Gold
was enjoying a solid spring rally until a couple weeks ago, nearing
major upside breakouts. But its nice advance has crumbled since,
really weighing on sentiment. Gold fell victim to a rare major
short squeeze in US Dollar Index futures. The surging USDX
motivated gold-futures speculators to flee rather aggressively. But
this will likely prove a short-lived anomaly, after which gold’s
assault on highs will recommence.
Gold’s seasonally-atypical weakness over the past couple weeks is
very important for speculators and investors to understand. It had
nothing at all to do with fundamentals, but was completely driven by
the hyper-leveraged gold-futures traders. These guys have long been
fixated on the US dollar’s fortunes, looking to its benchmark US
Dollar Index for trading cues. That can slave gold’s price to the
dollar at times.
6
weeks ago, gold slumped to a major seasonal low of $1310 the day
before the universally-expected 6th Fed rate hike of this cycle.
The gold-futures traders fervently believe Fed rate hikes are very
bearish for gold, so they usually sell leading into FOMC meetings
with potential hikes. This has happened before every Fed rate hike
of this cycle. The theory is higher US rates boost foreign
investment demand for US dollars.
The
ironic thing is modern history proves the opposite! Fed-rate-hike
cycles are
bearish for the US dollar and bullish for gold. The last cycle
ran from June 2004 to June 2006, where the Fed hiked 17 times in a
row for 425 basis points. Despite those aggressive and relentless
rate hikes, the USDX still slipped 3.8% lower over that exact span
while gold rocketed 49.6% higher! Clearly futures specs’
theory is sorely lacking.
The
Fed’s current rate-hike cycle out of extreme
zero-interest-rate-policy lows got launched in December 2015. Gold
was hammered to a 6.1-year secular low leading into it, as futures
specs were absolutely certain higher rates were bearish for gold and
bullish for the USDX. Yet again they were proven dead wrong, wrong,
wrong! As of the middle of this week, gold is up 23.0% since then
while the USDX fell 5.5%.
You’d think after some market thesis fails to work over and over
again for decades, traders would try something else. But not
futures speculators, they are a stubborn lot. So leading into every
likely Fed rate hike, they bid up the USDX and dump gold. Then
immediately after those rate hikes the dollar fails to surge and
gold doesn’t plunge, so they reverse those excessive trades driving
the dollar down and gold up.
So
like clockwork after the Fed’s latest rate hike in late March, gold
started rallying as gold-futures specs bought back in. Gold enjoys
a strong seasonal
spring rally in April and May, which I discussed in depth last
week. By mid-April, that propelled gold within spitting distance of
a major
bull-market breakout. Gold regained its $1365 bull-to-date high
from July 2016 on an intraday basis on April 11th, but failed to
push through.
Ironically futures speculators’ irrational obsession with the Fed
was again to blame. That day the FOMC released the minutes from its
March 21st rate-hiking meeting. Traders interpreted them as
hawkish, so the USDX was bought and gold was sold. For 24 trading
days in row between mid-March to mid-April, gold simply did the
opposite of whatever the USDX did on every single day but one.
The dollar ruled gold.
Gold
managed to hover near $1350 multi-year-horizontal-resistance
breakout territory for another week after those Fed minutes. But
that started changing on April 19th. That day the USDX rallied
0.3%, which was actually its biggest up day in a couple weeks.
USDX-futures speculators were excited because the yields on
benchmark US 10-year Treasury notes crested 2.9%. Higher yields are
great for the dollar, right?
For
decades I’ve closely followed speculators’ collective gold-futures
positions every week in the famous Commitments of Traders reports
published by the CFTC. I discuss them and their implications for
gold’s near-term price action in every weekly newsletter. But I
haven’t had the time to dig deeply into USDX futures. The analysts
who traffic in that realm said USDX short positions were the largest
seen in several years.
The
leverage inherent in currency speculation is extreme beyond
belief. Since major currencies tend to move slowly, the margin
requirements equate to maximum leverage of 50x, 100x, or even 200x!
That compares to the decades-old legal limit in the stock markets of
2x. At 50x, 100x, or 200x, mere 2.0%, 1.0%, or 0.5% currency moves
against traders’ positions would wipe out 100% of their capital
risked. It’s crazy!
So
when currency speculators are wrong, they have to exit positions
fast or risk getting obliterated. The traders short USDX
futures had no choice but to buy. The more long USDX futures they
bought to offset and close their shorts, the faster the dollar
rallied. That forced still more traders to buy to cover even if
they were running more-conservative leverage. This self-reinforcing
dynamic feeds on itself, fueling short squeezes.
As
the USDX buying mounted, the dollar’s rally accelerated in
subsequent days. Traders continued to use 10-year Treasury yields
as a fundamental excuse for their purely technical trading, as
within a week they crossed the psychologically-heavy 3% threshold to
3.03%. That was the highest seen since the very end of 2013! The
USDX rallied 0.3%, 0.5%, and 0.7% in the initial few trading days of
that buying to cover.
