Investors have pulled much capital out of gold in recent months in a
major mass exodus. Their sentiment waxed very bearish as gold was
pounded lower by extreme record gold-futures short selling. The
latest record stock-market highs also suppressed the perceived need
for diversifying portfolios with gold. But this heavy investment
gold selling is slowing, and should reverse sharply once stock
markets roll over again.
Not
too long ago in mid-June, gold was trading at $1302. It looked
fairly strong for the summer doldrums, its weakest time of the year
seasonally. But selling would soon return with a vengeance,
pummeling gold 9.9% lower over the next 2.1 months into mid-August.
That major slide leading into a late-summer low of $1174 certainly
cast a dark pall over psychology, fueling surging bearishness that
remains ubiquitous today.
While investment selling wasn’t the primary driver, it ultimately
contributed in a big way. This gold selloff that started normal
before snowballing to anomalous proportions was initially sparked by
a sharp rally in the US Dollar Index. It rocketed 1.3% higher in
mid-June on a major European Central Bank decision. It announced it
was finally ending its massive quantitative-easing campaign at
year-end, as widely expected.
But
the ever-cunning ECB officials led by Mario Draghi sought to soften
that hawkish blow with a side promise not to hike rates “at least
through the summer of 2019”. The euro plunged 1.8% on that, goosing
the US dollar. American gold-futures speculators took note, as they
often make trading decisions cueing off of short-term dollar
action. So they sold aggressively overnight, hammering gold 1.7%
lower the next day.
That
startling drop kicked off a self-feeding chain reaction that
cascaded for a couple months. Extreme short selling of gold
futures by speculators forced gold lower. The weaker prices
convinced these same traders to keep piling on more shorts, which
pushed gold lower still. This vicious circle of leveraged short
selling ultimately catapulted speculators’ total shorts to a series
of new crazy-extreme all-time record highs.
All
gold investors and speculators need to understand this dynamic, and
I explored it in
depth in an essay just a couple weeks ago. That
wildly-unprecedented gold-futures shorting is the primary reason
gold fell so sharply from mid-June to mid-August. But it had an
unfortunate side effect of spooking investors, so they too
soon started selling in sympathy. Those heavy investment outflows
exacerbated gold’s decline.
The
resulting gold selloff was very anomalous even for the summer
doldrums. This first chart is updated from my
early-June essay
warning about these then-imminent summer doldrums. It reveals how
gold has performed during the summers of every modern bull-market
year, from 2001 to 2012 and 2016 to 2018. To keep differing price
levels comparable, every year is individually indexed to 100 as of
May’s final close.
With
all gold action recast off that common base, this year’s huge
divergence from norms is very evident. The yellow lines show
individual-year indexed gold action, which tended to drift in a
+/-5% range from the last pre-summer close. All those yellow lines
are averaged together in the red line. That shows gold is usually
weakest in June, recovers in July, and then starts powering higher
in its strong seasonal autumn rally.
But
that usual summer script sure didn’t play out this year! The gold
action was sideways like usual into mid-June, but then deteriorated
sharply. Thanks to the extreme record gold-futures shorting on that
dollar rally along with the investment selling it spawned, gold
plunged 3.5% in June. That was far worse than the 0.2% average
slide in June in these modern bull-market years. That heavily
tainted sentiment in gold-land.
As
selling fueled even more selling gold fell another 2.3% in July,
also way behind its typical 0.9% gain that month. And the carnage
didn’t end in August despite gold carving a mid-month capitulation
low as speculators’ epic record gold-futures-shorting binge
climaxed. Gold shed another 2.0% last month, way behind its 2.2%
average August gain. So summer 2018 challenged 2008’s for the worst
of this modern era!
There are two key points here. First, this recent action was
incredibly anomalous even by gold’s weak standards in the summer
doldrums. It’s not often that gold-futures speculators short sell
at extremes that history had never before shown were even possible.
And to have that epic shorting orgy coincide with new stock-market
record highs was rotten luck. The resulting investment selling was
very abnormal too.
Second, this frenzy of heavy gold selling opened up a huge
divergence between where gold is now and where it ought to be
this time of the year. Normally gold’s
major autumn
rally is well underway by mid-September. The farther any market
is dragged from norms by extreme unsustainable action, the greater
the odds of an imminent mean reversion. Gold should surge fast as
the recent wild selling inevitably reverses.
