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Gold's Amazing Resiliency

Adam Hamilton
Jul 31, 2015

Gold has certainly had a rough summer, facing withering selling pressure from record futures shorting. The resulting new secular lows have greatly exacerbated the already-extreme bearish psychology long plaguing this metal. But considering the howling headwinds gold has suffered in recent years, it has actually proved amazingly resilient. This indicates strong latent demand due to accelerate as sentiment shifts.

The consensus view on gold today is overwhelmingly bearish, with virtually everyone convinced it is doomed to spiral lower indefinitely. They argue that gold yields nothing, so therefore why bother owning it? Especially with the first Fed rate hikes in over 9 years looming! As interest rates begin inexorably mean reverting higher, rising yields will leave gold even farther behind. Keynes' "barbarous relic" can't compete.

Provocatively while the threat of rate hikes is new, the extreme gold pessimism certainly isn't. Gold has been continuously deeply out of favor and despised since spring 2013. This is easily proved. Whoever your favorite bearish gold commentator is today, dig into his archives and read what he writing back in June and July 2013. You'll find strong conviction back then that gold was soon due to fall dramatically lower.

For two long years now, it has been super-fashionable to be exceedingly bearish on gold. That's been the easy mainstream stance to take. If I had an ounce of gold for every commentary I've read since mid-2013 somberly predicting sub-$1000 gold prices imminently, I could start my own central bank! Yet that wildly-popular notion that gold was staring into the abyss proved dead wrong, it refused to go significantly lower.

This has greatly confounded the gold bears, as everything has been heavily stacked against gold. It has weathered record futures shorting by speculators and record gold-ETF liquidations by stock investors, along with relentlessly climbing US stock markets and a soaring US dollar. It's hard to dream up a more-challenging gold scenario, yet it steadfastly bucked the epically bearish sentiment to remain amazingly resilient.

Any one of these fierce headwinds alone could've stopped gold in its tracks, and all four together should've destroyed it as the bearish analysts long predicted. Yet here we are years later in the most hostile conditions imaginable for gold, and it isn't all that much lower than its initial June 2013 low! This incredible show of relative strength was the result of big latent demand for gold despite horrendous psychology.

So if gold didn't crumble in the face of recent years' extreme futures and ETF selling, and surging stock markets and US dollar, what's going to happen as these screaming headwinds inevitably abate? There is only so much futures and ETF selling possible, and stock markets and the US dollar are forever cyclical with no uptrends lasting forever. When even one of these headwinds reverses, gold is going to surge.

Our chart this week looks at the last couple years of gold price action compared to the US flagship S&P 500 stock index, the US Dollar Index, American speculators' total gold-futures shorts, and the dominant American GLD gold ETF's holdings. Since all these series require far-different axes, they all had to be individually indexed to fit on one chart. The date set to 100 on these indexes was gold's original June 2013 low.

The main reason gold sentiment is so bearish is because traders are naturally myopic. We humans tend to greatly overweight the present when forming our opinions, forgetting history. But for those who want to view markets rationally so they can actually buy low, sell high, and multiply their wealth, perspective is everything. The roots of today's extreme gold pessimism stretch all the way back to the wild events of early 2013.

But understanding them requires some context. Between April 2001 and August 2011, gold powered an outstanding 638% higher in a massive secular bull. Although gold was still a contrarian play over this 10.4-year-long wealth-multiplying span, it was the best-performing sector in the world. The benchmark S&P 500 was mired in a secular bear and slipped 1.9% lower over that span, but gold shined brilliantly.

The smart contrarians like our subscribers were aggressively buying radically-out-of-favor gold stocks and silver stocks back in the early 2000s, after the last secular stock bull peaked. The flagship HUI gold-stock index skyrocketed 1165% higher over that same decade, turning countless prudent contrarians into multi-millionaires. So even though gold was overbought in summer 2011, it certainly wasn't hated in 2012.

Gold corrected sharply after that bull peak and then consolidated high, which is perfectly normal. Of course greedy euphoria dissipated after gold topped, but this metal was still doing very well. It averaged $1669 in 2012, up 6.1% from $1573 in 2011. All gold's problems that persist to this day began in early 2013. That's when the US Federal Reserve embarked on an extreme and wildly-unprecedented policy.

The US stock markets were stalling out in late 2012 after more than doubling in a powerful bull market over the preceding several years. But the US economy remained weak, so the Fed was very worried about flagging stock markets forcing the US back into recession. Falling stock prices erode consumer spending, as the wealth effect leaves Americans feeling poorer. So the Fed attempted to preempt any selloff.

