Gold Price Selloff Risk High / Commodities / Gold & Silver 2019

Gold surgeddramatically in recent weeks, powering higher to a decisive bull-marketbreakout.  Gold’s first major secularhighs in years have really improved sentiment, with bullishness mounting.  But gold-futures buying fuel is largelyexhausted, after the colossal amount expended to catapult gold back over $1400.  That leaves this metal at high risk of sufferinga major selloff, a healthy correction in an ongoing bull market.

Even the most-powerfulbull markets flow and ebb, taking two steps forward before one stepback.  Gold is certainly no exception.  At best in late June, its current bullextended to modest 35.4% gains over 3.5 years. Those weren’t linear, the path to gold’s recent breakout high was quitevolatile.  It included a 29.9% upleg, a17.3% correction, a 20.4% upleg, a 13.6% correction, and today’s upleg running21.2% at best.

This alternating repeatingbull-market pattern is simple, uplegs are inevitably followed by materialselloffs often extending into correction territory.  Periodic corrections are essential to keepbulls healthy, working off the excessive greed that builds as uplegs peak.  That risks sucking in too much capital toosoon, prematurely burning out bulls. Corrections rebalance sentiment, bleeding away greed to extend bulls’longevity.

Even though they areinevitable, normal corrections stress out the majority of traders.  The selling taints their psychology andclouds their perspectives of longer-terms trends in play.  They fret bulls are dying, and sell out tooearly and too low.  Instead correctionsshould be embraced, as they offer the greatest opportunities to buyrelatively low within ongoing bulls! Entering near correction lows amplifies gains.

While gold’s currentbull clocked in at 35.4% total in late June, its three major uplegs added up tomuch-larger 71.5% gains.  Traders had thepotential to more than double gold’s headline gains by attempting to buyrelatively low later in corrections and sell relatively high later in uplegs!  Although impossible to game bull-market swings’major lows and highs precisely in real-time, trading near them really boosts capitalgrowth.

The reason gold faces highrisk for its next major selloff today is speculators’ current positioning in gold futures.  Unfortunately spec gold-futurestrading has a wildly-disproportional influence over short-term gold pricelevels.  The dominant reason is theextreme leverage inherent in gold futures, which greatly multiplies thatcapital’s impact on gold prices.  This unfairreality has sorely vexed the gold market for decades.

When a normal investorbuys gold outright, $1 of capital exerts $1 of buying pressure on the goldprice.  That’s the way markets are supposedto work.  That can be extended with marginin the stock markets, which has had a hard legal limit of 2.0x since 1974.  $1 of capital using maximum margin to buy sharesin the leading GLD SPDR GoldShares gold ETF can exert $2 of buying pressure on gold.  That’s still reasonable.

But gold-futurestrading is way out in its own extreme realm. Each gold-futures contract controls 100 troy ounces of gold.  At this Wednesday’s data cutoff for thisessay, gold closed at $1417.  So each contractwields gold worth $141,700.  An investorwould have to put up $141,700 to control that much gold, or $70,850 using stock-market-legal-limitleverage on GLD shares.  Futures speculators only need $4,000!

That’s no typo, this weekthe CME Group only requires traders to have $4,000 cash in their accounts for eachgold-futures contract they want to trade. That is absurd, enabling extreme maximum leverage of 35.4x!  That means a fully-margined gold-futuresspeculator can exert $35 of buying or selling pressure on gold with each $1 deployed.  That temporarily outguns investors, eventhough they have vastly more capital.

The Federal Reserve hascapped stock-market leverage at 2.0x for 45 years because extreme leverage hasextreme risks.  At 35.4x, a mere 2.8% goldmove against speculators’ gold-futures bets would wipe out 100% of theircapital risked!  This constant threat ofruin forces these traders’ focus to an ultra-myopic short-term span, days orweeks at most.  All they can do is ridegold’s immediate momentum, piling on.

As if arbitrarilydeclaring $1 of gold-futures capital should have up to 35x the influence on gold prices as $1 invested outright isn’t ridiculous enough, it getsworse.  Unscrupulous traders can wield goldfutures’ extreme leverage like a weapon to manipulate gold prices at key technicaland sentimental junctures.  One way isspoofing, slamming the market with huge gold-futures orders that are canceledbefore being executed.

This is not theoretical. In late June the US Department of Justicelevied $25m of criminal fines on Merrill Lynch Commodities for this verybehavior!  And that’s just the tip of theiceberg for gold futures’ extreme leverage being abused to defraud normal investors.  This seriously needs to be legally capped atvastly-lower levels.  The DoJ’s actualpress release did a great job explaining how gold-futures spoofing works.

