The speculators are usually on the wrong side of the trade, and they’re so stacked to the short side, it’s nearly a record. Here’s why it matters…
Gold continues to drift near summer-doldrums lows, feeding and intensifying bearish sentiment. But an exceedingly-bullish event just happened which will ignite a major new upleg. Speculators’ gold-futures short positions have soared near all-time record highs! That means the recent heavy gold selling is exhausted, and massive proportional short-covering buying is imminent. That will catapult gold much higher.
Short-term gold price action is dominated by speculators’ gold-futures trading. This is counterintuitive as this group of traders and the capital they control are small compared to investors and their vast funds. But the futures guys still wield wildly-disproportional outsized influence over gold. It’s impossible to game short-term gold action if you’re not watching and analyzing speculators’ collective gold-futures trading activity.
The main reason this is true is the extreme leverage inherent in gold futures. Investors buy gold outright, using their own money without any margin. And if they choose to buy gold in the form of exchange-traded funds like the leading GLD SPDR Gold Shares gold ETF, stock-market leverage has been legally limited to a maximum of 2x since 1974. Futures speculation is an entirely different world shattering these norms.
Every gold-futures contract controls 100 troy ounces of gold, worth $122,500 at $1225 gold. But margin requirements, the cash speculators are required to keep in their accounts to trade, are vanishingly small. This week COMEX only required cash margins of $3100 per gold-futures contract. That is about 1/40th the value of the gold controlled, equating to extreme leverage around 40x. This greatly distorts gold prices.
At 40x leverage, every dollar speculators deploy in trading gold futures has 40x the price impact on gold as a dollar investors use to buy outright! This enables gold-futures speculators to punch far above their weights in bullying the gold price around. And 40x generates mind-boggling risks, as a mere 2.5% gold move against speculators’ positions will obliterate 100% of their capital risked. So they have to trade very differently.
While investors buy gold gradually over months and years, that extreme leverage inherent in gold futures forces speculators’ focus to hours and days. When a 1% move in gold drives 40% gains or losses, all that matters is the ultra-short-term. By necessity gold-futures speculators’ outlooks are incredibly myopic and their trading is very lumpy. They all have to act at once when gold moves materially against their positions.
This herd effect amplified by extreme leverage running up to 40x can really move the gold price. Those resulting big and fast moves heavily color investors’ sentiment, so they tend to pile on to whatever the futures guys are up to. When speculators are heavy sellers pounding gold lower, investors start worrying and selling in unison. That can really exacerbate and intensify whatever gold’s short-term trend happens to be.
And this summer that is certainly lower. This first chart is another update from my latest research on gold’ssummer-doldrums trading range published in early June. Gold tends to drift sideways to lower in market summers in bull-market years, this is its weakest time of the year seasonally. But this year’s gold action is worse than usual, slightly below support in recent weeks. Extreme gold-futures shorting is to blame.
This spilled-spaghetti mess of a chart is simple conceptually. Gold’s summer action in every modern bull-market year is individually indexed to its final pre-summer close at the end of May, which is set at 100. Then all price action is recast off that common base, making summers perfectly comparable regardless of prevailing gold prices. An indexed level of 95 for example simply means gold is down 5% summer-to-date.
Gold’s modern bull-market years ran from 2001 to 2012, skipped the intervening bear years of 2013 to 2015, and resumed in the next bull from 2016 to 2018. All this was explained in depth in my recent summer-doldrums essay. The yellow lines below show individual years’ indexed summer gold action from 2001 to 2012 and 2016. I rendered 2017’s in light blue this week, because it is relevant and predictive for this year.
All those individual years’ indexed gold prices are then averaged together in the red line, which distills out gold’s seasonal tendencies during market summers. On average gold has slumped 0.2% in Junes, rebounded 0.9% in Julies, and then surged 2.2% in Augusts as its major autumn rallies get underway. Finally the dark-blue line shows gold’s indexed trading action this year, which has been weak even for market summers.
As I warned in early June when gold was still trading near $1300, gold tends to drift sideways to lower this time of year. Market summers are simply devoid of the big recurring surges in outsized gold investment demand seen during much of the rest of the year. With no major income-cycle or cultural drivers of gold buying, gold languishes especially in the first halves of summers. It tends to meander within 5% of May’s close.
That normal +/-5% summer trading range held strong this year until mid-July, when gold slumped below its -5% support line. The driver was heavy gold-futures selling erupting on the release of Jerome Powell’s prepared remarks for his semiannual Congressional testimony on July 17th. The Fed chairman stayed consistently hawkish in his outlook for continuing rate hikes. Gold futures speculators irrationally fear rate hikes.
But gold certainly didn’t crater, at worst over the past couple weeks or so it was down 5.8% summer-to-date. That’s on the lower side, but still not significantly below trend. Not surprisingly this weaker-than-usual price action still really tainted sentiment. Speculators and investors alike are really down on gold, totally convinced it is doomed to spiral lower. But they are wrong like usual at extremes, a major rally is imminent.
