The
dovish Federal Reserve lit a fire under gold and its miners’ stocks
this week. As universally expected the FOMC hiked rates for the 9th
time in this cycle. But it also lowered its 2019 rate-hike outlook
bowing to the stock-market selloff. Traders dumped gold initially
thinking that wasn’t dovish enough. But market reactions to the
FOMC form over a couple days, and gold surged overnight. Its
post-Fed rally has great potential.
Gold-futures speculators dominate gold’s short-term trading action.
They punch way above their weight in capital terms thanks to the
extreme leverage inherent in gold futures. This week, the minimum
margin for trading each 100-ounce contract controlling $125,000
worth of gold at $1250 was just $3400! These traders can run crazy
maximum leverage as high as 36.8x, compared to the stock
markets’ legal limit of 2x.
At
10x, 20x, or 30x leverage, every dollar of capital deployed in gold
futures has 10x, 20x, or 30x more price impact on gold than a dollar
invested outright. Further compounding speculators’ hegemony over
gold prices, gold’s world reference price derives directly from US
gold-futures trading. Naturally extreme leverage means extreme
risk. At 37x a mere 2.7% gold move against positions wipes out
100% of capital risked!
In
order to survive, gold-futures traders are forced to have an
ultra-short-term focus. Their time horizons are measured in hours,
days, and maybe weeks instead of months and years. And there is
nothing that motivates them to trade aggressively like meetings of
the Fed’s Federal Open Market Committee. Gold volatility often
surges in their wakes, as speculators watch the US dollar’s reaction
and do the opposite in gold.
Gold-futures speculators are convinced Fed rate hikes are bearish
for gold because they are bullish for the US dollar. They logically
reason that the higher prevailing US interest rates, the more
attractive the US dollar becomes relative to other currencies. And
a stronger dollar usually means weaker gold since they are competing
currencies. That all sounds rational, but the big problem is
history doesn’t bear this out.
The
FOMC started today’s rate-hike cycle way back in mid-December 2015,
raising the federal-funds rate for the first time in 9.5 years.
Gold-futures speculators fled leading into that, ultimately crushing
gold to a deep 6.1-year secular low of $1051 the day after. But
that oversold extreme marked the birth of a new bull market that
would catapult gold 29.9% higher over the next 6.7 months! That
same bull persists today.
In
the 3.0 years since which includes this week’s 9th Fed rate hike of
this cycle, gold is still up 18.1% and the US Dollar Index is down
2.1%. That’s no anomaly either. This is actually the Fed’s 12th
rate-hike cycle since the early 1970s. During the exact spans of
the prior 11, gold
averaged strong
gains of 26.9%! That was an order of magnitude higher
than the stock markets’ 2.8% average gains per the flagship S&P 500.
Gold-futures speculators either don’t know market history or their
extreme leverage forces them to run as a herd no matter how
irrational that stampede is. They can’t afford to be wrong for long
or risk suffering catastrophic losses. This week they apparently
expected the FOMC to prove even more dovish on future rate hikes
than it was. That led to volatile gold action surrounding this
latest critical Fed decision on rates.
The
FOMC meets 8 times per year, about every 6 weeks. But up until now,
only every other meeting was accompanied by a Summary of Economic
Projections and followed by the Fed chairman holding a press
conference. That meant the Fed was only “live”, likely to hike
rates, once a quarter at that every-other meeting. Incidentally
Jerome Powell will start holding press conferences after every
meeting starting in January.
That
decision was made in mid-June, it had nothing to do with the recent
stock-market volatility. Since the Fed doesn’t want to spook
traders and ignite selloffs, rate hikes are well-telegraphed in
advance. 3 weeks after each FOMC meeting, its full minutes are
released. They are long and detailed, offering all kinds of clues
about whether top Fed officials are thinking about hiking rates at
their next FOMC meeting.
Market-implied Fed-rate-hike odds are always available through
federal-funds futures trading. The big wildcard at each live FOMC
meeting is a part of the SEP known as the “dot plot”. It collates
where each individual top Fed official personally expects the
federal funds rate to be in each of the next several years and
beyond. It’s literally a bunch of dots plotted on a table, hence
the name. It can really move gold futures.
Though Powell and other FOMC members stress the dot plot is not an
official rate-hike forecast or outlook by the Fed, traders
universally use it as such. A hawkish dot plot implies more future
rate hikes than the previous one, and dovish less. Gold, currency,
and stock-index futures speculators trade aggressively based on the
quarterly changes in the dot plot. FOMC statements and press
conferences also play roles.
At
the FOMC’s previous meeting accompanied by a dot plot in late
September, those forecasts implied top Fed officials expected this
week’s rate hike, another 3 in 2019, and 1 final one in 2020. But
market conditions were way different then. That decision came just
4 trading days after all-time record highs in the lofty
euphoria-drenched US stock markets. Top Fed officials are boldly
hawkish when stocks look awesome.
