Gold’s latest
slide to new secular lows has amplified the hyper-bearish sentiment
long plaguing it. More than ever, traders are universally convinced
gold is doomed to drift lower indefinitely. But these extreme gold
lows are not fundamentally righteous, they resulted from extreme
record gold-futures shorting. As these risky leveraged bets must
soon be covered, prices driven by them are artificial and
unsustainable.
One of the
greatest mistakes made in the markets is the common assumption that
prevailing price levels are justified by fundamentals. Nothing
could be farther from the truth. While prices do indeed gravitate
towards levels supported by supply and demand over the long term,
herd emotions drag them away in the short term. Popular greed
and fear have vastly more influence on current prices than
fundamentals.
While this
psychology-fueled price distortion always exists, it becomes most
evident at extremes. An example from the most extreme emotional
event of our lifetimes, 2008’s once-in-a-century stock panic, helps
illustrate this. In mid-November 2008 during that epic fear
maelstrom, gold plunged to $711 an ounce. Even though it had
averaged $905 in the first 8 months of 2008, traders assumed panic
lows were righteous.
But instead of
reflecting global supply and demand, they were the result of extreme
unsustainable fear that would soon dissipate as always. Traders
caught up in that powerful herd emotion foolishly sold right into
those major secular lows. In 2009 as that radically-unbalanced
sentiment normalized, gold rallied powerfully to average $974 that
year. Artificial lows driven by extreme psychology never last
for long.
Gold history is
rhyming with that panic episode again today. The extreme herd
bearishness has duped traders into believing gold in the $1050s is
justified by normal global supply and demand. But that’s just not
true. Gold’s fundamentally-righteous price levels have been
temporarily subverted by record short selling by American
gold-futures speculators. When they are soon forced to cover, gold
will rebound far higher.
Before we get into
the extreme shorting driving gold’s artificial lows today, consider
the latest definitive read on gold’s fundamentals recently released
by the World Gold Council. That was during this year’s third
quarter. Remember late July witnessed that extreme
gold-futures
shorting attack exquisitely timed to brazenly manipulate
gold’s price lower to run stops. This bashed gold to a major new
5.5-year secular low.
Gold hit $1084 in
early August, right in the very heart of Q3. If that was
fundamentally justified, a sharp deterioration of gold’s
fundamentals would have been evident that quarter. Since gold’s
average price plunged 12.2% year-over-year to $1125 in Q3’15 from
$1281 in Q3’14, gold’s supply and demand must have taken a major
turn for the worse right? That’s certainly the popular story
traders universally believe.
But the world’s
best fundamental gold data from the WGC showed overall global gold
demand rose by a robust 7.6% YoY in Q3’15. This was led by a
gigantic 27.1% surge in world investment demand! And jewelry
demand, about 4/7ths of overall demand, also grew by a healthy
6.4%. This jewelry demand was the strongest of any third quarter
since 2008! So if gold fundamentals collapsed in Q3, it wasn’t the
demand side.
Thus if Q3’s
secular gold lows were fundamentally justified, supply had to be the
culprit since demand was so darned strong. But the WGC reported
third-quarter gold supply only edged up a trivial 0.7% YoY, and
actual mine production which constitutes 3/4ths of that total
actually retreated 1.0%. Now you don’t need a doctorate in
economics to realize 8% demand growth on 1% supply growth doesn’t
fuel secular lows.
So what the heck
is happening to gold? It has suffered from excessive supply
growth in a sense, but virtually instead of physically.
American gold-futures speculators have been selling these contracts
at truly staggering rates, and unfortunately gold’s price in the US
futures market is the benchmark the world looks to. So this one
group of traders now commands a wildly-disproportionate impact on
gold’s price.
There are two
reasons, investors missing in action and extreme leverage. Back in
early 2013, the Fed launched its wildly-unprecedented open-ended
third quantitative-easing campaign. Fed officials deftly used the
ambiguity of these bond monetizations to jawbone stock markets
higher, resulting in recent years’
extraordinary
levitation. This seduced capital away from everything else,
investors
abandoned gold.