“...beginning by atleast 2008 and continuing through 2014, precious metals traders employed byMLCI schemed to deceive other market participants by injecting materially falseand misleading information into the precious metals futures market.  They did so by placing fraudulent orders for preciousmetals futures contracts that, at the time the traders placed the orders, theyintended to cancel before execution.”

“In doing so, thetraders intended to “spoof” or manipulate the market by creating the falseimpression of increased supply or demand and, in turn, to fraudulently induceother market participants to buy and to sell futures contracts at quantities,prices and times that they otherwise likely would not have done so.  Over the relevant period, the traders placedthousands of fraudulent orders.”  These crooksshould be in prison!

Compounding gold futures’gold-price impact, the American gold-futures price is gold’s global referenceone.  So gold-futures trading moving thegold price heavily influences and sometimes totally controls the entire goldmarket’s psychology!  Investors are motivatedto buy and sell gold outright based on what is happening in gold futures.  It’s impossible to understand and game goldwithout closely watching futures.

I had to break my chartinto two parts today, lest it get too busy to parse.  These superimpose gold’s price through itscurrent bull market over speculators’ gold-futures positioning.  Reported weekly by the CFTC in its famousCommitments of Traders reports, specs’ long contracts or upside bets on goldare shown in green while their short contracts or downside bets are rendered inred.  They usually dominate gold action.

The wildly-disproportionalinfluence on gold prices by speculators’ gold-futures trading is critical forall investors to understand.  Let’s startwith this gold bull itself, the cadence of its uplegs and corrections.  Its maiden upleg erupted in mid-December 2015out of deep 6.1-year secular lows in gold, and ultimately blasted up 29.9% in6.7 months by early July 2016.  Majorselloffs inevitably follow major uplegs in any bull.

So gold plunged 17.3%over 5.3 months into mid-December 2016 in a severe correction.  That was way bigger than normal, greatly exacerbatedby Trump’s surprise election victory in early November that year.  With Republicans controlling the presidencyand both chambers of Congress, stock markets soared on hopes for big tax cutssoon.  That crushed gold demand, as fully5/8ths of that correction came after the election!

While ugly, gold remainedin a bull market since that massive selloff didn’t cross the -20% thresholdfor a new bear market.  Gold quicklyrebounded from those deep lows and gradually powered to another nicebull-market upleg, up 20.4% over 13.3 months leading into late January 2018.  This gold bull’s second major upleg was followedby its second major correction, a 13.6% drop over 6.7 months by mid-August2018.

That birthed today’sthird major upleg, which had extended to 21.2% at best over 10.3 months by lateJune.  This past month saw gold get excitingagain after decisively breakingout of its years-long giant ascending-triangle technical formation to surgeto major new bull-market and secular highs. This bull’s pattern has been upleg, correction, upleg, correction,upleg.  What comes next in this series isobvious.

Gold is at high riskfor another major selloff, potentially a full-blown correction over 10% again,because of speculators’ gold-futures positioning.  This next chart illuminates what the specswere doing during each of this gold bull’s uplegs and corrections includingtoday’s newest one.  Thesehyper-leveraged traders with their outsized impact on gold prices have effectivelyexhausted their near-term buying, threatening big selling!

This gold bull’s initialupleg in largely the first half of 2016 was massive, the biggest in this bullso far at 29.9%.  That was partially fueled by gold-futuresspeculators buying a staggering 249.2k long contracts and buying to coveranother 82.8k short ones!  There are twokinds of buying and two kinds of selling in gold futures, and each set has thesame price impact on gold.  Thus they canbe lumped together for analysis.

Specs can buy new gold-futurescontracts to establish long positions, the normal way to buy.  But they also buy to cover and close previously-established short positions. The upward pressure on gold from buying longs and covering shorts is identical.  On the selling side they can sell their ownexisting longs, or effectively borrow gold-futures contracts they don’t own toshort sell them.  Both types hit gold thesame way.

Speculators’ totalgold-futures buying in this gold bull’s first upleg ran a mind-boggling 331.9kcontracts!  That’s the equivalent of1032.4 metric tons of gold.  Forcomparison, total global gold investment demand in the first half of 2016 ran1091.6t per the World Gold Council’s latest fundamental data.  That epic spec long buying catapulted theirtotal upside bets to an all-time-record high of 440.4k contracts as thatupleg peaked!

