The miserable
summer for precious metals grinds on, with both gold and silver
limping along near major lows. Such dismal price action has
exacerbated the extreme bearishness long plaguing this sector,
sparking even more capitulation. But this incredible weakness will
be short-lived, as it was driven by American futures speculators?
record short selling. That will soon reverse into guaranteed,
proportional buying.
In all markets
including precious metals, price is rightfully considered the
most-important fundamental signal. Prevailing price levels
are set by free-market buying and selling until supply and demand
meet. And gold and silver prices are exceptionally weak, with these
despised precious metals slumping down to challenge major new
5.2-year and 5.4-year lows this week. So their fundamentals must be
bearish, right?
The only
fundamental factors that can drive prices near major secular lows
are too much supply, too little demand, or some combination of the
two. And if the gold and silver markets are as oversupplied as
their prices indicate, they?re likely to keep drifting lower
indefinitely. This popular bearish thesis is universally believed
today, with virtually no dissent. There aren?t many contrarians
left to combat this overpowering groupthink.
But what if the
withering selling pressure devastating gold and silver this summer
is artificial? What if the traders dumping the precious
metals don?t actually own them in order to sell them? What if
2015?s apparent glut of gold and silver has been mostly borrowed
first and then sold? And what if these short sellers used extreme
leverage to dump these metals? This scenario radically changes
precious metals? outlook.
When traders who
actually own gold and silver sell it, they never have an obligation
to buy it back. And that?s the kind of potentially-permanent
selling the bearish consensus assumes is happening today. But short
selling is vastly different, as traders who don?t own gold and
silver have to borrow them first before selling. And these debts
must soon be repaid contractually and legally, making all short
selling temporary.
Short selling is
artificial and short-lived because every single ounce borrowed and
sold will be rebought in the open markets in the near future. Since
all short selling guarantees proportional buying as those
shorts are covered, price levels driven by shorting are a transitory
illusion that is not fundamentally righteous. And that?s exactly
what?s happening in both gold and silver today, a
short-selling-fueled fantasy.
American
speculators have just mushroomed their short positions in gold
futures and silver futures to all-time record highs! They
have never had bigger leveraged downside bets on the precious
metals, and thus have never had more near-term buying to do. When
this inevitable short covering begins, gold and silver prices are
going to surge dramatically higher. And then they will finally
reflect actual global fundamentals.
Unfortunately most
investors don?t follow gold and silver shorting, which is why
they?ve succumbed to the bearish hype today. It is overwhelmingly
centered in the American futures markets. Once a week, the US
Commodity Futures Trading Commission publishes reports detailing
futures positions called the Commitments of Traders. But these are
large, complex, and esoteric, certainly not easy to understand.
But since American
futures speculators have utterly dominated gold and silver
trading in recent years as investors fled, digging into the CoTs is
essential for serious investors. They fully explain why gold and
silver have been so weak, and why current price levels don?t reflect
global fundamentals. Our charts this week look at American
speculators? total long and short positions in gold and silver
futures, now at records.
The CFTC releases
its CoT reports late every Friday afternoon, current to the
preceding Tuesday close. So this data is the latest available when
this essay was published. And it shows astoundingly bullish
conditions in both gold and silver, with American speculators
legally on the hook to soon buy truly vast amounts of both precious
metals to close their extreme positions! A record short-covering
frenzy is imminent.
As of the last CoT
week, American speculators had borrowed to sell short an
unbelievable 179.0k gold-futures contracts! This was the highest
level seen in at least 16.5 years since early 1999, the extent of
our CoT data, and almost certainly ever. This latest record
narrowly eclipsed the previous record of 178.9k contracts shorted in
early July 2013. And that earlier event illustrates why excessive
shorts are so bullish.
Back in early
2013, the US Federal Reserve?s wildly unprecedented open-ended
third
quantitative-easing campaign ramped up to full steam. Unlike
QE1 and QE2, QE3 had no predetermined size or end date. Fed
officials used this to their advantage to actively manipulate
stock-market psychology. They were constantly jawboning about
ramping QE3 if necessary to arrest any material stock-market
selloff.
The Fed-fostered
notion that it was effectively backstopping stock markets
radically distorted the whole world?s financial markets. Traders
started to perceive stocks as riskless, and soon forgot that markets
are forever cyclical. They shunned prudent portfolio
diversification and sunk all their capital into levitating stock
markets, quickly buying every dip. And they dumped everything else,
including gold and silver.
This incredibly
unprecedented shift of capital away from precious metals into the
Fed-levitated stock markets was catastrophic. It led to
epically-extreme
gold-ETF selling in 2013?s second quarter, leading to gold
plummeting 22.8% then! That proved to be a hundred-year storm,
gold?s worst quarter in 93 years! So everyone including
American futures speculators figured gold was doomed to keep
spiraling lower indefinitely.
Thus they
aggressively borrowed all the gold futures they could and sold them,
ballooning their shorts to that last record in early July 2013.