And the extreme
leverage inherent in futures trading greatly amplifies the
price-moving firepower of speculators’ capital in gold. Since 1974,
the legal limit of leverage in the stock markets has been 2x. But
in gold-futures trading, the minimum maintenance margin for each
contract controlling 100 ounces of gold is only $3750 today. With
each contract worth $105,000 at $1050 gold, that’s extreme 28x
leverage!
At 28x leverage,
each speculators’ dollar deployed in gold futures has 28x the
price impact of a normal dollar from investors! And even if the
majority of gold-futures traders aren’t foolishly running maximum
leverage, where a mere 3.6% adverse price move would wipe out 100%
of the capital they risked, their gold-price impact is still an
order of magnitude or two higher than investors’. Their trading
dictates gold’s price.
And that’s exactly
what’s happened since 2013 when the Fed started grossly distorting
world financial markets. Gold’s woes are not the result of normal
global supply-and-demand weakness as everyone assumes, but
excessive virtual supply from American futures speculators.
This chart documents that and proves gold’s newest secular lows
are totally artificial and not sustainable, heralding a major
upleg.
Every week, the US
Commodity Futures Trading Commission publishes its famous
Commitments of Traders report. This CoT details the total futures
positions held by specific groups of traders including speculators.
Speculators trade gold futures solely to game the gold price, as
they neither produce nor consume physical gold. Their extreme
trading has turned gold into a house of mirrors greatly
distorting reality.
This chart reveals
speculators’ total long and short positions in gold futures in every
CoT week since 2013 in green and red respectively. The total
deviation of these positions from normal years’ levels is shown in
yellow. Finally the gold price is superimposed over this
gold-futures data in blue, along with key moving averages. Extreme
gold-futures selling is the whole story of gold in recent
years and weeks!

Before the Fed
decided to actively manipulate market psychology by intentionally
convincing traders it was backstopping stock markets, gold
averaged $1669 in 2012. That was the last time its price reflected
underlying global supply-and-demand fundamentals. The dominant
force driving gold ever since has been the short selling by American
futures speculators, the vultures preying on gold in the Fed’s
wasteland.
The gold price has
had a powerful, ironclad inverse correlation with the total
gold-futures shorts held by these traders. When they are
aggressively short selling as evidenced by a fast-rising red line,
the gold price falls sharply. Then right when any particular
short-selling episode peaks, gold bottoms. And then it rallies
sharply over the subsequent weeks as speculators reduce these
leveraged downside bets by covering.
As ridiculous as
it sounds, this CoT data inarguably proves that speculators’
leveraged gold-futures short selling in recent years has drowned out
every other gold-price driver. That includes worldwide physical
supply and demand, gold’s ultimate fundamental drivers. I’ve
written extensively about this extreme anomaly in recent years,
doing everything I could to lift the scales from investors’ eyes to
reveal this gold truth.
American
speculators’ gold-futures shorting has generally meandered in a
total-positions trading range between 75k-contract lower support and
150k-contract upper resistance in these recent Fed-distorted years.
They generally stop short selling when they have over 150k short
contracts outstanding, and generally stop covering near 75k. It’s
the excessive-shorting exceptions to this rule that force secular
gold lows.
Despite record
speculator gold-futures shorting, gold enjoyed strong support in the
first two-and-a-half years of the Fed’s stock-market levitation.
This ran between $1150 and $1200, and its durability resulted in
many long-side stop losses being set near this support. Bearish
speculators intentionally tried to shatter it in mid-July. One lazy
Sunday night, they short sold an astounding 24k contracts
in a single minute!
This extreme
gold-futures
shorting attack I’ve discussed in great depth indeed broke gold
to that major new secular low in early August. But it required
speculators to ramp their gold-futures shorts to an all-time-record
high of 202.3k contracts then. Our CoT data extends back to early
1999, so all the extreme gold-futures shenanigans in recent years
eclipse all that history and are certainly new all-time records.
Since it was
speculators’ gold-futures short selling that spawned those
late-summer secular gold lows, they weren’t sustainable as rare
contrarians like me argued at the time. Indeed, the speculators
would soon have to cover their excessive shorts. And that resulted
in gold rallying 9.6% over the next 10 weeks even while sentiment
remained utterly rotten. It’s critical to understand why excessive
shorting is so bullish.
