Gold Bleeding, Seasonal Pattern / Commodities / Gold and Silver 2022

Gold has sure been afour-letter word lately, suffering one of its worst bull summers.  The primary culprit was heavy gold-futuresselling on a parabolic US-dollar surge fueled by extreme Fed hawkishness.  But the resulting gold technical damage reallydisheartened investors, spawning additional relentless selling from them.  This investment bleeding has certainlyexacerbated gold’s downside, but its days are numbered.

With inflation ragingin its biggest super-spike since the 1970s, gold should be soaring today.  Instead it has been bludgeoned 14.3% lowerbetween mid-April to late July, defying long precedent.  And at the mid-week data cutoff for thisessay, gold had again been pummeled right back to those deep summer lows.  Technically gold looks pretty broken, whichhas whipped up bearish sentiment to suffocating extremes.

Gold was trading near$1,977 in mid-April just before the US Dollar Index started rocketing vertically.  In the past five months starting then, US headlineCPI inflation has run red-hot blasting up 8.3%, 8.6%, 9.1%, 8.5%, and 8.3%year-over-year!  That high-water Juneprint was the worst witnessed since way back in November 1981, a 40.6-yearhigh!  It’s hard to imagine a more-irrationalbackdrop for a major gold selloff.

Gold skyrocketed duringthe last similar inflationsuper-spikes in the 1970s.  In thefirst the CPI blasted from +2.7% YoY to +12.3% over 30 months into December1974.  Gold’s monthly-average prices fromtrough to peak CPI months launched 196.6% higher!  During the second the CPI exploded from +4.9%YoY to +14.8% in 40 months climaxing in March 1980.  Gold’s monthly-average prices were amoonshot, up 322.4%!

In last week’s essay, Ianalyzed the recent heavy-to-extremegold-futures selling that is still dogging gold.  The crazy leverage inherent in futures enablesthose speculators to punch way above their weights in gold-price impact.  The good news is their capital firepoweravailable for dumping gold is quite finite and already mostly-spent.  They will soon do massive mean-reversionbuying which will catapult gold sharply higher.

But tragically temporaryfutures-driven gold-price distortions greatly affect investors’ psychology.  They have seen gold floundering in recentmonths contrary to all history, fueling overwhelming bearishness.  They assume gold has somehow fundamentallydisconnected from inflation, so they are abandoning it.  Their resulting selling hasn’t been massive,but it keeps on dripping and dripping like Chinese water torture.

Had gold-futuresspeculators not duped gold investors into thinking gold’s ultimate-inflation-hedgestatus has failed, gold’s recent price action wouldn’t have been as ugly.  This chart is updated from my latest gold-summer-doldrums essay of early July.  It indexes gold’s summerperformances to May’s final closes in all modern gold-bull years.  Gold has just suffered one of its worstsummers in this multi-decade span!

Between mid-April beforethat massive gold-futures selling erupted to last week, speculators dumped thegold-futures equivalent of 541.3 metric tons of gold!  Those hyper-leveraged traders are forced tohave myopic ultra-short-term time horizons, and all they cared about is the soaring USDX.  They dumped gold futures in lockstep with thatleading dollar benchmark rocketing up to unsustainable 20.2-year secular highs.

That epic dollarstrength was driven by extreme hawkish jawboning by Fed officials, monsterrate hikes and wildly-unprecedented levels of quantitative-tighteningmonetary destruction from the FOMC, the European Central Bank dragging its feeton raising rates, and Europe’s severe energy crisis caused by its heavy relianceon Russian imports.  The euro has long dominatedthe USDX at 57.6% of its total weighting.

Before that enormousgold-futures selling slammed gold, investment demand was growing.  Unfortunately comprehensive global gold supply-and-demanddata is only released once per quarter by the World Gold Council, in itsfantastic Gold Demand Trends reports. But thankfully there is an excellent highly-correlated high-resolutionproxy for overall world gold investment demand that is published daily,revealing real-time trends.