The
primary driver of gold’s coming snap-back rally will be record
gold-futures short-covering buying that is proportional to
recent months’
record-extreme shorting. And investment buying will bolster and
amplify that, just like investor selling did on the way down. The
more gold rallies, the more investors are attracted to deploy
capital back into it. The near-term upside alone is big given the
huge seasonal divergence now.
Normally in bull-market years, gold is trading 4.9% above its final
pre-summer close by this week. But this year it’s a whopping 7.3%
under May’s exiting level now. To fully close this gap, gold would
have to surge 13.1% higher from here to $1362! And the coming rally
ought to unfold rapidly. Gold-futures short covering out of
extremes can quickly mushroom into full-blown short squeezes due to
futures’ extreme leverage.
Gold’s investment situation today isn’t as crazy as those epic
record gold-futures shorts, but it is still way lower than normal
and thus very bullish. This next chart looks at the physical gold
bullion held in trust for investors in the leading and dominant GLD
SPDR Gold Shares gold ETF. GLD’s holdings offer a unique
high-resolution read on what’s going on with gold investment
demand, as they are actually reported daily.
Most
gold fundamental data is only available quarterly, or monthly at
best. GLD’s holdings offer a near-real-time view of whether
investors are buying or selling gold. It is the world’s largest
gold ETF by far in terms of holdings, according to the World Gold
Council. At the end of Q2’18, GLD’s 819.0 metric tons of gold were
3.0x larger than its next-biggest competitor’s. The largest foreign
gold ETF in Germany only held 181.7t.
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.
This
chart divides GLD-holdings and gold-price action into calendar
quarters. That happens to be very useful for fundamental analysis
because the World Gold Council’s definitive reads on global gold
supply and demand also cover calendar quarters. Called Gold Demand
Trends, these excellent quarterly reports are essential reading for
all gold investors. They help illuminate a great deal in the
often-murky gold markets.
Gold’s price change in each calendar quarter is noted above, along
with both GLD holdings’ percentage and absolute-tonnage changes in
these same spans. The latter are highlighted in green when they’re
a build, showing stock-investor capital flowing into gold. Yellow
shows draws, when investors are selling gold to pull capital out.
GLD’s draws have been major recently as investors fled the
record gold-futures shorting.
This
summer’s gold-investment-selling story starts earlier though, back
in mid-April. Gold was trading at $1352 then, right on the verge of
a major
bull-market breakout that would’ve unleashed much investment
demand. But then a strong US Dollar Index short-squeeze rally
erupted, propelling the dollar up sharply for about 6 weeks or so.
That also motivated the gold-futures speculators to sell short,
driving gold lower.
So
after hitting a 10.0-month high of 865.9t in mid-April, the heavy
differential GLD-share selling actually started in early May. By
the end of May heading into the summer doldrums, GLD’s holdings were
off 2.2% already to 847.0t. After another sharp drop in early June,
they stabilized at 828.8t for a couple of weeks running. But as
gold started falling on that extreme gold-futures short selling,
investors worried.
There were 44 trading days between mid-June and mid-August where
gold plunged 9.9%. During this span, GLD suffered 22 separate draw
days averaging a substantial 0.4%! That compares to just 3 build
days, so gold investment selling dominated. Overall GLD’s
holdings fell 6.7% during that summer gold drop, this ETF forced to
spew out 55.3t of physical gold bullion as investors fled gold with
it spiraling lower.
And
that heavy investment selling didn’t cease as gold bottomed near
$1174 in mid-August. Investors kept on liquidating gold, dumping
their GLD shares faster than gold itself was being sold. Short-term
trends in gold investment demand are ignited and largely driven by
the gold price action resulting from the gold-futures speculators’
leveraged trading. Investment-capital flows lag futures and
take on a life of their own.
In
financial markets, buying begets buying and selling begets selling.
Most traders simply pile on existing trends, they aren’t
contrarians. So despite gold bouncing since mid-August as those
epic record futures shorts started to be covered, the investment
selling continued. As of the middle of this week gold had rallied
2.6% out of its deep mid-August low to $1204. Yet the heavy
differential GLD-share selling persisted.
GLD’s holdings fell another 4.0% to 742.2t in this past month or
so. Out of another 23 trading days, fully 12 suffered draws
averaging 0.3%. There wasn’t a single GLD build, no capital flowing
into gold from the US stock markets. While Q3’18 isn’t quite over
yet, quarter-to-date GLD’s holdings have plunged 9.4% or 76.8t!
That’s a major reason along with that futures-shorting frenzy that
gold’s price is 3.9% lower QTD.
