Gold, silver, and their miners’ stocks plummeted out of the blue this
week, shattering their bull-market uptrends. Gold-futures speculators
had been holding excessive long positions for months, weathering all kinds of
selling catalysts. But once gold slipped through key support, long-side
futures stop losses started to trigger unleashing cascading selling.
Understanding this event and its implications is crucial for traders.
This week’s precious-metals carnage was a big surprise, erupting suddenly with
no technical warning. Gold had been faring quite well after hitting
its latest interim high of $1365 in early July. That was driven by
heavy fund buying of gold-ETF shares in the wake of late June’s unexpected
pro-Brexit vote. After those big capital inflows dried up, gold
consolidated high. At worst by late August it had pulled back 4.1% to
$1308.
Then gold spent all of September grinding higher along its
bull-market uptrend’s support, which was an impressive show of
strength. Speculators were holding large near-record long positions in
gold futures. Since these bets are so hyper-leveraged, that greatly
elevated the risks of a snowballing selloff. I wrote extensively about gold’s record selling
overhang back in mid-July, and that threat has lingered ever since.
But despite all kinds of excuses to do so, the futures speculators never
rushed for the exits. Every week their collective bets on gold are
detailed in the CFTC’s famous Commitments of Traders reports. Back in
late June, speculators’ gold-futures long contracts climbed above 400k for
the first time in history. Then a couple weeks later in early July,
they climbed to an all-time record high of 440.4k contracts as gold
peaked.
That presents a big selling risk due to the extreme leverage
inherent in futures trading. Every contract controls 100 troy ounces of
gold, worth $135,000 at $1350. Yet back in July, the minimum cash
margin speculators were required to deposit for each gold-futures contract
they traded was just $6000. This week it is running $5400. That
works out to maximum leverage to gold of 22.5x and 25.0x, insanely high!
For many decades the legal limit in the stock markets has been 2.0x,
making gold futures more than an order of magnitude riskier. At
extreme 10x, 15x, 20x, and 25x leverage, mere 10.0%, 6.7%, 5.0%, and 4.0%
adverse moves in gold against speculators’ positions would wipe out fully
100% of the capital they risked! So when these guys are wrong, they
have to be quick to exit their trades or risk total annihilation.
As late 2015’s huge
gold-futures selloff battering gold to deep 6.1-year secular lows proved,
there is nothing these speculators fear more than Fed rate hikes.
Despite history proving in spades that gold actually thrives during Fed-rate-hike cycles,
this group of traders wrongly views them as gold’s nemesis. So they
tend to sell aggressively when data or news increases the likelihood of more
rate hikes sooner.
Yet some remarkable events this past summer made it look like gold-futures
speculators were coming around to gold’s historical strength in rate
hikes. For 13 of the 15 CoT weeks since late June when their collective
gold-futures longs first climbed over 400k, these same excessive 400k+ levels
held. That was despite gold’s summer doldrums, new
record stock-market highs, and a vastly-more-hawkish outlook on the Fed.
Fed-rate-hike odds at upcoming FOMC meetings are calculated in real-time
based on federal-funds futures trading. The hedgers and speculators
participating in this market are very sophisticated and the best-informed in
the world on likely Fed policy. This market is so important that
historically the FOMC has never hiked until these futures-implied rate-hike
odds exceed 70%, in order to avoid shocking the markets.
Back on August 12th, these rate-hike probabilities had collapsed way down
to 6%, 8%, and 39% at the FOMC’s next few meetings. Over the next
couple weeks culminating with Janet Yellen’s highly-anticipated Jackson Hole
speech on August 26th, these rate-hike odds rocketed to 36%, 41%, and
64%! That was without a doubt the most-hawkish couple-week span of
economic data and Fedspeak seen in many years.
