Gold Selling Exhausting
Gold has been afflicted by relentless selling over the past few weeks or so, forcing it to major lows. While summer-doldrums weakness is typical, gold's recent drop is on the large side even for this time of year. It was fueled by truly-extreme short selling by gold-futures speculators, which is quickly exhausting. That is paving the way for gold's major autumn rally to start marching higher any day now, a very-bullish omen.
A month ago when gold was still near $1300, I published my latest research on its summer doldrums. The first halves of market summers including Junes and early Julies have long tended to be the weakest times of the year seasonally for gold. They are simply devoid of the recurring seasonal demand surges gold enjoys during most of the rest of the year. With investors not interested in buying, gold languishes.
There are no major income-cycle or cultural drivers of outsized gold investment demand during these vexing summer doldrums. And many investors are mentally checked out anyway, enjoying the summer vacation season with their families. So gold usually drifts listlessly sideways to lower in early summers. Sometimes enough bearishness coalesces to catalyze significant selling, which is certainly the case this year.
This first chart is updated from my recent summer-doldrums essay, revealing how gold has performed in market summers in modern bull-market years. They run from 2001 to 2012, skip over the intervening bear years of 2013 to 2015, then recommence in 2016 to 2018. Because gold's price varied so greatly over this span, all individual years' summer price action is indexed to 100 as of Mays' final closes each year.
The individual summer trading patterns of all these bull-market years from 2001 to 2017 are rendered in yellow. Together they define gold's typical summer trading range. They are all averaged together in the red line, distilling down gold's core seasonal tendencies. Then superimposed over the top of all that in blue is gold's current price action in 2018. After a typical summer start, gold took a sharp turn for the worse.
Market summers deviate from true orbital summers, running June, July, and August proper. Traders likely think this way because of the major vacation weekends bracketing these summer months in the US. So gold's last close in May is the entry point off which summer price action is measured. That's recast at 100 in this chart to keep all modern bull-market years' price action perfectly comparable in percentage terms.
On average between 2001 to 2012 and 2016 to 2017, from late May to mid-June gold slumped 1.0% to its major seasonal summer-doldrums low. From there gold tended to start recovering, leaving June with modest average losses of 0.2%. This first-half-of-summer weakness usually passes by mid-July, so that month saw solid average gains of 0.9%. Those are driven by gold's major autumn rally getting underway.
As that gathers steam with investors refocusing on markets following vacations, August actually averaged hefty 2.2% gold gains! So technically the summer doldrums encompass the first 5 to 6 weeks of market summers, all of June and early July. Thus we ought to be through the worst of gold's seasonal weakness this summer. That's even more likely considering how much gold fell below its early-summer mean so far in 2018.
Gold actually proved relatively strong early on, rallying 0.3% month-to-date by June's 10th trading day which is gold's major seasonal low. That was all the more remarkable considering it came the day after a major Fed decision. The Federal Open Market Committee not only hiked its federal-funds rate for the 7th time in this cycle, but upped its forecast for future rate hikes. Such hawkishness has hammered gold in the past.
Gold-futures speculators dominate gold's near-term price action, especially when investors are missing in action like during market summers. Gold futures allow insane extreme leverage. Back on June 14th when gold hit $1302, a single gold-futures contract controlling 100 troy ounces was worth $130,200. Yet traders were only required to maintain cash margin balances of $3100 per contract, which is next to nothing.
Thus gold-futures speculators were able to run maximum leverage up to 42.0x! Even this week following gold's sharp selloff since, 40.4x is still possible. That gives fully-margined gold-futures speculators 40x the price impact on gold as an investor buying outright! So $1 of margin supporting gold-futures selling hits gold as hard as $40 of investment selling. That gives futures traders outsized influence over gold's price.
Running such extreme leverage is hyper-risky, as a mere 2.5% gold-price move against traders' positions would wipe out 100% of their capital risked. Thus these gold-futures speculators are naturally forced to have an ultra-short-term focus. Fundamentals are meaningless to them, all they care about is what gold is likely to do over the coming hours and days. They can't afford to be wrong for long at extreme 40x leverage!
