Near-Record Gold Shorting / Commodities / Gold & Silver 2019

Gold has failed to gaintraction over the past couple months, normally a seasonally-strong time.  That has really weighed on sentiment, leavingtraders increasingly bearish.  Goldinvestment demand has flagged dramatically with lofty stock markets spewinggreat euphoria.  That’s given gold-futuresspeculators the run of the market, where they have sold aggressively includingextreme shorting.  But that’s actuallyvery bullish.

Gold price action isdriven by the collective trading of both investors and speculators.  The former control vast amounts of capital, whichdominates gold prices when it is migrating in or out.  But investors’ interest in gold withers whenstock markets are super-high.  Whenstocks seemingly do nothing but rally, there’s no perceived need to prudentlydiversify stock-heavy portfolios with counter-moving gold.  It falls out of favor.

Extreme stock-market euphoria is gold’sprimary problem now, acting like kryptonite for gold investment.  This week the flagship US S&P 500broad-market stock index clawed back to a new all-time record high.  That extended its monster rebound rally sincelate December’s near-bear lows to 24.8%! The farther the stock markets advance, the more gold is forgotten.  Investors have relentlessly pulled capital backout of gold.

The best proxy for goldinvestment demand is the physical gold-bullion holdings of the world’s dominantgold exchange-traded fund, the American GLD SPDR Gold Shares.  In early October soon after the S&P 500peaked but before it started plunging in its severe 19.8% correction, GLD’s holdingsslumped to a deep 2.6-year low of 730.2 metric tons.  I explained these stock-market and GLD dynamics in depth lastweek.

Then the very day the stock markets firstdropped hard, investors remembered gold. Over the next 3.8 months into late January, GLD’s holdings surged 12.8%to 823.9t on heavy capital inflows from American stock investors.  That helped push gold 8.9% higher in thatspan.  But as euphoria came roaring backas the S&P 500 rebounded sharply from its deep selloff, gold’s relativeluster again faded in investors’ eyes.

Between late Januaryand this week, they’ve dumped GLD shares much faster than gold itself was beingsold.  That has forced GLD’s holdings9.2% lower in the last 2.8 months to 747.9t, helping push gold’s price down 2.7%.  Over4/5ths of gold’s stock-market-correction-driven investment surge has nowbeen erased, leaving GLD’s holdings just 2.4% above their secular lows of earlyOctober before stocks plunged!

The gold-investmentselling via GLD in recent months has been relentless, especially in Februaryand now April.  During February’s 19trading days, 13 saw GLD draws averaging 0.4%. And as of the middle of this week, April’s 17 trading days so far haveseen 12 GLD-draw days also averaging 0.4%. Gold has faced unyielding selling pressure from American stock investors as the S&P 500 levitated ever higher.

There’s an old proverbstating “when the cat’s away, the mice will play”.  That concept perfectly applies to the goldmarket.  When investors are away, thegold-futures speculators will play.  Investors’capital just dwarfs speculators’, so when gold investment demand is robust spectrading is drowned out and usually irrelevant. But when investors aren’t interested, the gold-price impact ofgold-futures trading is magnified.

These traders alreadypunch far above their weights, their capital being far more potent thaninvestors’ on a dollar-for-dollar basis. Gold futures allow extremeleverage far beyond anything legal in the stock markets.  Each gold-futures contract controls 100 troyounces of gold, which is worth $127,500 at $1275.  But gold-futures speculators are onlyrequired to keep $3,400 cash in their accounts for each gold-futures contract.

That gives them absurdmaximum leverage up to 37.5x, compared to the decades-old 2.0x limit in stockmarkets!  At 30x leverage, every dollardeployed in gold futures has literally 30xthe price impact on gold as another dollar used to buy gold outright.  Just $1 of gold-futures capital flows yieldthe same gold-price result as $30 of investment capital flows.  Gold-futures trading’s impact on gold iswildly disproportionate.

Further amplifyinggold-futures speculators’ outsized influence, the American gold-futures priceis gold’s global reference one.  So when heavygold-futures selling blasts that headline price lower, the resulting negative psychologyquickly infects the rest of the world gold markets.  Gold-futures trading is effectively the tail that wags the gold-investmentdog.  This vexing problem shouldn’t beallowed to exist, but it does.