Amazingly in light of last year’s panicking precedent, gold-futures
speculators held firm with their excessive longs. During those two CoT
weeks closest to that rocketing-rate-hike-odds span, speculators only dumped
a collective 9.8k gold-futures contracts! Thus gold only slid 1.2%
lower. That was an incredible display of strength in the face of a
soaring rate-hike threat, so speculators’ high longs looked durable.
Until this Tuesday, which started out rather unremarkably with no
gold-futures-moving news at all. Gold had closed at $1313 on Monday,
still above August 31st’s pullback low of $1308. Gold was trading right
there when the US trading day rolled around. Those futures-implied
rate-hike odds at Monday’s close ran 11%, 62%, and 64% for the FOMC’s next
few meetings in early November, mid-December, and early February.
So there was virtually no chance of an imminent rate hike in early
November right before the critical US elections. Provocatively, Fed
hawkishness wasn’t a factor at all in Tuesday’s plunge. While
there was some hawkish Fedspeak on Tuesday, it was nothing out of the
ordinary for recent months. By the close Tuesday after gold had
plummeted, those rate-hike odds had barely budged to just 13%, 59%, and 62%.
So why did gold plunge 3.3% lower on Tuesday, its worst daily loss in 3.3
years, after weathering all kinds of selling catalysts all summer? This
first chart showing speculators’ collective long and short bets in
gold-futures contracts helps illuminate that wild selling anomaly. This
data comes from those weekly Commitments of Traders reports, which are
published on Friday afternoons but current to preceding Tuesdays.
While gold had carved higher lows in September along its bull-market
uptrend’s support, since its early-July peak its high consolidation had also
suffered from lower highs. Thus hyper-leveraged gold-futures
speculators were wary of a breakdown, so they set extensive stop losses
right below late August’s $1308 low. There were a bunch of these
contingent sell orders clustered around $1305, and even more near $1300.
Heading into Tuesday, speculators’ gold-futures longs remained near record
highs. While the latest CoT data current to Tuesday’s selloff won’t be
available until a few hours after this essay is published, total spec longs
were way up at 412.1k contracts the week before. That was the 7th
highest out of 926 CoT weeks since early 1999! So these near-record
longs heading into Tuesday really exacerbated gold’s plunge.
This overwhelming gold bullishness also extended to short-side futures
trades, bets gold would head lower. Total spec shorts were only running
near 97.5k contracts in the latest CoT data, not far above their lowest
levels of 2016’s young gold bull of 93.0k in late August. With
gold-futures speculators heavily long and not very short, gold was at
risk of suffering intense selling pressure with little buying to offset it.
Early on Tuesday as gold drifted below $1305, breaking late August’s low,
the futures selling intensified as stops were hit. Stop-loss orders are
very wise even for stock investors with no leverage or margin at all, and are
absolutely essential for futures speculation given its extreme
leverage. As these stop losses triggered, more automatic gold-futures
selling piled on. This pushed gold even lower, tripping still more
stops.
And with speculators so heavily long gold, there were tons of stops to
trigger as gold broke through its key psychological support at
$1300. Watching this all unfold in real-time, the selling looked
orderly but relentless. I didn’t see any sense of panic, just
mechanical forced selling cascading as stop levels were hit in
succession. There was no apparent gold-futures shorting attack
either, like the one perpetrated in July 2015.
Sometimes short sellers try to instantly force the gold price lower with
the explicit intention of unleashing cascading futures selling from
triggering enough long-side stops. Within a matter of seconds, a
large short seller will dump 10k to 20k gold-futures contracts to hammer the
gold price. I was suspicious of that kind of thing Tuesday morning, but
didn’t see the telltale huge-volume-spike signature it generates.
The timing was excellent for a shorting attack as the Chinese markets are
closed all week for a major national holiday. That means Western
futures speculators playing gold downside wouldn’t have to fear Asian buying
offsetting and nullifying their shorting. There were rumors of a large
hedge fund stuck in a forced-liquidation scenario, but that only arose well
after gold had already started plunging that morning.
