Gold
and its miners’ stocks have proven rare bastions of strength during
recent weeks’ market carnage. They are powering considerably higher
while nearly everything else burns. The markets’ major sentiment
shift is accelerating a young gold upleg, which ought to grow much
larger as speculators and investors continue returning. Their
collective gold positioning remains very low, making for abundant
gold upleg fuel.
October’s outperformance by gold and gold stocks has been
impressive. As of Wednesday, the flagship US S&P 500 broad-market
stock index had plunged 8.8% month-to-date. That heavy selling was
led by the market-darling mega tech stocks, pummeling the NASDAQ
down 11.7% MTD! Stock investors are starting to pay the piper for
getting far too complacent in
bubble-valued
markets, the reckoning is underway.
But
contrarians prudently positioned in gold and its miners’ stocks have
enjoyed large divergent gains as flight capital floods in. Gold has
surged 3.4% MTD despite the US Dollar Index’s strong 1.3% rally.
The long-forsaken gold stocks have nicely amplified those gains,
refusing to get sucked into the maelstrom of heavy stock-market
selling. The leading HUI gold-stock index has blasted 8.2% higher
MTD, 2.4x gold’s upside!
While mid-October’s stock-market plunge out of the blue jumpstarted
gold, its young upleg was already stealthily underway. Gold
bottomed at $1174 in mid-August after getting pummeled by all-time
record
gold-futures short selling by speculators. It quickly rebounded
as high as $1210 in late August, but drifted back down as low as
$1183 in late September. This anemic gold upleg was already 7+
weeks old in mid-October.
Though gold didn’t respond much the first day the S&P 500 plunged
3.3%, the next day’s 2.1% follow-on selling galvanized gold
interest. It rocketed from $1194 to $1223 that day, a huge 2.5%
rally that made for its biggest up day since late June 2016’s
surprise pro-Brexit vote in the UK! Those massive gold gains
propelled the HUI a huge 7.4% higher that day. Capital was deluging
back into this moribund contrarian sector.
While the gold and gold-stock gains in recent weeks were impressive,
they remain quite small. From their respective mid-August and
early-September lows, gold and the HUI were only up 5.0% and 13.9%
as of the middle of this week. That’s hardly even upleg territory,
a mere start. Gold’s last major upleg unfolded in roughly the first
half of 2016. While it was on the smaller side by historical
standards, it offers perspective.
Gold
surged 29.9% higher in just 6.7 months, catapulting the major gold
stocks as measured by the HUI 182.2% higher in largely that same
span! So what we’ve seen in recent weeks is nothing compared to the
last major gold upleg, let alone far-bigger previous ones. Today’s
young gold upleg is only getting started. And with gold upleg
fuel still abounding, odds are it and the resulting gold-stock
upleg will grow much larger.
Gold
bull-market uplegs usually unfold in the same telescoping fashion.
They are initially ignited by gold-futures speculators covering
shorts. These traders are usually the only buyers at major lows
following corrections when sentiment is hyper-bearish. They buy
offsetting gold-futures long contracts to close out their existing
short contracts at profits. This short covering is the spark that
first kindles major gold uplegs.
That
short covering soon burns itself out, as short-side traders have
relatively-little capital compared to the other gold buyers. But it
often propels gold high enough for long enough to entice
long-side gold-futures speculators to return. They command much
more capital than the shorts, and their buying soon becomes
self-feeding. The more gold-futures contracts they buy, the more
their peers start chasing that momentum.
That
long-buying second stage eventually evokes gold uplegs’ third stage,
the primary one and largest by far. All the gold-futures
buying extends gold’s rally enough to get investors interested in
returning. They control vastly more capital than futures
speculators, so once they start buying gold is off to the races in a
major new upleg. Unlike short-lived gold-futures buying, gold
investment buying can run for many months on end.
Stage-one gold-futures short covering is the initial trigger that
ignites stage-two gold-futures long buying. And all that futures
buying together eventually jumpstarts stage-three investment
buying. As investors start to return to gold in a material way,
gold’s upleg accelerates in a self-sustaining virtuous
circle. The more capital investors pour into gold, the more it
rallies. The more gold climbs, the more investors want to buy.
Today’s young gold upleg is starting to follow that usual
three-stage
pattern of fueling buying. And since vast amounts of
gold-futures short covering, gold-futures long buying, and
investment buying still remain based on current positions, this gold
upleg is likely to power way higher before it eventually
gives up its ghost. Gold looks exceptionally bullish today with
upleg fuel abounding, portending much bigger gains to come.
