Gold Stocks Bull Market Breakout Potential / Commodities / Gold and Silver Stocks 2019

Gold has faded from interestin the past couple months, overshadowed by the monster stock-market rally.  But gold has been consolidating high, quietlybasing before its next challenge to major $1350 bull-market resistance.  A decisive breakout above will really catchinvestors’ attention, greatly improving sentiment and driving major capital inflows.  With gold-futures speculators not very longyet, plenty of buying power exists.

Last August gold waspummeled to a 19.3-month low near $1174 by extreme all-time-record short selling in gold futures.  The speculators tradingthese derivatives command a wildly-disproportional influence on short-term goldprice action, especially when investorsaren’t buying.  Gold-futures trading bulliesgold’s price around considerably to majorly, which can really distortpsychology surrounding the gold market.

The main reason is theincredible leverage inherent in gold futures. This week the maintenance margin required to trade a single 100-troy-ouncegold-futures contract is just $3400.  That’sthe minimum cash traders have to keep in their accounts.  Yet at the recent $1300 gold price, eachcontract controls gold worth $130,000.  Sogold-futures speculators are legally allowed to run extreme leverage up to 38.2x!

That’s extraordinarilyrisky of course.  A mere 2.6% adversemove in gold against traders’ fully-leveraged positions would result in 100% totallosses.  It’s amazing these guys cansleep at night.  For comparison, thestock markets’ legal limit has been 2x leverage since 1974.  10x, 20x, 30x+ is crazy, and has been veryproblematic for gold for decades.  Itgreatly amplifies gold-futures speculators’ impact on gold prices.

Every dollar deployedin gold futures at 30x leverage literally has 30x the influence on gold prices as a dollar invested in goldoutright!  So even though gold-futuresspeculators have far less capital available than investors, it is way morepotent amplified up to 38x!  Thus whengold investment demand is weak like recently with stellar stock-marketcomplacency, gold-futures speculators utterly dominate gold price action.

Their collectivetrading effectively controls gold psychology too, since the American gold-futuresprice has become the world’s leading gold reference one.  Investors start feeling bullish on gold and buyingusually only after gold-futures speculators push its price higher.  And gold-futures selling leaves investorsbearish and worried, impelling them to exit gold.  Gold-futures trading is the tail that wags the gold-investment dog!

So everyone interestedin gold has no choice but to follow what the gold-futures speculators as a herdare doing.  The US Commodity FuturesTrading Commission publishes weekly data showing their collective positioning,the famous Commitments of Traders reports. They are released late Friday afternoons, and show traders’ aggregategold-futures long and short contracts held as of the preceding Tuesday closes.

Despite gold’s solidupleg since those deep mid-August lows, these traders still have lots of buying power left to push goldconsiderably higher.  This first chart superimposesthe daily gold price in blue over specs’ weekly total gold-futures long andshort contracts in greed and red.  Thegreat majority of gold’s upleg-to-date gains have been driven by short-coveringbuying.  Very bullishly the larger longbuying is still yet to come.

In mid-August whentoday’s gold upleg was born, speculators’ total gold-futures shorts rocketedway up to 256.7k contracts!  That was thehighest witnessed in the 19.6 years since early 1999, almost certainly anall-time record.  That unprecedented orgyof extreme shorting hammered gold from roughly $1300 down to $1175 in a couplemonths or so.  That sharp futures-drivengold plunge naturally devastated psychology.

The gold-futurestraders were effectively borrowing gold they didn’t own to dump in the markets,hoping to buy it back later at lower prices and profitably repay thosedebts.  They were doing it at extreme 30x+leverage, proportionally amplifying their capital’s price impact.  That record shorting spree had nothing to dowith fundamentals, it was a snowballing momentum thing.  Yet investors were spooked into selling in sympathy.

In mid-June when goldtraded just over $1300, total spec shorts were only 100.3k contracts.  But over the next 10 CoT weeks theyskyrocketed 156% higher to that record 256.7k. The resulting gold carnage led American stock investors to sell shares in theleading GLD SPDR Gold Shares gold ETF much faster than gold was being sold.  That forced its gold-bullion holdings 60.1metric tons or 7.2% lower in that short span!

Gold bottomed the veryweek gold-futures short sellers had exhausted themselves, reached the limits oftheir available capital.  Since then goldhas powered nicely higher on balance, enjoying a 14.2% upleg over the next 6.2months into mid-February.  Gold peakednear $1341 then and has been consolidatinghigh ever since.  This upleg has beenalmost fully driven by gold-futures buying, which is totally normal.

To close gold-futuresshort positions and repay those debts, speculators have to buy gold-futureslong contracts to offset them.  Theybought to cover an enormous 112.3k short contracts in this upleg’s span, mostlyunwinding last summer’s record shorting spree. They also added another 46.8k long contracts, leveraged upside bets on gold’sprice.  Despite all that gold-futuresbuying, there is still room for much more.