Keep these numbers in mind.  This gold bull’s greatest upleg soared 29.9%higher on 331.9k contracts of total buying by gold-futures speculators.  That forced their total longs to theirhighest levels ever seen of 440.4k contracts. As I’ll discuss shortly, today’s latest gold upleg is skating ever closerto those extreme levels.  The ice getspretty thin in that rarefied air of likely gold-futures buying being essentiallyexhausted.

This gold bull’s firstmajor correction was largely driven by specs reversing that huge long build inlargely the second half of 2016.  Note thegreen spec-longs line above collapsed symmetrically to its massive surge in thepreceding upleg.  Specs dumped 164.5klong contracts and short sold 25.8k more over that severe correction’s exactspan.  That adds up to 190.3k contracts oftotal selling, the equivalent of 592.0t.

During gold-bull uplegsthe green spec-longs line rises while the red spec-shorts line falls.  Then in following corrections that reverses, thegreen line falling while the red one rises. Gold-futures buying and selling is heavily driving these majorbull-market cycles in gold, and that’s not going to change until regulatorswake up and radically curtail gold futures’ extreme inherent leverage.  Gold’s second upleg straddled 2017.

That was somewhatpeculiar, as the spec gold-futures long buying of 80.6k contracts and shortcovering of 4.1k only totaled 84.7k.  Thatwasn’t much considering gold’s strong 20.4% upleg gains.  But realize that gold upleg effectively toppedmuch earlier in early September 2017. Its later upleg peak was marginal. As gold challenged its $1350 bull-market resistance, total spec longs soaredas high as 400.1k contracts!

This gold bull’s secondcorrection mostly unfolded during the first half of 2018, and was a textbook-perfectexample of heavy spec gold-futures selling. Their green longs line plunged by 98.3k contracts, while their red shortsline rocketed an enormous 128.9k contracts higher.  That correction bottomed last August as totalspec shorts soared to their own all-time-record high of 256.7k contracts!  That portended the next upleg.

Back in early September,I wrote an essay on the “RecordGold/Silver Shorts!”.  Published whengold still languished way down at $1196, I concluded then “gold andsilver soon soared on short-covering buying following all past episodes of excessiveand record short selling.  There’snothing more bullish for gold and silver than extreme shorts! ... Recordfutures shorts are the best gold and silver buy signals available.”

Speculators’ collectivegold-futures positions provide both excellent buy signals near major gold lowsand excellent sell signals near major gold highs.  Smart contrarians get really bullish on goldwhen specs are really bearish as evidenced by relatively-low longs andrelatively-high shorts.  And it is just asprudent to get short-term bearish on gold when specs are excessivelybullish with relatively-high longs and -low shorts.

This is exactly the situationwe’re in today, and it’s growing ominously extreme.  This gold bull’s third upleg powered 21.2%higher at best so far as of late June, propelling this metal to a new 6.1-yearsecular high of $1423.  This awesome decisive-bull-breakoutupleg was again fueled by enormous gold-futures buying by speculators.  They added 99.4k long contracts, while buyingto cover a staggering 153.4k short ones!

That adds up to totalbuying of 252.8k contracts as of gold’s latest peak in late June, or theequivalent of 786.3 metric tons of gold! That’s relevant because it is already 76% of the total gold-futures buyingthat unfolded during this gold bull’s huge maiden upleg in early 2016.  Back then popular gold psychology was waxingreally bullish, fostering that extreme gold-futures buying.  Getting that high again today is a tallorder.

The current gold-futurespicture is even worse.  While gold hitits latest interim high in late June, the gold-futures speculators kept on buyingsince.  The weekly CoT reports are publishedlate Friday afternoons current to the preceding Tuesdays.  So the latest data available this week iscurrent to last Tuesday July 2nd.  Thatsaw still more big spec buying, they added another 16.5k longs and coveredanother 10.2k shorts.

That extends this upleg’stotal spec long buying to 115.9k contracts and short covering to 163.6k, makingfor a larger 279.5k total.  Thus today’s upleghas already seen speculators buy 84% of the gold-futures contracts that theydid during early 2016’s massive maiden upleg! That doesn’t leave much room to keep on adding more longs andcovering more shorts to propel gold to major news highs in the coming weeks.

As of last Tuesday,total spec longs were already way up in nosebleed territory at 374.0k contracts!  Out of the last 1070 CoT weeks since early1999, only 2.2% saw spec longs higher. And that is getting closer to their all-time-record high of 440.4k inearly July 2016.  While they couldconceivably go higher, that’s a hard ceiling until proven otherwise.  Gold-futures speculators and their capital arefinite, relatively small.