That is the combinedholdings of the leading American GLD SPDR Gold Shares and IAU iShares GoldTrust gold exchange-traded funds.  Accordingto the WGC, at the end of Q2 their combined holdings of 1,560.5t accounted forfully 41.1% of all the gold held by all the world’s physically-backed goldETFs!  That dwarfed the distant third oneat just 7.5%.  GLD and IAU dominate becausethey are tied to US stock markets.

These mighty ETFs actas conduits for the vast pools of American stock-market capital to slosh intoand out of gold.  When their gold-bullionholdings are rising, investors are shifting capital into gold on balance.  When they are falling, investors are pulling capitalback out.  In plenty of quarters inrecent years, moves in GLD+IAU holdings alone accounted for the great majorityof changes in overall global investment demand!

In Q2’22 for examplewhen gold started rolling over on that heavy-to-extreme gold-futures dumping,the combined GLD+IAU holdings fell 47.5t.  That was nearly 6/10ths of the 80.3t total drop in world investmentdemand last quarter per the WGC’s latest GDT. Some quarters have actually seen GLD+IAU holdings changes exceed globalgold-investment-demand changes, these behemoths dominate gold capital flows!

Between late April whenthat parabolic US-dollar surge unleashed huge gold-futures selling to themiddle of this week, GLD+IAU holdings have suffered a 172.8 metric-ton draw.  While this was dwarfed by that colossal541.3t of gold-equivalent futures selling in that span, the investment bleedingstill boosted that marginal gold supply by almost a third!  714.1t of identifiable gold selling in under5 months is gigantic.

That’s far too muchsupply too fast for markets to absorb normally, even in the midst of the worstinflation super-spike since the 1970s. Given that level of bullion flooding the markets, gold actually lookspretty resilient only falling 14.3%.  Gold-futuresspeculators fleeing aggressively on the soaring USDX scared gold investorsinto joining in on that selling, amplifying gold’s downside for dreadfulsummer performance.

This next chart superimposesGLD+IAU holdings over gold technicals during the past several years or so.  The big draw in recent months spawned by thatheavy-to-extreme gold-futures selling is painfully obvious.  But interestingly just as gold-futuresspeculators have exhausted their capital firepower for selling, gold-ETFholdings are also near major lows.  Thatimplies investment selling will soon slow then reverse to big buying.

Like almost allinvestors, gold ones are momentum-chasers.  They only want to buy when gold is rallyingdecisively, which generates bullish excitement that those upside gains willpersist.  Earlier this year as goldpowered higher in another upleg, American stock-market capital flooded into GLDand IAU.  Their holdings soared 141.4t inQ1, a strong 9.6% build!  Over half of thatcame after Russia invaded Ukraine.

The vast hordes ofRussian soldiers, armored personnel carriers, main battle tanks, artillery, helicopters,and supply trucks blitzed across the borders in late February.  That biggest European war since World War II triggered great geopolitical uncertainty. So gold blasted from $1,898 just before Russia’s formal invasion to$2,051 in early March.  That sharp 8.1%geopolitical spike over just a couple weeks wasn’t sustainable.

It left gold really overbought,which I warned at the time.  Indeed goldsoon reversed symmetrically lower as the initial shock of Russia’s war passed,leaving traders accepting it as the new norm. But even as gold corrected, investment demand remained solid and GLD+IAUholdings continued to rise.  Bymid-April gold had stabilized at $1,977, and American stock investors were stillbolstering their meager gold allocations.

Gold investors’ resolvedidn’t start wavering until after that massive gold-futures selling erupted asthe US dollar soared.  That day goldclosed at $1,977, the USDX ran 99.9.  Byearly September when the US Dollar Index hit that extreme 20.2-year secularhigh, it had soared a huge-for-a-major-currency 10.4% which hammered gold 14.0%lower in that same span!  That persistentgold weakness scared investors.

