Gold
and silver were thrashed this past summer, relentlessly pounded to
deep new lows. That has fueled extreme bearishness, with traders
convinced the precious metals’ fundamentals are rotten. But epic
all-time-record futures short selling by speculators was the real
culprit. These unprecedented shorts must soon be covered with
proportional buying, which is super-bullish for gold and silver
prices in the coming months.
Traders generally assume fundamentals drive short-term price action,
that real imbalances in supply and demand push prices to
market-clearing levels. Unfortunately these core underlying
dynamics are heavily distorted in gold and silver. Futures
speculators who never own these precious metals are able to wield
wildly-disproportional outsized influence over their prices. The
main reason is extreme leverage inherent in futures.
Investors usually buy gold and silver outright, paying cash in
full. That’s the equivalent of 1x leverage. Every dollar of
investment capital deployed in the precious metals provides one
dollar of buying power to bid them higher. For many decades in the
stock markets, the legal limit to leverage has been 2x. Thus using
the leading GLD SPDR Gold Shares gold ETF or SLV iShares Silver
Trust ETF, investors can hit 2x.
That
effectively doubles their buying power, so each dollar invested in
GLD or SLV at minimum margin puts two dollars of buying pressure on
gold or silver. But borrowing half the purchase price of anything
comes with big risks, also doubling gains and losses on capital
invested. So the great majority of gold and silver investors
prudently prefer buying outright. Futures speculation is a
radically-different world!
Each
CMX gold-futures contract controls 100 troy ounces of gold, while
each CMX silver-futures contract represents 5000 troy ounces of
silver. But futures speculators are barely required to keep any
cash in their accounts to actively trade these contracts. As of
this week, the minimum margin required for each gold-futures
contract was just $3100 and silver-futures contract was only $3600.
That enables extreme leverage.
July
and August were miserable months for the precious metals, far worse
than usual even in the
weak summer
doldrums. Gold dropped 4.2% in that recent short span, while
silver plunged 9.9%. Gold and silver averaged $1217 and $15.29 in
these last couple months, which are relatively-low levels. But 100
ounces of gold and 5000 ounces of silver were still worth a hefty
$121,700 and $76,450 respectively!
That’s what investors would have to pay to own and control that much
gold or silver equivalent to one futures contract. But the futures
speculators only needed to have $3100 or $3600 in their accounts to
effectively control the same amounts of precious metals. That
equates to maximum leverage of 39.3x in gold futures and
21.2x in silver futures! Such extremes allow speculators to
dominate short-term pricing.
Speculators running minimum margin greatly amplify their effective
buying power in gold and silver. Just one dollar deployed in gold
futures can exert up to $39 in pressure on gold prices. Thus
capital deployed by fully-leveraged speculators can have 39x the
gold-price influence as investment capital! Silver futures
aren’t quite as crazy at 21x, but that’s still radically beyond the
2x legal limit in the stock markets since 1974.
This
extreme leverage magnifies risks proportionally, forcing futures
speculators to have an ultra-short-term focus in order to survive.
At 39x leverage, a mere 2.6% gold price move against speculators’
bets would wipe out 100% of their capital risked! At 21x, a 4.8%
adverse silver price move would drive a total loss of capital. So
unlike investors, futures speculators’ entire worldview is condensed
into hours, days, and weeks.
They
are short-term trend riders by necessity, all piling on to whatever
gold and silver happen to be doing regardless of fundamentals. And
since mid-June, they’ve been aggressively crowding in on the
short side of the trade in both gold futures and silver
futures. On June 14th gold and silver looked way different, up at
$1302 and $17.15 on close. It was looking like a decent summer
until a sharp rally erupted in the US dollar.
Tacitly acknowledging that gold is money, gold-futures speculators
look to the US dollar for trading cues. They sell gold
futures when the dollar rises, and vice versa. On that lazy day in
June, the US Dollar Index blasted 1.3% higher. The European Central
Bank had released a huge decision that morning, to finally end its
massive
quantitative-easing campaign as expected. But that hawkish blow
was mitigated by a last taper.
Instead of terminating its QE money printing at the end of
September, the ECB announced it would be cut in half for one more
quarter before ceasing at year-end. A final extension was widely
discussed in trading circles before that ECB meeting, yet for some
reason currency traders still interpreted it as some kind of
dovish surprise. So they sold the euro hard, hammering it 1.8%
lower that day which goosed the US dollar.
