The
euphoric US dollar rocketing stratospheric to extreme multi-decade
highs slammed gold this week! That vertical surge ignited heavy
gold-futures selling, hammering gold into a serious technical
breakdown. The resulting sentiment damage was severe, with traders
now convinced gold is doomed to spiral much lower. But a major
reversal is imminent in the radically-overbought dollar, which will
catapult gold higher.
Gold
has two primary drivers, investment demand and gold-futures
speculation. Investment capital flows are much-larger and
ultimately far-more-important. But because of the extreme leverage
inherent in gold futures, speculators punch way above their weights
in influencing gold price action. They totally dominate gold when
investors are mostly missing-in-action. And the US dollar’s
fortunes are their main trading cue.
Each
gold-futures contract controls 100 ounces of gold, worth $180,600
entering this week. But traders are only required to maintain
$7,200 cash margins in their accounts for each contract traded.
That makes for maximum leverage of 25.1x, over an order of magnitude
greater than the 2x legal limit in the stock markets. At 25x, each
dollar traded in gold futures has 25x the gold-price impact
of a dollar invested outright!
But
that kind of leverage is exceedingly-risky, as a mere 4% gold move
against speculators’ bets wipes out 100% of their capital risked.
Always facing fast total ruin, these traders’ time horizons are
forced to be ultra-short-term. They can only care what gold prices
are doing in coming hours or days, even weeks are too distant. That
extreme-leverage-necessitated myopia often leaves gold inversely
slaved to the US dollar.
The
leading dollar benchmark is the venerable US Dollar Index, which was
birthed a half-century ago in March 1973. It is now dominated by
the euro, which commands fully 57.6% of the USDX’s weighting!
The Japanese yen, British pound, and Canadian dollar are
way-less-consequential at 13.6%, 11.9%, and 9.1%. Normally the US
dollar meanders gradually, but in recent months it has soared
parabolic in a monster rally.
This
first chart superimposes the raw US Dollar Index over a technical
construct called the Relative USDX or rUSDX. It simply divides the
daily USDX close by its 200-day moving average, yielding multiples
that reveal how stretched this world reserve currency is in
constant-percentage terms. This flags when the US dollar is really
overbought or oversold, which greatly increases likelihoods for
imminent major reversals.
This
rUSDX flattens this benchmark’s 200dma to plane at 1.00x, which the
dollar travels around tending to form horizontal trading ranges.
Those are defined based on rUSDX action over the past five calendar
years. This indicator’s current extremely-oversold support level is
0.95x, while its opposing extremely-overbought resistance zone
starts at 1.04x. Normally the USDX doesn’t break these boundaries
for long.
But
since Q2 dawned several months ago, the euphoric US Dollar Index has
rocketed parabolic defying almost all precedent. Astounding dollar
buying blasted it to a mind-boggling 1.090x its 200dma in mid-May,
and 1.091x this week! These are among the most-extreme
dollar-overboughtness levels on record. This is neither normal
nor sustainable, which guarantees the USDX needs to reverse sharply
lower soon.
In
early January 2021, the USDX birthed a major new upleg out of a deep
2.8-year low. Over the next 14.0 months into early March 2022, this
currency gradually powered 10.9% higher in a perfectly-normal
uptrend. Its moderate upslope was sustainable, as the USDX
rarely grew overbought and mostly stayed between its lower support
and upper resistance. That even included in the turmoil after
Russia invaded Ukraine.
That
normal gradual dollar rally wasn’t a problem for gold, which still
climbed 4.2% over that exact span. And inside that over exactly one
year leading into early March 2022, gold actually rallied to great
22.0% gains! Even a stronger dollar behaving normally usually
doesn’t shake loose big gold-futures selling. The hyper-leveraged
specs mostly respond to sudden big-and-sharp USDX moves,
which force them to react.
Those flared from late March to mid-May, when huge anomalous dollar
buying catapulted the USDX an amazing 7.1% higher in just six
weeks! That parabolic dollar surge ignited when the USDX was
already quite overbought based on the rUSDX’s trading range, at
1.033x. That overboughtness stretched to an off-the-charts-extreme
1.090x when the dust settled, which was truly extraordinary dwarfing
most precedent!