In
early October Powell doubled down on this hawkishness, saying in an
evening speech that the federal-funds rate was “a long way from
neutral at this point, probably” and that “We may go past neutral.”
The very next day the stock markets started sliding and haven’t
looked back since. By this Monday that selloff had gradually
mushroomed into a moderate 13.1% correction in the S&P 500. Many
blame it on Fed hawkishness.
Facing withering criticism led by president Trump himself, Powell
tried to walk back his own many-more-rate-hikes-to-come outlook in
late November after the S&P 500 had passed the 10% correction
threshold. Powell said “Interest rates are still low by historical
standards, and they remain just below the broad range of estimates
of the level that would be neutral for the economy...” Stock
selling was softening the Fed.
While traders fully expected the 9th rate hike of this cycle
Wednesday, they were sure the dot-plot outlook of future rate hikes
would be far more dovish than late September’s 5 including this
week’s. Gold rallied nicely in anticipation, climbing from $1214
before Powell’s second speech to $1249 the day before this latest
FOMC meeting. In the hours before this new dot plot’s release, gold
was bid to a new upleg high of $1261.
Market expectations were for just 1 rate hike in 2019 compared to
the previous 3 implied, followed by an actual rate cut in 2020!
That seemed excessive, so I figured top Fed officials would kill one
of the hikes next year leaving 2 in 2019 and remove 2020’s lone hike
as well. While this latest dot plot was indeed dovish as expected,
it wasn’t dovish enough. 2019’s outlook shrunk to 2 more
hikes, and 2020’s kept that final one.
So
instead of going from 4 future hikes down to 1 or 2 as hoped, the
dot plot only retreated from 4 to 3. Both dollar-futures and
gold-futures speculators expected more dovishness, leading to
moderate gold selling after the dot plot. Gold fell from $1251 just
before its release to $1242 a couple hours later, and closed 0.6%
lower on the day. Stock markets fared worse, the S&P 500 falling
1.5% to a new correction low!
But
the impact of FOMC decisions usually takes a day or two to settle
out. They are released at 2pm New York time when Asian and European
markets are closed. So until foreign traders get their chances to
react to the Fed, the market outcome isn’t known. Even American
traders have to get past their initial kneejerk reactions, so the
next trading day following the FOMC is crucial as actual
implications sink in.
Gold
was slowly bid heading into Thursday in Asian markets, heading back
up near $1248 by the time Europe was opening. And then gold quickly
surged to $1256, a new closing upleg high. In US afternoon trading
the day after this FOMC decision, gold surged as high as $1266! Top
Fed officials’ future rate-hike outlook falling from 4 to 3 might
not have been dovish enough, but it was still certainly dovish
absolutely.
Seeing the Fed waver on future rate hikes in response to the
mounting stock-market selloff this quarter is super-bullish for gold
and its miners’ stocks going forward. Both gold-futures speculators
and normal investors remain way under-deployed in gold, with vast
room to buy. Odds are this week’s dovish FOMC will accelerate major
gold and gold-stock uplegs. That’s happened after past Fed rate
hikes in this cycle too.
This
first chart superimposes gold prices over the total gold-futures
long and short contracts speculators hold, which are rendered in
green and red respectively. All 9 Fed rate hikes of this cycle are
highlighted in blue. Gold has often surged strongly on gold-futures
buying in recent years following FOMC rate-hiking decisions, or more
precisely dot-plot changes in the future-rate-hike outlook. Gold is
set up to surge again.
Again this entire gold bull was born the day after the Fed’s first
rate hike of this cycle, resulting in that big initial 29.9% gold
upleg over 6.7 months in essentially H1’16. That left gold
overbought so it started to correct like normal. But that was
greatly exacerbated by Trump’s surprise election victory which
ignited a monster stock-market rally on hopes for big tax cuts
soon. Investors aggressively fled gold to chase stocks.
But
gold bottomed in mid-December 2016 the day after this cycle’s second
rate hike, and soon started surging sharply higher. Yet
gold-futures speculators didn’t learn their lesson, and continued to
dump gold heading into FOMC decisions with expected rate hikes.
Gold rallied strongly immediately out of the 3rd, 5th, and 6th hikes
of this cycle, and soon after the 4th and 8th. Rate hikes have
definitely proven bullish for gold!
The
7th rate hike in mid-June 2018 was a major exception. Gold fell
sharply in subsequent days as gold-futures speculators lapsed into a
stunning extreme
record orgy of short selling. Initially sparked by a US dollar
rally, that epic gold-futures shorting soon took on a life of its
own driving total short contracts to their highest levels ever
by far! That ultimately blasted gold to a deep and unsustainable
19.3-month low in mid-August.