Out of all the world’straders, only a tiny fraction are willing to run extreme 35x leverage and riskruin on being slightly wrong on gold’s near-term direction.  New gold highs really don’t mint sizablenumbers of new gold-futures speculators either, as the risks are so crazy.  And this small pool of gold-futures tradersreally don’t control much capital compared to broader markets.  They’d be irrelevant without their extremeleverage.

So at some pointgold-futures buying pressure literally exhausts itself.  All the specs who want to be long gold havealready bought in, expending all their available capital firepower.  We can’t know in advance if it will happen at375k longs, 400k, 425k, or 450k, but odds are it will be somewhere around there.  Once the specs are all-in, all they can dois sell to start unwinding their excessively-bullish bets.  That will hammer gold.

This relatively-younggold bull has seen three prior episodes where specs liquidated high longs, asseen in the falling green line above. Those were during this bull’s two corrections and a milder pullback inlate 2018.  Gold fell sharply each time,and this next episode of major spec long selling won’t prove different.  At their latest 374.0k levels, spec longs are really high today with little room to buy and tons of room to sell!

The near-term gold riskis compounded by the fact spec shorts are also really low, just 87.2kcontracts as of the last CoT report.  That’sjust a hair over the lowest levels of this entire bull market, 82.5k seen inlate March 2018.  So spec short-coveringbuying isn’t likely to go much lower, and in any case has a hard limit as thesedownside bets get closer to zero.  Like speclong buying, spec short covering is largely exhausted.

Total spec gold-futureslongs approaching bull-market and all-time-record highs, coupled with totalspec gold-futures shorts just over bull-market lows, is very bearish forgold over the near-term!  Remember bynecessity these guys are short-term momentum followers, their extreme leveragewill slaughter them if they are on the wrong side of gold for long.  When gold noses over, their selling willintensify and cascade.

It certainly has thepotential to snowball forcing another correction-grade gold selloff over10%, which equates to a demoralizing sub-$1281 gold price.  We might get lucky, the bullish new-highpsychology could retard gold-futures selling. If the normalization of specs’ gold-futures bets is very slow, goldcould see a milder pullback largely consolidating high.  But we can’t bet on that based on all thebull-market precedent.

The greatest hope ofgold evading a big selloff on gold-futures selling is investors returning in a bigway.  They control vastly more capitalthan the gold-futures speculators, so when they are buying aggressively thatcan easily absorb and overpower any gold-futures selling.  But while new-high psychology has spawned someinvestment buying, it has only been sporadic so far with euphoric US stockmarkets near record highs.

Meanwhile traders shouldprepare for the next major gold selloff, possibly this gold bull’s third correction.  That means tightening trailing stop losses on existing long positions in gold and the stocks of its miners.  On stoppings, cash should be accumulated andnot redeployed.  It is simply too riskyto add material new long positions in gold and gold stocks untilspeculators’ extreme gold-futures positioning considerably normalizes.

To multiply yourcapital in the markets, you have to trade like a contrarian.  That means buying low when few others arewilling, so you can later sell high when few others can.  In recent months well before gold’s breakout,we recommended buying many fundamentally-superior gold and silver miners in ourpopular weekly and monthly newsletters.  This week their unrealized gains ran as highas 112.8%, 105.0%, and 95.2%!

You need to stayinformed about gold cycles and gold-futures positioning to profitably trade thehigh-potential gold stocks.  Our newslettersare a great way, easy to read and affordable. They draw on my vast experience, knowledge, wisdom, and ongoing researchto explain what’s going on in the markets, why, and how to trade them with specificstocks.  Subscribe today and take advantageof our 20%-off summer-doldrums sale!  Thenyou’ll be ready to buy back in relatively low for gold’s next major upleg.

The bottomline is gold is at high risk for a major selloff today.  Speculators’ gold-futures positioning has grownexcessively-bullish, leaving their buying firepower largely exhausted.  That leaves vast room for big selling to snowballon the right catalyst.  This bull’s priorepisodes where specs had similar really-high longs and really-low shorts heraldedmajor gold corrections.  Extreme bets musteventually be normalized.

Such correctionsare normal and healthy within ongoing bull markets, rebalancing sentiment toensure longer lives with greater ultimate gains.  These corrections should be embraced, as theyyield the very best opportunities to buy relatively low within powerful bulls.  Gold’s current bull is likely to run foryears yet, so gird yourself for a major selloff and be ready to buy back inaggressively once it has largely run its course.

Adam Hamilton, CPA

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