Major gold uplegs have three stages, eachdriven by distinctive buying from different groups of traders.  Uplegs are always born and initially fueledby gold-futures short covering, as speculators are motivated to buy to cover andrealize their shorting profits.  Shortcovering quickly becomes self-feeding, as resulting fast gold-price gains forceother short-side traders to rapidly buy to cover or face catastrophic leveragedlosses.

Thus that stage-one short-coveringbuying quickly burns itself out after a couple months or so.  But it first pushes gold high enough for longenough to convince long-side gold-futures speculators to return.  Theycommand way more capital than the short-side guys, as evidenced by the greenlong line in this chart usually being much higher than the red short line.  Spec gold-futures long buying is uplegs’second stage.

That unfolds moregradually than short covering, typically 6 months or longer.  Long-side traders not only have lots morecapital to deploy, but their buying is voluntary.  They have to really believe gold is headinghigher to make such risky hyper-leveraged upside bets.  In contrast short covering is mandatory and ofteninvoluntary, as those effective debts must legally be repaid.  Stage-one buying directly ignites stage two.

Gold has real bull-market breakout potential in thecoming months because this current upleg hasn’t yet seen much gold-futures longbuying.  Stage two is underway, but themajority is likely still yet to come. The green total-spec-gold-futures-longs line above proves this.  At best in mid-February near gold’s latesthigh, total spec longs peaked at 305.0k contracts.  And they have since retreated sharply to243.8k as of last Tuesday.

Both levels are really low by bull-to-date precedent.  This young secular gold bull was born out ofdeep 6.1-year secular lows in mid-December 2015.  Its maiden upleg was big and fast, gold rocketed29.9% higher in just 6.7 months in essentially the first half of 2016.  As that peaked in early July 2016, total speclongs hit an all-time record high of 440.4k contracts!  Gold-futures traders piled on, helping fuelbig upside momentum.

Total spec shorts that sameCoT week ran 100.2k contracts.  Thatupleg had been partially driven by the gold-futures speculators buying amonster 249.2k longs while covering 82.8k shorts.  Gold crested at $1365 in early July, whichremains this bull’s best level today. Over the subsequent years $1350 would repel gold multiple times, becoming major overhead resistance as gold keptfailing to break out above it.

Speculators soonstarted to unwind their excessive long positions, helping hammer gold 17.3%lower by mid-December 2016.  That heavygold-futures selling was greatly exacerbated by stock markets surging afterTrump’s surprise election victory.  Thisgold bull’s second upleg emerged from the ashes, driven first by gold-futuresshort covering which soon ignited gold-futures long buying.  That was also the first upleg’s order.

Gold powered another20.4% higher to $1358 by late January 2018, and once again gave up its ghostright near that key $1350 resistance. Gold-futures speculators ultimately played a smaller role in that uplegas investors returned.  Gold investmentbuying is the third stage of gold uplegs, which can grow far larger thangold-futures-driven stages.  Futuresbuying is a two-stage ignition mechanism to attract investors.

Total gold-futures longsonly climbed 80.6k contracts during that second upleg, while shorts only slipped4.1k.  That’s somewhat misleading though,as the precise upleg dates mask the green long line trending higher while thered short line trended lower.  When thatupleg peaked, total spec longs and shorts were running 356.4k and 121.9kcontracts.  The former was still muchhigher than today’s levels, a very-bullish omen.

This gold bull’s firsttwo uplegs failed with total spec longs farhigher than today’s 243.8k, averaging 398.4k contracts.  Second-stage spec long buying has exhausteditself and killed uplegs between roughly 350k to 450k contracts in this goldbull.  So the sub-250k levels seen last Tuesdayremained way too low to likely signal a mature gold upleg.  Speculators still have room to do themajority of their stage-two long buying!

This gold upleg ishighly likely to see at least another 100k contracts of long buying, and potentiallyup to 200k if gold returns to favor! That is the gold-futures equivalent to another 311 to 622 metric tons ofgold.  That will almost certainlycatapult gold much higher, just like during this bull’s prior uplegs.  Given where gold is today, this creates major bull-market breakout potential.  A concerted assault on $1350 is likely.

Throughout this entiregold bull, gold has never been higher with sub-250k spec longs than it is todaynear $1300!  Usually the yellow metal wasonly around $1250 at this kind of positioning. So we are now witnessing gold’shighest basing in its bull market relative to spec longs.  $1350 isn’t much higher than $1300, justanother 3.8%.  There’s a good chance the remainingstage-two buying will drive gold there.

While it’s certainlynot exact, 50k contracts of gold-futures long buying in this bull’s other golduplegs have often pushed gold $50 higher. Again we are almost certain to see another 100k and potentially a bestcase of 200k.  So gold has never beenbetter positioned in this bull market to surge up to and through its multi-year$1350 resistance!  A decisive breakout above$1350 would change everything in the gold market.

Gold-futuresspeculators are necessarily trapped in the short term by their extremeleverage.  They don’t care what golddoes, they just want to ride its momentum. Investors are way different, with no leverage at all they have along-term focus.  There’s nothing thatexcites them more, and drives more capital inflows into gold, than new bull-market highs.  Higher highs prove gold is still marching,portending more future gains.