Most
of that shorting spree has been covered since, fueling most of
gold’s young upleg since. But the long-side gold-futures
speculators who control much more capital than short-side guys have
barely started to buy. Short covering is legally mandated to
repay the debts incurred by borrowing to short sell. But long
buying is totally voluntary, speculators have to believe gold is
heading higher to make leveraged bets on it.
At
the end of November the day before Powell’s about-face on how far
rates were from neutral, the total gold-futures longs held by
speculators had crumbled to just 204.9k contracts. That was a
serious 2.9-year low, levels last seen in late January 2016 just as
this gold bull was starting to march higher. So gold-futures
speculators are nearly as under-deployed in gold as they were near
the end of its last secular bear!
That
leaves vast room for them to buy to reestablish normal positions.
Back in essentially the first half of 2016, speculators added 249.2k
longs while covering 82.8k shorts to help catapult gold 30% higher.
It’s amazing to see similar long-buying potential today, with
speculators’ total longs running just 7% up into their past year’s
trading range. We’re nearing the tipping point where short covering
ignites far-bigger long buying.
Gold
bull uplegs have
3 distinct stages that trigger and unfold in telescoping
fashion. They all start out of major lows with that mandatory
gold-futures short covering, the first stage. That eventually
pushes gold high enough for long enough to entice long-side
gold-futures speculators to return, the second stage. I suspect
this week’s dovish FOMC meeting could prove the catalyst that
ignites big stage-two gold buying.
This
latest dot plot may not have been dovish enough for traders, but Fed
dovishness will snowball with stock-market weakness. The lower the
stock markets slide, whether or not Fed hawkishness is really to
blame, the more pressure on the FOMC to slow or even stop its
future-rate-hike tempo. Gold-futures speculators will crowd into
gold to chase its upside momentum with their feared rate-hike
boogeyman fading.
But
all the stage-one and stage-two gold-futures buying that fuels young
gold uplegs is just the prelude to far-larger stage-three
investment buying. After gold’s upleg grows large enough and
lasts long enough to spawn investor interest, their capital inflows
soon dwarf anything the gold-futures speculators could ever manage.
There’s also precedent in this cycle for Fed rate hikes soon leading
to surging gold investment demand.
A
great high-resolution proxy for gold investment-demand trends is the
amount of physical gold bullion held in trust by the dominant GLD
SPDR Gold Shares gold ETF. It effectively acts as a conduit
for the vast pools of American stock-market capital to slosh into
and out of gold. Just a couple weeks ago I wrote an essay on how
GLD works and why it is critically important to gold prices,
especially during
stock selloffs.
This
next chart looks at GLD’s holdings superimposed over the gold price,
with all 9 Fed rate hikes of this cycle highlighted. While
gold-futures trading usually dominates gold prices, it is still
easily overpowered by material flows of American stock-market
capital into or out of gold via GLD. Investors have started to
return to gold again on the stock-market selloff, and this
prudent reallocation should accelerate on Fed dovishness.
The
last time American stock investors were worried enough about
stock-market selloffs to redeploy into gold for refuge was that
first half of 2016. Since gold is a rare counter-moving asset that
tends to rally as stock markets weaken, investment demand soars when
the S&P 500 slides long enough to ignite serious concerns. We’re
certainly getting to that point again, as worries are mounting about
this latest major selloff.
Gold
went from being left for dead in mid-December 2015 to surging 29.9%
higher in just 6.7 months solely on American stock investors
returning! This is no generalization, the hard numbers prove it
without a doubt. The world’s best gold fundamental
supply-and-demand data comes from the venerable World Gold Council.
It releases fantastic quarterly reports detailing the global buying
and selling happening in gold.
Gold
blasted higher on stock weakness in Q1’16 and Q2’16. According to
the latest data from the WGC, total world gold demand climbed
188.1 and 123.5 metric tons year-over-year in those key quarters.
That was up 17.1% and 13.2% YoY respectively! But the real stunner
is exactly where those major demand boosts came from. It wasn’t
from jewelry buying, central-bank buying, or even physical
bar-and-coin investment.
In
Q1’16 and Q2’16, GLD’s holdings alone soared 176.9t and 130.8t
higher on American stock investors redeploying into gold after
back-to-back S&P 500 corrections. Incredibly this one leading gold
ETF accounted for a staggering 94% of overall global gold demand
growth in Q1’16 and 106% in Q2’16! So there’s no doubt without
American stock investors fleeing into gold via GLD this gold bull
never would’ve been born.
Gold
was holding those sharp gains throughout 2016 until Trump’s surprise
presidential victory unleashed a monster stock-market run on hopes
for big tax cuts soon. Gold was pummeled in Q4’16 as American stock
investors pulled capital back out to chase the newly-soaring S&P
500. That quarter total global gold demand per the WGC fell 103.4t
YoY or 9.0%. GLD’s 125.8t Q4’16 holdings draw accounted for 122% of
that!
