Gold Defies Hawkish Fed / Commodities / Gold and Silver 2022

Gold defied anotherhawkish Fed decision this week, consolidating high in its immediate wake.  That was an impressive show of strength,after this extreme Fed tightening cycle hammered gold for a half-year or so.  That strong performance reflects gold-futuresspeculators’ weakening resolve to keep shorting.  With their long-side selling exhausted, they havemassive mean-reversion buying to do which is super-bullish for gold.

Gold was looking reallygood technically heading into this week’s latest Federal Open Market Committeemeeting.  Since late September, it had blasted11.5% higher in a powerful rebound on big gold-futures short-coveringbuying.  That catapulted gold back aboveits key 200-day moving average on FOMC eve, by the most since mid-June.  Gold was a hair away from a decisive 200dma breakout,after escaping its downtrend.

The FOMC decisionitself wasn’t a surprise, with the Fed hiking its federal-funds rate by 50basis points.  That was a sharp slowdownfrom the streak of monster 75bp hikes executed at its previous four meetings.  The FOMC statement was virtually unchangedfrom its last iteration in early November. With this week’s 50bp hike universally expected, that didn’t fazegold-futures speculators.  They focused onsomething else.

Once a quarter afterevery other FOMC decision, the Fed releases its Summary of Economic Projectionsby individual top Fed officials.  This isbetter known as the dot plot, since it shows where they see FFR levels headingin the future.  Though notoriously unreliablein predicting where the FFR is actually going according to the Fed chairhimself, traders lap that up.  This weekit proved more hawkish than expected.

The FOMC targets a 25-basis-pointrange for the FFR, so Fed officials’ projections are at midpoints.  In the last dot plot in late September, theycollectively predicted 4.63% exiting 2023. That means the FOMC targeting 4.5% to 4.75%.  Traders expected that median dot to climb by25bp to 4.88%, reflecting 4.75% to 5.0%.  Instead it surged 50bp to 5.13%, implying a 5.0%-to-5.25% FFRtarget heading into year-end 2023.

To hit that, the FOMC wouldhave to hike another 75bp after this week’s 50bp.  That didn’t seem like a big deal after theFed’s ultra-aggressive shock-and-awe campaign of 425 basis points since mid-March!  A normal rate-hike cycle over those sevenFOMC meetings would’ve been 175bp, a quarter point each.  So if the Fed really goes 500bp total, 85% ofthat is already done.  And again the dotplot is a terrible predictor.

A year ago after theFOMC’s mid-December-2021 meeting, these same top Fed officials projected a year-end-2022FFR at just 0.88%!  These elite centralbankers also thought US GDP would surge up 4.0% this year, while their preferredPCE inflation gauge would climb just 2.6%.  They were dreadfully wrong, now seeing the FFR, GDP, and PCEleaving 2022 at 4.38%, a stall-speed +0.5% economy, and raging +5.6% inflation!

Still that mere extraquarter-point projected hike really moved markets.  The flagship S&P 500 stock index was up0.8% heading into that FOMC decision, but plunged to a 0.6% closing loss in thecouple hours after.  Gold was stable near$1,810 leading into it, right at its prior day’s upleg closing high.  Yet despite those hawkish dots, gold merelydropped to $1,799.  Spec gold-futuresselling was muted for a hawkish surprise!

That was despite thesegold-bullying traders’ main cue goading them into dumping more futures.  The US Dollar Index swung from about a 0.4%daily loss before the FOMC to a 0.2% gain soon after.  That was a sizable rally for the world’sreserve currency.  Yet gold soonrecovered from that minor 0.6% loss to flat, then only edged 0.1% lower onclose.  Gold defied the hawkish Fed since futures speculators didn’t dump.

That was even moreimpressive given the Fed chair’s surprisingly-hawkish press conference ahalf-hour after that FOMC decision. Jerome Powell didn’t mince words, unloading a double-barreled blast ofmore hawkish jawboning.  In my line ofwork I listen to all his pressers live, and was amazed to hear him be soaggressive after that epic 425 basis points of federal-funds rate hikes in just9.0 months!  He really piled on.

His word of the presserwas “restrictive”.  Powell warned “I’vetold you today we have an assessment that we’re not at as restrictive enoughstance, even with today’s move.”  He ledoff warning “Restoring price stability will likely require maintaining arestrictive policy stance for some time.” On inflation he said “But it will take substantially more evidence togive confidence that inflation is on a sustained downward path.”

So while traders hadexpected Powell to come across as dovish in his remarks after such blisteringrate hikes this year, instead he waxed quite hawkish.  After past post-FOMC Fed-chair press conferenceswith hawkish comments, gold has fallen hard on futures selling.  Yet this week the yellow metal ignored allthat to grind sideways in the FOMC’s wake. That’s very-bullish behavior given that ugly selloff-spawning setup!

