Gold
has been battered lower in recent months as gold-futures speculators
fled in dread of the Fed-rate-hike boogeyman. As universally
expected, the Fed’s 5th rate hike of this cycle indeed came to pass
this week. When gold didn’t collapse as irrationally feared, the
cowering futures traders were quick to start returning. Past Fed
rate hikes have actually proven very bullish for gold, and this
latest one will be no exception.
Back
in early September, gold was sitting pretty near $1348. It had
rallied dramatically out of its usual summer-doldrums low in its
typical major
autumn rally, blasting 11.2% higher in just 2.0 months. But
even way back then, Fed-rate-hike fears for the FOMC’s December 13th
meeting started creeping in. When gold peaked on September 7th,
federal-funds futures implied December rate-hike odds running just
32%.
Over
the next 8 trading days leading into the September 20th FOMC meeting
where the Fed birthed its unprecedented
quantitative-tightening campaign, those rate-hike odds climbed
as high as 62%. That day’s FOMC statement and subsequent Janet
Yellen press conference blasted the December rate-hike odds even
higher to 73%. So gold slumped back down to $1300 as futures
speculators sold in trepidation.
By
early October as these futures-implied rate-hike odds hit 93%, gold
fell as low as $1268. Over the mere one-month span where December
rate-hike odds nearly tripled from 32% to 93%, gold dropped
5.9% on heavy spec gold-futures selling. That erased nearly 6/10ths
of its autumn rally, which really weighed on sentiment. Gold still
managed to stabilize around the $1280s in late October and November.
Starting early last month, federal-funds futures traders became so
totally convinced the Fed would hike this week that their implied
odds hit 100%. They stayed pegged at total certainty for 27
trading days in a row. Gold was able to stage a minor rally to
$1294 surrounding Thanksgiving, but speculators resumed dumping gold
futures in early December. Thus gold fell as low as $1242 leading
into this week’s FOMC decision.
Gold-futures speculators have always deeply feared Fed rate hikes.
Their rationale is simple and sounds logical. Since gold pays no
interest or dividends, it will struggle to compete with bonds and
stocks in a higher-yielding world following Fed rate hikes.
Therefore gold investment demand will wane, leading to lower gold
prices. Speculators always attempt to front run their forgone
conclusion by selling gold futures.
This
scenario has played out for three Decembers in a row now.
The Fed kicked off this rate-hike cycle back in mid-December 2015
with its first rate hike in 9.5 years. A year ago in mid-December
2016 the FOMC made its second rate hike. And following two more
hikes earlier this year, the Fed’s newest mid-December hike this
week was the 5th of its current cycle. Gold-futures speculators
sold aggressively into all.
So
gold’s slump into this week on more Fed-rate-hike fears is certainly
nothing new. The lead in to this December FOMC meeting is starting
to feel like that old Bill Murray movie Groundhog Day. So the key
question gold investors need to ask today is how did speculators’
excessively-bearish gold-futures bets play out after the prior
couple Decembers’ rate hikes? Did gold crumble in the face of
higher rates as feared?
This
first chart superimposes gold during this current Fed-rate-hike
cycle over speculators’ collective long and short positions in gold
futures. Gold is rendered in blue, and speculators’ total number of
upside and downside contracts in green and red respectively. This
gold-futures data comes from the CTFC’s weekly Commitments of
Traders reports, which are published every Friday afternoon current
to the preceding Tuesday.
Gold-futures speculators have long been utterly convinced gold’s
mortal nemesis is Fed rate hikes and the resulting higher prevailing
interest rates. They fervently believe a sterile asset like gold
simply can’t compete in a rising-rate environment. And to their
credit, these elite traders sure aren’t afraid to put their money
where their mouths are. Their trading surrounding past December
hikes illuminates gold’s path today.
Way
back in December 2008, the Federal Reserve panicked and slashed
interest rates to zero for the first time in its history. For
years after that, top Fed officials talked about normalizing rates
but never had the courage to start. But finally in late October
2015, the FOMC started getting serious about ending its ridiculous
ZIRP anomaly. The Fed warned it might “be appropriate to raise the
target range at its next meeting”.
That
would be December 16th, 2015. Since there hadn’t been a Fed rate
hike in nearly a decade, the gold-futures speculators freaked
out. Extreme selling erupted as they rushed to dump gold-futures
long contracts while catapulting their short positions higher. So
between mid-October and early December that year, gold plunged 11.4%
to a major new secular low. Surely rate hikes doomed zero-yielding
gold!
