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Gold Correction Not Over

Adam Hamilton
Dec 06, 2019

Gold has been correcting following last summer's powerful bull-breakout upleg. Since peaking, gold has inexorably drifted lower in a well-defined downtrend. Traders are wondering when this necessary and healthy sentiment-rebalancing selloff will bottom, paving the way for gold's next upleg. But this correction still has a ways to run, according to speculators' gold-futures positioning which dominates gold's price action.

Gold has enjoyed a strong 2019, still up 15.0% year-to-date as of the middle of this week. Unfortunately its gains have been overshadowed by a bigger stock-market surge, driven by extreme Fed easing. This central bank shifted its rate outlook from hiking to cutting, made 3 rate cuts in just 3.0 months, and birthed its massive 4th quantitative-easing campaign to monetize Treasuries! That's incredible in just a half-year.

The resulting stock-market euphoria from the hyper-easy Fed squelched traders' interest in gold. Yet it still enjoyed a strong surge after breaking out to its first new bull-market highs in 3.0 years in late June. Over the next 2.5 months it blasted 14.3% higher, a major move compressed into such a short span of time. That climaxed a bigger 32.4% upleg that unfolded over 12.6 months, the largest of this secular bull so far.

That upleg peaked at $1554 in early September, a 6.4-year secular high for gold. Gold greed was getting excessive then, threatening to morph into euphoria. Most analysts and traders expected big additional gains continuing in the foreseeable future. But critical data revealed the opposite, that a correction was necessary. I warned our newsletter subscribers as September dawned, two trading days before gold topped.

I wrote, "Gold is overextended, due for a healthy bull-market correction over the near-term. Its technicals are way too overbought, and its sentiment way too greedy. Too many buyers have flooded in too quickly, exhausting gold's near-term upside potential. My best guess is a 6%-to-12% gold selloff, which the major gold stocks will leverage like usual by 2x to 3x." That contrarian outlook was generally scoffed at back then.

But I was soon proven right in being short-term bearish on gold. It indeed began correcting, and that total selloff extended to 6.4% over 2.8 months as of Thanksgiving Eve. Gold's technical action since then has carved a parallel series of lower highs and lower lows, a textbook downtrend. And the same data that led me to forecast an imminent correction back when it seemed crazy argues that more downside is still coming.

Decades of gold cycles have proven that this metal has one overwhelmingly-dominant short-term price driver. That is how speculators are trading gold futures! Usually nothing else matters over time horizons measured in low-single-digit months. The unique nature of the gold-futures market lets the guys trading in it punch way above their weights in influencing gold's technical behavior. Several key factors explain this.

Gold-futures trading allows extreme levels of leverage that would be absurd in the stock markets. This week for example, traders are only required to keep $4,500 cash in their accounts for each gold-futures contract they hold. Yet these each control 100 troy ounces of gold that is worth $147,500 at this week's $1475 prevailing gold levels. That enables radical leverage up to 32.8x, supercharging these traders' capital!

Gold-futures traders don't have to run minimum-margin and maximum-leverage, but that's the main allure of that entire market. At 10x, 20x, or 30x, every dollar they deploy in gold futures has 10x, 20x, or 30x the impact on gold's price as a dollar invested outright! So gold-futures speculators' trading has a wildly-disproportional impact on prevailing gold prices. This is even further exacerbated by a couple more things.

The risks inherent in running 10x, 20x, or 30x leverage are enormous. Traders amplifying their bets that much will suffer total 100% losses if gold merely moves 10%, 5% or 3.3% against their positions! That in turn forces these speculators to have an ultra-short-term focus. All they can care about is what gold is likely to do in the coming hours, days, and maybe weeks on the outside. Months and years may as well be eternity.

So gold-futures trading is by necessity almost entirely driven by current momentum. These guys pile into buying when gold is rallying, then exit en masse when it is falling fueling cascading selling. Bearing such extreme risks, closely following the herd is necessary for survival. And specs' gold-price influence is even more amplified because that gold-futures price happens to be gold's world reference oneeveryone else keys off.

Investors around the globe make buying and selling decisions based on what the US gold-futures price is doing. When the gold-futures specs are bidding it higher, investors often join in boosting gold's upside. Then when the former sell, the latter usually follow intensifying gold's downside. The entire gold realm's psychology is driven by how the gold-futures price is faring, and thus how speculators are trading those contracts.

So it's exceedingly important to follow gold futures if you have or want any capital deployed in gold itself, its leading GLD SPDR Gold Shares gold ETF, or the gold miners' stocks. If you don't stay abreast of specs' collective gold-futures trading, you'll never be able to buy relatively low then sell relatively high by gaming gold's endless uplegs and corrections. Now futures are strongly arguing gold's correction isn't over yet.

Gold-futures specs' collective positioning is published weekly, in the famous Commitments of Traders reports from the US Commodity Futures Trading Commission. Released late Friday afternoons, these are current to preceding Tuesday closes. While this data would be even more valuable if published at a daily resolution, the weekly read still flags when both gold uplegs and corrections are likely to give up their ghosts.

