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Gold Demand Fragile

Adam Hamilton
Oct 11, 2019

Gold investment demand was strong in the months following gold's decisive breakout to new bull-market highs in late June. The metal's upside momentum fueled big capital inflows, accelerating its gains. But soon after gold's upleg stalled, so did the investment buying. With stock markets still near record highs, the normal portfolio-diversification motive for owning gold is lacking. Thus recent gold demand is fragile.

Gold investment demand is a major driver of gold price trends. Gold naturally surges when investment capital is flooding in, and slumps when it flows back out. While investment demand is a relatively-minor fraction of overall global gold demand, it is the most-volatile major demand category by far. The best data available on world gold supply and demand is published quarterly by the venerable World Gold Council.

Over the last 5 calendar years, gold investment demand has accounted for 20.4%, 22.3%, 36.9%, 29.8%, and 26.5% of total global gold demand. But the absolute-tonnage difference in investment from its worst to best year in that span was a whopping 84.3%! In comparison jewelry, gold's largest demand category, only varied by 20.5%. The huge variability in investment demand gives it an outsized impact on gold prices.

The latest fundamental data available from the WGC is current to Q2'19. In the first half of this year, gold investment demand ran 26.8% of the world total. That is right in line with the 27.2% average from 2014 to 2018. And H1'19's total gold investment demand of 584.5 metric tons was right in line with half of the last 5 calendar years' annual average at 592.6t. Gold investment was looking pretty normal before late June.

But everything changed when gold finally decisively broke out to new bull-market highs. Today's gold bull was born way back in mid-December 2015, out of deep secular lows. Its maiden upleg soared to a big 29.9% gain in a blisteringly-fast 6.7 months. Then for 2.9 long years, gold couldn't break out above that early crest. Despite major lows trending higher and no bear-market-grade selloffs, there were no higher highs.

So investors' interest waned, and apathy slowly morphed into bearishness. Without new bull highs, the powerful new-high psychology couldn't kick in. That greatly expands gold's visibility through financial-media exposure, and motivates investors to buy aggressively to chase the momentum. That all finally started to change on June 20th, when gold's $1389 close finally eclipsed its initial $1365 peak from July 2016.

Gold's bull-breakout surge ignited after top Fed officials changed their bias on the future interest-rate direction from hiking to cutting. That major dovish shift lit a fire under gold. Just after that, gold investment demand exploded. Thankfully there's a great daily proxy for it since the definitive WGC read is only published quarterly. That is found in the holdings of the leading GLD SPDR Gold Shares gold ETF.

While there are plenty of gold ETFs around the world, GLD was the original. Launched all the way back in November 2004, it has grown into a behemoth. As of the end of Q2, GLD's 794.0t of gold held in trust for its shareholders accounted for 31.2% of all the gold held by all the world's gold ETFs! That dwarfs the 2nd- and 3rd-largest gold ETFs at 11.6% and 7.6%. GLD's size gives it unparalleled impact on gold prices.

GLD effectively acts as a conduit for the vast pools of American stock-market capital to slosh into and out of physical gold bullion. Often when quarters see big gold moves in either direction, the change in GLD's holdings alone accounts for most of the change in totalglobal gold demand! And since GLD's managers publish its holdings daily, they offer an invaluable high-resolution read on gold-investment-demand trends.

GLD's mission is to track the gold price, and it can't succeed unless supply-demand differentials between its share price and the underlying gold market can be equalized. Excess GLD-share supply and demand is shunted directly into physical gold itself, ensuring GLD's price exactly mirrors gold's. If GLD's holdings are rising, American stock-market capital is flowing into gold. If they are falling, investment money is exiting.

When stock investors bid up GLD shares faster than gold is rising, its price threatens to decouple to the upside. To prevent that failure, GLD's managers issue enough new shares to offset that excess demand. They use the money raised to buy more physical gold bullion, pushing GLD's holdings higher. Thus rising GLD holdings are the best daily indicator available of rising gold investment demand, which is bullish for gold.

When stock investors sell GLD shares faster than gold is falling, its price will break away from gold to the downside. GLD's managers must step in to absorb that excess supply. So they sell physical gold bullion and use the money to buy back GLD shares. The result is GLD's share price continues to track gold, but its underlying holdings shrink. GLD's holdings are the most important daily data available for gold investors.

Current GLD-holdings trends imply the recent strong gold investment demand is fragile. That is short-term bearish for gold, amplifying downside risks when investors start to flee. This chart superimposes GLD's holdings in blue over the gold price in red during this secular bull. GLD-holdings growth has stalled out multiple times in this latest upleg when gold momentum flagged. Investment demand hasn't been durable.