After years of broken promises to end ZIRP, the Fed indeed hiked for
the first time in 9.5 years in mid-December 2015. Gold rallied 1.1%
that day, but plunged 2.1% the next to edge down to a brutal
6.1-year secular low of $1051. With relatively-low longs and
extreme record short positions, speculators had heavily bet that was
just the beginning of gold’s woes. Their positions were
exceedingly bearish into that hike.
But
gold didn’t collapse as they expected, it stabilized. Speculators
had sold such huge amounts of gold-futures contracts that their
selling was exhausted. Thus they had no choice but to start
unwinding their own hyper-leveraged bearish bets. So after that
initial Fed rate hike of this cycle, speculators first bought to
cover their extreme shorts and then aggressively bought long
contracts. This is readily evident in this chart.
So
instead of cratering on the brand-new Fed-rate-hike campaign, gold
skyrocketed on massive gold-futures buying by the very speculators
convinced rate hikes would slaughter it. Over the next 6.7 months
gold blasted 29.9% higher into its first new bull market
since 2011! One of its primary drivers was these speculators adding
249.2k gold-futures long contracts while cutting 82.8k short ones
over that gold-surge span.
Unfortunately gold-futures speculators command a
super-disproportional wildly-outsized impact on gold price levels
because of these contracts’ extreme inherent leverage. Each
contract controls 100 troy ounces of gold, which is worth $125k this
week. Yet speculators are now only required to maintain $4450
margin in their accounts for each contract held, which equates to
incredible maximum leverage to gold of 28.1x!
That
means any amount of capital deployed in gold futures by speculators
can have up to 28x the price impact on gold as investors
buying it outright. 28x is exceedingly dangerous though, as a mere
3.6% adverse move in gold prices would wipe out 100% of the capital
bet by futures speculators. This forces them to have an
ultra-short-term focus in order to survive. They can’t afford to be
wrong for very long.
While their collective conviction that Fed rate hikes are like
Kryptonite for zero-yielding gold might sound logical, history
proves just the opposite! Back before that initial Fed rate
hike of this cycle, I undertook
a comprehensive
study of how gold reacted in every Fed-rate-hike cycle in modern
history. If speculators were right about Fed rate hikes’ bearish
impact on gold, it would be fully confirmed in past Fed-rate-hike
cycles.
The
history was stunning, as you can read about in an update on this
groundbreaking
work we published in March 2017. Prior to today’s rate-hike
cycle, the Fed had executed fully 11 between 1971 and 2015. They
are defined as 3 or more consecutive federal-funds-rate increases
with no interrupting decreases. During the exact spans of all 11,
gold averaged a strong 26.9% rally! Fed rate hikes are
actually bullish for gold.
Breaking down this critical historical precedent further, gold
rallied big in 6 of these cycles while slumping in the other 5. It
averaged huge gains of 61.0% in the majority in which it
powered higher! Generally the lower gold was relative to recent
years when entering a new rate-hike cycle, and the more gradual
those Fed rate hikes were, the better its upside performance. Both
conditions describe today’s 12th cycle perfectly.
And
in the other 5 where gold suffered losses, they averaged an
asymmetrically-small 13.9% retreat. The futures speculators’
cherished notion that Fed rate hikes crush gold is totally false,
an irrational myth they deluded themselves into believing.
You’d think with tens of billions of dollars of capital at stake
with extreme leverage these elite traders could take the time to
study historical precedent on gold and rate hikes.
While gathering and crunching all this data since 1971 certainly
isn’t trivial, why not simply look to the last Fed-rate-hike cycle
for some guidance? Between June 2004 to June 2006, the FOMC hiked
the FFR at every meeting for 17 consecutive hikes. Those
totaled 425 basis points, more than quintupling the federal-funds
rate to 5.25%. If higher rates and yield differentials slay gold,
it should’ve plummeted at 5%+.
Yet
during that exact span, gold powered 49.6% higher! There’s
literally zero chance today’s hyper-easy Fed will dare hike rates 17
times or get anywhere near 5%. The new Fed chairman Jerome Powell
that Trump nominated to replace Janet Yellen in early February is
widely viewed as a Republican clone of the Democratic Yellen.
