The
gold-futures and silver-futures short positions held by speculators
have rocketed up to extremes in recent weeks. These elite traders
are aggressively betting for further weakness in gold and silver
prices. But history has proven extreme shorts are a powerful
contrarian indicator. Right as speculators wax the most bearish as
evidenced by their collective bets, gold and silver decisively
bottom and birth major new rallies.
Futures trading has a wildly-outsized impact on gold and silver
prices, especially over the short term. It is amazing how much
volatility futures speculators’ collective buying and selling
generates, often drowning out everything else. Two factors are
responsible for this dominance. The extreme leverage inherent in
futures trading and the unfortunate fact the resulting gold and
silver prices are the world’s reference ones.
Normal investment capital flows occur with no leverage, the vast
majority of stocks and bonds are bought outright. So buying and
selling isn’t multiplied. Some stock traders use margin, which for
many decades has been legally capped at 50% in the US. So they can
borrow up to half their stocks’ purchase prices, or run 2x
leverage. That gives any given capital flows, buying or selling,
twice the price impact of outright ones.
But
futures speculation allows truly extreme leverage, in a league of
its own. US gold-futures contracts each control 100 troy ounces of
gold. At $1250, that’s worth $125,000. But the margin requirement,
the capital necessary in a trading account to hold that contract, is
just $3950 this week. That enables traders to run leverage as
high as 31.6x! That acts as a strong price-impact multiplier on
all their buying and selling.
Silver futures are similar, with US contracts each controlling 5000
troy ounces. That commands $80,000 worth of silver at $16. But
this week traders are only required to put up $5000 in cash to buy
or sell each contract. That makes for maximum leverage of 16.0x,
well under gold’s extremes but still enormous by normal-market
standards. Futures effectively greatly amplify the price impact
of relatively-small amounts of capital.
Every dollar of gold and silver buying and selling by outright
investors has one dollar of price impact. But at 32x or 16x
leverage, every dollar speculators move into or out of gold and
silver futures has the same short-term price impact as $32 or $16 of
outright investment! This extreme leverage grants these futures
speculators wildly-outsized influence over price action.
This is incredibly distorting and super-unfair to investors.
But
unfortunately that’s the way the markets work these days.
Compounding futures trading’s extremely-disproportional price
impact, the resulting gold and silver prices have long been
considered the world’s reference ones. So big gold and
silver moves fueled by futures speculators can greatly affect
universal sentiment, convincing other traders including investors to
follow futures speculators’ lead exacerbating moves.
I
sure wish this wasn’t the case. Without the extreme leverage
inherent in futures speculation, gold and silver prices would be far
less volatile and more closely reflect global physical supply and
demand on an ongoing basis. But because futures traders’ capital
flows are so radically multiplied, all investors and speculators
interested in gold, silver, and their miners’ stocks have no choice
but to closely follow futures action.
There’s one key way to do that, through the weekly Commitments of
Traders reports published by the US Commodity Futures Trading
Commission. Released late each Friday afternoon but current to the
preceding Tuesday close, the CoTs detail speculators’ total long and
short positions in gold and silver futures. Analyzing these weekly
changes in collective bets and their trading ranges over time is
very illuminating.
The
CoTs break down all futures traders into three categories, hedgers,
large speculators, and small speculators. The hedgers produce or
consume physical gold commercially in their businesses, and use
futures to mitigate gold-price risks to their operations. The
speculators take the opposite side of hedgers’ trades, as futures
are a zero-sum game. I lump both large and small speculators
together for analysis.
This
simple chart superimposes the daily gold price over the weekly total
long and short gold-futures contracts held by speculators. Their
long contracts, bullish bets that gold is heading higher, are
rendered in green. And their short contracts, bearish bets that
gold is going lower, are shown in red. It’s impossible to
understand short-term gold and silver price action unless you
closely follow this weekly data from the CoTs.
The
reason I’m writing this essay is the past couple weeks’ gold-futures
developments are exceedingly bullish! Speculators have taken
on a massive new leveraged short position in gold as evidenced by
the soaring red line. They are wildly-bearish as a group, totally
convinced gold is heading lower in coming weeks and months. But
after every past gold-futures shorting extreme, gold has instead
blasted sharply higher!