They gradually fled as theyellow metal was pummeled lower by heavy-to-extreme gold-futures selling.  That investor exodus evident in GLD+IAUholdings greatly accelerated in July after gold broke below the psychologically-important$1,800 level.  Nevertheless, that identifiablegold investment selling accounted for just under a quarter of the totalselling including that colossal gold-futures dump.  Investors follow gold’s lead.

Though they commandvastly more capital than the gold-futures speculators, the latter’s extremeleverage grants them outsized influence on gold prices.  That often runs 25x or higher, enabling everydollar traded by these specs to exert up to 25x+ the impact on gold prices comparedto a dollar invested outright!  Thus the smallgold-futures-trading tail often wags the far-larger gold-investment dog, whichis endlessly infuriating.

As of Wednesday, therehave been 101 trading days since GLD+IAU holdings peaked in late April soonafter gold started getting pummeled. Fully 76 of those have seen GLD+IAU draws!  Although they have mostly been small, between0.0% to 0.2%, they have proven utterly relentless.  Since gold’s ugly futures-driven $1,800breakdown in early July, 44 out of 52 trading days have seen draws like Chinesewater torture.

Almost every tradingday sees American stock investors sell GLD and/or IAU shares faster than golditself is being sold, forcing these ETFs to sell bullion.  They have to do this to fulfill their missionof tracking gold prices.  When gold-ETF-sharesupply exceeds gold’s, gold-ETF-share prices threaten to decouple from goldprices to the downside.  So ETF managershave to step in and buy back shares to sop up excess supplies.

They raise the capitalto make these purchases by selling some of their gold bullion.  As gold crumbles on that anomalous gold-futuresselling, investors are fleeing pulling their capital out of gold.  But that should be running its course soonhere for a couple reasons.  Most importantlyas I analyzed in my gold-futures essay last week, that selling is exhausted.  Speculators have run out of room to keep dumpingcontracts.

Total spec longs havedwindled way down to a fresh 3.3-year low, while total spec shorts remainway up near their recent 3.7-year high!  Once these hyper-leveraged traders have doneall the selling they can do, that leaves only room for buying.  So huge mean-reversion buying to normalizeexcessively-bearish bets soon erupts out of such extremes.  That catapults gold sharply higher, enticinginvestors to resume chasing it.

After the last timespecs’ gold-futures positioning was this lopsided in May 2019, their necessary buying blasted gold 21.5% higher over just 3.3 months into that September!  Much like today, investors had been fleeingbefore gold’s futures-driven bottom pushing GLD+IAU holdings relentlessly lower.  But soon after that gold-futuresnormalization ignited, investors flooded back in with a vengeance amplifyinggold’s upside.

This dynamic istypical, as major gold uplegs have three stages of telescoping drivers.  First speculators start buying to cover gold-futuresshorts near major gold lows.  That short coveringis legally required to close out those downside bets, usually resulting insizable realized profits.  While that isquickly expended within a month or two, it pushes gold high enough for longenough to convince long-side specs to return.

Since gold-futures longstend to outnumber shorts by 2x to 3x, long-side speculators have more capital.  They flood back into gold to ride its upsidemomentum, amplifying its gains.  Thatvoluntary buying tends to unfold over three to six months.  It drives gold higher still, leaving itsuptrend decisive enough to attract back investors and the vastly-larger poolsof capital they command.  Their buying isultimately the biggest by far.

Soon gold willinevitably V-bounce sharply higher after some economic data or market news sparksbig mean-reversion gold-futures buying. That will eventually propel gold high enough for long enough to convinceinvestors to start returning.  The fasterand bigger gold’s futures-driven surge, the quicker and larger gold investment demandwill come back.  And investors have massiveroom to reallocate back into gold.

GLD+IAU holdings have tumbledway back down to 1,453t mid-week.  Thoseare deep lows last seen 2.4 years ago emerging from March 2020’s pandemic-lockdownstock panic.  Gold rocketed 40.0%higher in just 4.6 months out of that last peak-despair anomaly, largelydriven by a phenomenal 35.3% or 460.5t build in GLD+IAU holdings during thatshort span!  They peaked up near 1,801tafter gold started correcting.