Powell will stay Yellen’s course, gradually hiking to new norms way
below past FFR levels.
But
gold-futures speculators didn’t learn their lesson after getting
massively burned by their excessively-bearish bets leading into this
12th modern Fed-rate-hike cycle’s opening increase. They did the
same thing again a year later leading into the Fed’s
heavily-telegraphed second hike in mid-December 2016. They
aggressively dumped gold-futures longs, and ramped shorts, leading
into the FOMC’s year-ago decision.
While irrational rate-hike fears remained a prime motivator to sell
gold futures, those decisions certainly were aided by the stock
markets. After Trump’s surprise election win in early November last
year, the stock markets rocketed higher in Trumphoria on hopes for
big tax cuts soon. Gold investment demand really wanes when
record-high stock markets generate much euphoria, killing demand for
alternatives led by gold.
So
just like a year earlier, following last December’s second Fed rate
hike of this cycle gold dropped to a major low of $1128 the very
next day. In 5.3 months gold had plunged 17.3% partially thanks to
gold-futures speculators dumping 164.5k long contracts while adding
25.8k short ones. But yet again just as their collective bets hit
peak bearishness on another Fed rate hike, gold was ready to reverse
sharply higher.
The
reason is excessive gold-futures selling by speculators is
self-limiting. Despite the market power their extreme leverage
grants them, their capital is finite. They only have so many long
contracts they are willing and able to sell, and only so much
capital available to short sell gold futures. So once they near
those limits, a reversal is inevitable. They soon have to resume
buying longs again while covering shorts.
So
for the second year in a row, gold blasted higher out of its major
lows immediately after a December Fed rate hike. Over the next 8.7
months leading into early September, gold powered 19.5% higher with
speculators adding 111.0k long contracts. They were starting to
learn their lesson on shorting a young bull market though, as their
total shorts fell just 1.0k contracts over that span. This 2017
gold upleg was impressive.
Gold
not only rallied on balance through the 3rd and 4th Fed rate hikes
of this cycle in mid-March and mid-June, but climbed despite this
year’s extreme stock-market euphoria generated by the endless
new record highs. Speculators temporarily shorted gold-futures to
near-record
levels leading into gold’s usual summer doldrums, but that
artificial low soon gave way to a powerful autumn rally. Gold has
held strong.
Despite surging Fed-rate-hike odds leading into this week’s
universally-expected 5th hike of this cycle, gold was even able to
stabilize from early October to early December. But as the third
Fed rate hike in as many Decembers loomed closer, gold-futures
speculators again lost their nerve in recent weeks. That’s readily
evident in the newest CoT report before this essay was published,
current to Tuesday December 5th.
As
another December rate hike looked certain, gold-futures speculators
jettisoned 39.2k long contracts and short sold another 17.4k more
in a single CoT week! That total selling of 56.7k contracts was
the equivalent of a staggering 176.2 metric tons of gold. That
ranked as the third-largest CoT week of spec gold-futures selling
out of the 988 since early 1999. These goofy traders were freaking
out again over a rate hike.
The
Fed indeed hiked for the 5th time in this 12th modern cycle as
widely forecast, taking the FFR up to a range between 1.25% to
1.50%. I suspect gold-futures speculators expected top Fed
officials’ outlook for 2018 rate hikes to rise from the prior
dot plot’s three published a quarter earlier. But 2018 rate-hike
projections didn’t budge, holding at exactly the same average in
this week’s newest mostly-neutral dot plot.
So
speculators resumed buying gold futures right as the FOMC released
its decision and rate-hike projections at 2pm this past Wednesday.
Gold surged 1.0% higher that day, paralleling its 1.1% rate-hike-day
gains two years earlier that was about to kick off a major new
bull market. Gold remained up 18.3% in the Fed’s current
rate-hike cycle to date, solid gains considering futures
speculators’ erroneous beliefs.
Odds
are their excessively-bearish bets battering gold in recent months
will prove every bit as wrong this December as they did in the last
couple years’ Decembers! Gold will likely again stage a powerful
rebound rally into 2018 as these hyper-leveraged traders reestablish
long positions. They don’t have many short contracts to cover,
continuing last year’s trend. Leveraged shorting of a healthy bull
market is suicidal.
Just
like following the prior couple Decembers’ Fed rate hikes, gold
investment buying will likely resume as well. Through speculators’
collective trading’s adverse impact on gold leading into hikes,
investors too get worried about gold in higher-rate environments.