So gold-futures speculators are obsessed with anything that can quickly move gold. Topping that list are Fed actions, the US dollar's fortunes, and major US economic reports like today's monthly jobs number. Often all three of these are interrelated. The dollar is more likely to be bid higher on a hawkish Fed, and the Fed is more likely to hike rates if economic data is strong. So these things can really bully gold around.
At every other FOMC meeting, top Fed officials' individual federal-funds-rate outlooks are summarized on a table traders call the dot plot. Released quarterly, this can really unleash gold-futures trading moving gold fast. If the dot plot is more hawkish than expected, indicating more near-term rate hikes likely, gold often gets sold hard. The Fed's 2nd rate hike of this cycle in mid-December 2016 set recent years' precedent.
That day the FOMC's latest dot plot went from implying 2 more rate hikes in 2017 to 3. Despite history proving the opposite, gold-futures speculators believe higher interest rates are bearish for gold. So they aggressively dumped gold futures, hammering gold 1.4% lower that day and 1.2% the next. And after other FOMC meetings accompanied by more-dovish-than-expected dot plots, gold has been strongly bid higher.
So when that newest dot plot last month came in hawkish, there were high odds gold would suffer a sharp selloff. Especially in the dark heart of the summer doldrums, when investors aren't around to moderate or overpower speculators' gold-futures trading. On June's latest Fed Day, top FOMC officials' collective rate-hike outlook climbed from 3 total hikes in 2018 to 4. That should've unleashed serious gold-futures selling.
But amazingly it didn't, gold rallied 0.3% on the 13th despite this latest hawkish dot plot. And even more remarkable was its 0.2% gain the next day to $1302. That morning the European Central Bank made a major policy announcement. It declared it was ending its enormous quantitative-easing campaign at the end of 2018, but tried to mollify currency traders by promising it wouldn't hike rates before next summer.
So despite the hawkish end of ECB QE, the euro plummeted 1.8% on the dovish surprise of a promise to hold off on rate hikes. Since the euro accounts for almost 58% of its weight, the US Dollar Index blasted 1.3% higher on that. That made for the best up day by far of the dollar's entire recent short-squeeze rally that has really weighed on gold since mid-April. Gold could've easily fallen 1% to 2% on that dollar surge.
But surprisingly gold-futures speculators didn't sell on the 14th, oddly ignoring that blistering dollar surge. With gold holding rock-solid through two major selling catalysts erupting right in the middle of the summer doldrums, they looked to be waning. Gold's resilience was very impressive. But unfortunately all of that collapsed the very next morning. The gold-futures speculators resumed heavy selling with a vengeance.
Early on the 15th, the US published its target list of Chinese imports worth $50b annually to be subjected to new 25% tariffs effective today July 6th. For some reason that triggered huge gold-futures selling. These traders have ignored most other escalating-trade-war threats in recent months, but that day they didn't. Over the 4 hours following that announcement, a staggering 260k gold-futures contracts changed hands!
So gold plunged from $1299 right before that tariff warning to a serious 1.7% loss that day to $1279. A lot of traders believe the US dollar will be bid higher in trade wars. They could ignite stock-market selloffs leading to safe-haven dollar buying. And other countries could increasingly devalue their own currencies to partially offset the adverse price impact of US tariffs on their exports. That could lead to a stronger dollar.
But the dollar sure wasn't rallying that day, with the USDX finishing dead flat. Yet gold selling started that day that persisted right into this week. As of this Monday, gold had fallen in 10 of the 12 trading days starting with that odd gold-futures selling blitz on trade-war fears. That dragged gold 4.6% lower in that short span, nearing the bottom of its usual +/-5% summer-doldrums trading range. That is super-weak action.
Gold plunged 3.5% last month, vastly worse than that modern-bull-market-year average loss of 0.2% in June. After ignoring another Fed rate hike, a hawkish-dot-plot surprise, and then a surging US dollar thanks to a "dovish" ECB, gold-futures speculators finally capitulated over the last several weeks or so. Odds are that largely exhausted their selling, paving the way for gold's major autumn rally to erupt very soon.