This chart looks at specs' total gold-futures long and short contracts during this secular gold bull, which was born back in mid-December 2015. Gold's daily close in blue is superimposed over the weekly spec total longs rendered in green and total shorts in red. Gold's price action is very highly correlated with this specific group of traders' gold-futures buying and selling. Their trading dominatesgold's short-term price action.

The primary reason I was confident bucking the crowd and predicting an imminent gold correction back in early September's greed is readily evident here. Speculators' total gold-futures long contracts soared to 433.0k at the end of August, which was the second-highest ever witnessed out of all 1078 CoT weeks since early 1999 at that point! That 3.1-year high was merely 1.7% below July 2016's all-time record of 440.4k.

Because of the extreme risks inherent in gold-futures trading, only a tiny fraction of traders will ever dare try it. And the capital they wield is finite, actually relatively small compared to the broader gold market. So once spec longs near all-time highs, odds are high their buying firepower is about exhausted. Even when gold prices get high and exciting, traders don't rush to open new futures accounts to chase those gains.

High spec longs alone aren't enough to kill gold uplegs, spec shorts must also be considered. Gold-futures trading has two types of buying and selling. Traders can buy to add new longs, or buy to cover and close existing shorts. They can sell by dumping existing longs, or selling to open new shorts. But the leveraged price impact on gold is identicalregardless of which side of the trade that buying or selling comes on.

As spec longs surged near records in late August, spec shorts collapsed. They dropped to just 79.9k contracts, the lowest levels seen in gold's entire 3.7-year-old secular bull by that point. Spec shorts have an effective floor, they never fall to zero. There is always some contingent of futures traders betting that gold is heading lower. Extremely-high spec longs and extremely-low spec shorts are very short-term bearish.

When speculators have bought all the longs and covered all the shorts they are likely to, their buying firepower is exhausted. That leaves room for nothing but selling, forcing gold lower. Another way to digest this is to view total spec longs and shorts in terms of their gold-bull-market trading ranges. As gold peaked in early September, spec longs and shorts were running 96% and 8% up into those respective bands.

The most-bearish-possiblenear-term setup for gold is 100% longs and 0% shorts, which that positioning was close to. The most-bullish-possible is the opposite, 0% longs and 100% shorts, since that reveals maxed selling potential leaving nothing but buying likely. Speculators' exceedingly-bullish gold-futures bets showing buying exhaustion in late August and early September are the sole reason gold peaked and corrected.

Again that necessary and healthy selloff to rebalance sentiment has so far run 6.4% over 2.8 months as of last week. Many analysts and traders believe that is enough, that gold's next major upleg is starting to get underway. Unfortunately specs' gold-futures trading since gold's latest topping, and their collective positioning now, strongly imply gold's correction remains alive and well with sizable downside still coming.

CoT data is only offered at a weekly resolution. But taking specs' total longs and shorts from Tuesdays nearest to gold's early-September peak and late-November correction-to-date low shows how much selling they've done. Over that 12-CoT-week span they've sold 46.8k long contracts, which is why gold is drifting lower. Oddly that was partially offset by 14.6k contracts of short-covering buying, netting total selling to 32.3k.

32.3k contracts of spec gold-futures selling over 12 CoT weeks as of the latest CoT report is trivial, next to nothing really. There are plenty of single CoT weeks that see spec longs or shorts swing by a huge 20k+ contracts. Thus overall so far in gold's correction there has been no major spec gold-futures selling! That means it is still coming, as gold corrections never end until specs' aggregate bets are finally normalized.

This secular gold bull has suffered two prior major corrections, both driven by excessively-bullish spec gold-futures bets mean reverting back to and through normal levels. During gold's first correction which was a brutal 17.3% largely in H2'16, specs dumped 190.3k contracts between selling longs and adding new shorts. That was 5.9x the gold-futures selling seen so far in gold's still-anemic current correction!

This bull's second correction mostly came mid-2018, when gold fell 13.6%. That was fueled by an even-larger 227.2k contracts of total spec selling. The only reason that correction was smaller is it happened over a longer timeframe. That 227.2k was 7.0x as large as the mere 32.3k seen so far in gold's latest correction. This gold bull's two earlier corrections averaged 208.9k contracts of spec gold-futures selling!

Now we don't necessarily have to get back to 200k again. Gold's decisive bull-market breakout this past summer radically improved gold psychology. Speculators and investors alike are much more likely to buy back in sooner now that they know gold's long-stalled secular bull is still kicking. But I can't imagine a major gold-bull correction without at least 100k contracts of spec selling. And we're only 1/3rd there so far!

The latest CoT week reported by the time this essay was published was current to Tuesday November 26th. Because of the Thanksgiving holiday, that wasn't even released until this latest Monday afternoon. Total spec longs and shorts ran 384.2k and 78.7k contracts in that newest read. Both are very bearish for gold prices over the near term. Those longs were still nearly in the 97th percentile out of all CoT weeks!