Since gold had just plunged so drastically, there?s no doubt that
the popular fear and bearishness then was far greater than it is
today. Betting on gold falling farther looked like an easy sure
bet. But it was anything but since futures short selling
played such a big role in that drop.
Every gold-futures
contract controls 100 ounces of the yellow metal, which was worth
$120k at $1200 gold levels back then. But the futures regulators
only required traders to keep just over $5k of capital in their
accounts to borrow and sell each $120k contract! That represented
maximum leverage of 29 to 1, insanely risky compared to the
decades-old legal limit in stock markets of 2 to 1. Such positions
aren?t durable.
If gold merely
rallied 3.5% out of those extreme summer-2013 lows, fully-leveraged
futures speculators would lose 100% of their capital risked.
Anything beyond 3.5%, and they would have to throw additional
capital in to maintain the required margin. So once gold inevitably
started rallying again from the most extreme levels of despair we?ll
see in our lifetimes, these leveraged futures speculators quickly
rushed to cover.
The way short
positions are closed in futures markets is by buying offsetting
long contracts. The upside price impact from buying a long
contract to close a short or buying a new long is identical. Over
the next 16 weeks, American futures speculators bought 95.3k long
contracts to cover their shorts. Despite one of its worst sentiment
environments ever, gold still powered 18.2% higher in under 9 weeks
on this short covering alone!
Short selling is
very different from normal long selling since it must all soon
reverse into guaranteed and proportional long buying. So a
major price low in any market driven by extreme short selling is
always short-lived. This has played out multiple times in gold in
recent years, as this chart reveals. Speculators will borrow and
sell gold futures, driving it down to a major low. But then they
will rush to cover, and gold surges.
Gold has rarely
faced a tougher scenario than the past couple years. The
Fed-levitated
stock markets destroyed the demand for critical
portfolio-diversifying alternative investments, led by gold. The
resulting extreme gold weakness devastated gold psychology, leaving
it overwhelmingly bearish. On top of that, the US dollar
rocketed
parabolic since last summer, another product of the Fed?s epic
market distortions.
Yet even facing
such howling headwinds with everything stacked against it, gold
still saw sharp short-covering rallies after American futures
speculators? shorts grew too excessive. This created a trading
range of these positions in recent years as you can see in this
chart, running from about 75k-contract support up to 150k-contract
resistance. Speculators? shorts returned to support multiple times
in recent years.
And right after
episodes when these leveraged downside bets on gold exceeded 150k
contracts like they are at today?s record, major short covering soon
ensued. This led to sharp gold rallies blasting 16.2% higher in
10 weeks on average. These are big gains anytime, let alone
when everyone is hyper-bearish on gold. And since speculators?
gold-futures shorts are so epic today, the next short-covering rally
will likely be huge.
Even since 2013 in
these surreal Fed-distorted markets, speculators have bought to
cover their total shorts down to 75k contracts several times. The
last short-covering spree ended in early February 2015 at 70.4k
contracts, a buying frenzy that catapulted gold 14.2% higher in just
over 10 weeks. So it is very conservative to expect speculators to
once again buy down their short positions to return back to 75k
support.
From their current
record extreme of 179.0k, it will require a staggering 104.0k of
long-contract buying to return to 75k. And since each contract
controls 100 ounces of gold, this collectively represents 323.5
metric tons of buying on short covering alone by this single
group of traders! That is a colossal amount of gold buying in a
short period of time, several months on the outside. Short covering
soon feeds on itself.
Today at $1150
gold, each futures contract is worth $115,000. Yet the minimum
maintenance margin per contract is now only $3750. So futures
speculators can run leverage up near 31x, astoundingly
risky. At such levels, a mere 3.3% gold rally would wipe out 100%
of the capital they risked! So once gold starts moving, these
speculators have to rapidly cover to avoid catastrophic losses. So
they buy aggressively.
And their very
short covering accelerates gold?s gains, putting pressure on the
rest of the speculators who are not running minimum margin and
maximum leverage. So they are soon forced to buy to cover too,
putting even more upside pressure on the gold price. So once even a
minor gold rally ignites a serious bout of short covering, it rarely
stops until it has fully run its course. And today we are in for a
massive one!
That 104k
contracts of short covering necessary to return to recent years?
support of 75k again is the equivalent of 323.5 tonnes of gold. And
it will all hit over several months or so. Let?s call it 3, since
the average duration of short-covering frenzies in recent years is
10 weeks. That is 107.8t of additional gold demand monthly
that doesn?t exist now. And according to the World Gold Council,
that is wildly bullish.
The WGC?s latest
figures showed average global investment demand in gold of 92.9t per
month in the first quarter of 2015. So for the several months it
takes to unfold, American futures speculators? short covering alone
will increase worldwide gold investment demand by an amazing
116%! This will fuel a sharp gold rally as always. At the
recent-year average of 16.2%, gold would surge to $1335 in 10 weeks.