Strategically the major uplegs and corrections in gold tend to follow investment demand as represented by GLD's holdings. GLD's massive physical-gold-bullion hoard swells when gold is rising on balance, and shrinks when it is falling. That powerful 29.9% maiden upleg of this bull mostly in H1'16 was driven by an enormous 55.7% or 351.1t build in GLD's holdings! Big investment-capital inflows push gold higher fast.

Gold's brutal subsequent 17.3% correction within H2'16 was partially driven by a 14.2% or 138.9t GLD-holdings draw. American stock investors dumping GLD shares en masse to pull capital out of gold hits its price hard. This gold bull's second 20.4% upleg straddling 2017 only saw a trivial 0.8% or 7.0t GLD build. Gold investment demand isn't gold's only major driver, it competes with another major one often eclipsing it.

Speculators' collective trading in gold futures, which is done at wildly-extreme leverage, usually trumps gold investment demand. Gold-futures trading is more important over the short-term, while investment demand fuels longer-term trends. So what is happening in GLD's holdings must be integrated with what is going on with specs' gold-futures positioning. I last took a deep dive into that in another essay a month ago.

This gold bull's second major correction unfolded largely in H1'18, where gold dropped 13.6%. GLD's holdings fell 8.9% or 75.9t in that span, showing investment outflows were a major factor. Our current upleg is this gold bull's third, which saw gold blast 32.4% higher at best in early September. Over that 12.6-month span, GLD's holdings surged 15.8% or 122.5 metric tons. Most of that came in recent months.

Back in mid-May gold was languishing in the high $1200s, investors wanted nothing to do with it. GLD's holdings slumped to 733.2t, which was just 0.4% above being a 3.2-year secular low! Sentiment was just dismal in gold and its miners' stocks. Ever the contrarian betting against the herd, heading into that I wrote an essay on "Gold-Bull Breakout Potential". Bearish sentiment flags times to buy low ahead of surges.

Gold investment demand started picking up again as gold recovered in early June, on more tariff threats from Trump. By mid-June, GLD's holdings had climbed 4.2% or 30.9t in 5 weeks. That along with gold-futures buying helped fuel a nice 4.9% gold rally. But the real fireworks came after the June 19th FOMC meeting, where top Fed officials started predicting rate cuts instead of hikes. That ignited furious gold buying.

Gold finally broke out to its first new bull-market high in 2.9 years the very next day. GLD's holdings were dead flat both those days, but the second day after the Fed American stock investors flooded back in with a vengeance. On June 21st, GLD's holdings skyrocketed 4.6% or 34.9t higher on extreme differential demand for GLD shares! That was the biggest daily percentage build since September 2008 in the stock panic.

There's nothing more bullish for gold than sustained investment demand, as stock-market capital is vast compared to the gold market. But with the flagship US S&P 500 stock index hitting new record highs, the motivation wasn't there to prudently buy gold to diversify stock-heavy portfolios. Investors were buying gold just to chase its upside momentum. So once that stalled, so did their gold capital inflows via GLD.

Gold's decisive bull-market breakout initially lasted 4 trading days in late June, where gold closed at $1389, $1399, $1419, and $1423. Gold didn't see any more highs for the next several weeks, leading to that GLD-share demand withering. From late June to mid-July, GLD's holdings traded in a very-tight range between 794.0t to 802.0t. Gold investment inflows didn't resume until gold made more highs in late July.

It closed at $1425 on July 17th, unleashing the next round of momentum-chasing gold investment buying. From then until gold's latest $1554 peak in early September, differential GLD buying flowed and ebbed with gold's progress. When gold achieved new bull-market highs, American stock investors would get excited and flood into GLD. But when gold stalled or retreated, their buying mostly dried up in real-time.

Gold blasted another 10.7% higher in that 7-week span straddling August, partially driven by a huge 12.1% or 96.5t GLD-holdings build! But the specific GLD-build days were highly conditional. If gold wasn't hitting new upleg highs on any particular trading day, investment demand just wasn't there. This isn't unusual, as investors love chasing momentum. But investment demand isn't always so contingent.

Some of the biggest and strongest gold uplegs happen when US stock markets are weakening. Gold is the ultimate portfolio diversifier, tending to rally when stocks sink. So investors flood into it regardless of what the gold price is doing when they expect material stock-market selling ahead. In those scenarios GLD's holdings build on balance most of the time, not dependent on new gold highs. That is durable demand.

The problem with momentum-driven gold investment demand is it's fragile. When gold upside stalls or flags as speculator gold-futures buying moderates or reverses to selling, investment capital flows follow. Investors have no reason to shift more of their portfolios into gold other than chasing gains, so they tend to sell when those gains cease. That puts downward pressure on gold, exacerbating a selloff vicious circle.

The more investors sell, the faster gold falls. The faster gold falls, the more investors sell. Momentum-driven gold investment demand amplifies selloffs, rather than retarding them like diversification-driven gold investment demand. For the better part of several weeks after gold's early-September peak, GLD holdings started drifting lower again. As gold dropped 4.3% over 7 trading days, GLD's holdings fell 2.4% or 21.4t.