In late 2012, it launched and expanded its third quantitative-easing campaign. This was classic debt monetization, creating money out of thin air to buy bonds and manipulate interest rates lower. But QE3 was a very different beast from the earlier QE1 and QE2. Unlike its predecessors, QE3 was totally open-ended. It had no predetermined size or end date, which was radically unprecedented in a century of Fed history.

The Fed used this QE3 uncertainty to its advantage, deftly manipulating stock-trader psychology. 2013 saw Fed officials constantly jawboning about expanding QE3 if necessary to arrest any material stock-market selloff. Traders understood this exactly as the Fed intended, thinking the Fed was effectively backstopping stock markets! They came to believe stocks were riskless, that market cycles had been eradicated.

This Fed Put concept attracted torrents of capital to the US stock markets in early 2013, short circuiting the end of that cyclical bull that had been born in early 2009. Money managers flocked to the surging stock markets, dumping everything else to raise capital. This included gold, which was shunned as prudent portfolio diversification with alternative investments was totally forgotten. So gold utterly collapsed.

Check out the first half of 2013 in this chart above, where the gold price plunged 26.4%! This was due to a combination of an epic record mass exodus from the global flagship GLD gold ETF and extreme gold-futures shorting by American speculators. In Q1'13 and Q2'13, American stock traders dumped their GLD shares so aggressively that this ETF was forced to liquidate 129.6 tonnes and an astounding 251.8t of gold!

GLD is simply a conduit for the vast pools of stock-market capital to flow into and out of physical gold bullion. It can only fulfill its mission of tracking the gold price if differential buying and selling pressure on its shares can be directly equalized into the underlying physical gold market. So a deluge of gold supply slammed the markets in little time as American stock traders jettisoned GLD shares to buy general stocks.

This greatly emboldened American futures speculators to make leveraged downside bets on gold. So they dramatically ballooned their gold-futures shorts in the first half of 2013, adding even more supply pressure. In Q1'13 and Q2'13, their total shorts exploded by 37.9k and 76.9k contracts, which is the equivalent of another 117.9t and 239.1t of gold respectively. All this marginal supply crushed gold prices.

The sole reason gold plunged 26.4% in the first half of 2013 was this combined 691.2t of gold supply cast into the markets from the extreme GLD selling by American stock traders and extreme shorting by American gold-futures speculators. That was far too much gold to absorb so rapidly, working out to 115.2t per month over that extraordinary span. World Gold Council statistics help put this into perspective.

According to the WGC, average monthly global gold investment demand in 2012 before all this Fed-driven madness ran at 135.2t. So with supply temporarily overwhelming demand as capital fled gold to chase the Fed's incredible QE3-driven stock-market levitation, gold collapsed. That was a once-in-a-century superstorm for gold, with this metal suffering its worst quarterly drop in 93 years in Q2'13!

It was that extraordinarily anomalous event that created the extreme bearishness continuing to plague gold today. In the financial markets, price action drives sentiment. So after gold cratered in the first half of 2013, psychology was epically bearish. Rather than seeing that episode as a once-in-a-lifetime anomaly that had already burned itself out, analysts and traders alike extrapolated that extreme selling indefinitely.

So they started making all kinds of wildly-bearish gold-price predictions. Virtually everyone expected to see gold soon plunge below $1000, and at least half the commentaries back then were forecasting $850 or less. I remember one guy vociferously arguing for $500! The more bearish the commentators, the more popular they became. Traders love to have their ears tickled, to hear views that support their own.

So with everyone super-bearish on gold after its worst quarterly plunge in nearly a century, of course this dominant worldview fed on itself. Bearish traders wanted their outlooks rationalized, so they sought out bearish commentary. And bearish commentators were happy to oblige, telling traders whatever they wanted to hear to maximize their own popularity and product sales. The problem was they were wrong.

Markets are forever cyclical, both in terms of prices and sentiment. Once a price has fallen so far, selling is exhausted. After GLD's holdings plunged 28.2% in the first half of 2013, the weak hands were out. And gold-futures shorting is finite, there are only so many speculators willing to make those super-risky hyper-leveraged bets. And once fear and bearishness inevitably peak, they can only abate from such extremes.

So when gold hit $1199 on a closing basis on June 27th, 2013, that once-in-a-lifetime selling anomaly was already over. Yet the extreme bearishness persisted to today. Traders have foolishly chosen to ignore history and believe that the Fed is miraculously omnipotent. That this central bank has the ability to magically manipulate stock markets higher and thus gold lower forever. So stocks remain adored, and gold despised.