Exiting June, gold was stable in the $1240s with typical dull
summer-doldrums
sideways trading action. But as July’s trading dawned on the 3rd,
anomalous heavy selling slammed gold. During that holiday-shortened
trading day when many if not most American traders were away on
vacations, gold plunged 1.8% to $1219. There was no identifiable
catalyst, like great US economic data or a big US dollar rally, to
justify that.
Since the 4th was the Independence Day market holiday, that CoT week
ended on the 3rd. So later that Friday when that CoT report was
released, speculators’ extreme gold-futures selling was revealed.
In a slow and dead holiday week, they jettisoned 14.9k long
contracts while adding 27.7k short ones! In gold futures, any
weekly swing in speculators’ collective bets over 20k contracts is
considered very large and notable.
So
seeing them dump 42.6k contracts out of the blue in one lazy summer
CoT week was staggering. That is equivalent to 132.6 metric tons of
gold, a vast amount. According to the World Gold Council, the
definitive arbiter on global gold supply and demand, worldwide gold
investment demand in Q1’17 totaled 398.9t. That averages out to
30.7t per week. That CoT week’s extreme gold-futures selling ran a
colossal 4.3x that!
Our
CoT data extends all the way back to January 1999, now encompassing
967 weeks. That’s certainly a big sample size over a long secular
18.5-year span. Specs’ extreme short selling in that CoT week
ending July 3rd ranked as the 7th-largest witnessed over that
entire span, and almost certainly ever! It was truly exceptional
gold-futures short selling, which was disturbingly odd with no
discernable catalyst.
Adding both that short-side ramp and the long-side liquidation
together, that CoT week’s selling was the 15th biggest on record.
While gold sentiment is almost always weak and bearish in the summer
doldrums, such epic gold-futures selling didn’t make any sense.
These speculators usually need some motivating news to get them to
trade so aggressively, like major US-economic-data surprises or big
US-dollar gyrations.
At
that CoT report’s release a couple Fridays ago, I found this selling
blitz very interesting. But one week doesn’t make a trend. For
some unknown reason, gold-futures speculators were whipping
themselves into a bearish frenzy right when gold usually sees
major seasonal
lows. Unfortunately that tainted the gold outlook for
investors, who fell in line with futures speculators to start
relentlessly selling GLD shares.
This
American GLD SPDR Gold Shares gold ETF is the world’s leading and
dominant gold-investment vehicle, acting as a conduit for the vast
pools of US stock-market capital to flow into and out of physical
bullion. After that anomalous July 3rd gold-futures selling bashed
gold below its 2017 uptrend’s support, capital started fleeing GLD.
GLD shares were sold faster than gold itself, fueling a series of
substantial draws.
Thanks to the sentiment multiplier effect of that leveraged
gold-futures selling, GLD’s holdings fell 0.7% on July 3rd, another
0.7% on the 5th, and 0.6% on the 7th when that CoT report was
released. That was the worst cluster of investor gold selling since
this year dawned. GLD’s managers had to liquidate some of their
gold bullion to buy back the excess GLD shares for sale,
exacerbating the weakness in gold prices.
But
the gold selling still didn’t cascade and snowball like the futures
specs expected. Gold stabilized in the $1210s, low enough to feed
bearish psychology but not so ugly as to spawn real panic selling.
With gold essentially flat in the subsequent CoT week ending July
11th, I didn’t expect much from the CoTs. So boy was I shocked when
they showed speculators’ extreme gold-futures short selling
persisting!
In
this latest CoT week before this essay was published, speculators
sold 6.0k long contracts while continuing short selling like
madmen. They added another astounding 27.4k short contracts, which
proved the 8th-largest on record out of those 967 CoT weeks. Over
the two newest CoT weeks, specs dumped 55.1k gold-futures
contracts. That was actually the second-biggest shorting spree
ever over a two-CoT-week span!
With
back-to-back weeks of epic short selling, something was definitely
up. Maybe it was benign, as gold sentiment is almost always very
bearish during the summer doldrums. The biggest gold down day in
that latest CoT week came on Jobs Friday the 7th, a 1.0% loss. US
jobs growth in June at +222k proved much better than the +179k
expected, on top of +47k in past-month revisions. That is hawkish
for Fed rate hikes.