Over the past couplemonths as mounting stock-market euphoria seduced investment capital out ofgold, speculators’ gold-futures selling has soared to extremes at times.  That really exacerbated the counter-seasonaldownside pressure on gold prices.  Thisheavy selling is evident in the weekly Commitments of Traders reports from theCFTC, which detail speculators’ collective long and short positions in goldfutures.

This chart superimposesseveral years of daily gold prices in blue over the weekly CoT data.  Total spec long contracts are shown in greed,and total shorts in red.  The fallinglongs and rising shorts since gold last peaked near $1341 in mid-February are abig reason for its recent weakness.  Butthe lower specs push their longs and the higher they ramp their shorts, the more bullish gold’s near-term outlookgrows.

A couple weeks ago Idug deeper into gold futures’ impacton gold prices in recent years, so I’m going to focus on recent months here.  On February 19th when gold surged to $1341,total spec longs and shorts were running 305.0k and 138.5k contracts.  While those longs remained way below recentyears’ peaks, they were still near the highest levels seen in the past year.  I developed a simple metric to quantify that.

This chart shows thegeneral rule on gold-futures trading driving gold price action.  When speculators are buying by either addingnew longs or covering existing shorts, gold rallies.  When they are selling existing longs oradding new shorts, gold retreats.  So thelower spec longs, and the higher spec shorts, the more bullish gold’s near-termoutlook.  The opposite is also true,higher longs and lower shorts are bearish for gold.

Gold’s biggest uplegsin recent years emerged from relatively-low spec longs and/or relatively-highspec shorts.  Figuring out how low orhigh both sides of this trade happen to be can be done by looking at currentlevels compared to their trading ranges overthe past year.  When gold peaked at$1341 9 weeks ago, total spec longs were running 96% up into their 52-weektrading range.  That was certainlyrelatively high.

That left speculatorslittle room to buy more gold-futures long contracts unless they expanded theirtotal capital allocation back to bigger prior-year levels.  If they didn’t, they had a lot more room tosell than to buy.  That same CoT week,total spec shorts were running 32% up into their own past-year tradingrange.  Thus the short-side guys had probableremaining room to cover 1/3rd of their shorts, which was relatively low.

If investors had been buying gold, if the mounting stock euphoria hadn’tbeen sucking capital out of gold, speculators’ gold-futures positioning wouldn’thave mattered much.  But with investorsmissing in action, the gold-futures traders were ruling the roost.  And they started selling heavily in the CoTweek ending on Tuesday March 5th.  Beaware that CoT weeks always run from Tuesday closes to Tuesday closes.

Gold began that CoTweek looking great, trading at $1328. But speculators started selling gold futures, pushing gold down towards$1300.  That is a hugely-importantpsychological level for gold, which seems to attract gold-futures stop losseslike gravity.  So as $1300 neared andfailed, gold-futures selling ramped up massively.  That CoT week ended with specs dumping 34.0klong contracts while adding 11.9k short ones!

A 20k+ contract changein either spec longs or shorts in a single CoT week is the threshold where hugebegins.  20k contracts control the equivalentof 62.2 metric tons of gold, way too much for normal markets to absorb in a singleweek.  That big bout of spec gold-futureslong selling that kicked off the last couple months’ gold slump wasexceptional.  At that point 1053 CoT weekshad passed since early 1999, a long span.

That CoT week’s spec longselling ranked as the 20th largest ever witnessed, a rare event.  And in terms of speculators’ totalgold-futures selling including both longs and shorts, it was the 11th largest on record!  It’s important to realize that gold-futuresselling of that magnitude is unusual, unsustainable, and self-limiting.  The lower spec longs and the higher spec shorts,the less gold futures these traders have left to sell.

That extreme selling blitz puking out the equivalent of 142.6t of gold in asingle CoT week would probably have been the end of it without the growingstock-market euphoria.  Gold usually carvesa major seasonal low in mid-March before powering higher in its spring rally.  But with the S&P 500 levitating and investorsstill selling gold on balance, sentiment stayed fairly bearish so gold-futuresspecs had the run of the market.