Overnight gold-futures speculators started aggressively selling on
that surging dollar, crushing gold 1.7% lower to $1279 the next
day. That unleashed heavy gold-futures short selling which
slowly cascaded as summer wore on. And silver-futures
speculators look to gold for trading signals. Thus as gold spiraled
lower on surging shorting, silver suffered the same thing in
sympathy. It would eventually snowball into a bloodbath.
Thankfully speculators’ gold-futures and silver-futures trading
activity is tracked, so we can observe its impact on prices. Late
every Friday afternoon, the US Commodity Futures Trading Commission
issues a weekly Commitments of Traders report. These detail
speculators’ collective futures positions current to the preceding
Tuesday close. So the latest-available data when this essay was
published was August 28th’s.
CoTs
classically divided futures traders into commercials and
non-commercials. Those are hedgers that use underlying commodities
in their businesses and speculators simply gambling on prices
without any intention of ever seeing those commodities. The
speculators are divided again into large and small, or those that
have to report their futures positions and those that don’t. This
system is now called “Legacy” CoTs.
In
September 2009 these many-decades-old CoT reports majorly changed,
with a new “Disaggregated” format introduced. It separates out
futures positions differently into four new categories which include
money managers. But I still prefer the tried-and-true legacy format
since its history is about 6x longer than the new
disaggregated format. And what those classic CoTs now reveal in
gold and silver is stunning!
These charts superimpose daily gold and silver prices over
speculators’ weekly positioning in gold and silver futures per those
legacy CoTs. The reason gold and silver prices were pummeled 9.9%
and 15.8% lower between mid-June and mid-August was crazy-extreme
all-time-record short selling in gold futures and silver futures!
Speculators’ total long and short contracts are rendered in green
and red respectively.
Gold
was actually enjoying a solid resilient summer before mid-June.
Remember that was when the supposedly-dovish ECB announcing the end
of its huge QE campaign crushed the euro and thus boosted the US
Dollar Index. The last CoT before that fateful day came a couple
days earlier on June 12th. At that point speculators held 240.9k
gold-futures long contracts and 100.3k short ones, perfectly-normal
levels.
But
for some strange reason, that 1.3% USDX surge sparking a 1.7% gold
plunge the next day unleashed utterly-fierce gold-futures short
selling. In the CoT week straddling that pivotal event, specs added
a truly-astounding 35.5k gold-futures shorts! That ranked as the
2nd-highest ever witnessed out of 1026 CoT weeks since early
1999. That’s where our CoT dataset goes back to, encompassing the
entire modern era.
And
that excessive short selling fed on itself instead of
abating. The more gold-futures speculators were effectively
borrowing to sell short, the lower gold prices fell. That
encouraged more traders to climb on to that gold-shorting
bandwagon. In any single CoT week, any change in spec longs or
shorts that’s larger than 20k contracts is considered huge. The
subsequent summer shorting oscillated around that extreme level.
After that initial epic shorting blitz, 6 of the next 8 CoT weeks
saw spec gold-futures shorting just keep on ballooning with 14.7k,
17.9k, 29.0k, 13.4k, 19.7k, and 19.7k short contracts added!
Nothing like this has ever happened before, it was far beyond any
precedent. That incredible extreme record shorting spree didn’t run
its course until the August 21st CoT, forcing total spec shorts up
to 6 new all-time records in the process!
I’m
calling these all-time records because I’ve seen complete charts of
the full history of CoT data, but again our dataset goes back to
early 1999. Before the last couple months, the previous record of
specs’ total gold-futures shorts was 202.3k contracts in August
2015. But between the CoT weeks ending on July 24th to August 21st,
stunning new records of 209.7k, 211.4k, 231.1k, 250.8k, and 256.7k
contracts were hit!
Running from the weekly CoT reports current to Tuesday closes, gold
dropped 7.8% over that incredible 10-CoT-week span where total spec
shorts skyrocketed from 100.3k contracts to 256.7k. That
156.4k-contract surge in gold-futures shorts was the largest ever
witnessed, an insane orgy of short selling. And it bears the full
futures blame for gold’s fall, as speculators actually added 17.5k
gold-futures longs in that span.
On
the last CoT Tuesday before this epic shorting, gold closed at
$1295. When the dust had settled, it was pummeled to $1194 on the
CoT Tuesday spec shorts peaked. So gold fell about $100 on the
most-extreme gold-futures short selling in history by far. That
really discouraged traders not paying attention to why gold fell,
leading them to assume poor fundamentals must be to blame. But it
was really just shorting.