It
had already become the biggest dollar short squeeze since
soon after Trump won the election in late 2016. That heavy futures
buying forced the USDX to surge 1.5% in those first 3 trading days.
Although that sounds trivial, at 50x, 100x, or 200x leverage it
hammers speculators to catastrophic 75%, 150%, or 300% losses! I
wonder how these guys can sleep at night bearing such ridiculous and
unforgiving levels of risk.
Gold-futures speculators run extreme leverage too, but much less
than currency traders. This week a single gold-futures contract
controlling 100 troy ounces of gold worth $130,500 only required
speculators to keep $3100 cash margins in their accounts. That
equates to 42.1x maximum leverage! For traders running at
the edge, every 1% adverse move in gold would wipe out an insane 42%
of their capital risked.
So
these guys nervously watch gold on a minute-by-minute basis. And in
a fascinating confirmation that gold is indeed a currency, they look
to the US dollar for their trading cues. They started selling their
gold-futures positions as the dollar started rallying. That drove
gold 0.2%, 0.7%, and 0.9% lower in the first 3 trading days of that
USDX short squeeze that ignited on April 19th, forcing gold down
1.9% overall to $1324.
Our
lone chart this week looks at gold during this
current
Fed-rate-hike cycle superimposed on the long and short positions
large and small speculators hold in gold futures. Again these are
published once a week in those Commitments of Traders reports. All
6 Fed rate hikes of this cycle are also highlighted, to show how
gold is bludgeoned lower leading into them which spawns strong
rebound buying in their wakes.
While the weekly
CoTs are current to each Tuesday, they are released late Friday
afternoons. Thus the newest-available CoT when this essay was
published covers the week ending April 24th. That includes those
initial few trading days of that USDX-futures short squeeze. And
it’s very illuminating, showing why gold was pummeled back down from
major-breakout levels and its strong spring rally was
short-circuited.
For
pre-dollar-rally baselines, on Tuesday April 17th speculators held
284.2k long and 98.9k short gold-futures contracts. These were
running 27% and 15% up into their own past-year trading ranges.
Thus these traders had the capital firepower and room to still do
about 3/4ths and 6/7ths of their near-term long buying and short
selling. Of course buying gold-futures longs is bullish for gold,
while shorting is bearish.
When gold-futures
shorts are low, there’s always the risk speculators will
aggressively sell on the right catalyst coming along. That forces
gold’s price lower. And this unlikely dollar short squeeze erupting
out of the blue proved that triggering event. On seeing the
USDX surge, the gold-futures specs were quick to start jettisoning
longs and ramping shorts. Thus gold fell 1.2% on the 1.4% USDX
rally over that CoT week.
The magnitude of
this initial gold-futures selling became evident in the next CoT
report current to April 24th. During that CoT week, specs sold 7.9k
gold-futures long contracts while adding another 15.6k on the short
side. That made for big total CoT-week selling equivalent to
73.0 metric tons of gold. That is simply far too much for
normal buying to absorb. Thus the only possible outcome was a lower
gold price.
Just this week,
the World Gold Council released its latest Gold Demand Trends report
for Q1’18. That’s the definitive source for world gold fundamental
supply-and-demand data. In Q1, global gold investment demand
averaged 22.1t per week. So heavy gold-futures selling easily
overwhelms that. Gold always falls when the futures specs get
on a selling kick. They flood the market with too much short-term
supply.
That
dollar-short-squeeze reaction left specs’ collective long and short
gold-futures positions running up 22% and 30% into their past-year
trading ranges. So these traders still had room to do about 4/5ths
of their likely near-term long buying, but expended a significant
chunk of their shorting firepower. That left total spec shorts at a
12-CoT-week high of 114.5k contracts. The higher spec shorts, the
more bullish gold gets.
Short positions in
futures are bullish because they necessitate proportional near-term
buying. In selling short, speculators essentially borrow futures
from other traders to sell. The specs are legally obligated to buy
back those contracts relatively soon to close out those trades and
repay those effective debts. So futures shorts are guaranteed
near-future buying, whether they are in the USDX, gold, or
anything else.
This essay was
penned and proofed Thursday, and then published Friday morning. The
newest CoT data current to this Tuesday May 1st won’t come out until
late Friday afternoon about 4 hours after this essay went live. So
while I can’t wait to see the latest CoT, I can only speculate about
it at this point. During this latest CoT week, the USDX-futures
short squeeze continued which drove more spec gold-futures
selling.