Still gold defied thesurging stock markets to rally like usual, climbing back to $1322 by March 25th.  The gold-futures speculators were responsible,adding 20.4k new long contracts while covering 15.4k short ones in the CoT weekending a day later.  That was the equivalentof 111.3t of gold buying.  But over the nextCoT week, that reversed into heavy selling. That again surrounded gold plunging backunder $1300.

For decades now I’veintensely studied and closely watched the markets in real-time.  I get up at 5am and follow the data and newsfeeds until 4pm or later.  Usually whengold or the stock markets make some big intraday move, it’s explainable by newsor data.  Neither gold’s 1.7% plunge onMarch 1st, nor its later 1.4% drop on March 28th, had any apparent catalysts!  But both days saw gold break back below$1300.

Running extremeleverage up to 37.5x, gold-futures speculators can’t afford to be wrong forlong.  A mere 2.7% gold price moveagainst their positions would wipe out 100% of their capital risked at suchleverage!  So these guys have to maintainan ultra-short-term price-dominated focus, and they have to run tight stop losses or risk quickruin.  Long-side gold-futures tradershave long clustered stops near that key $1300 level.

So when gold falls backthrough $1300 from above, mechanical stop-loss orders start triggering resultingin forced long selling.  That quickly pushes gold even lower, trippingmore stops to fuel cascading selling.  Bythe time the dust settled in that CoT week ending on April 2nd with gold batteredback to $1291, total spec gold-futures longs had plummeted 35.3k contracts!  They weren’t short selling then, as shortsfell 2.1k.

That massive long dumpwas again exceptional, ranking as the 18th largest ever witnessed out of 1057CoT weeks since early 1999 at that point. Speculators can’t maintain such crazy selling rates for long, as just 7weeks at that pace would drive their longs to zero which will neverhappen.  For the second time in 4 CoTweeks, extreme spec gold-futures long selling hammered gold from well above $1300to back below.

But gold soon startedrecovering even while investors mesmerized by stock euphoria exited.  Gold again climbed up over $1300, hitting$1308 on April 10th.  This metal really wantsto power higher even with investment capital fleeing to chase the lofty stockmarkets.  Yet once again extreme gold-futuresselling erupted in the latest CoT week reported before this essay waspublished, which ended last Tuesday April 16th.

For the third time in 7weeks, extreme gold-futures selling flared as gold passed back down below$1300.  Once again there were no significantdata or news catalysts around the world, gold-futures selling just snowballedto a stunning degree.  That CoT weektotal spec longs dropped another 17.5k contracts, close to that 20k+ hugethreshold.  But total spec shortsexploded an utterly-astounding 36.9k contracts higher!

That single-CoT-weekshorting was so crazy it ranked as the 2ndhighest ever witnessed out of the 1059 CoT weeks since early 1999!  The only bigger shorting week was back inmid-November 2015, soon after the Fed telegraphed its first rate hike of the recent cycle.  Yet that record shorting would soon provevery bullish for gold, birthing a major bull market.  Gold surged 29.9%higher in 6.7 months in the first half of 2016.

Considered together inthat latest reported CoT week ending April 16th, speculators’ total long andshort selling rocketed to 54.4k contracts! That is the 5th highest on record,incredibly extreme.  The 1st and 4thweighed in at 70.4k and 56.7k, and both occurred in December 2017.  That record gold-futures selling also provedvery bullish, as gold soon surged sharply to challenge a major bull-market breakout above$1350.

Big gold-futuresselling is always bullish for gold, because those bearish bets will soon beunwound with proportional buying.  This current episode won’t prove anexception, especially with near-record shorting.  While making bullish long-side gold-futurestrades is voluntary, short covering is mandatory.  Shorting is effectively borrowing gold futuresthat traders don’t own, those contracts have to be repurchased and paid back.

Between gold’s latestinterim high in mid-February to this extreme latest-reported CoT week, total speclongs collapsed 68.5k contracts or 22.5%. That’s a lot in a short span, leaving longs running just 32% up intotheir past-year trading range.  Thatmeans specs easily have room to do over2/3rds of their likely near-term long buying, and much more if higher goldprices excite traders enough to bet at previous years’ scales.