But despite the universal extreme bearishness plaguing gold in recent years, it has been amazingly resilient! Again this chart shows gold indexed to 100 as of that initial late-June-2013 low, along with the S&P 500, US Dollar Index, American speculators' gold-futures shorts, and GLD's holdings individually indexed to their own levels on that fateful day as well. Despite the unfavorable events since, gold has held strong.

From June 2013 until October 2014, the lion's share of this post-early-2013-selloff period, gold remained above its June 2013 lows as you can see on this chart. On average over that 16-month span, gold was trading 7.5% above that initial June 2013 low. It's only in the past 9 months that gold has fallen below, and over that span since starting in November 2014 gold averaged just 0.4% under its June 2013 low!

This perspective is critical, so take the time to fully digest it. In the 25 months since gold's extraordinary-anomalous once-in-a-century superstormlow, 2/3rds of the time has seen gold averaging 7.5% over that low and 1/3rd merely 0.4% under! Over that entire 25-month span, gold traded 4.7% above those June 2013 lows on average. That's super-strong performance compared to the legions of gold bears' dire predictions!

And it's certainly true that gold recently slumped to its worst lows of not only this entire post-early-2013-selloff span, but in 5.3 years. The $1090 gold low seen in July 2015 sure feels a heck of a lot worse than the $1199 in June 2013. That's why bearish commentary and extreme downside predictions have again exploded in popularity in recent weeks. Traders are bearish, so they want their views rationalized.

But considering the howling headwinds facing gold in recent years, seeing this metal down 9.2% at worst near its weakest seasonal time of the year is pretty impressive! Go back to that chart above and consider everything else that's happened in the past couple years. To see gold holding strong not too far from its initial $1200ish lows is an amazing show of strength, highlighting strong latent investment demand.

Since gold's initial June 2013 low, the wildly-unprecedented US stock-market levitation thanks to the Fed's extreme zero-interest-rate and quantitative-easing policies continued. The S&P 500 climbed another 32.1% higher at best as of late May 2015. And of all things that affect American investment demand for gold, stock-market levels are the most important. Gold is an alternative investment moving counter to stocks.

Investors continue to believe the US stock markets can rally forever, that the Fed has succeeded in nullifying stock-market cycles. History proves this silly notion is the height of folly, central banks can only delay and therefore intensify cycles. This artificial Fed-fueled stock-market levitation is going to reverse as the Fed is forced by global markets to start normalizing its extreme policies, a huge long-term undertaking.

When these lofty overvalued and overextended US stock markets inevitably roll over, gold is going to return to favor. Investors will suddenly remember the great wisdom of prudent portfolio diversification, and rush to reallocate capital to gold which rallies as stock markets weaken. And they are so radically underinvested in gold today that it will take serious buying persisting for years to even hit a 5% gold allocation.

And much of this gold buying from stock investors will funnel through that GLD gold-ETF conduit. Since gold's initial June 2013 low, GLD's holdings have dropped by another 29.8% at worst. That's another 289.3t of supply over the last 25 months, a lot of gold. Yet despite this ongoing differential selling pressure in GLD shares, gold's price has proved amazingly resilient. When GLD buying inevitably returns, gold will soar.

GLD's holdings slid to a 6.8-year low this month after that gold-futures shorting attack. They hadn't been that low since 2008's stock panic. After that, investors realized they were underinvested in gold. It is a super-important portfolio diversifier since it has a rare inverse correlation with stocks. So over the next 21 months, they bought enough GLD shares to force its holdings 94% higher. Gold surged 42% over that span.

If someone had predicted a couple years ago that gold would hold strong while the US stock markets shot another third higher and GLD's holdings fell nearly a third lower, not even the ultra-rare gold bulls like me would've believed them. Yet here we are. The only way gold could weather such raging headwinds intact is if there is big latent buying demand out there despite the pessimism to absorb this supply.

And the Fed-levitated stock markets and ongoing GLD mass exodus certainly weren't the only serious headwinds facing gold. The US Dollar Index also soared 20.9% higher at best as of March 2015 since gold's June 2013 low. That parabolic dollar surge was the result of Fed-rate-hike hopes, since higher domestic interest rates make a currency look relatively more attractive and competitive internationally.