So American stockinvestors easily have room to buy enough GLD and IAU shares to force a big 350t-ishholdings build.  And with inflationraging out of control today thanks to extreme Fed money printing in the wake of that panic, today’s potential buying is far bigger.  Between March to August 2020 as investors floodedinto gold to chase its upside, headline CPI inflation was effectively nonexistentaveraging up 0.8% YoY.

The US dollar’spurchasing power wasn’t rapidly eroding then, and the stock markets weren’t sufferinga bear on extreme Fed tightening.  So theinvestment case for gold today is radically stronger than it was inmid-2020.  Eventually investors are goingto realize they need to diversify more of their bleeding stock-heavy portfolioswith counter-moving gold.  During these pastsix months the CPI averaged scary 8.5%-YoY gains!

One of the most-famousstock-market books in history is Charles Mackay’s extraordinary 1841 study thatall investors need to read, “Extraordinary Popular Delusions and the Madness ofCrowds”.  I was in high school the firsttime I digested it, which helped shape my future as a contrarian speculator andinvestor.  Whenever investors as a herd cometo believe some extreme is righteous and will last forever, it reverses hard.

The supremely-irrationalgold-and-dollar situation today reeks of another extraordinary populardelusion.  Even lowballed CPI inflationis running at its hottest since the 1970s, and real-world inflation is doubleor triple those headline numbers.  Using 1970sCPI methodology, today’s watered-down CPI would be about twice as high.  These soaring general price levels are rapidlydebasing the US dollar’s purchasing power.

It takes many moredollars today to buy anything than it did a couple years ago!  So it is madness for the US Dollar Index tobe trading at multi-decade highs, the sole reason gold-futures selling has beenso anomalously extreme.  Unlike the globaldollar supply which was foolishly more than doubled by the Fed in just acouple years after that stock panic, the world aboveground gold supply onlygrows about 1% annually.

So gold won’t lose itspurchasing power as the dollar burns down around it.  For centuries gold has been the go-toinvestment during times of serious monetary debasement, raging inflation.  That won’t end now simply because of atemporary gold-price distortion fueled by unsustainable gold-futures sellingthat soon has to proportionally reverse. As gold comes roaring back, investors will return in droves acceleratingits gains.

Gold will quickly meanrevert higher as stage-one gold-futures short covering fuels stage-two gold-futureslong buying which ignites stage-three investment buying.  Within a few months of this getting underway,gold will rebound back into the $1,900s or even $2,000s!  The biggest beneficiaries of gold normalizingto reflect this super-bullish inflationary backdrop will be the gold miners’stocks, which have been brutalized.

While gold fell 14.3% betweenmid-April to late July on that extreme anomalous futures selling, the GDX gold-stock ETF plummeted a horrific 43.5% from mid-April to early September!  Gold stocks are radically oversold comparedto their strong fundamentals, and are overdue for colossal mean-reversion gainsfar exceeding gold’s.  After that stockpanic the last time GDX was this low, it skyrocketed 134.1% higher in 4.8months!

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The bottom line is goldinvestment has been bleeding relentlessly since late April, exacerbating gold’srecent weakness.  Investors fled as goldwas bludgeoned lower by heavy-to-extreme gold-futures selling on the US dollar’sparabolic surge to lofty secular highs. Those investment-capital outflows in recent months accounted for justunder a quarter of gold’s total identifiable selling, way behind the lion’s shareof futures.

But that anomalousgold-futures selling has exhausted itself, reaching excessively-bearish levelsthat will fuel huge mean-reversion buying. That will catapult gold sharply higher, soon attracting back investors.  They have vast buying to do to rebuild tinygold allocations, especially with inflation raging out of control and a stock-marketbear awakening.  Prevailing gold prices areheading way higher after this distortion passes!

Adam Hamilton, CPA

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