrarian
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The bottom line is
today?s hyper-bearish gold psychology is dead wrong. Like all
financial markets, gold is forever cyclical. It?s not going to keep
on falling perpetually. The extreme central-bank-spawned gold
selling of recent years is exhausted, everyone who wants to sell
into secular lows has already done so. That leaves only buyers
poised to flood back in as gold decisively rallies to mean revert
much higher.
Gold?s next mighty
upleg will be jumpstarted by American futures speculators covering
their near-record shorts back down to reasonable levels. Gold?s
resulting upside momentum will convince other futures traders to
pile in on the long side, further accelerating its gains. And that
will ultimately get investors interested in redeploying in gold
again. They will have to buy for years on end to regain normal
portfolio diversification.
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