While the data cutofffor this essay is Wednesday, I’m writing it on Thursday morning.  Gold did weaken overnight, but realize boththe Bank of England and European Central Bank did big 50bp hikes early on ThursdayNew York time.  Since the ECB overall wasn’tas hawkish as expected, the euro fell hard boosting the US dollar.  That was more responsible for Thursday’sgold-futures selling than the post-FOMC reaction.

Six weeks earlier just afterthe previous FOMC decision, I wrote a bold contrarian essay arguing that the Fed’s dollar/gold shock wasending.  The USDX had soared on theFed’s monster hikes up to that point, hitting an extreme 20.4-year secularhigh.  That unleashed massive gold-futures selling crushing gold sharply lower.  I penned thatthe day after that last FOMC decision, when gold languished at $1,631 on close.

With gold just 0.5%above its panic-grade late-September low after that fourth monster 75bp FFR hikein a row, my contrarian thesis was ignored. But as this updated chart reveals, I was correct.  The USDX crumbled after early November’s FOMCdecision, fueling enough big gold-futures short covering to blast gold sharplyhigher.  From FOMC day to FOMC day, theUSDX collapsed 7.5% while gold soared 10.5%!

My contrarian thesissix weeks ago with gold on the verge of falling to major new lows wassimple.  While top Fed officials canspout all the hawkish Fedspeak they want, the FOMC has limited room to hike the FFR.  At that point it had done an extraordinarily-extreme375bp of hiking in just 7.6 months, leaving the target range at a 3.88%midpoint.  That wasn’t very far from thedot-plot terminal FFR of 4.63% exiting 2023.

With 375bp already doneand another 75bp predicted as of then, fully 5/6ths of this rate-hike cycle hadalready passed!  With not many hikesleft, I argued then that “the Fed’s ability to keep shocking the dollar andgold is coming to an end.”  I concluded“Their federal-funds rate is nearing terminal-level projections, leaving littleroom for more hawkish surprises.”  That wasvery bearish for the US dollar and very bullish for gold.

So I continued then, “Withoutthose to keep goosing the parabolic US dollar, it is overdue to roll over hardin massive mean-reversion selling.  Thatweaker dollar will fuel huge normalization buying in gold futures, which havebeen driven to bearish extremes.”  Thoughfew believed that was even possible then, that is exactly what happened since!  Gold’s strong performance into and after thisweek’s FOMC confirms this thesis.

When investors’ interestin gold wanes due to insufficient upside momentum, those hyper-leveraged gold-futuresspeculators dominate its price trends.  Theextreme leverage they run enables them to punch way above their weights in bullyingaround gold.  Their trading explains allgold’s volatile price action this year. And it was heavily influenced by the US dollar’s reactions to 2022’smany hawkish surprises from the Fed.

That really started inmid-April after the latest headline CPI inflation print soared 8.5% year-over-year,arguing for more-aggressive Fed rate hikes. The FOMC obliged, catapulting the USDX parabolic into a truly epic 14.3%rally from then into late September! Gold plummeted a brutal 17.9% in that same span, spurred by the USDX’sbullish reactions to hawkish Fed surprises. Enormous gold-futures selling fully drove that.

Speculator gold-futurespositioning data is only available weekly as of Tuesday closes, in Commitmentsof Traders reports.  During that 24CoT-week span where gold plunged mid-year, specs dumped a huge 145.9k longcontracts while short selling another 80.0k. That’s the equivalent of a staggering 702.8 metric tons of gold selling,far too much for markets to absorb in that short span!  Specs dumped all that they could.

Despite their extremeleverage via futures, their capital firepower is quite limited.  By late September as gold carved a deep stock-panic-gradelow of $1,623, specs’ total gold-futures longs and shorts were running 0%and 100% up into their past-year trading ranges!  That’s the most-bullish-possible near-termsetup for gold, indicating probable selling is exhausted leaving room for nothingbut big mean-reversion buying.

Heading into that lastFOMC meeting in early November, spec gold-futures positioning hadn’t changedmuch.  Total spec longs and shortswere still 4% and 95% up into their past-year trading ranges.  Specs still had massive room to buy longs andbuy to cover shorts, which would drive gold sharply higher.  After the last time spec gold-futures positioningwas so extreme in May 2019, gold rocketed up 21.5% in 3.3 months!

So with speculators’selling capacity largely tapped out and the Fed’s ability to keep hawkishlyshocking traders dwindling, gold was due for some serious gold-futures buying.  That’s what catapulted gold up 10.5% betweenthese last couple FOMC meetings.  Interestingly all that came on the short side of the trade, with specs buying to cover60.9k contracts in the last five reported CoT weeks or 189.5 GE tonnes.

Still specs’short-covering buying isn’t finished, as last Tuesday their shorts were still30% up into their past-year range.  Thatshould fall near zero before they are done buying, so about a third of thatshort covering is still coming.  Gold’sstrong performance after early November’s hawkish FOMC meeting and it againdefying this week’s hawkish encore makes leveraged gold-futures short selling aheck of a lot riskier!