But once another Fed rate hike passes and gold doesn’t collapse on
cue as expected, investors resume buying. Their inflows are
the most important of all.
While gold investment is usually done outright with no leverage,
investors’ vast pools of capital dwarf the gold-futures speculators’
limited firepower. So gold investment trumps gold-futures
speculation. This final chart looks at the best daily approximation
of investment available, the holdings of the leading GLD SPDR Gold
Shares gold ETF. When its holdings are rising, American
stock-market capital is returning to gold.
When
investors aren’t interested in gold, their lack of buying allows
gold-futures speculators to dominate short-term price action. But
once investors buy or sell gold en masse, that easily overpowers
whatever the futures traders are up to. The main reason gold
exploded into a new bull market after that initial rate hike in
December 2015 was massive differential GLD-share buying by
American stock investors in early 2016.
During that same 6.7-month span where gold rocketed 29.9% higher in
a new bull, GLD’s physical gold bullion held in trust for
shareholders soared 55.7% or 351.1t! Gold then collapsed after
Trump’s election win as GLD’s holdings shrunk 14.2% or 138.9t in 5.3
months leading into last December. While GLD’s holdings kept
slumping after the December 2016 hike, they soon climbed modestly
and stabilized in
2017.
Early 2018 is likely to see big gold investment buying much closer
to early 2016’s than early 2017’s, which will help catapult gold
dramatically higher again. The extreme record stock-market rally of
2017 that generated such epic euphoria isn’t likely to persist into
2018. As stock markets finally roll over into a long overdue major
correction or more likely new bear market, investment capital
will flood back into gold again.
Though few investors realize it yet, 2018 is going to look radically
different from 2017. The major central banks that have injected
trillions of dollars of capital since 2008’s stock panic that
levitated stock markets are slamming on the brakes. The Fed
is ramping its new quantitative-tightening campaign that destroys
the QE money created out of nothing to a $50b-per-month pace by
Q4’18, something never before witnessed.
At
the same time the European Central Bank is slashing its own
quantitative-easing campaign from this year’s €60b-per-month pace to
just €30b monthly starting in January. Together Fed QT and
ECB QE tapering will drive $950b of central-bank tightening in 2018
and then another $1450b in 2019 compared to this year! I explained
all this in depth in late October in
a critical essay
for all investors to fully digest.
As
the Fed and ECB reverse sharply from their unprecedented easing of
recent years to unprecedented tightening in the coming years, these
record-high, euphoric,
bubble-valued
stock markets are in serious trouble. As they roll over
and sell off, investors will rush to prudently diversify their
stock-heavy portfolios with counter-moving gold. There’s nothing
more bullish for gold investment demand than
weakening stocks.
So
contrary to recent weeks’ and months’ erroneous view that Fed rate
hikes are bearish for gold, history proves just the opposite is
true. Gold has thrived in the 11 modern Fed-rate-hike cycles before
today’s, and it has powered higher on balance in this 12th one.
While you wouldn’t know it after this past year’s extreme Trumphoria
rally, Fed rate hikes are actually bearish for stocks and thus
quite bullish for gold.
The
last time investors flooded into gold in early 2016 after that
initial December rate hike, gold powered 29.9% higher in 6.7
months. The beaten-down gold miners’ stocks greatly amplified those
gains, with the leading HUI gold-stock index soaring 182.2% higher
over roughly that same span! Gold stocks are again deeply
undervalued relative to gold,
a coiled spring
ready to explode higher in this gold bull’s next major upleg.
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The bottom line is
Fed rate hikes are bullish for gold, and this week’s is no
exception. Gold has not only powered higher on average in past
Fed-rate-hike cycles, but has rallied strongly in the current one.
After each past December rate hike which gold-futures speculators
sold aggressively into, gold dramatically surged in the subsequent
months. These guys always buy after getting excessively bearish,
forcing gold higher.
Gold’s next upleg
following the Fed’s 5th rate hike since late 2015 is likely to get a
massive boost from weaker stock markets. The same thing happened a
couple years ago during the last US stock-market correction. As the
Fed and ECB drastically reverse and slash their liquidity injections
in 2018, these wild central-bank-inflated stock markets are in
serious trouble. Gold investment demand surges when stocks weaken. |