Extreme gold-futures short selling is exceedingly bullish for
gold! Relatively-high spec shorts mark major gold bottoms right
before major new uplegs or even entire bull markets are born.
Today’s gold bull birthed in December 2015 ignited out of
near-record shorts. And ever since gold has soon rallied sharply
out of relatively-high spec shorts, which spark major uplegs. These
recent episodes are highlighted in red above.
There’s nothing more bullish for gold than extreme spec shorts
because of how short selling works. Most trading attempts to first
buy low then later sell high. But short selling reverses this
normal order, starting with selling high before later attempting to
buy low. Speculators can’t sell something they don’t have though,
so they have to effectively borrow gold futures to short
them. These debts must soon be paid back.
Mechanically gold-futures shorts are effectively repaid and closed
by buying offsetting long contracts. So excessive spec shorts are
literally guaranteed proportional near-future buying! These
traders are legally obligated to cover their shorts in the near
future. They are usually the only buyers out of major gold lows,
and that buying to cover is mandatory. And just like shorting, that
covering soon becomes self-feeding.
In
gold-futures trading, the downside gold-price impact of selling a
long contract owned or shorting a new contract is identical. So is
the upside impact of buying a new long contract or buying one to
offset and close a short. The more buying to cover speculators do,
the faster gold’s price rises. And the sharper gold’s climb, the
more other speculators are forced to cover their own shorts or face
catastrophic leveraged losses.
Thus
short-covering gold-futures buying quickly snowballs, catapulting
gold sharply higher. Gold uplegs actually have
three major
stages, and futures short covering is the first one. This
involuntary mandatory buying pushes gold high enough for long enough
to encourage other futures speculators to return on the long side in
stage two. Eventually gold’s gains grow large enough to entice back
investors in stage three.
The
scale of this summer’s extreme gold-futures shorting was off the
charts, which means the inevitable coming short-covering will be
proportionally huge. Again over that 10-CoT-week span from
mid-June to late August, total spec shorts skyrocketed 156.4k
contracts. That works out to a 15.6k-contract-per-week shorting
rate. In the standard metric-ton terms gold fundamentals are
usually discussed in, that’s 48.6 tonnes.
The
definitive arbiter of global gold supply-and-demand data is the
World Gold Council, which publishes awesome Gold Demand Trends
reports quarterly. Q2’18’s was released in early August. In the
first half of this year, total global gold investment demand ran
570.1t. That averages out to 21.9t per week. Yet in that wild
10-CoT-week summer-shorting-spree span, futures specs were puking
out 48.6t of new supply weekly!
So
it’s no wonder gold prices fell so sharply with futures supply
more than doubling the normal investment demand. While gold
futures are nearly completely paper gold, not traded physically, the
world reference gold price is based on gold-futures action. So it
plunged on that extreme gold-futures short selling. But gold will
bounce right back up in symmetrical proportional fashion when the
short covering gets underway.
To
mean revert back down to mid-June levels of 100.3k, total spec
shorts need to collapse by 156.4k contracts from their epic
all-time-record high of 256.7k on August 21st. Short-covering
rallies unfold fast out of extremes, over a couple months or
so. Speculators can’t afford to hold on to their shorts for long as
gold rallies against their hyper-risky leverage. This implies
buy-to-cover rates of 19.5k contracts weekly for 8 weeks.
That’s the equivalent of 60.8t of gold per week, or nearly triple
the average H1’18 global gold investment demand! And gold-futures
short-covering buying is on top of normal investment demand, so
overall it is poised to quadruple. Gold will rocket higher on such
heavy buying. And that’s conservative, as after past extreme
shorting episodes total spec shorts tended to not only mean revert
but overshoot to the low side.
That
would at least slash them back to their 52-week low of 82.5k
contracts seen back in late March. If you run the numbers, that
implies 174.2k contracts of short-covering buying which is the
equivalent of a massive 67.7t per week over that typical
couple-month short-covering span! And short-covering buying doesn’t
happen in isolation, again the resulting sharp gold-price gains
bring back other long-side traders.
They
control way more capital than short sellers, as evidenced by the
green total-longs line above being much higher than the red
total-shorts line the vast majority of the time. Total spec longs
are quite low today given the extreme bearishness in gold, just
252.9k contracts in the latest August 28th CoT. That’s just 10% up
into their past-year trading range. Getting back to the top would
require another 147.3k of buying!
Stage-two spec gold-futures long buying generally unfolds over 3 to
6 months. In tonnage terms that would add another 35.2t to 17.6t of
weekly buying on top of normal gold investment demand as well
as the initial short-covering frenzy! The resulting coming gold
gains ought to be big and fast coming from today’s crazy-extreme
all-time-record levels of spec gold-futures shorting. Consider the
precedent here.