That still leaves a heck of a lot more room for selling than for buying. And those shorts were actually a fresh new gold-bull low! Gold-futures speculators are unlikely to buy to cover many more shorts, but have vast room to ramp their short selling again. Total spec longs and shorts in this latest CoT week were way back to 78% and 0% up into their gold-bull trading ranges. The most-bearish possible is again 100% and 0%.

Rather dishearteningly for traders looking to redeploy aggressively in gold and its miners' stocks, this latest CoT in late November showed spec longs and shorts nearly identical to levels right as October dawned. That means the last 8 CoT weeks have seen no net progress in normalizing specs' excessively-bullish gold-futures bets! The lion's share of the gold-futures selling that is inevitable remains yet to come.

Major gold-bull uplegs generate lots of greed, which takes time to dissipate even after they roll over into corrections. Traders are so excited about gold's prospects after big surges that they ignore downtrend technicals. They fervently believe gold is ready to start rallying strongly again. So they stay deployed for weeks or even months. Spec longs and shorts have stayed really high and low continuouslysince late July.

But eventually gold's correction downtrend reaches a tipping point which unleashes serious gold-futures selling. Ominously gold's major topping in mid-2016 after this bull's maiden upleg was similar to what we've seen recently. Gold surged strongly, on specs aggressively buying longs and covering shorts. Their total longs and shorts hovered near those resulting extremes for several months after, big selling didn't appear.

Yet gold wasn't out of the woods until it did, until specs' lopsided bets were normalized through big selling which is the only way. Gold drifted lower nonthreateningly until it finally eventually breached major support, which happened to be $1300 back then. Because of their extreme leverage and the huge resulting risks, gold-futures speculators have to set tight stop losses. Once they start tripping, it's game over.

When gold drifts low enough, gold-futures stops trigger. That unleashes more automatic selling, which of course accelerates gold's slide. That in turn trips more stops, resulting in a vicious circle of cascading selling. That's when the lion's share of gold corrections arrive, crushing traders who didn't heed the warning of spec-gold-futures extremes. New gold uplegs can't start until specs' gold-futures bets are normalized.

That doesn't mean selling so epic it pummels longs and shorts back to that most-bullish-possible-for-gold 0% and 100%. In a well-established secular gold bull with generally-improving psychology, somewhere near 50% and 50% should prove adequate to rebalance sentiment. But even those levels require far more selling coming from last week's 78% longs and 0% shorts. Make no mistake, gold's correction isn't over yet.

If you're looking to redeploy into gold, GLD, gold stocks, or their own leading GDX Gold Miners' ETF, it is imperative to closely watch specs' collective gold-futures positioning. That dominant driver of gold's near-term price action is what is going to give the green light for gold's next upleg. That's why I carefully analyze every weekly CoT report in our weekly and monthly newsletters, showing subscribers what's likely.

There are plenty of other indications gold's correction remains young too. At just 6.4% over 2.8 months at worst so far, it remains small compared to this bull's prior couple corrections averaging 15.5% selloffs over 6.0 months. And gold has yet to return to its key 200-day-moving-average baseline, which is major technical support in ongoing bulls. Last week at its latest low, gold remained 4.0% above that key metric.

So don't jump the gun here and get excited for gold early, before this necessary rebalancing has more fully run its course. Growing your wealth in the markets requires buying low before later selling high. The former is way more important, as lower entry levels guarantee bigger gains later. Gold simply won't be able to bottom, yielding the lowest entry prices in gold stocks, until specs' gold-futures bets mean revert.

To multiply your capital in the markets, you have to trade like a contrarian. That means buying low when few others are willing, so you can later sell high when few others can. In the first half of 2019 well before gold stocks soared higher, we recommended buying many fundamentally-superior gold and silver miners in our popular weeklyand monthlynewsletters. We later realized big gains including 109.7%, 105.8%, and 103.0%!

To profitably trade high-potential gold stocks, you need to stay informed about the spec gold-futures trading that drives gold. Our newsletters are a great way, easy to read and affordable. They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what's going on in the markets, why, and how to trade them with specific stocks. Subscribe today and take advantage of our 20%-off sale! Get onboard now so you can mirror our coming trades for gold's next upleg after this correction largely passes.

The bottom line is gold's correction isn't over yet. The only reason its downtrend has proven modest so far is gold-futures speculators have yet to do any major selling. Their longs have lingered at very-high levels since gold's latest interim high, while their shorts ground along near bull-market lows. That means the lion's share of the necessary gold-futures selling to drive this correction is still yet to come. Beware!

Gold-futures selling typically starts gradually after major gold uplegs peak, then later eventually cascades into a steeper climax. Residual greed persists for some time after toppings, and gold-futures stop losses usually don't start tripping en masse until a few months later. Today the specs still have massive room to sell but little room to buy more. This imbalance has to be rectified before gold's next major upleg starts marching.


Dec 06, 2019
Adam Hamilton, CPA

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

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