We can’t know for sure what happened in speculators’ collective longs and
shorts until this latest CoT week’s data is released late Friday afternoon
after this essay is published. But I strongly suspect the data will
show a sharp plunge in speculators’ long contracts due to forced selling as
their stops were hit, along with a sizable but not major jump in short
contracts. This new CoT report should illuminate much.
While I was well aware of the risk of cascading gold-futures selling due
to speculators’ excessive longs, and have warned about it in all of
our newsletters for several months, Tuesday’s running of the stops was still
a major surprise. Since gold-futures speculators had weathered gold’s
technical weakness and that enormous Fed-hawkishness ramp in late August, I
figured the risks of them selling en masse were waning.
No such luck though. Tuesday’s surprise plunge was exceptionally
damaging to sentiment, naturally spawning a vast surge in bearishness.
And it definitely shattered gold’s bull-market uptrend. Still, the
technical damage to 2016’s young gold bull is fairly modest. Gold was
merely driven back to pre-Brexit-vote levels that were first seen in this
bull in mid-March. That does nothing to invalidate or threaten gold’s
bull.
As of Wednesday’s close, the data cutoff for this essay, gold’s total
pullback since early July extended to just 7.2%. That’s still fairly
mild, and vastly smaller than bull-slaying territory. In addition,
gold’s plunge forced it back near its 200-day moving average. 200dmas
usually prove strong support within ongoing bull markets. So
odds are high gold will catch a bid very soon here and bounce right back up
into its bull uptrend.
Obviously given futures speculators’ Fed-rate-hike obsession, this
morning’s monthly US jobs report is a key factor in the timing of gold’s
bounce. This essay draft was finalized Thursday after close, before
that jobs data arrived. By the time you read this, you’ll know if jobs
missed expectations which is dovish for Fed-rate-hike expectations fueling a
gold rally on a futures bid. Or jobs could’ve beat, pushing gold the
other way.
But there’s one thing we can be absolutely sure of, speculators’
gold-futures trading was the sole culprit behind Tuesday’s gold plunge.
While speculators drive short-term gold action, its new bull this year is the
result of heavy stock-market capital inflows into physical gold bullion via
shares in the leading GLD SPDR Gold Shares gold ETF. If investors
played a role in Tuesday’s gold plunge, GLD’s holdings would reveal it.
This chart looks at GLD’s physical gold-bullion holdings held in trust for
its shareholders, which this ETF reports daily. GLD is exceedingly important
because it acts as a direct conduit for stock-market capital to flow
into gold, driving it higher. In order to keep GLD achieving its
mission of mirroring gold, this ETF’s managers have to quickly equalize any
excess buying or selling pressure on GLD shares directly into gold itself.
GLD shares have their own supply-and-demand profile independent from
gold’s. So when American stock investors bid up GLD shares faster than
gold is being bought, this ETF threatens to decouple from gold to the
upside. GLD’s managers must shunt that excess demand into gold to
maintain tracking. So they issue enough new shares to offset the excess
demand, and use the proceeds to buy more gold bullion.
Differential GLD-share demand is actually the whole story of 2016’s gold
bull! In the first quarter of this year, the GLD holdings build of
176.9 metric tons represented a whopping 80.6% of the total worldwide
gold-demand growth year-over-year. In the second quarter, the GLD
holdings build’s share shot up to a staggering 93.6% of total global
gold-demand growth! Differential GLD-share buying is gold’s dominant
driver.
The reason gold’s young bull stalled out in the third
quarter is because American stock investors’ GLD-share demand
evaporated. The Q1, Q2, and Q3 GLD builds of 176.9t or 27.5%, 130.8t or
16.0%, and -0.2% or -2.1t fully explain why gold surged in the first half of
this year before consolidating high last quarter. With stock-market
capital inflows so dominantly critical to gold’s bull, they were a suspect in
Tuesday’s plunge.