Back
in early December 2015, total spec shorts neared then-record levels
at 191.6k contracts. Gold was hammered to a 6.1-year secular low on
irrational
Fed-rate-hike fears. But as specs were forced to cover which
unleashed huge mean-reversion long buying, gold soared 29.9% higher
in just 6.7 months! Gold sentiment was even worse in late 2015 than
it has been in recent weeks, universal bearishness flags lows.
Fast-forward to summer 2017, when gold plunged on extreme
gold-futures shorting once again on those historically-baseless
Fed-rate-hike
worries. That July I published an essay with a similar analysis
and contrarian bullish outlook as today’s called
Gold/Silver
Shorts Extreme. In it I explained that the near-record extremes
in gold-futures and silver-futures shorts were incredibly bullish
over the near-term.
Spec
gold-futures shorts soared to 189.2k contracts in mid-July 2017,
closing in on an all-time record at the time. That certainly wasn’t
sustainable, a spark to ignite the guaranteed proportional
short-covering buying was soon inevitable. And indeed it blasted
gold 11.2% higher in just 2.0 months. A similar rally today off of
mid-August’s deep 19.3-month gold low of $1174 would drive it back
up to $1305 by mid-October!
But
with total spec shorts a whopping 35.7% higher this time
around, the resulting gold rally driven by mandatory short covering
should be at least proportionally larger. We’ve never before
witnessed a short squeeze as frantic gold-futures speculators
attempt to unwind at least 156.4k excessive short contracts as
rapidly as they can. It wouldn’t surprise me at all to see gold
surge 20%+ over the next few months or so.
That
would catapult it to $1408 off those mid-August lows, which would
yield the long-awaited
major bull-market
breakout above $1350. New bull highs nearing $1400 would
motivate investors with their vastly-larger pools of capital to
flood back into gold, kicking off stage three early. And
they have a lot of buying to do to reestablish positions. Since
mid-June, GLD’s physical gold-bullion holdings have dramatically
plunged.
Because that gold-futures-driven price is gold’s dominant reference
one, particularly-one-sided trading by the gold-futures speculators
can drag investors in. The price action resulting from
speculators’ short-term gold-futures machinations can overpower
investors’ normally-rational psychology. This summer they
sold aggressively
in sympathy, pummeling GLD’s holdings 9.9% or 81.8t lower.
That’ll be bought back as gold recovers.
The
situation in silver futures is even more bullish, with spec shorts
way up at an even-more-extreme all-time-record high of 120.2k
contracts in late August! That is mind-bogglingly epic, so all this
gold-futures short-covering analysis applies to silver futures
too. Just like gold, silver is on the verge of its biggest
short-covering frenzy ever witnessed. Silver’s coming
mean-reversion rebound rally ought to well outstrip gold’s.
I
won’t rehash all the gold analysis for silver, but consider silver’s
numbers. The 52-week low in specs’ silver-futures shorts was 41.5k
contracts in mid-September 2017. Getting back there would require
an astounding 78.6k contracts of short-covering buying. That’s the
equivalent of 393.3m ounces of silver! If that short-covering
buying unfolds over 8 weeks, it would boost global silver demand by
49.2m ounces a week.
According to the venerable Silver Institute, in 2017 total global
silver demand ran 1017.6m ounces. That is the equivalent of 19.6m
weekly, which includes everything not just investment demand. The
coming silver short-covering frenzy has the potential to boost this
by 251% for a couple months or so! There’s no way silver wouldn’t
soar on such proportionally-extreme silver-futures buying. Silver
too looks wildly bullish.
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 just rocketing
up to crazy-extreme all-time-record highs in recent weeks, gold and
silver look exceptionally bullish today. We are likely on the verge
of massive new uplegs in these precious metals, yielding big gains
for smart contrarians.
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
radically undervalued today, having just suffered a rare
capitulation plummet as gold and silver plunged on that record
shorting. They’re screaming buys!
At Zeal we’ve
literally spent tens of thousands of hours researching
individual gold and silver stocks and markets, so we can better
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The key to this
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The
bottom line is speculators’ gold-futures and silver-futures short
positions have soared to crazy 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 inherent in gold futures and silver
futures. The resulting sharp short-covering rallies soon entice in
new long-side futures speculators and later investors with their
vastly-larger pools of capital. Record futures shorts are the best
gold and silver buy signals available. |