But I strongly
suspect that gold?s imminent short-covering rally will be
significantly larger coming from such extreme record levels of short
selling. The bigger the short positions, the more buying is
naturally required to unwind them back to reasonable levels. So
instead of gold looking utterly hopeless today as everyone believes,
it has an exceedingly-bullish setup. Major lows fueled by shorting
are artificial and short-lived.
There are a couple
more key observations from this gold chart before we move on to
silver. Note that the gold price has had an incredibly-strong
inverse correlation with American speculators? total level of
gold-futures shorts in recent years. When this short selling is
temporarily adding futures supply, gold falls. And when it reverses
into buying, gold rallies. Speculators? shorting is literally
the whole story on gold recently!
With investors
still missing in action thanks to the Fed?s gross market
distortions, speculators are ruling the roost. But provocatively,
gold has been relatively resilient despite their extreme shorting
this year. Even in the midst of its worst time of the year
fundamentally in terms of
seasonal demand
spikes, the gold price hasn?t fallen below its
early-November-2014 lows despite speculators? futures shorting being
much higher.
That means there
are buyers out there absorbing this excessive gold-futures selling.
Imagine how much this latent demand will explode once gold rallies
enough to convince these hardcore contrarians that things are
finally changing. Gold is poised for a massive short-covering
rally, almost certainly the largest one in recent years given
the record extremes of shorts that have to be bought back. This is
super-bullish!
And amazingly, the
situation is even more extreme in silver futures.
Speculators also just ramped their leveraged downside silver bets to
their highest levels since at least 1999, and almost certainly
ever. And unlike gold which barely edged out record shorting,
today?s silver-futures shorting is far higher than the last record.
So silver too is on the verge of a massive-if-not-record
short-covering frenzy running parallel with gold?s.
In this latest CoT
week, American futures speculators? total short bets on silver
soared to 81.6k contracts! This is astoundingly high, levels that
defy all reason. In recent years, these positions have returned to
27k-contract support no fewer than 5 times. Mean reverting to that
same level from today?s extremes will require 54.6k contracts of
short-covering buying. And at 5000 ounces per contract, that is a
vast amount of silver.
We are talking
about 273.0m ounces of silver that will be bought in the
futures markets within several months or less. Assuming 3 months,
this equates to marginal new buying that doesn?t exist today of
91.0m ounces per month! According to the Silver Institute, average
global silver investment demand in 2014 ran just 16.5m ounces a
month. So this short covering alone would temporarily boost that
demand by 552%!
Short-covering
episodes in recent years have fueled silver gains of up to 32.6% in
just over 8 weeks. And while silver prices also have a strong
inverse correlation with speculators? futures shorting, this
relationship has moderated in the last year or so. I suspect the
reason is sentiment plays a far-greater role in silver?s
price levels than in gold?s. And silver?s sentiment is totally
dependent on gold?s fortunes.
So silver is
essentially
slaved to gold, with traders always looking to gold?s price
action for their silver trading cues. Silver can?t enjoy major
uplegs unless gold is rallying and traders expect it to keep on
climbing into the future. Obviously with gold sentiment so
hyper-bearish in recent years, this necessary prerequisite to strong
silver uplegs hasn?t existed. But sentiment is forever cyclical,
bullishness will return.
A secondary reason
silver?s short-covering upside price action has been muted in the
past year is its lower leverage. At $15 silver each futures
contract controls $75,000 of this metal, but the minimum margin is
still $7,000 per contract. That works out to maximum leverage under
11x, far lower than the 31x in gold futures. Lower leverage means
lower risk, which makes short covering somewhat less frantic.
But with
speculators? total silver-futures short positions so mind-bogglingly
high, odds are the coming silver short-covering frenzy will really
surprise to the upside. Of course investors and speculators can bet
on these coming mean reversions of excessive futures shorting in
physical gold and silver and their leading ETFs, the GLD SPDR Gold
Shares and SLV iShares Silver Trust. But they will only pace the
metals? gains.
Radically-greater
upside exists in the beaten-down gold and silver miners! Just this
week, their leading index slumped to an astounding 12.1-year low.
The last time gold and silver stocks were trading at these dismal
price levels, gold and silver were trading near $350 and $5! These
miners are truly priced at
fundamentally-absurd levels today with gold and silver 3.3x and
3.0x higher. They will greatly leverage the metals? gains.
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The bottom line is
American futures speculators? gold and silver shorts just surged to
record levels. It was almost exclusively this marginal supply that
recently forced the precious metals down near major secular lows.
But borrowed futures are temporary artificial supply that must soon
reverse into guaranteed proportional buying as they are covered.
Thus excessive shorting is an exceedingly-bullish omen.
Even in recent
years with gold and silver facing howling headwinds from the
Fed-distorted stock and currency markets, the futures-short-covering
episodes fueled large double-digit gains unfolding over a few months
or less. And given today?s record levels of shorts, the next
short-covering frenzy is likely to drive considerably-larger
rallies. They will greatly improve sentiment, getting even
investors interested again.
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