The dollar rally
actually accelerated in this newest CoT week ending Tuesday, as
shown by the sharp 1.9% rally in the USDX. Thus gold’s CoT-week
selloff also grew to 2.0%. That was 2/3rds larger than the prior
CoT week’s 1.2%. So odds are the gold-futures selling ballooned
significantly in this latest CoT week. That implies another 35k
to 40k gold-futures contracts were dumped, with the majority likely
on the short side.
Assuming the prior
week’s spec gold-futures-selling mix of 1/3rd long and 2/3rds short
holds, total spec longs could’ve dropped another 12.9k contracts
while shorts could’ve soared 25.8k. If that proves true, total spec
longs and shorts could have been running near 14% and 54% up into
their past-year trading ranges as of this Tuesday. That would mean
the majority of the likely gold-futures shorting
is already done!
While I don’t have
the USDX-futures data and background to analyze in depth, odds are
the USDX is in a similar opposite place. I suspect the majority of
the dollar short covering has already run its course. That paves
the way for this sharp dollar rally to at least peter out and
probably reverse. Trade-war fears are going to flare again
soon as the distraction of stocks’ Q1 earnings season passes, which
is bearish for the dollar.
If you look at the
chart above, the green line shows specs’ total gold-futures long
contracts. Note even a CoT week ago that was trading below
bull-market support. There is big room for these traders to
flood into gold on the long side when the USDX inevitably stalls or
reverses. They likely now have the capital firepower to do about
6/7ths of their potential near-term buying! That portends big gold
upside in coming weeks.
While gold’s
strong seasonal
spring rally was interrupted by this surprise USDX-futures short
squeeze, I doubt it was killed. Gold was driven to a new seasonal
low of $1304 this week, under its previous $1310 of mid-March. Thus
all the usual spring-rally buying in April and May will likely be
compressed into this month alone! That means gold could
enjoy a major mean-reversion bounce rally in the coming weeks.
During the 10
trading days as of the middle of this week since the dollar’s sharp
rally started, gold has moved inversely proportionally to the
USDX on every trading day but one. 8 of these trading days of the
past couple weeks saw the dollar rally, and gold’s biggest losses of
0.9% both occurred on the dollar’s best up days of 0.7%. Gold’s
down days were all about the same size as the dollar’s up days,
mirror images.
But in the 2
trading days of the past couple weeks when the USDX retreated
modestly, gold surged way out of proportion to the dollar’s
weakness. These trivial 0.2% and 0.1% USDX slides allowed gold to
rally a relatively-outsized 0.6% and 0.5%! Gold wants to rally,
and will likely quickly surge back up near major-breakout levels
soon after this dollar-rally pressure abates. And that’s likely
going to prove very soon.
The mounting
US/China trade war has been pushed out of the financial-media
spotlight by Q1 corporate earnings, which have soared on the big
corporate tax cut. But earnings season is winding down just as
major trade-war deadlines are looming for the US to implement recent
tariff announcements. The dollar looks far less attractive to
foreign investors if tariff threats become reality, their capital
will seek refuge elsewhere.
And though the
extreme leverage inherent in gold futures enables their speculators
to wield outsized influence on short-term price action, investors’
capital massively dwarfs the speculators’. So when investors’ vast
funds start bidding on gold again, likely on the next major
stock-market selloff driving demand for prudent portfolio
diversification, gold-futures specs’ influence will be overwhelmed
and drowned out.
Add in strong
spring seasonals to all this, and gold has a fantastic foundation
for a strong rebound rally. Speculators’ low gold-futures longs are
very bullish, as they will rush to buy back in to ride any upside
momentum in gold. Speculators’ mounting gold-futures shorts are
increasingly bullish, as these will have to be covered and closed by
buying offsetting longs. And investors’
super-low gold
allocations are wildly-bullish.
So odds are gold’s
atypical counter-seasonal drop in the last couple weeks driven by
the surprise USDX short squeeze will soon reverse hard. It
won’t take much buying to drive gold back up near those major bull
breakout levels around $1365. And gold powering higher again will
quickly turn sentiment around, with buying begetting more buying.
The dollar depressing gold prices leaves this metal more bullish,
not less so.
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The bottom line is
gold’s recent weakness is the result of a rare major short squeeze
in US Dollar Index futures. The resulting dollar rally spooked
gold-futures speculators, who rushed to sell to avoid getting
slaughtered by their extreme leverage. While that short-circuited
gold’s spring rally, this anomaly won’t last. Gold-futures
speculators and gold investors are far too bearish and
under-allocated, with big room to buy.
The USDX short
covering is likely running out of steam, which will clear the way
for gold’s big seasonal spring rally to resume. All that delayed
buying will likely be compressed into May, and drive gold back up
near recent major-bull-breakout levels. Any dollar/gold reversals
will force gold-futures specs to quickly buy to cover their
ballooning shorts. The resulting rally will entice in long-side
traders, then gold is off to the races. |