Fast-forward to summer 2018, and investors again started shifting
out of gold to chase euphoric US stock markets nearing new record
highs. That forced GLD’s holdings to a deep 2.6-year low, investors
hadn’t been so underinvested in gold since early in this bull
market when they started flooding back in helping to catapult gold
sharply higher. That gives them massive room to buy back in since
their allocations are so low.
This
mass exodus
of American stock-market capital out of gold via GLD ended in
mid-October the exact day the S&P 500 started plunging in
what’s grown into this newest correction-grade selloff! Ever since
GLD’s holdings have continued recovering on more capital inflows,
helping to drive gold higher. This trend should only accelerate as
stage-two gold-futures long buying on Fed dovishness further lifts
gold prices.
Investors are often as momentum-driven as futures speculators, but
over much-longer time horizons. So as this young gold upleg grows,
gold is going to look much more attractive to them. Their desire to
chase its upside performance is really intensified by material
stock-market weakness. That makes gold stand out as not just a
safe-haven capital-preservation hedge, but a way to grow wealth
while everything else burns.
And
as goes gold, so go the stocks of its miners. Last week I wrote a
whole essay detailing the imminent
major upside
triple breakout in gold stocks likely to be triggered by a
dovish FOMC. That indeed started to happen this week before
the Fed, as this updated GDX chart shows! The GDX VanEck Vectors
Gold Miners ETF is the leading gold-stock investment vehicle and
benchmark, and remains poised for massive gains.
Three major resistance zones have converged at GDX $21. They
include its 200-day moving average, past-year descending-triangle
overhead resistance, and the old consolidation basing trend’s
support. In anticipation of a gold rally on a dovish Fed, GDX
closed above $21 on Tuesday. And in the hours before that FOMC
decision Wednesday, it hit $21.47 intraday which was very-bullish
decisive-breakout territory.
But
when futures speculators bid the US dollar higher and pushed gold
lower on this latest dot-plot rate-hike outlook not being dovish
enough, the gold stocks reversed hard. GDX plummeted a staggering
7.3% intraday across that FOMC decision! It closed 5.4% lower,
making for absurd 9.0x downside leverage to gold’s small 0.6% Fed
Day loss. That was a wildly-irrational downside anomaly that never
should’ve happened.
In
trying to figure out why after Wednesday’s close, I waded through
dozens of gold stocks to see if there was some adverse news besides
a not-dovish-enough FOMC. There was nothing. But provocatively in
after-hours trading soon after the US stock-market close, many if
not most of the gold stocks had already regained 2/3rds to 3/4ths
of that day’s crazy losses! So traders realized that kneejerk
selloff wasn’t righteous.
Indeed right out of the gates Thursday GDX surged 4.1% higher
erasing over 7/10ths of the extreme Fed Day losses. Remember market
reactions to FOMC decisions usually aren’t fully apparent until the
entire next trading day, after the implications have sunk in and
overseas traders have reacted. Gold stocks’ major-upside-breakout
thesis portending a powerful new upleg remains intact, the
Fed likely accelerated it.
The
beaten-down gold miners’ stocks remain the
last cheap sector
in the entire stock markets, a coiled spring ready to soar as gold
returns to favor. The more shorts covered and longs bought by
gold-futures speculators, and the more capital investors allocate
back into gold, the greater the upside the gold miners’ stocks have
as gold powers higher. Their potential gains are enormous, dwarfing
anything else in 2019.
Again the last time major stock-market weakness rekindled gold
investment demand was essentially the first half of 2016, when gold
powered 29.9% higher. That drove a parallel monster 151.2%
gold-stock upleg per GDX, making for huge 5.1x upside leverage.
The gains in major gold stocks generally amplify gold upside by 2x
to 3x, and smaller mid-tier miners with superior fundamentals tend
to do much better than that.
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The
bottom line is this week’s FOMC decision is very bullish for gold
and its miners’ stocks going forward. While only seeing 1 of 3
projected 2019 rate hikes axed wasn’t considered dovish enough, it
still showed the Fed’s hawkish resolve is cracking. That dovishness
will mount the longer stock markets remain weak, further shortening
and shrinking this rate-hike cycle. That green lights capital
returning to gold in a big way.
There is massive room to buy back in, with both speculators’
gold-futures longs and stock investors’ gold held via GLD just
modestly above major multi-year lows. Dovish Fedspeak, weaker stock
markets, and higher gold prices will really motivate them to
reestablish normal gold positions and portfolio allocations. The
gold miners’ stocks will be the major beneficiaries of higher gold
prices, nicely leveraging gold’s gains. | 