What
gold-futures speculators and gold investors are actually doing
and likely to do in coming months is discernable from two key
datasets. The first is the weekly Commitments of Traders reports
published by the CFTC, which detail speculators’ collective
positions in gold futures on a weekly basis. The second is the
physical gold bullion held in trust by the leading and dominant
American GLD SPDR Gold Shares gold ETF.
We’ll start on the gold-futures side, as that’s where gold uplegs’
stage-one and stage-two buying comes from. This chart shows large
and small speculators’ total long and short gold-futures contracts
held, in greed and red respectively. Gold is superimposed over the
top in blue. Despite gold’s sharp rally when the S&P 500 plunged,
the great majority of likely gold-futures buying is still yet to
come which is really bullish.
Gold’s woes that ultimately birthed today’s young upleg are recent.
This classic contrarian investment actually fared pretty well from
early 2017 to mid-2018, climbing higher on balance and holding above
a rising support line for 17.4 months. Gold was trading at $1302 in
mid-June before enormous gold-futures short selling erupted on a
sharp USDX rally. That extreme short selling snowballed into a
record shorting spree.
From
mid-June to mid-August, speculators’ gold-futures shorts skyrocketed
a stupendous 156% or 156.4k contracts! That catapulted them to an
extreme new all-time record high of 256.7k, as you can see above in
red. That shattered the previous record of 202.3k from August 2015,
which helped spawn that last major gold upleg in H1’16. Gold fell
9.9% in 2.1 months when that epic record short ramp was underway.
In
early September I wrote an extensive essay on those
record
gold-futures shorts explaining why they were so darned bullish.
There’s nothing more bullish for gold than extreme speculator shorts
because of how short selling works. These traders reverse the
normal trading order by first selling high before later attempting
to buy back low. But speculators don’t actually have the gold
futures they want to sell short.
So
they must effectively borrow gold futures to short them. And
these debts legally have to be paid back soon. Mechanically
gold-futures shorts are repaid and closed by buying offsetting long
contracts. Thus speculators’ excessive gold-futures shorts are
literally guaranteed proportional near-future buying! And
the incredible leverage inherent in gold futures means this short
covering often unfolds fast, over a couple months.
Back
in early September, the minimum margin required for controlling each
100-troy-ounce gold-futures contract was $3100. This week it’s
$3400. At $1200 gold, 100 ounces are worth $120,000. But a trader
running at the margin limits can effectively buy or sell that much
gold with crazy 35.3x leverage! In stock markets the legal
maximum has been 2x for decades now. At 35x, trading gold futures
is extraordinarily risky.
For
every 1% the gold price moves against traders’ positions, like
rallying when they are short, they lose 35% of their own capital
risked. A mere 2.9% gold rally would wipe out fully 100% of their
capital at 35x leverage! And in mid-October on the S&P 500’s second
big down day alone, gold surged 2.5%. That was driven by frantic
speculators rushing to buy longs to cover their extreme near-record
gold-futures shorts.
The
weekly CoT reports are current to Tuesday closes, but aren’t
published until late Friday afternoons. So the latest-available
data on speculators’ gold-futures positions when this essay was
published was current to October 16th, the CoT week straddling that
sharp 5.3% 2-day plunge in the S&P 500. Just as I warned in early
September, speculators’ near-record short-side bets resulted in
record short-covering buying.
That
CoT week speculators bought to cover an astounding 48.1k
gold-futures short contracts! That was a new all-time record high,
shattering the previous CoT-week record of 41.5k from March 1999.
Covering of this magnitude is exceedingly rare. Out of the 1033 CoT
weeks since early 1999, only 11 witnessed short covering over 25k
contracts. That frenzied short covering is why gold’s price
exploded higher that day.
Remember major gold uplegs are initially ignited by stage-one
gold-futures short-covering buying. And despite speculators
panicking as stock markets plunged and covering nearly 1/5th of
their near-record shorts in a single CoT week, their remaining
shorts are still extreme. They were running way up at 205.0k
in that latest CoT report, which would’ve been a record high before
late July 2018. Much more covering is coming.
To
just mean revert back down to mid-June levels before this summer’s
record orgy of shorting, these elite traders still have to buy to
cover another 104.7k contracts! That’s 2.2x what they did in that
initial CoT week, and the equivalent of a huge 325.6 metric tons of
gold still due to be bought from short covering alone.
Short-covering buying out of extremes tends to unfold rapidly, over
just a couple months or so.
So
assume 7 more CoT weeks of speculators covering shorts on balance,
which works out to 46.5t of gold per week. According to the World
Gold Council’s definitive fundamental data, in the first half of
2018 total global gold investment demand averaged 21.9t per week.
So speculators’ buying to cover alone could boost this by 2.1x
over the next couple months! That will naturally propel gold
considerably higher.