The
last epic dollar surge erupted during March 2020’s pandemic-lockdown
stock panic, when the USDX soared 8.2% in only two weeks! But even
that merely left the rUSDX running 1.049x, and such
extremely-overbought levels proved short-lived like usual.
Through all of Q2’22, the rUSDX averaged 1.066x which is
unbelievable! Such a sudden big-and-fast dollar spike slammed gold
5.7% lower during that six-week span.
So
what the heck happened to fuel this blistering USDX soaring to such
exceedingly-overbought levels? There were three drivers, the
plummeting US stock markets, the most-extreme hawkish pivot the
Federal Reserve has ever executed, and European Central Bank
dithering crushing its euro. All of these events were
incredibly-unusual, together they are totally-unique, and they are
neither sustainable nor repeatable.
Burning stock markets ignite big safe-haven demand for the US
dollar, as traders flee to cash. During that six-week span into
mid-May where the US Dollar Index’s parabolic 7.1% surge erupted,
the flagship S&P 500 US stock index collapsed an ugly 14.6%! This
same dynamic is what launched the USDX 8.2% higher in less than two
weeks in March 2020, as the S&P 500 cratered a brutal 16.1% in that
same panic span.
But
the US stock markets started sliding in early January 2022, and it
wasn’t until later in mid-June when the S&P 500 formally entered
bear-market territory ultimately falling 23.6% on close. So
flight-capital buying wasn’t the sole driver of the USDX’s epic
parabolic surge. The unprecedented extremely-hawkish Fed is
definitely the primary reason the dollar soared stratospheric,
driven by Fed-official jawboning and actions.
In
mid-March 2022, the Fed’s Federal Open Market Committee deciding
monetary policy ended its zero-interest-rate policy in place since
March 2020’s stock panic with a 25-basis-point rate hike. In late
March as the USDX started rallying, major Wall Street banks started
predicting larger 50bp hikes at the FOMC’s coming meetings in
early May and mid-June. The Fed indeed lifted its federal-funds
rate another 50bp at the former.
That
hike alone was really-hawkish, the first 50bp one the FOMC had dared
since way back in May 2000! And the Fed chair predicted more 50bp
hikes were coming, although he effectively took 75bp off the table
after that early-May FOMC meeting. Adding to its extreme
hawkishness, the FOMC released its plan for its second
quantitative-tightening bond-selling campaign to start unwinding its
epic QE4 money printing.
Between March 2020’s pandemic-lockdown stock panic and mid-April
2022, the Fed mushroomed its balance sheet a ludicrous 115.6% or
$4,807b higher! That radically-unprecedented quantitative-easing
money printing more than doubled the US monetary base and
thus effectively the US-dollar supply in just a couple years!
That’s why
inflation is raging out of control, far more money bidding up
prices on everything.
In
early May the FOMC declared QT2 would start in June, then quickly
ramp up to $95b of monthly bond selling in just three months! That
monetary destruction would
dwarf the failed
QT1 in every way, which took an entire year to reach a
far-smaller $50b-per-month terminal velocity. That combination of
more big rate hikes and big QT coming proved the most-hawkish Fed
pivot by far in its entire century-plus history!
Currency traders are heavily focused on yield differentials between
countries, with higher interest rates driving capital inflows to
chase better returns. In just a couple months the ultra-aggressive
Fed had killed both ZIRP and QE4, and started reversing both by
hiking fast and announcing QT2. Meanwhile the ECB was dragging its
feet despite soaring Eurozone inflation, with its main interest rate
actually below zero!
Since September 2019, the ECB’s deposit-facility rate has been
negative 50bp. That left a gaping chasm between it and the
Fed’s FFR running near a positive-88bp midpoint after early May’s
meeting. So the euro was increasingly sold in favor of the US
dollar, amplifying the latter’s gains. Remember the USDX
effectively is the euro, since that common currency now accounts for
over 4/7ths of its entire weighting.
Gold’s performance during those six weeks the dollar skyrocketed
into mid-May actually proved quite resilient. The yellow metal only
fell 5.7%, less than the USDX’s extreme 7.1% rally! During that
March-2020 episode where the USDX soared 8.2% in under two weeks,
gold had collapsed 11.2% on extreme gold-futures selling. And
bottoming near $1,811 in mid-May 2022, gold held near major
uptrend support.