A strong dollar weighs on gold primarily because futures speculators use it as a cue for their own gold trading. And indeed American speculators' gold-futures shorts positions rocketed higher as the US dollar was soaring earlier this year. And they kept on climbing even after the dollar peaked, hitting new all-time record highs this month. It was this extreme futures shorting that forced gold to its latest lows.

With gold investors missing in action over the past couple years thanks to the Fed's epic financial-market distortions, American speculators' gold-futures shorting has totally dominated gold's price action. And their total short positions were an astounding 19.5% above June 2013's levels last week. But this is an extreme anomaly. In the entire 25 months since gold's initial low, these positions were 30.3% lower on average.

Today there are many bearish commentators claiming gold-futures shorting can continue indefinitely, so gold can't rally. If you look at what these same guys were writing in June and July 2013, you will see the very same claim. Yet despite the extreme bearishness and fierce headwinds plaguing gold in the last couple years, speculators' gold-futures shorting was mostly lower. Short selling is finite, it burns itself out.

And just like the Fed's artificial stock-market levitation, the recent extreme short selling will also reverse and mean revert far lower. And that will take tremendous pressure off gold, allowing it to rally fast. If gold proved so amazingly resilient despite the periodic sharp surges in gold-futures shorting in recent years, imagine how much potential it has to rally as shorts are covered and don't revisit their recent extremes.

To see gold essentially flat during most of the past couple years despite the Fed's stock-market levitation, heavy GLD-share liquidation, parabolic US dollar surge, and record speculator gold-futures shorting is just incredible. Any one of these headwinds alone could very well have battered gold much lower as the bears have long predicted. Yet all four of them together failed to do it, which is very bullish for gold!

Someone out there is buying lots of gold, enough to offset all the serious selling in recent years. And sooner or later Western investors who've shunned gold will figure that out. As the stock markets and US dollar inevitably roll over into their next down cycles, as buyers return to GLD and futures shorts are covered, gold is poised to blast higher on strong latent demand. Contrarians who buy in early ought to earn fortunes.

This foolish and historically-proven-false notion that central banks are omnipotent and can manipulate markets indefinitely is ridiculous. Chinese investors are starting to understand this, after watching their own stock markets plummet by nearly a third in less than a month despite the most-locally-powerful central bank in the world throwing the kitchen sink at that selloff trying to arrest it. The stock markets still plunged.

And Fed rate hikes are actually bullish for gold! During the Fed's last rate-hike cycle between June 2004 and June 2006, gold blasted 50% higher despite the Federal Funds Rate more than quintupling to 5.25% over that span! And gold skyrocketed 24.3x higher between early 1971 and early 1980 while the Fed was forced to hike its FFR from 3.5% to 20.0%! Gold thrives in rising rates because they really hurt stock markets.

Gold's amazing resiliency in the past couple years despite everything stacked against it proves there is big latent buying going on somewhere in the world. And that will explode to the surface and catapult gold higher once these extremely-anomalous central-bank-conjured headwinds inevitably abate. The coming gold mean reversion higher can be played via this metal itself or the leading GLD SPDR Gold Shares ETF.

But vastly-greater upside potential exists in the left-for-dead gold miners. Their leading index recently slumped to an astounding 12.8-year low. The last time gold stocks traded at prevailing price levels, gold was in the $310s! Today it is a whopping 3.5x higher, which means seeing the same gold-stock prices is fundamentally-absurd. The best of the gold-mining stocks are due to skyrocket as gold mean reverts higher!

So if you really want to multiply your wealth, invest in this most-despised and undervalued sector by far on the planet. Brave contrarians who did this in the early 2000s enjoyed massive gains over 17x! This is the kind of contrarian speculating we specialize in at Zeal. Decades of experience have taught us that no extreme lasts forever, with the greatest gains won by betting on anomalous extremes soon reversing.

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The bottom line is gold has been amazingly resilient in the past couple years. Despite everything that's been arrayed against it, gold has held strong mostly above its initial extreme June 2013 lows. Not a Fed-levitated stock market, not ongoing GLD liquidations, not a soaring US dollar, not record speculator gold-futures shorting, and not epic bearishness could force gold significantly below its panic levels of two summers ago.

That can only mean there's been big global buying to absorb the additional Western supply and offset the absence of Western investors. That latent demand should explode as the US stock markets, US dollar, and speculators' gold-futures shorts inevitably start mean reverting lower, and GLD's holdings start rebounding. If gold could fare so well when everyone hated it, it's really going to dazzle as it regains favor.


Jul 31, 2015
Adam Hamilton, CPA

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