Eventually gold will power high enough for long enough to convince
long-side gold-futures speculators to start buying again. As the
higher green line above shows, they control a lot more capital than
the short-side guys. While they wield that same extreme leverage,
their buying is totally voluntary. They don’t need to first borrow
in order to buy low then sell high. Their collective bets just
bounced off a deep 2.7-year low.
Merely to mean revert back to their 52-week high of 356.4k long
contracts, these speculators would have to buy another 119.4k from
the latest CoT week’s low levels. That’s the equivalent of
another 371.5t of gold. Stage-two gold-futures long buying by
speculators generally unfolds over 3 to 6 months. Assuming the
conservative latter gives us about 25 more weeks of buying on
balance, averaging out to 14.9t per week.
That
alone would boost baseline global gold investment demand from the
first half of this year by 68%! And that’s not including
that stage-one short-covering buying. You better believe gold will
power a lot higher from here if world investment demand swells by
2/3rds for a half-year or so on gold-futures long buying. Massive
gold upleg fuel remains on both the short and long sides of gold
futures with current positioning.
When
gold surged 29.9% higher to enter a new bull in the first half of
2016, speculators’ total shorts fell by 82.8k contracts while their
longs soared by 249.2k. That made for 332.0k of total buying.
Including this first CoT week of buying on that mid-October
stock-market plunge, gold’s young upleg today easily has the
potential to see at least 152.7k contracts of short-covering
buying and another 129.3k of long buying.
That
adds up to 282.0k contracts, equivalent to a colossal 877.1 metric
tons of gold! World investment demand in H1’18 totaled just 570.1t
for comparison. With the buying fuel for this upleg running around
85% of what drove early 2016’s 30%ish one, this gold upleg should
have no problem rallying over 25% from its mid-August lows.
That would carry gold to $1467, a
major bull
breakout above the previous $1365 peak.
Nothing excites investors more than new bull-market highs,
which motivates them to chase the strong momentum. They allocate
larger fractions of their vast pools of capital into gold, leading
to sustained buying dwarfing anything the gold-futures speculators
can manage. This stage-three investment buying is what makes gold
uplegs awesome. All the futures buying leading into it is
ultimately just a triggering mechanism.
This
next chart looks at American stock investors’ capital flowing into
and out of gold through the lens of that dominant GLD gold ETF.
Unlike most gold fundamental data only available quarterly, GLD’s
holdings are published daily. They offer a near-real-time view
into whether investors are buying or selling gold. I wrote
a whole essay
in late September explaining the mechanics of GLD and its importance
to gold prices.
GLD’s mission is to track the gold price, but GLD shares’ supply and
demand is independent from gold’s own. Thus GLD’s managers have to
equalize excess GLD-share buying or selling pressure directly into
physical gold itself or this ETF’s share price will decouple. So
GLD effectively acts as a conduit for the vast pools of
American stock-market capital to slosh into and out of gold. GLD’s
changing holdings reflect this.
When
investors are buying GLD shares faster than gold is being bought,
the GLD-share price threatens to breakaway to the upside. GLD’s
managers prevent this by issuing enough new GLD shares to satisfy
the excess demand. Then they plow the resulting proceeds
directly into gold bullion which boosts this ETF’s holdings. So
rising GLD holdings mean investment capital is flowing into gold,
which naturally bids it higher.
But
the opposite happened in recent months as investors dumped GLD
shares faster than gold was being sold. GLD’s share price would’ve
failed to the downside if its managers hadn’t stepped in to sop up
that excess supply. They raised the capital to buy back GLD shares
by selling some of its gold bullion held in trust for shareholders.
Thus falling GLD holdings reveal investment capital flowing out of
gold, pushing it lower.
GLD’s physical-gold-bullion holdings held for its investors peaked
at 871.2 metric tons in late April, and started to shrink as stock
investors pulled capital from gold. Strong stock markets and that
extreme gold-futures-shorting-driven gold selloff contributed to the
bearish sentiment and mass exodus. But that gold-negative trend
reversed sharply when the stock markets started plunging in
mid-October, a major inflection.
Gold
tends to rally when stock markets weaken, making it the ultimate
portfolio diversifier. Between late April and early October, GLD’s
holdings relentlessly dropped 16.2% or 141.0t. GLD’s capital
outflows in Q3’18 were the worst by far since Q4’16 when Trump’s
surprise election victory really goosed the stock markets and thus
hammered gold. By early October, GLD had gone an incredible 2.6
months without any builds!