Unfortunately the WGC’s new Q3’18 GDT won’t be published until early
November, about a month after quarter-end. So there’s no way yet to
understand just how material GLD’s big 76.8t QTD draw has been to
overall global gold demand. But this is serious differential
selling, on track for the biggest quarterly draw by far since
Q4’16! Then GLD’s holdings plummeted 13.3% or 125.8t helping crush
gold 12.7% lower.
Remember what happened in Q4’16? Trump stunned the world by pulling
off a universally-unexpected surprise election victory to win the US
presidency. Gold was consolidating high before that, but started to
plunge afterwards as stock markets soared on taxphoria. With the
Republicans newly controlling not only the presidency but both
chambers of Congress, investors flooded into stocks on hopes for
big tax cuts soon.
Gold
is a contrarian asset class, the ultimate portfolio diversifier. It
tends to thrive when stock markets are weakening. So as they surged
after that fateful late-2016 election, gold was sold hard. And that
extreme differential GLD-share selling played a dominant role
globally. Per the WGC’s latest data, worldwide gold demand fell
103.2t year-over-year in Q4’16. GLD’s massive 125.8t holdings drop
accounted for 122% of that!
So
had American stock investors not pared their gold exposure by
dumping GLD shares, gold’s worldwide demand would’ve risen. And
gold would’ve likely rallied. When American stock investors stage a
mass exodus from GLD shares, that resulting physical gold bullion
puked into the markets hammers gold much lower. I strongly suspect
we’ll see the same thing in Q3’18, that GLD’s draws will dominate
overall global demand.
Recent months’ heavy gold-investment selling actually forced a major
breakdown in GLD’s holdings in the context of this young gold bull.
Gold indeed remains in a bull market birthed from deep secular lows
back in mid-December 2015 because it has yet to see a 20%+ retreat
from peak levels. For the great majority of this bull-market span,
GLD’s holdings rarely fell below 800t. That acted as strong
support in gold selloffs.
But
the summer-2018 gold selling was so overpowering that GLD’s holdings
were driven modestly below 800t in mid-July before falling
decisively under in early August. Odds are that strong bull-market
support will soon be regained, requiring big investment gold
buying. The catalyst could simply be gold rallying on extreme
gold-futures short covering bringing back investors. But stock
markets will likely play a major role!
The
main reason gold consolidated and drifted on balance from Q1’17 to
Q2’18 was investors were largely missing in action. GLD saw
neither significant builds nor draws in any of those 6 quarters, so
gold couldn’t do much even on futures speculators’ endless
machinations. It wasn’t until this current quarter that gold broke
lower partially on heavy differential GLD-share selling.
Stock-market selling will turn this around.
This
last chart looks at gold superimposed on the flagship American S&P
500 broad-market stock index (SPX). The big thing that highly
motivates investors to return to gold is correction-grade
selloffs in the US stock markets. Those are 10%+ declines in
the SPX. It was actually moderate SPX corrections marching in
back-to-back that originally ignited this gold bull in the first
place! Gold thrives
on stock weakness.
Back
in mid-2015 gold looked a heck of a lot worse than today, slumping
towards a deep 6.1-year secular low towards year-end. Speculators
were selling gold futures aggressively ahead of the Fed’s
telegraphed first rate hike
of this cycle.
They’re convinced there’s nothing more bearish for gold than Fed
rate hikes, which is irrational since history has
proven the
opposite! So investors fled gold in sympathy, dumping GLD
shares.
But
gold perked up a bit after the SPX’s first correction in 3.6 years
heading into late 2015 finally shattered the unnaturally-calm
stock-market facade. That was the result of the Fed’s unprecedented
quantitative-easing money-printing campaigns
artificially
levitating the stock markets for years. But that single 12.4%
SPX correction over 3.2 months didn’t dent epic complacency for
long, so gold soon slumped to deep lows.
But
then a second correction erupted shortly after, the SPX
falling 13.3% in 3.3 months heading into early 2016. That wasn’t
major by correction standards, still closer to 10% than 20%. But
seeing over a half-year of persistent stock-market weakness finally
shocked investors out of their Fed-drugged stupor. They suddenly
remembered stock markets rise and fall, and that they should
diversify their portfolios with gold.
So
gold skyrocketed up out of those last meaningful stock-market
corrections, blasting 29.9% higher in just 6.7 months. And you want
to know what the dominant driver was? Heavy differential
GLD-share buying by American stock investors! As the previous
chart shows, in Q1’16 gold surged 16.1% higher on an enormous 27.5%
or 176.9t GLD build. Investors purchased GLD shares far faster than
gold was being bought.