There’s nothing gold-futures speculators fear more than Fed rate
hikes, although history is crystal clear that is supremely
irrational. Gold
has actually thrived during past Fed-rate-hike cycles! But this
totally-false rate-hikes-doom-gold mindset has driven many past
episodes of major gold-futures selling. The fact today’s started an
entire CoT week earlier when there was no economic-data catalyst
implies something more.
For
many years now, gold-futures speculators have wielded their extreme
leverage like a weapon with the nefarious intent of actively
manipulating gold prices lower. Seeing such epic gold-futures
shorting in back-to-back CoT weeks in this quiet time of the year is
highly suspicious. It really could’ve been a
gold-futures
shorting attack in slow motion, a sustained attempt to force the
gold price lower than fundamentally justified.
Only
the speculators who executed these trades will ever know their
motivations. But the hard results are exceedingly bullish for
gold. 55.1k gold-futures contracts, the equivalent of 171.2 metric
tons of gold, sold short in two weeks merely pushed this metal 2.6%
lower. That’s not much considering the deluge of selling,
especially near gold’s major seasonal lows when sentiment and
technicals are most vulnerable.
If I
was short gold futures, I’d be sweating bullets after such
near-record gold-futures shorting had such a modest downside impact
on gold prices. There had to be huge buying somewhere in the world
to offset that extreme futures supply. The only other two-CoT-week
span in history with more short selling ended in November 2015,
where gold plunged 4.3%. And that was in one of gold’s
strongest months
of the year seasonally.
This
orgy of extreme short selling left speculators’ total gold-futures
shorts way up at 189.2k contracts at the end of this latest CoT
week. That’s huge! Out of those 967 CoT weeks since early 1999,
that proved the 6th highest on record. The top four
clustered around the all-time high of 202.3k back in early August
2015. Number five was 191.6k in December 2015, right before gold’s
current bull market was stealthily born.
Speculators haven’t been so short gold futures since mid-December
2015 when gold slumped to a 6.1-year secular low on the
Fed’s first rate
hike in a decade. Right from those extreme lows, gold exploded
almost 30% higher in the next half-year or so. Spec shorts this
high are exceedingly-rare bull-birthing levels! After every
major spike in gold-futures short selling in history, gold has
rocketed higher in major rallies.
I’ve
written entire
essays on the powerful inverse relationship between gold prices
and spec shorting. Excessive or extreme gold-futures short selling
is so immediately bullish for gold for a couple reasons. Like all
traders, futures speculators’ capital is finite. By the time they
ramp their collective shorts back up near historical extremes, their
selling is largely exhausted. They don’t have the firepower
to short much more.
Short selling itself is very risky. Normal sellers first have to
own something before they sell it. But short sellers effectively
borrow gold-futures contracts from other traders in order to sell
them. Short selling is selling something that isn’t owned,
which creates legal obligations to soon repay those debts. In
futures this is accomplished by buying long contracts to offset and
close short ones, which is very bullish for gold.
All
gold-futures short selling is soon followed by proportional
offsetting buying. So that 55.1k contracts of shorting in the
past couple CoT weeks guarantees 55.1k contracts of imminent
buying! Gold’s upside price impact is identical from short-side
speculators buying longs to close their positions and long-side
speculators adding new longs. While normal long buying is
voluntary, short-covering long buying is mandatory.
And
once short covering gets underway, it quickly feeds on itself
due to that extreme leverage inherent in gold futures. At 30x, a
mere 3.3% gold rally would wipe out 100% of the capital risked by
fully-leveraged gold-futures speculators! So once gold starts
powering higher again, they have to cover fast or face
truly-catastrophic losses. Their short-covering buying pushes gold
higher, triggering even more buying which snowballs.
The
faster gold surges on short covering, the more other speculators are
forced to buy to cover their own shorts. Long-side speculators jump
in to buy aggressively when gold rallies too, and they control much
more capital. Their buying amplifies gold’s upside and puts even
more pressure on remaining shorts to buy back their shorted
contracts to get out of harm’s way. Nothing’s more bullish for gold
than excessive shorts!
So
coming out of near-record gold-futures shorting over the past couple
CoT weeks driving near-record spec shorts, a major gold rally
is almost certain. With spec longs relatively low now and gold
moving out of its usual
summer-doldrums
weakness into August, this rally ought to prove quite powerful.