But the hard daily holdings data released by GLD’s managers conclusively
proves that stock investors had nothing at all to do with Tuesday’s gold
plunge! These holdings were dead flat at 948.0t the very day
that gold plummeted 3.3%, indicating GLD shareholders were selling no faster
than the gold-futures speculators. On Wednesday, GLD experienced an
utterly trivial 0.0% draw taking its holdings to 947.6t.
This was a big relief too, and very bullish for gold. If Tuesday’s
plunge had been driven by the investors who fueled gold’s new bull market,
that could be the vanguard of more investor selling. And if investors
abandon gold now, its young bull is doomed since their buying is the only
thing that pushed gold higher this year. As of the data cutoff for
this essay, thankfully investors remain strong hands and aren’t fleeing.
Unlike futures speculators’ ultra-short-term focus necessitated by their
super-risky hyper-leverage, gold investors are long-term players. Their
gold positions are held outright, so a 3% drop in gold is just a 3%
unrealized loss, not orders of magnitude greater like futures speculators’
amplified losses. As long as investors don’t start dumping gold, its
bull market remains alive and well and due for a major rebound higher.
But when investors are away, the speculators will play. Gold
investment buying via GLD shares stalled in Q3 because stock markets soared
to new record highs on hopes of more central-bank easing after that Brexit
vote. Since gold generally moves counter to stock markets,
investment demand wanes when stocks thrive. The lack of investor buying
gives futures speculators an outsized impact on gold’s price.
Thankfully wild gold-price moves driven by extreme gold-futures trading
are very short-lived. The great leverage inherent in futures
necessitates that major position shifts occur rapidly. These traders
can’t afford to react gradually to adverse gold moves, so they all act at
once resulting in quick violent action that soon fades. Since Tuesday’s
gold-futures stop running didn’t spill into Wednesday, it’s probably over.
The worst impact of that surprise mass liquidation of gold-futures longs
came in the gold miners’ stocks. Since their profits amplify the gold
price, gold stocks took a colossal hit on Tuesday. The leading gold-stock benchmark HUI
NYSE Arca Gold BUGS Index plummeted 10.1% to gold’s 3.3% loss on
Tuesday! While that 3.1x leverage was reasonable for such a sharp gold
plunge, it was gold stocks’ worst day in 14.5 months.
The gold-stock carnage sparked by that futures-driven gold plunge was
breathtaking. Any stock traders who prudently had stop losses to
protect their capital, including us, watched their gold stocks plummet to
their stops and get sold. This stop running was automatic forced
selling just like that seen in futures, exacerbating the sharp gold-stock
plunge. It made for an exceedingly-challenging day for gold-stock
traders.
Just like in gold, this bull-market-uptrend-breaking gold-stock plummet
was a total surprise technically. The gold stocks as measured by the
HUI had already suffered a
massive correction of 22.0% between their early-August bull-to-date high
and the end of that same month. That looked like a durable bottom
sentimentally and technically, as gold stocks spent all of September grinding
higher along bull-uptrend support.
But unfortunately they were just below that support line when Tuesday’s
cascading gold-futures selloff hit. So the resulting capitulation-like
snowballing selling fueled by stop losses being triggered in rapid succession
also shattered the gold stocks’ young-bull uptrend. The HUI was
battered back down to mid-April levels, extending this sector’s total
correction to an enormous 28.4% over 2.0 months! It was brutal.
Naturally this calamity wreaked tremendous sentiment damage among
gold-stock traders that will take some time to repair. Nevertheless,
just like in gold Tuesday’s plummet did nothing to put the new gold-stock
bull in jeopardy. While its uptrend was reshaped, this sector was still
up an astounding market-dominating 83.1% year-to-date at Tuesday’s
close. And it left the HUI right at its 200dma, major bull support.
So once gold inevitably catches a bid again soon here, likely on the
Fed-levitated stock markets rolling over, gold stocks are going to surge
higher again. Despite the technical damage, the core fundamentals of
this sector remain very strong. Remember that in the second
quarter, the latest data available, the elite gold miners of GDX and gold juniors of GDXJ had
average all-in sustaining costs of just $886 and $887!