Investors haven’t seena new gold-bull high since way back in early July 2016, which feels like foreverago in these markets.  As the months andyears paraded by and gold kept failing to best $1350, most investors graduallylost interest in gold.  While its bull-marketlower-support zone has gradually risen, the horizontal upper resistance reallytainted psychology.  Gold has been viewedas consolidating, not in a bull.

But 100k to 200kcontracts of spec gold-futures long buying starting near $1300 has real potentialto blast gold back above $1350.  A decisivebreakout is 1%+ beyond that, or $1364. Once gold climbs back over $1365, it will start hitting new bull-to-datehighs.  That will bring gold back intothe financial news in a big way, rekindling investor interest and capitalinflows.  The resulting bullish sentimentbecomes self-feeding.

Major stage-three investmentgold buying gets way more likely the higher gold forges above $1350.  It’s ironic that although investment is all aboutbuying low when assets are out of favor, the great majority of investorsinstead prefer to buy high.  They love chasing winners, and increasinglycrowd into positions the higher their prices climb.  There’s no doubt new bull-market gold highswill fuel big excitement in this metal.

Gold’s bull-market breakoutpotential in the coming months is amplified by a couple other major factors.  Gold is in a seasonally-strong time of theyear, enjoying its seasonal springrally.  That provides a solid sentimentaltailwind that should help motivate gold-futures speculators to continue rebuildingtheir low gold-futures long positions. Their buying also becomes self-feeding the higher and longer gold runs.

Far more importantly,gold-investment levels are really low thanks to the monster stock-market rally since late December.  With the US stock markets skyrocketing fromugly near-bear severe-correction lows to nearly regaining September’s all-timehighs, complacency and euphoria are epic. Stock investors have virtually no fear of a major stock-market selloff,which like usual has greatly retarded gold investment demand.

But these lofty stockmarkets are dangerously overvalued and overbought, heading into a Q1’19 earnings season which is looking to be theweakest in years.  When the stock marketsroll over again, investors will again remember the wisdom of prudently diversifyingtheir stock-dominated portfolios with gold. It tends to rally when stock markets weaken, a rare and desirable quality.  The next material stock selloff will goosegold.

Back in December whenthe flagship US S&P 500 stock index plunged 9.2%, gold surged 4.9%higher.  Any material stock-market selloff,regardless of the reason, will quickly rekindle gold investment demand.  And if investors start buying even beforegold-futures speculators’ stage-two long buying is complete, a decisivebreakout back above $1350 is all but certain. This gold bull’s upside breakout potential is very real.

The biggest beneficiariesof higher gold prices reviving interest in its bull market will be the gold miners’ stocks.  The major gold miners of theGDX VanEck Vectors Gold Miners ETF usually amplify gold’s own moves by 2x to3x.  So a 10% gold rally will oftentranslate into 20% to 30% GDX gains.  Butwhen gold really shifts back into favor among investors, the upside can be fargreater.  We’ve already seen that in thisbull.

This GDX gold-stock-bullchart is updated from last week’s essay, where I explained the bullish gold-stock situation in depth.  So check that out if you needto get up to speed.  But for our purposestoday, note the last time gold powered to new bull-market highs excitinginvestors was during this bull’s first upleg largely in the first half of2016.  GDX skyrocketed 151.2% higher inessentially the same span of that 29.9% gold upleg!

That made for outstanding 5.1x upside leverage to gold from themajor gold miners.  The smaller mid-tierand junior gold miners of the GDXJ VanEck Vectors Junior Gold Miners ETF dideven better.  With their superior fundamentals andlower market capitalizations, mid-tierupside is much better than the majors. Even if gold merely challenges $1350 again, the gold stocks will surge dramaticallyhigher as traders flock back.

So while the lack of interestin gold and its miners’ stocks these days is understandable, it isunfortunate.  The biggest gains are won by buying relatively low before everyonegets excited about an asset or stock sector. Once gold and the gold stocks start surging again as $1350 nears,speculators and investors alike will have to buy much higher.  Deploying aggressively before new bull highsshould yield impressive gains.

One of my core missionsat Zeal is relentlessly studying the gold-stock world to uncover the stockswith superior fundamentals and upside potential.  The trading books in both our popular weekly and monthly newsletters are currentlyfull of these better gold and silver miners. Mostly added in recent months as gold stocks recovered from deep lows,our unrealized gains are already running as high as 76% this week!

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The bottom line is thisgold bull now has the highest major-upside-breakout potential of its entirelifespan.  This latest gold upleg fueledby gold-futures buying hasn’t matured yet, as speculators’ long positioning remainsquite low.  For the first time in thisbull, gold is already consolidating high around $1300 before most of the likelygold-futures long buying has run its course. That makes an assault on $1350 very likely.

If gold can break decisivelyabove that multi-year resistance and start forging new bull-market highs, its psychologywill greatly improve.  Investors will takenotice and start buying again, driving gold higher and fueling mounting bullishness.  The gold miners’ stocks will be the biggestbeneficiaries of new bull-market gold highs. Their stocks soared the last time investors were excited about this goldbull, rapidly multiplying wealth.

Adam Hamilton, CPA

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