And over the last 8reported CoT weeks, total spec shorts rose 19.5k contracts.  That left them 37% up into their own past-yeartrading range.  That’s not high, but itstill leaves a lot more shorts that have to be covered with offsetting buyingas gold reverses higher again.  Totalspec selling since February 19th ran 88.0k contracts, the equivalent of 273.9tof gold.  That’s helped force gold 4.8%lower from $1341 to $1276.

The bright side of allthis gold-futures selling is it is inherently self-limiting and self-correcting.  The more these traders sell, the less they have left to sell.  And the higher the odds they will startbuying in a big way to mean revert their recent bearish bets back tonormal.  One of these days some catalystwill arise that will spark major spec gold-futures buying.  Gold will surge sharply for weeks as buyingnormalizes bets.

The biggest casualty ofrecent months’ extreme near-record gold-futures selling was the gold miners’stocks, which amplify moves in gold.  Themajor gold miners of the leading GDX VanEck Vectors Gold Miners ETF tend toleverage gold’s action by 2x to 3x.  Thathas weighed on gold-stock prices and psychology since mid-February.  GDX slumped while gold-futures speculators batteredthe gold price lower.

Despite that extremegold-futures selling nearing records, and incredible stock-market euphoria stuntinggold investment demand, the gold stocks have weathered this storm reallywell.  GDX did knife back under its upleg’ssupport, nearing its 200-day moving average which is much-stronger support.  But the major gold stocks have provenimpressively resilient overall, largely consolidatinghigh as gold swooned.

Again gold was pounded4.8% lower over those 8 CoT weeks starting near $1341 and ending way down near$1276.  At 2x to 3x normal leverage, thegold stocks would’ve plunged almost 10% to 15%. Yet over that exact span GDX merely slid 5.7%, just 1.2x gold’sloss!  And GDX’s leverage was healthybefore that as gold rallied, running2.8x at best by mid-February.  Thegold stocks have really been holding their own.

Gold stocks are set tosurge again once gold reverses decisively higher, which is increasingly likelyany day now.  These lofty euphoric stockmarkets are going to inevitably encounter some catalyst sparking significant selling,which will snowball after such a massive and long rally steeped in such epic complacency.  Gold investment demand will turn on a dime asstock markets roll over, just like back in early October.

And when gold startsmoving higher, the hyper-leveraged gold-futures speculators will rush to buyand pile on to its upside momentum.  And afterslashing their longs and ramping their shorts over the past couple months, theyhave major buying to do toreestablish bullish positioning relative to gold to ride its next rally.  As leveraged gold-futures capital inflowsforce gold higher, gold stocks will really amplify its gains.

The last time major goldinvestment buying lined up with major gold-futures buying by the speculatorswas in roughly the first half of 2016. That catapulted gold 29.9% higher in 6.7 months kicking off thisbull.  The major gold stocks as measured byGDX soared 151.2% in essentially that same span, amplifying the big gold gainsby 5.1x.  Gold stocks are the place to bewhen traders are pouring capital back into gold!

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. We’ve added plenty of new trades since mid-February as older ones werestopped out, which are ready to surge much higher as gold recovers.

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The bottom line is goldhas been bludgeoned by extreme gold-futures selling in the past couple months,culminating in near-record shorting.  That’swhat forced gold lower during its usual spring-rally timeframe.  With investors seduced by the lofty euphoricstock markets, gold-futures speculators have been running roughshod over goldprices.  But their heavy selling is self-limiting,and will reverse into proportional buying.

Speculators’ bigbearish shift in gold-futures positioning will have to be normalized, resultingin big buying that will push gold higher. That upside momentum could really grow, especially when stock marketsroll over and again rekindle gold investment demand.  The biggest gains as gold mean reverts backhigher will come in the stocks of its miners. They’ve proven resilient as gold swooned, and are poised to surge again.

Adam Hamilton, CPA

April 19, 2019

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Adam Hamilton, CPA

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