Gold’s summer selloff this year was driven by one thing, extreme gold-futures short selling by speculators. They were shorting at near-record levels, catapulting their total short contracts to near-record extremes. Unfortunately the resulting gold-price weakness spooked investors, who have sold heavily in sympathy as I analyzed in last week’s essay. But there’s nothing more bullish for gold than extreme gold-futures shorts!
In order to short sell gold futures, speculators effectively have to borrow gold they don’t have. They then sell someone else’s gold, hoping to profit if they can buy it back later at a lower price to repay their debts. Every contract sold short is legally obligated to soon be closed by buying a long contract to offset it. So gold-futures short selling literally guarantees proportional buying in the near future, driving gold sharply higher.
Before we dig into this year’s near-record gold shorting, last summer offers a great example of what to expect after extreme shorting. A year ago last week, I wrote a similar essay pointing out the extreme gold-futures shorts. Much like this year, they had pushed gold near the lower support of its usual summer trading range as evident in the light-blue line above. That left sentiment exceedingly bearish a year ago.
Being in the financial-newsletter business for a couple decades now, I have unique insights into how traders are feeling. I receive countless e-mails when they are dejected or euphoric. A year ago and over the last couple weeks, I’ve been deluged with feedback telling me what a fool I am to be bullish on gold. Clearly it’s heading much lower! Our actual newsletter sales also rise and fall with the perceived gold outlook.
But when speculators’ gold-futures shorts are extreme, an imminent sharp short-covering rally is certain. Between early July and early September last year, gold powered 11.2% higher on that dynamic! That’s a big rally in just 2.0 months by any standard. Literally the worst and most-foolish time to be bearish on gold is when gold-futures speculators are as evidenced by their extreme shorts. Gold always surges from there.
This year’s major autumn gold rally that will start powering higher any day now should prove considerably larger than last year’s. The next couple months’ gains in the dark-blue summer-2018 indexed gold line above ought to easily exceed the light-blue summer-2017 ones. It’s a pity only hardened contrarians will enjoy these coming big gains, as most traders get mired in popular bearish sentiment and refuse to buy low.
Late every Friday afternoon speculators’ collective gold-futures positions current to preceding Tuesdays’ closes are detailed in the CFTC’s famous Commitments of Traders reports. The latest CoT read when this essay was published is as of Tuesday July 17th. That was actually a couple days before gold’s latest summer-2018 low under $1223 was hit. I was so excited last Friday when I saw speculators’ near-record shorts.
This chart tracks the weekly total long and short contracts collectively held by gold-futures speculators per those CoT reports. Gold is superimposed on top. Nearly all of gold’s short-term price action is explained by what these hyper-leveraged traders are doing. Gold rallies sharply when they are adding longs and/or covering shorts, and it falls sharply when they are dumping longs and/or adding shorts. They dominate gold!
Last Friday’s latest July 17th CoT report was utterly stunning. In that CoT week speculators sold short an enormous 29.0k additional gold-futures contracts! That was near-record shorting for a single CoT week, ranking as the 6th highest out of the 1020 CoT weeks since early 1999. And that wasn’t even the first near-record shorting this summer! The 2nd-highest shorting ever seen of 35.5k contracts hit the June 19th CoT.
This extreme gold-futures short selling is readily evident in this chart, the vertical leaps in the red total-spec-shorts line in recent weeks. That alone would be super-bullish for gold, as these excessive shorts soon have to be covered and closed by buying offsetting longs. Note again last summer how sharply gold surged when specs rushed to cover their shorts. Their extreme leverage makes short covering self-feeding.
I’ve been a professional speculator and investor for decades, blessed with earning a fortune without any leverage at all. Personally I think running 40x leverage is ludicrously crazy. It’s hard to be right on what prices will do in the next hours or days, and a mere 2.5% gold move doubling or obliterating capital risked is too much to bear. So when gold starts rallying, these speculators short gold futures have to scramble to buy.
When shorts are extreme it doesn’t take much of a catalyst to ignite a major short squeeze. Once a tiny fraction of speculators buy to cover, the resulting minor gold rally forces their peers to follow suit. A little 0.5% gold rally out of the blue drives nearly-instant 20% losses, at 1.0% they double to 40%. The more speculators buy offsetting longs to close out their shorts, the faster gold rallies. That forces everyone else to cover.
This short-covering frenzy continues until the extreme shorting spike leading into it is fully erased. That takes from a few weeks to a couple months or so, and gold surges strongly the entire time. Early 2016, early 2017, and mid-2017 are great examples from today’s gold bull clearly evident in this chart. Short-covering buying begets even more buying, soon catapulting gold high enough to bring back long-side speculators.
They command way more capital than the short-side guys, as evident in the green longs line above running much higher than the red shorts line. That forced involuntary short covering soon ignites a new virtuous circle of buying that larger voluntary long buying soon joins. These are the first two stages of major gold-bull uplegs, ultimately driving gold high enough to bring back investors in far-larger stage-three buying.