By definition,
shorting is selling something that traders don’t own and therefore
have no means to sell. So they borrow whatever they are
shorting from other traders. They believe the price is going to
keep on falling, so they reverse the usual buy-low-then-sell-high
trading strategy to sell high then buy low. As they have to
buy back and return what they borrowed from other traders, they turn
a profit if the price falls.
Speculators
selling short gold futures are under a legal contractual obligation
to return the gold-futures contracts they borrowed to sell. This
means all gold-futures shorting is guaranteed near-future buying.
Each short contract is covered mechanically by buying an offsetting
long contract, and the upside gold-price impact of this short
covering is identical to buying new longs. This covering is
proportional to the shorting.
And the extreme
leverage inherent in gold-futures trading greatly amplifies the
legal imperative to cover shorts. Again at maximum 28x leverage, a
mere 3.6% gold rally would wipe out 100% of the capital that these
traders risked shorting. As gold continued rallying, they would
face ruinous margin calls forcing them to contribute far more
capital to maintain those positions. So there’s a visceral
incentive to quickly cover.
This makes short
covering inherently self-feeding. If even a tiny fraction of
speculators buy gold-futures contracts to offset and cover their
shorts, the gold price rises. This puts serious pressure on the
rest of the speculators to cover their own leveraged shorts,
accelerating gold’s rally. The more shorts covered, the faster gold
rallies. The faster gold rallies, the more speculators have to
cover. It’s a powerful virtuous circle.
The frenzied
covering following early August’s record extreme shorting event
created a strong new gold uptrend in the subsequent months. This
gold rally was poised to continue, and start enticing investors back
in to take the buying baton from speculators covering shorts. But
then the Fed surprised in late October with a hawkish FOMC
statement warning the first rate hike in nearly a decade was
likely in December.
There is nothing
gold-futures speculators fear more than Fed rate hikes. They
believe higher rates are gold’s ultimate nemesis, since gold yields
nothing. As higher rates lift general yields, they are sure that
gold investment will collapse as investors migrate away. While this
certainly sounds logical, the problem is history proves just the
opposite. Gold actually tends to thrive during
Fed-rate-hike cycles, powering higher.
It turns out there
have been 11
Fed-rate-hike cycles since 1971. In the majority 6 of them,
gold actually rallied an average of 61.0% higher during the
exact Fed-rate-hike cycle spans! During the last one that ran
between June 2004 and June 2006, the Fed made 17 consecutive hikes
more than quintupling its federal-funds rate to 5.25%. Yet gold
still surged 49.6% higher over that exact span! How can this be?
Higher rates are
far more damaging to
overvalued stocks
and bonds, and gold is the classic alternative investment that moves
contrary to stock markets. So gold investment demand for
prudently diversifying portfolios soars when the Fed is hiking
rates! Gold only fell an average of just 13.9% in the other 5
Fed-rate-hike cycles because they began when it was already
overbought way up near major secular highs.
But with the
extreme leverage inherent in gold-futures trading, these speculators
can’t afford the luxury of thinking beyond the next hour. So when
they see gold fall as their peers sell even on a historically-false
premise, they pile on. And that piling on of extreme gold-futures
shorting since the FOMC’s late-October meeting with that hawkish
surprise has reached record extremes. That’s why gold hit new lows.
There have been 4
full CoT weeks since that October 28th FOMC meeting. And since the
recent years’ extreme gold anomaly courtesy of the Fed has forced me
to become a gold-futures-trading expert, I have been watching the
records fall in this past month with sheer amazement. Overall in
that span, American futures speculators have dumped 66.7k long
contracts while also adding 87.2k short ones. That is truly epic!
On a few words in
an FOMC statement from a Fed that has consistently lied about
the duration of its zero-interest-rate policy continuously since its
stock-panic birth in December 2008, this single group of traders
liquidated 1/4th of their longs and catapulted their shorts 7/8ths
higher! That 153.9k contracts of gold futures speculators dumped
was the equivalent of 478.6 metric tons of gold, an impossible
amount to absorb.
That equates to
119.6t of virtual supply per week, dwarfing the WGC-reported weekly
gold investment demand year-to-date as of the end of Q3 of 17.5t!