Per
the latest WGC GDT data, total global gold demand surged 188.7t YoY
that quarter. Thus American differential GLD-share buying alone
accounted for 94% of that worldwide demand boost! This gold bull
wouldn’t have been born without US investors’ stock-market capital
flooding into gold via GLD. And that continued into Q2’16, where
gold rallied another 7.4% on another 16.0% or 130.8t build in GLD’s
holdings.
The
WGC reports overall world gold demand climbed 123.5t YoY that
quarter. Thus capital pouring into GLD was responsible for 106% of
the total global increase in gold demand! In this entire young gold
bull so far, the key to gold’s fortunes have been what American
stock investors are up to. Gold powers higher when they are
aggressively buying GLD shares, then slumps when they are selling
them at differential rates.
In
addition to gold getting hit on that record gold-futures shorting in
recent months, another reason for the recent investor mass exodus
was the record-high SPX. In late August it hit a series of
new all-time peaks for the first time since late January, spawning
epic levels of complacency, greed, and even hubris. At extreme
highs investors assume stocks will rally forever, so they have no
need for counter-moving gold.
Interestingly after another long 2.0-year span without a
stock-market correction thanks to that taxphoria rally following
Trump’s victory, the SPX corrected in early February this year. It
plunged 10.2% in just 0.4 months, which was a
sharp-yet-shallow-and-short correction. It was largely ignored by
euphoric investors just like the first correction in years heading
into late 2015. The next SPX correction will be the second.
Will
it rekindle big new gold investment demand just like that second
correction leading into early 2016? I think there’s a good chance
it will. Risks abound in these lofty stock markets that investors
will no longer be able to ignore in the next material selloff. They
include literal
bubble valuations today, mounting trade-war threats, and most
importantly the Fed’s accelerating
quantitative-tightening campaign to start unwinding QE.
I’m
planning on writing an entire essay on Fed QT and these record stock
markets next week, as QT is on the verge of going full speed in
Q4’18. Stock investors have been able to ignore QT despite stocks
being clearly levitated by QE, but they can’t disregard this
unprecedented threat forever. Gold should be a go-to asset class
when their fears of what havoc QT will wreak on overvalued
QE-inflated stocks finally mount.
So
investors’ recent anomalous gold exodus will likely soon reverse.
It is already slowing as that extreme gold-futures short
selling abates. After plunging 5.6% in August, GLD’s holdings are
only down 1.7% month-to-date in September as of the middle of this
week. Gold investment selling looks to be finally exhausting even
with stock-market euphoria still off the charts. Soon buyers will
return, slowly driving GLD builds.
And
as these incredibly-high and precarious stock markets inevitably
roll over, that initial trickle of gold investment buying will
eventually grow into a flood. The last time investors got worried
about weakening stock markets in early 2016, gold soared 29.9%
higher in just 6.7 months birthing today’s bull. And the gold
miners’ stocks greatly leveraged those gains, skyrocketing 182.2%
higher in roughly that same span!
The
only reason those strong gold and gold-stock advances stalled and
broke was that extreme taxphoria stock-market rally in the wake of
Trump’s surprise win. That frenzied corporate-tax-cut anticipation
is over and won’t be back, as those tax cuts went into effect this
year. There’s nothing left to spawn super-bullish sentiment
anymore. As stock markets roll over, gold and the battered gold
stocks will
return to favor.
At Zeal we’ve
literally spent tens of thousands of hours researching
individual gold stocks and markets, so we can better decide what to
trade and when. As of the end of Q2, this has resulted in 1012
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 +19.3%!
The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, before renewed investment demand
drives gold and its miners’ stocks far higher. An easy way to keep
abreast is through our acclaimed
weekly and
monthly
newsletters. They draw on my 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.
Subscribe today,
for just $12 an issue you can learn to think, trade, and thrive like
contrarians!
The
bottom line is investors’ recent exodus from gold is likely on the
verge of reversing. As revealed by GLD’s holdings, their heavy
selling is already slowing as that extreme record gold-futures
shorting winds down. Gold investment demand will return with a
vengeance once these lofty stock markets inevitably roll over into
their next correction or long-overdue bear. That will restore gold
to favor for diversifying portfolios.
The last back-to-back stock-market
corrections actually ignited today’s gold bull almost a few years
ago even though they were modest. American stock investors alone
flooding into GLD shares catapulted gold sharply higher. When the
next serious bout of stock-market weakness unavoidably arrives, they
will once again remember stocks can’t rally forever. Then they will
start flocking back to gold to hedge falling stocks. |