Speculators' collective gold-futures positions are reported late Friday afternoons in the CFTC's famous Commitments of Traders reports. These CoT reads are current to the preceding Tuesday closes, so the latest data available when this essay was published was June 26th's. At that point just under 3/4ths of gold's total selloff over the past several weeks or so had happened, thus most of the recent picture is evident.
This next chart looks at gold-futures speculators' total long and short contracts per those weekly CoTs rendered in greed and red respectively. Gold is superimposed over the top of that in blue. When these traders are buying gold futures, both by adding new longs and covering shorts, gold rallies. When they are selling gold futures, both by dumping longs and adding new shorts, gold falls. That's what just happened.
A day before that latest FOMC decision and hawkish dot plot in mid-June, speculators held 240.9k gold-futures long contracts and 100.3k short ones. Those were both pretty low, which meant gold's outlook was mixed heading into Fed Day. Speculators had lots of room to add new longs, which was bullish for gold. But they also had big capital firepower available to ramp their short selling, which was certainly bearish.
One way to visualize the near-term gold-price implications of specs' collective gold-futures positioning is to consider their total longs and shorts relative to their past-year trading ranges. On Fed eve in mid-June, total spec longs were running just 3% up into their past-year trading range. Speculators had already sold them down aggressively during the recent USDX-short-squeeze rally, leaving them with relatively little left to sell.
The CoT week before, total spec longs had actually fallen to a deep 2.3-year low. Speculators had not been less bullish or more bearish on gold since early February 2016, before today's bull became official! They were effectively all-out on the long side, so heavy long selling was very unlikely regardless of what the Fed or ECB did. All the downside risk was on the short side, as I had warned our subscribers in early June.
Total spec shorts were running just 17% up into their own past-year trading range on Fed eve in mid-June. That meant these traders likely still had room to do 5/6ths of their probable near-term short selling if the right catalyst arose. A hawkish dot plot would probably be it, although that heavy shorting didn't erupt until a couple trading days later on trade-war news. And that short selling soared to near-record extremes!
In the next CoT week that straddled the Fed, ECB, and that US announcement of imminent major tariffs on Chinese goods, total spec longs actually climbed a sizable 9.1k contracts. But that impressive buying in the summer doldrums was far overpowered by a stupendous 35.5k contracts of new gold-futures short selling by the speculators! Together that added up to the equivalent of 82.3 metric tons of gold dumped.
That's far too much for normal demand to absorb in any single CoT week, let alone in the dark heart of the summer doldrums when investors are on the sidelines. According to the latest fundamental data from the World Gold Council, global investment demand averaged 22.1t per week in Q1'18. So nearly 4x that being flung into the markets by gold-futures speculators was far too much to digest, thus gold plunged.
The astounding part of all this is that 35.5k contracts of gold-futures shorting made for the 2nd-highest on record out of all 1016 CoT weeks since early 1999 by that point! That was only exceeded by another epic shorting blitz in mid-November 2015 leading into the Fed's first rate hike of this cycle. Extreme gold-futures short selling is wildly unsustainable, which makes it a very-bullish indicator for gold following such episodes.
Unlike long-side buying which speculators are never compelled to do, short covering is mandatory. In order to sell short gold futures, traders effectively have to borrow them first. Those debts legally must be repaid in the near future. The way that is done mechanically is through buying long contracts to offset and close out those shorts. So gold-futures short selling is guaranteed symmetrical near-future buying!
The upside price impact on gold of buying long contracts to cover shorts and normal long-side buying is identical. So gold rallies sharply on short-covering long buying after heavy shorting. The more extreme speculators' gold-futures shorting, the bigger the subsequent buying to cover and close those positions. And in the next CoT week after that near-record one, specs shorted another 14.7k gold-futures contracts.
So as of June 26th, in just two CoT weeks gold-futures speculators had short sold a gargantuan 50.3k contracts! That's the equivalent of 156.3t of gold, a huge amount. That left total spec shorts way up at an 11.0-month high of 150.6k contracts. They hadn't been higher since last summer early in gold's major autumn rally. In past-year-trading-range terms, total spec longs and shorts were running 6% and 64% up in.