That 153.9k contracts of selling over 4 CoT weeks was easily a
dominant new all-time record. The previous one before this
past month was just 121.4k, seen in May 2004. And out of 878 CoT
weeks before that since early 1999, only 4 had seen 100k+ contract
4-week dumps.
And the records
keep on coming, particularly in the third CoT week of the last 4
that ended on November 17th. Total spec gold-futures shorting in
the 2 CoT weeks leading into that ran 74.9k contracts, an epic 53%
greater than the previous 2-CoT-week record of 48.7k in March 2015.
The shorting in that recent late-November CoT week alone, 41.1k
contracts, was the most ever witnessed in any single CoT week by
far.
It was fully 1/3rd
higher than the previous record. So the drastic gold-futures
shorting ramp by the American speculators following that
late-October hawkish FOMC surprise has been the most extreme ever
seen on multiple fronts by huge margins! Given such
radical record gold-futures shorting, it should be no surprise that
gold was artificially forced down to marginal new 6.1-year secular
lows this past week.
With such an
astounding onslaught of record extreme gold-futures selling, the
fact gold only fell 7.8% over that crazy 4-CoT-week span is an
incredible testament to its fundamental resiliency. There remain
lots of investors interested in buying gold low out there, and they
were voraciously snapping up gold at the artificial lows the
American speculators temporarily wrought. And their shorting is
reaching exhaustion.
After epic
single-CoT-week gold-futures short selling of 33.8k and 41.1k
contracts in the second and third CoT weeks of the last four, this
momentum collapsed in the latest CoT week ending November 24th at
mere 2.8k-contract growth. That strongly implies that all the
speculators foolhardy enough to sell gold near major secular lows
with extreme leverage have already done so. That means short
covering nears.
All excessive
gold-futures shorting is proportional guaranteed near-future
buying. After
past episodes
of extreme shorting in recent years, speculators’ self-feeding
covering buying propelled gold an average of 16.2% higher in 10
weeks. A similar merely-average short-covering rally today from
this week’s secular gold low would blast gold up near $1225. That
alone would likely entice investors to start returning in mass.
But I suspect this
next short-covering frenzy is going to be much larger than average.
Not only was the recent speculator shorting at off-the-charts record
levels, it helped push speculators’ total gold-futures bets on both
the long and short side to a record deviation from their
normal-years average. The last time gold traded normally was from
2009 to 2012, after 2008’s stock panic but before 2013’s gross Fed
distortions.
As of this latest
CoT week, speculators’ total gold-futures bets are a combined
211.1k contracts away from these normal-years norms! That’s a
new record high even exceeding early August’s levels. Just to mean
revert to this normal baseline on both the long and short side, not
even overshoot, speculators are going to have to buy 211.1k
gold-futures contracts. That alone would fuel an incredibly
powerful gold upleg.
On top of this,
gold sentiment is ridiculously bearish now thanks to these
artificial gold lows courtesy of this extreme speculator
gold-futures shorting. So as the great sentiment pendulum
inevitably starts to swing in the opposite direction again,
investment capital is going to start to return too. Investors
remain radically
underinvested in gold even by recent years’ standards, and their
buying will accelerate gold’s gains.
The markets are
perpetually symmetrical, so record extreme selling is almost always
followed by proportional buying. This portends an imminent major
gold upleg, initially sparked by mandatory speculator short
covering, extended by voluntary speculator gold-futures long buying
to re-establish positions, and finally handed off to investors and
their vastly larger pools of capital. Gold looks epically bullish
going forward!
Smart contrarian
investors tough enough to fight the groupthink herd emotions can
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The bottom line is
gold’s new secular lows are totally artificial and unsustainable.
They are the result of record extreme gold-futures short selling by
American speculators, in stark contrast to gold’s strong physical
fundamentals. This epic shorting arose from these traders’
historically-proven-false belief that Fed rate hikes devastate gold
investment demand. And their radical short selling is running out
of steam.
This means the
symmetrical guaranteed gold-futures buying is imminent as those
excessive shorts are covered. As usual that will propel gold
sharply higher, erasing these fake new secular lows that were never
fundamentally righteous. Speculators’ massive short covering
following such extreme shorting will be amplified by long futures
buying and investment capital returning, unleashing a mighty gold
upleg.
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