Near-record short selling always leads to massive subsequent
gold-futures buying, which tends to unfold fairly rapidly.
Gold’s 30% rally confirming a new bull market in the first half of
2016 was driven by speculators adding 249.2k long contracts while
covering 82.8k short ones. Today’s buying potential is similar. To
get back to last summer’s 400k-contract long levels when gold was in
favor, speculators would have to buy 136.9k long-side contracts. To
return their shorts to normal levels between 2009 to 2012, 123.8k
need to be covered.
That
adds up to 260.7k contracts of gold-futures buying possible if not
likely in the second half of 2017! That’s the equivalent of 810.9
metric tons of gold. As usual this will start out with short
covering, but the resulting gold rally will entice back much more
capital from long-side speculators. This could drive gold another
20% higher from this summer’s levels, which is up around $1500!
That’s seriously-impressive upside.
Interestingly silver’s situation today is even more bullish than
gold’s! Silver has been beaten like a rented mule this year,
pummeled lower while gold remained relatively high. That
underperformance was driven by the biggest surge in silver-futures
short selling ever witnessed! That catapulted silver shorts way up
to a stunning new all-time record high of 93.6k contracts in
the latest CoT week before this essay was published.
All
the gold-futures shorting analysis above applies equally to
silver-futures shorting. When these guys are forced to cover their
absurdly-massive shorts, silver is going to soar. Normal
levels of silver-futures shorts from 2009 to 2012, the last normal
market years, ran 21.5k contracts. That means buying to cover is
way up at 72.1k potential contracts! That’s the equivalent of
360.5m ounces of silver, vast beyond belief.
According to the venerable Silver Institute, total global silver
demand last year was 1027.8m ounces. So we are talking about
imminent near-term short-covering potential exceeding a third
of annual worldwide demand! Silver shot up about 50% in roughly the
first half of 2016 on 55.6k contracts of long buying and 30.0k of
short covering. Over 5/6ths of that silver-futures buying is likely
coming again in short covering alone!
The
short-covering-fueled silver-price gains will entice in heavy
silver-futures long buying as usual, really amplifying silver’s
upside. So another 50% gain isn’t a stretch at all, which would
blast silver up above $23 from its recent lows. Gold’s own
short-covering rally will spark big silver buying too, as gold has
long been
silver’s dominant driver. Silver is wildly bullish today
given the record shorts in highly-leveraged futures!
Over
and over again history has proven the worst time to be bearish on
gold and silver is when futures speculators are, as evidenced by
high shorts and low longs. And with their shorts at near-record and
record levels today, gold and silver look exceptionally bullish. We
are likely on the verge of major if not massive new bull-market
uplegs in these precious metals, which will yield big gains for
smart contrarian traders.
These can be played in the metals themselves, their leading GLD and
SLV ETFs, or the stocks of their miners. The latter offer the
greatest potential gains by far, as their profits really leverage
higher gold and silver prices. The stocks of the elite gold and
silver miners are
wildly undervalued and incredibly out of favor today, so their
upside potential is truly vast as gold and silver mean revert higher
on huge short covering.
At Zeal we’ve
literally spent tens of thousands of hours researching
individual gold and silver stocks and markets, so we can better
decide what to trade and when. As of the end of Q1, this has
resulted in 928 stock trades recommended in real-time to our
newsletter subscribers since 2001. Fighting the crowd to buy low
and sell high is very profitable, as all these trades averaged
stellar annualized realized gains of +22.0%!
The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, like when futures speculators are
running near-record and record gold and silver shorts. An easy way
to keep abreast is through our acclaimed
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and get deployed before the short covering is unleashed!
The bottom line is
speculators’ gold-futures and silver-futures short positions have
soared to near-record and record extremes in recent weeks. These
elite traders are hyper-bearish, and betting heavily for more
precious-metals downside. But gold and silver soon soared on
short-covering buying following all past episodes of excessive and
record short selling. There’s nothing more bullish for gold and
silver than extreme shorts!
All futures sold
short must soon be offset by proportional near-term buying to close
out those trades. It quickly feeds on itself thanks to the
incredible leverage of gold futures and silver futures. The
resulting sharp short-covering rally soon entices in new long-side
futures speculators and later investors with their vastly-larger
pools of capital. Excessive and record futures shorts are the best
gold and silver buy signals available. |