So specs are naturally losingtheir enthusiasm for it.  But the reasonI’m writing this essay is what has happened on the long side.  Since early November, as of thelatest-reported CoT week total spec longs have actually slumped 5.6kcontracts despite gold surging sharply higher!  That is 17.6t of gold-equivalent sellingcounter to gold’s young mean-reversion rally. Spec longs remain just 4% up into their past-year range!

Shockingly as of last Tuesday,total spec longs were just 0.7% above their late-September levels when goldbottomed near $1,623!  That was despitegold being much higher at $1,772 that day.  Virtually no long-side buying yet is super-bullish for gold.  Spec longs are proportionally more importantthan shorts, since longs outnumbered shorts by an average of 1.9x over thispast half-year.  Big long buying is stillcoming.

To return to mid-Aprillevels before the Fed’s hawkish surprises launched the US dollar stratospheric,the gold-futures specs would have to buy a staggering 144.2k long contracts!  And they still have room for yet another13.8k of short-covering buying.  Thatadds up to 491.5t of gold-equivalent buying likely in the next few months,dwarfing that 189.5t of short-covering buying so far!  That would powerfully accelerate gold’supleg.

With gold now defying Fedhawkishness to surge higher between these latest FOMC meetings, specs are goingto get more interested on betting for more gold upside.  Their buying will feed and amplify that, fuelinga virtuous circle of capital inflows. Gold uplegs have three stages, starting with gold-futures short covering,extending to gold-futures long buying, which eventually entices in vastlylarger investment buying.

We are about 2/3rds ofthe way through stage one, and stage two hasn’t even started yet!  Gold’s young-upleg gains could easilydouble to triple over the next half-year or so as speculators return tolongs to normalize their excessively-bearish bets and investors follow.  The biggest beneficiaries of a major goldupleg underway will be the gold miners’ stocks. They are already surging as this updated chart shows.

I analyzed this in depthin last week’s essay on goldstocks surging back.  The red line isgold, while the blue line is gold stocks’ leading benchmark the GDX VanEck GoldMiners ETF.  At best between its ownpanic-grade late-September lows and early December, GDX has already surged37.4% higher!  That has already amplifiedgold’s own parallel gold-futures-buying-fueled mean-reversion upleg by anexcellent 3.2x.

But this younggold-stock upleg is only getting started if gold continues powering higher onbig spec gold-futures buying.  Back inmid-April before all this Fed-hawkish-surprise carnage in gold, GDX was tradingup near $41.  To return to those modestlevels alone would mean another 37.9% rally from this week’s FOMC-dayclose.  And as I discussed in last week’sessay, gold stocks’ upside potential is far bigger than that.

All this matters because cultivating excellent contrarian information sources is essential tothriving in the markets!  If you followthe mainstream herd in buying and selling, you’ll be doomed to buy high asgreed reigns after major surges then sell low as fear returns after serious selloffs.  Doing it the right way by first buying low duringfear then later selling high in greed requires fighting the crowd, which ischallenging to master.

For 20+ years now we’vepublished a couple contrarian newsletters to help speculators and investors do justthat.  While I was writing those essayson gold bottoming including that controversial early-November one on the Fed’s dollar/gold shock ending,we were aggressively filling our newsletter trading books with greatfundamentally-superior mid-tierand junior gold stocks and silver stocks at outstanding bargain prices.

Their gains are alreadytrouncing the major gold miners dominating GDX, like usual.  As of FOMC eve this week, we had unrealized gainsin our recent newsletter trades running as high as +73.7%!  The only way to maximize your odds of buyinglow then selling high is analyzing the markets with a contrarian bent.  That means doing extensive research toidentify probable trend changes before the herd realizes they are happening.

If you regularly enjoy myessays, please support our hard work!  Fordecades we’ve published popular weekly and monthly newslettersfocused on contrarian speculation and investment.  These essays wouldn’t exist without that revenue.  Our newsletters 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.

That holistic integratedcontrarian approach has proven very successful, yielding massive realizedgains during gold uplegs like this overdue next major one.  We extensively research gold and silver minersto find cheap fundamentally-superior mid-tiers and juniors with outsized upsidepotential as gold powers higher.  Our tradingbooks are full of them already starting to soar.  Subscribetoday and get smarter and richer!

The bottom line is goldis continuing to defy a hawkish Fed. After blasting higher since the last FOMC meeting, gold held strong afterthis week’s.  Despite the dot plot callingfor more rate hikes than expected and a really-hawkish Fed-chair presser, materialgold-futures selling didn’t erupt.  Gold’ssurge has left it too risky to resume leveraged shorting, while speculators’long-side capital firepower for selling is exhausted.

Gold’s young mean-reversionupleg is likely to grow much larger in coming months as specs continue to normalizetheir excessively-bearish bets.  Theyhave about a third of their likely short-covering buying left, as well as all theirmuch-larger long-side buying!  Specs are nowrealizing the Fed’s ability to hawkishly surprise is ending, with most of this extremerate-hike cycle passed.  That’s super-bullishfor gold and its miners.

Adam Hamilton, CPA

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