That
should’ve been the end of both that anomalous dollar soaring and the
resulting gold-futures selling slamming gold lower. Indeed the
radically-overbought USDX retreated a sharp 3.0% into late May,
helping gold rebound 1.7%. But gold-futures speculators weren’t
interested in buying, and investors were missing-in-action heading
into gold’s usual
summer doldrums in June. Weak seasonals left gold’s bounce
anemic.
Meanwhile the Fed’s extreme hawkishness continued to mount. In
early June, May CPI inflation came in red-hot and
worse-than-expected soaring 8.6% year-over-year! That was this
lowballed-headline-inflation gauge’s hottest print since December
1981! Fed officials panicked again on that, shattering their
forward guidance to float a 75bp trial balloon in the Wall
Street Journal the next trading day. That soon came to pass.
At
the FOMC’s mid-June meeting, they executed a colossal 75bp rate
hike which was the first of those since November 1994! They
nearly doubled their year-end-2022 FFR outlook from a 1.88% midpoint
in mid-March to 3.38%! And the Fed chair himself said additional
big 50bp or 75bp hikes were likely at the FOMC’s coming meetings.
With the FFR near +1.63% compared to the ECB’s -0.50%, the euro
plunged again.
Meanwhile the ECB kept dithering in June while Eurozone
inflation raged from long years of the ECB’s own excessive money
printing. Early last month ECB officials finally pledged to hike
rates at their next meeting in late July, but only by 25bp. That
would still be the ECB’s first hike since July 2011! The ECB also
said it would finally end its QE as July dawned, several months
after the Fed with no hint of any QT.
That
propelled the US Dollar Index back up to multi-decade highs
in both mid- and late June, though gold still held its own drifting
between $1,806 to $1,856 in the second half of last month. The
worst of the summer doldrums had passed, and gold was still mostly
hovering near its own 200dma. Gold’s resilience through Q2’s
monster USDX rally is evident in its own Relative Gold chart, using
the same methodology above.
But
the heavy gold-futures selling between mid-April to mid-May and then
again in mid-June had left the yellow metal weak. The worst thing
about speculators’ extreme gold-futures leverage is resulting
outsized gold moves affect investors’ sentiment. With gold
not yet reflecting this biggest inflation super-spike since the
1970s, investment selling started picking up in late June.
Quarter-end window dressing played a role.
Investment funds have to report their holdings to their investors
after each quarter. So they often sell a quarter’s losers and buy
winners to make their picking look better. The best high-resolution
daily proxy for global gold investment demand is the combined
holdings of the leading and dominant GLD SPDR Gold Shares and IAU
iShares Gold Trust gold exchange-traded funds. They started wilting
in recent weeks.
From
mid-April to mid-May during specs’ initial gold-futures puking on
that skyrocketing dollar, GLD+IAU holdings fell 3.6%. But as gold
stabilized into mid-June, they rebounded a decent 1.4%. Then
heading into quarter-end with gold languishing seemingly oblivious
to red-hot inflation, they shrunk another 1.8%. That left gold at
$1,806 exiting June, near speculators’ gold-futures stop losses
which cluster by round prices.
Gold
was still holding its own last week despite lofty USDX heights.
Those were partially driven by the ECB already welshing on ending
QE in July. In order to fight yield fragmentation between
well-run core countries and heavily-indebted peripheral ones, the
ECB president pledged a new QE campaign starting in early July just
weeks after the ECB said QE was ending! That left the euro reeling
entering this new quarter.
The
other side of quarter-end window dressing is fund managers’ herd
chasing early in new quarters. These professional money managers
are rarely contrarians, extrapolating current trends persisting for
the indefinite future. So they love to pile into winners to
chase upside momentum, and sell losers which they assume will
keep spiraling lower. Thus the wildly-overcrowded long-US-dollar
trade was aggressively joined.
So
this Tuesday as traders returned from the long US holiday weekend,
extreme US-dollar buying blasted the USDX a humongous 1.3%
higher! That unleashed heavy gold-futures selling, likely
shorting although we won’t know for sure until the latest weekly
Commitments-of-Traders report released after this essay was
published. So gold cratered 2.2% to $1,768 as gold-futures stop
losses were triggered, devastating sentiment.