Remember the S&P 500 clawed to more all-time record highs in late
August and late September, so gold was deeply out of favor with
investors. Why prudently diversify small fractions of stock-heavy
portfolios with counter-moving gold when stock markets seem to do
nothing but rally indefinitely? But that trend reversed hard
that very day the S&P 500 plunged 3.3% out of the blue in
mid-October, GLD demand exploded.
As
stock investors shocked from their euphoric and complacent stupor
rushed to buy GLD shares, there was so much differential buying
pressure it forced a major 1.2% holdings build! That was the
largest in 6.7 months, and the first build at all since late July.
One serious day of stock-market selling was all that was needed for
investors to remember gold. That differential buying pressure
persisted in subsequent days.
GLD’s holdings enjoyed further 0.8% and 0.6% build days late that
week and early the next, and have seen additional builds this week.
This early stage-three investment buying spawned by renewed fears
that stock markets can fall too has already boosted GLD’s
holdings by 2.7% or 19.5t in just a couple weeks. And while stock
selloffs help initially ignite gold investment buying, it soon
becomes self-feeding.
Investors love chasing winners, so buying begets buying. The
more anything rallies, the more investors want to buy it. The more
capital they deploy into it, the more it rallies. That last major
gold upleg back in the first half of 2016 was also sparked by a
stock-market correction, with the S&P 500 retreating 13.3% in 3.3
months. As of this week this latest stock-market selloff was still
a large pullback at 9.4% over 1.1 months.
That
early-2016 correction bottomed in mid-February, as gold was just
nearing $1250. But once it had been ignited, that big differential
GLD buying pressure continued until early July ultimately pushing
gold lots higher to $1365. Most of that gold upleg happened
after the stock markets had already bottomed and started
marching higher again. The thing that killed that gold upleg was
finally a new record high in the S&P 500.
Between mid-December 2015 and early July 2016, GLD’s holdings soared
55.9% or 352.6t higher which was a major driver of that 30%ish gold
upleg. To revisit those bull-to-date-high GLD-holdings levels
today, this ETF would have to add another 252.6t of gold to its
holdings from its recent early-October low. So there’s again plenty
of room for massive stage-three gold investment buying to
catapult this upleg far higher!
Investors were and remain
radically
underinvested in gold, it barely even registers in their
portfolios any more. When GLD’s holdings sunk to 730.2t in early
October, that was a deep 2.6-year low. American stock investors
hadn’t been less deployed in gold since mid-February 2016 when
gold’s last upleg was still young before powering much higher. Like
gold-futures speculators, investors too are positioned for big
buying.
So
gold upleg fuel abounds today! Gold-futures speculators
still have massive stage-one short-covering buying left to do, and
have barely even started their also-huge stage-two mean-reversion
long buying. And the big stage-three investment buying that will
ultimately follow the gold-futures buying is already getting
underway early. Such enormous buying likely coming will drive
gold’s young upleg much higher.
And
while it’s not strictly necessary beyond ignition, I suspect
stock-market weakness will persist and fuel even more gold
investment demand. As I warned at the end of September when the S&P
500 remained near record highs, Q4’18 is the first quarter ever that
would see Fed quantitative tightening run at its terminal
$50b-per-month pace. I wrote an important essay detailing why
that is this
stock bull’s death knell.
To
merely unwind half of the Fed’s $3.6t of QE-conjured money created
in preceding years, QT would have to run at full steam for 30
months! These QE-inflated stock markets trading at bubble
valuations are going to struggle greatly with QT underway. So
October’s stock-market weakness is likely the start of a major bear
market, not a temporary correction before new record highs. That
will greatly boost gold demand!
The
gold miners’ stocks
will really
leverage gold’s coming gains as its young upleg grows. When
gold’s last upleg surged 29.9% higher in the first half of 2016,
that HUI major-gold-stock index skyrocketed an enormous 182.2%
higher in roughly that same span! While that was extreme 6.1x
upside leverage, 2x to 3x is common and expected. Gold stocks are
already amplifying gold’s surge since mid-October by 2x.
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The
bottom line is this young gold upleg is accelerating, greatly
boosted by this month’s unexpected plunging stock markets. Despite
speculators’ record gold-futures short covering on that drop, the
lion’s share of that stage-one gold-upleg-driving buying is still
yet to come. And stage-two gold-futures long buying is barely
starting. So abundant buying fuel remains to propel gold
dramatically higher in coming months.
That
futures buying ultimately ignites the far-larger stage-three
investment buying, which soon takes on a life of its own. But the
shock of that out-of-the-blue stock-market plunge started attracting
investors back to gold early. They remain radically underinvested
in gold, with huge buying to do to reestablish some normalcy in
portfolio allocations. Weaker stock markets will accelerate this
overdue shift of capital back into gold. |