The lower spec longs and higher spec shorts, the more bullish gold's near-term outlook. When longs are low all these traders can do is buy since their selling is exhausted. And the same is true when shorts are high, the available capital firepower for selling short has been expended so the only action traders can take is covering shorts. Thus the most-bullish situation possible for gold is 0% longs and 100% shorts.
Given gold's continuing weak price action in this latest CoT week ending this Tuesday July 3rd, I suspect there's been some long selling and even more shorting. Thus we are probably getting as close to 0% longs and 100% shorts as we've been since last year's summer doldrums. And as the gold trading action coming out of them proved, that's really bullish for gold's outlook over the coming weeks and months.
A year ago in early July, total spec longs and shorts hit 10% and 100% up into their past-year trading ranges. Over the next couple CoT weeks they stabilized at 7% and 100% then 6% and 99%. These elite traders had exhausted nearly all their likely selling, leaving them nothing to do but buy. I wrote an essay last July highlighting the extreme levels of gold-futures shorting. Last summer looked much like this one.
The Fed hiked rates for the 4th time in this cycle in mid-June 2017. Over the next several weeks, gold dropped 4.2% to $1212 on Jobs Friday July 7th. That ought to sound familiar, as gold was down 4.1% between the day before last month's latest Fed rate hike and this Monday. And once again the monthly US jobs report just came out this morning. Like this week, a year ago everyone was very bearish on gold.
But with speculators' gold-futures selling so exhausted, that miserable sentiment didn't matter. These guys couldn't sell much more, and they were soon forced to start buying to cover their extreme shorts. That fed on itself, pushing gold high enough to entice in new long-side buying. Thus between early July and early September 2017, gold surged 11.2% higher in a nice autumn rally. Another one is imminent.
If gold bottomed earlier this week at $1242, a similar gain this year would catapult it to $1381 by late September or so. That would drive a major bull-market breakout above both $1350 resistance and the $1365 bull-to-date peak from way back in July 2016! Seeing new bull-market highs would get investors excited about gold again. They would start flooding back in in a big way fueling the next major bull-market upleg.
Just like early last July, with speculators' gold-futures selling largely exhausted these traders will soon have to start buying to cover. That's the first stage of major gold uplegs, as that early buying drives gold high enough to first bring back long-side gold-futures speculators and later investors. Gold is well set up for a major autumn rally in the coming weeks and months, with spec longs and shorts nearing 0% and 100%.
Far from being something to fret about, the summer doldrums are a gift for prudent contrarian investors and speculators. They offer the best seasonal buying opportunities of the year in gold, silver, and their miners' stocks. Late last summer as gold powered 11.2% higher, the benchmark HUI gold-stock index leveraged that to a strong 22.7% gain in that exact span. Today's dirt-cheap gold stocks have far-greater potential.
They are deeply out of favor, either despised or totally ignored. And they are wildly undervalued, trading at levels implying gold prices were radically lower than prevailing levels. The gold miners are earning fat profits even at $1250 gold, and those will really amplify gold's gains as it rebounds out of these summer-doldrums lows. Now is the time to get deployed into great individual gold stocks or their best ETFs like GDXJ.
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The bottom line is the recent gold selling is exhausting. While gold tends to be weak in early summers as investors zone out, this year's downside has been worse than usual. While their longs were already low entering summer, the gold-futures speculators just unleashed a near-record shorting blitz on trade-war fears. But that's wildly unsustainable, guaranteeing symmetrical near-future buying as those shorts are covered.
Low spec longs and high spec shorts leave gold perfectly positioned for another major autumn rally this year. That could ignite any day, and ought to push gold high enough to achieve the long-awaited bull-market breakout to major new highs. Now is the time to buy gold, silver, and especially their miners' stocks at today's dirt-cheap prices around these seasonal lows. Big gains later require buying low out of favor.
Jul 06, 2018
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