So the gold-mining sector remains very profitable at $1250 gold or
even lower. And interestingly, the gold miners’ third-quarter operating
results coming out in the next 5 weeks or so are going to prove way better
than the second quarter’s. Q3’s average gold price powered 6.0% higher
quarter-on-quarter, so the next batch of quarterly gold-miner results are
going to be very appealing to investors and drive much buying.
If you suffered a mass stopping this week, you’re not alone. Such an
extreme gold-stock down day that erupted from just over correction lows had
to trigger the vast majority of stops out there. While it is certainly
discouraging seeing much or most of your gold-stock and silver-stock
portfolio stopped out, it is merely a setback on the road to huge major-upleg
gains. They are well worth suffering an occasional selling anomaly.
Here’s the math. Assume the capital you have invested in gold stocks
for the next upleg has an indexed value of 100. Even if all your
positions are stopped at 20% losses, that takes the value to 80. But
the key is remembering uplegs in gold-stock bulls are massive.
In early 2016 the HUI blasted 131.8% higher in just 3.3 months for
example! 50% to 100%+ upleg gains within gold-stock bulls are totally
normal and common.
Take that 80 indexed portfolio value after the mass stopping and redeploy
into the resulting capitulation lows, and 50% to 100% upleg gains will
catapult it back up to 120 to 160. Those are total portfolio gains of
20% to 60%, typically in well under a year! While suffering a stopping
is suboptimal and frustrating, it doesn’t great impede capital growth and
wealth multiplication if redeployed since gold-stock uplegs are so big.
Tuesday’s anomalous futures-driven stop running hammering gold, silver,
and their miners’ stocks truly changed nothing whatsoever on the fundamental
front. The precious metals remain in strong new bulls almost certain to
mean revert radically higher from here following their extreme secular lows
of late 2015. This sector is extremely oversold, and due for a
sharp rebound higher kicking off the next major uplegs.
Investors and speculators can play them in the leading gold and gold-stock
ETFs of GLD, GDX, and GDXJ. But as always the greatest gains will come
in the individual gold stocks and silver stocks with superior
fundamentals. While they were slammed this week on snowballing
stop-loss selling, they are going to come roaring back with a vengeance once
gold inevitably catches a bid. Today’s buy-low opportunity is fleeting.
At Zeal we too suffered a mass stopping on this week’s improbable
anomalous plunge. But decades of experience have taught me that extreme
gold-stock selloffs late in bull-market corrections have to be quickly
bought to ride subsequent sharp V-bounces higher. So even on Tuesday
afternoon before the dust settled, we already started aggressively
redeploying in the beaten-down gold stocks at amazing prices.
We bought 10 fundamentally-superior gold stocks and silver stocks in our
acclaimed weekly
newsletter published Tuesday afternoon, with more buying to come. That
along with our monthly
draws on our vast experience, knowledge, wisdom, and ongoing research to
explain what’s going on in the markets, why, and how to trade them with
specific stocks. This expertise is most valuable and essential when
traders are most scared, since that’s when the best bargains are found.
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an issue!
The bottom line is gold suffered an anomalous futures-driven selloff this
week. As the gold price drifted lower through key support levels,
futures stop losses were triggered. This automatic mechanical selling
forced gold even lower, tripping more stops so futures selling
cascaded. The resulting plunges in gold, silver, and their miners’
stocks shattered their young-bull-market uptrends and greatly damaged
sentiment.
But these bull markets are very much alive and well despite this technical
carnage. Investors weren’t dumping gold, and extreme gold-futures
selling is always short-lived. So the precious metals are due for a
sharp rebound higher out of deeply-oversold conditions, likely fueled by gold
catching a bid on stock-market weakness. This will ignite these bulls’
next major uplegs, yielding huge gains for brave contrarians.
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