The
euro collapsed 1.6% that day, nearing parity with the soaring US
dollar! That herd rush into the dollar and out of the euro and gold
continued this Wednesday, with another sizable 0.5% rally leaving
the USDX way up at 107.1! That was an extreme 19.7-year secular
high, and extraordinarily-overbought levels with it stretched
way up to 1.091x its 200dma! The euro fell another 0.8%, while gold
lost another 1.6% to $1,740.
As
this rGold chart shows, that was a serious technical breakdown
for the yellow metal. Its longstanding uptrend support was
shattered in just two trading days this week, driven by these
anomalous dynamics. Heavy gold-futures selling slammed gold lower
on the euphoric long-dollar trade, which spawned another big 1.7%
GLD+IAU-holdings draw in Q3’s opening few trading days. This was a
total bloodbath for gold.
But
these extreme moves aren’t sustainable, and have to soon
reverse sharply given how stretched both the USDX and gold are.
While the former is crazy-overbought at 1.091x its 200dma, gold is
now deeply-oversold at just 0.944x its own! That’s nearing the
0.92x extremely-oversold zone in rGold’s own five-year trend.
Neither super-overbought nor super-oversold levels last long, since
they exhaust buying and selling.
Today’s extreme dollar greed has probably sucked in almost all
traders willing to buy high. Conversely the extreme euro and gold
fear has likely scared away nearly all traders susceptible to being
frightened into selling low. That leaves nothing but sellers for
the USDX and nothing but buyers for the battered euro and gold!
Speculators’ gold-futures positioning
was already
excessively-bearish before this week’s selloff.
Every CoT week’s latest data on this is analyzed in our popular
newsletters. CoT data current to Tuesday closes is released late
Friday afternoons. The latest available before this essay was
published was current to June 28th. Then speculators’ total
gold-futures long and short contracts were running 1% and 71% up
into their past-year trading ranges. Gold’s most-bullish-possible
near-term setup is 0% longs and 100% shorts.
After gold plummeted 2.8% in this newest CoT week ending July 5th on
heavy gold-futures selling, we’re likely looking at the
most-gold-bullish spec-gold-futures setup in years! All it will
take to ignite massive mean-reversion buying catapulting gold
sharply higher is some news catalyst unleashing overdue big
US-dollar selling. That will likely prove weaker-than-expected
major US economic data, which is Fed-dovish.
Despite today’s anomalous gold prices driven by heavy gold-futures
selling on an unsustainable monster USDX rally, gold’s fundamentals
remain strong. It is destined to power far higher in today’s latest
inflation super-spike. During the last couple in the 1970s,
monthly-average
gold prices nearly tripled during the first then more than
quadrupled in the second! Gold prices will adjust much higher
to reflect monetary excess.
Collateral damage from gold’s recent aberrant plunge crushed the
gold miners’ stocks. While gold is down 15.2% at worst over 3.9
months since early March’s peak on Russia invading Ukraine, the
leading GDX gold-stock ETF has collapsed 34.5% since mid-April! The
gold stocks are even more oversold than gold, ready to
reverse and soar in a massive mean-reversion higher as gold-futures
buying resumes soon.
So
for contrarian traders mentally-tough-enough to really walk the walk
in buying low, these battered gold stocks are a phenomenal buying
opportunity. As these unsustainable USDX, euro, and gold
anomalies reverse, the
gold miners’
stocks will soar amplifying gold’s upside. GDX typically
leverages material gold moves by 2x to 3x, with the smaller
fundamentally-superior mid-tier and junior gold miners doing far
better.
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The
bottom line is dollar euphoria just slammed gold. Currency traders
stampeded into an already-wildly-overcrowded long-dollar trade to
chase upside momentum. That catapulted the US Dollar Index up to
unsustainable extraordinarily-overbought levels. New multi-decade
dollar highs spooked gold-futures speculators into dumping even more
contracts, hammering gold even lower into deeply-oversold territory.
But
such anomalous technical extremes on both sides can never last long,
and will soon reverse sharply. The likely catalyst is this extreme
Fed hawkishness moderating on weakening US economic data. That will
ignite snowballing USDX selling which will bludgeon it sharply
lower. Gold-futures speculators will be forced to aggressively buy
to cover their shorts, catapulting gold higher unleashing big long
and investment buying. |