Gold got a reprieve in late September, surging back over $1500 to close at $1515 on the 20th after the stock markets started sliding on bad US-China trade-war news. Gold rallied for a few days hitting $1532, which was well short of its $1554 September 4th high. But that again unleashed momentum-driven gold investment demand, so GLD's holdings surged 4.7% or 41.3t to a 2.9-year high. They've flatlined ever since.

Over the past couple weeks as gold meandered around $1500, GLD's holdings traded in another tight range between 920.8t to 924.9t. Not even some significant stock-market weakness into early October sparked any meaningful differential GLD-share buying. When the S&P 500 plunged 3.0% in October's first couple trading days and gold rallied 1.9%, GLD's holdings merely climbed a trivial 0.3% or 2.9t!

Momentum-driven gold investment demand thrives on new gold highs. Gold rallying out of a selloff often isn't enough to fuel excitement. And gold falling materially is likely to lead to sizable investment selling as investors flee. Since they aren't trying to diversify stock-heavy portfolios, they'll have a low tolerance for corrections. The recent fragile momentum-driven gold investment demand reversing is a big risk for gold.

Again speculators' gold-futures trading is gold's dominant short-term driver. As I warned a month ago, their collective bets were and have largely remained excessively bullish. They've been effectively all-in longs and all-out shorts, leaving them little room to buy more but vast room to sell. The resulting gold-futures-selling overhang is ominous, making a big and sharp gold selloff necessary to normalize their bets.

As gold rolls over into the resulting correction, the recent investors are going to flee. They will dump GLD shares way faster than gold itself is being sold, forcing GLD's managers to sell down their physical-gold-bullion holdings to buy back that excess GLD-share supply. That investment-driven selling pressure will amplify gold's downside, and spawn more psychological pressure for other traders to join in the selling.

Since GLD's holdings peaked at 924.9t in late September, at worst they've merely slipped a trivial 0.4% to 920.8t by early October. That 4.1t draw is a rounding error. Remember this gold bull's first and second corrections saw massive 138.9t and 75.9t GLD draws before gold bottomed! That averages out to 107.4t, or 26.2x larger than GLD's worst draw so far in gold's probable third bull-market correction. Selling is coming.

With each passing trading day the evidence for gold being in another correction grows. For 5 weeks now it has been drifting lower on balance, carving lower highs and lower lows in a well-defined downtrend. The 4.1t of GLD selling so far is a tiny fraction of the huge 160.8t GLD build from just before gold's bull-market breakout in late June to GLD holdings' late-September peak. A 75t-to-100t draw would be justified!

This gold bull hasn't seen any corrections without major differential GLD-share selling. And after GLD's holdings skyrocketed on momentum buying since mid-summer, a mean reversion lower is highly likely. Any material GLD-share selling will exacerbate gold's inevitable futures-driven selloff. That's a big near-term risk for gold and the stocks of its miners. Last week I wrote an essay on the gold-stock correction underway.

The GDX VanEck Vectors Gold Miners ETF is their leading benchmark. Compare this updated chart with GLD's holdings in the first chart. Note that whenever gold investment outflows help push gold lower in major corrections, the gold stocks get hammered. GDX's brutal 39.4% and 31.3% bull-market corrections coincided with major GLD-draw periods. Fragile gold investment demand is also a serious gold-stock risk!

Since I discussed gold stocks' situation and outlook in depth last week, I'm not going to reiterate all that here. The point is gold-stock speculators and investors need to follow GLD's holdings to stay abreast of gold investment demand. The gold miners' stocks enjoy strong gains when gold sees capital inflows from investors. But boy when those investors flee for any reason, the gold stocks really take it on the chin!

Recent months' gold-investment-demand behavior exacerbates gold's near-term selloff risks. When the gold-futures speculators are forced to unwind their excessively-bullish positions, investors are going to join in. Their buying since mid-summer has been totally momentum-driven, dependent on a steady stream of exciting new gold highs. With diversification not a concern, they will sell hard as gold retreats.

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The bottom line is recent months' strong gold investment demand is fragile. Those inflows from American stock investors have been conditional, totally dependent on gold's upside momentum. Their differential GLD-share buying has stopped whenever gold's advance stalled or flagged. With the US stock markets way up near all-time-record highs, there's little perceived need for portfolio diversification driving durable demand.

So as this latest strong gold upleg inevitably rolls over into a healthy bull-market correction, investment selling is going to exacerbate gold's downside. When gold's gains turn to losses, momentum-chasing investors won't hesitate to flee. Their selling and speculators' gold-futures selling will reinforce and amplify each other. A major gold correction will crush gold stocks, but create great buying opportunities in its wake.


Oct 11, 2019
Adam Hamilton, CPA

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