Gold blasted sharply higher out of every past episode of extreme gold-futures shorting, and today’s won’t be an exception. And not only was last CoT week’s shorting at extreme near-record levels, it forced total spec shorts to a rare extreme near-record high. As of July 17th which was before gold’s latest summer-doldrums low, total spec shorts had rocketed to an incredible 196.3k contracts! That’s mind-bogglingly high.
Out of those same 1020 CoT weeks since early 1999, that ranks as the 5th-highest spec shorts ever seen! And it’s so close to a new all-time record, as only one other episode saw marginally more shorting. Back in July and August 2015 late in the last gold bear, a continuous 4-CoT week span saw total spec shorts hit 201.6k, 201.9k, 202.3k, and 198.6k contracts. That was in response to a rare gold-futures shorting attack.
Because of that extreme leverage inherent in gold futures, they are highly susceptible to manipulation. Very rarely, a massive trader will attempt to bash gold lower by short selling a colossal amount of gold futures virtually instantly. I define gold-futures shorting attacks as 20k+ contracts dumped within a few minutes. Their goal is simple, to force gold low enough fast enough to run long-side stop losses to trigger more selling.
If it wasn’t for those summer-2015 gold-shorting-attack-spawned record levels of spec shorts, this past week’s would be the highest ever witnessed! 196.3k contracts is still a 2.9 year high, the most seen in this entire young gold bull. These near-record shorts guarantee proportional near-term buying as they are covered by buying offsetting longs. That means gold’s usual autumn rally will power sharply higher in coming weeks.
When spec gold-futures shorts hit near-record extremes, their selling is exhausted. Again there are only a relatively-small number of traders willing to shoulder the potentially-unlimited risks involved in short selling hyper-leveraged gold futures. When their finite capital firepower is fully deployed, there is no else crazy enough to short further. With no material selling left, only buying is possible which fuels short squeezes.
The gold-futures buying about to be unleashed is massive. Over this past year, total spec shorts have averaged 116.4k contracts. Merely to mean revert back to that average will require specs to cover 79.8k contracts within a couple months on the outside! That’s the equivalent of 248.3 metric tons of gold. Say that takes 8 weeks, it averages to 31.0t a week. That would more than double recent gold investment demand.
The World Gold Council’s latest definitive read on global gold investment demand covers Q1’18, which averaged 22.1t per week. So adding another 31.0t of gold-futures short-covering buying on top of that would temporarily boost demand by 140% alone! But that’s way too conservative, as it doesn’t account for mean-reversion overshoots after extreme gold-futures shorting or the big long-side buying gold’s rallies drive.
It’s much more likely this coming major gold short squeeze sees speculators buy down their gold-futures shorts to at least this past year’s lows. That was 82.5k contracts in late March. That implies we could see a staggering 113.8k contracts of short covering alone, the equivalent of 353.9t of gold or 44.2t per week over 8 weeks. Gold would surge so fast on anything like that that long-side speculators would rush back in.
Their total longs ran 269.9k contracts in that latest July 17th CoT, up just 21% into their past-year trading range. That implies they still have room to do 4/5ths of their likely near-term long buying! Note in this chart that after spec shorts hit extremes the resulting short-covering frenzies motivate long-side traders to buy longs back up near highs within the next 3 to 6 months or so. That portends far more gold buying coming.
Total spec longs’ 52-week high of 400.2k contracts came in mid-September 2017 after last year’s autumn gold rally. Revisiting those levels would require another 130.2k contracts of long buying on top of all that short covering! That’s the equivalent of 405.0t of gold, or another 15.6t per week if it unfolds over a half-year. If that is condensed into one quarter instead, it works out to another 31.2t per week which is huge.
The potential gold upside coming with 113.8k contracts of short covering and another 130.2k of new long buying is enormous. There’s literally nothing more bullish for gold than extreme near-record gold-futures shorting leading to extreme near-record total spec shorts. All that excessive shorting that first pushes gold lower is guaranteed proportional near-future buying. Gold’s setup today is the most bullish seen in years!
So there are great odds this year’s imminent major autumn gold rally will easily exceed last year’s big 11.2% in 2.0 months. Gold stocks leveraged those gains by 2.0x with a 22.7% HUI rally in that same span. That leading GDX VanEck Vectors Gold Miners ETF surged a similar 20.2%. And today’s dirt-cheap gold stocks have far-greater potential in the coming months, since gold’s coming rally should be bigger.
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 $1225 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 before they rebound sharply.
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The bottom line is speculators’ gold-futures shorting just surged at extreme near-record rates to extreme near-record levels! That’s what drove this summer’s worse-than-usual weakness. But this is really rare and exceedingly bullish for gold. Speculators’ gold-futures-shorting firepower is finite, and once their outstanding shorts near records that selling is exhausted. That leaves only buying, catapulting gold sharply higher.
All big gold-futures-shorting spikes are guaranteed proportional near-future buying, as those effectively-borrowed shorts must soon be repaid by buying offsetting longs to cover them. This results in frenzied short squeezes that birth major new gold uplegs and even bull markets. There is literally nothing more bullish for gold than near-record gold-futures shorts! This summer’s weak gold will soon reverse sharply higher.
Adam Hamilton, CPA