Gold & silver were pounded lower all summer, but as Adam Hamilton points out, the unprecedented amount of shorts must soon be covered. Here’s more…
Gold and silver were thrashed this past summer, relentlessly pounded to deep new lows. That has fueled extreme bearishness, with traders convinced the precious metals’ fundamentals are rotten. But epic all-time-record futures short selling by speculators was the real culprit. These unprecedented shorts must soon be covered with proportional buying, which is super-bullish for gold and silver prices in the coming months.
Traders generally assume fundamentals drive short-term price action, that real imbalances in supply and demand push prices to market-clearing levels. Unfortunately these core underlying dynamics are heavily distorted in gold and silver. Futures speculators who never own these precious metals are able to wield wildly-disproportional outsized influence over their prices. The main reason is extreme leverage inherent in futures.
Investors usually buy gold and silver outright, paying cash in full. That’s the equivalent of 1x leverage. Every dollar of investment capital deployed in the precious metals provides one dollar of buying power to bid them higher. For many decades in the stock markets, the legal limit to leverage has been 2x. Thus using the leading GLD SPDR Gold Shares gold ETF or SLV iShares Silver Trust ETF, investors can hit 2x.
That effectively doubles their buying power, so each dollar invested in GLD or SLV at minimum margin puts two dollars of buying pressure on gold or silver. But borrowing half the purchase price of anything comes with big risks, also doubling gains and losses on capital invested. So the great majority of gold and silver investors prudently prefer buying outright. Futures speculation is a radically-different world!
Each CMX gold-futures contract controls 100 troy ounces of gold, while each CMX silver-futures contract represents 5000 troy ounces of silver. But futures speculators are barely required to keep any cash in their accounts to actively trade these contracts. As of this week, the minimum margin required for each gold-futures contract was just $3100 and silver-futures contract was only $3600. That enables extreme leverage.
July and August were miserable months for the precious metals, far worse than usual even in the weak summer doldrums. Gold dropped 4.2% in that recent short span, while silver plunged 9.9%. Gold and silver averaged $1217 and $15.29 in these last couple months, which are relatively-low levels. But 100 ounces of gold and 5000 ounces of silver were still worth a hefty $121,700 and $76,450 respectively!
That’s what investors would have to pay to own and control that much gold or silver equivalent to one futures contract. But the futures speculators only needed to have $3100 or $3600 in their accounts to effectively control the same amounts of precious metals. That equates to maximum leverage of 39.3x in gold futures and 21.2x in silver futures! Such extremes allow speculators to dominate short-term pricing.
Speculators running minimum margin greatly amplify their effective buying power in gold and silver. Just one dollar deployed in gold futures can exert up to $39 in pressure on gold prices. Thus capital deployed by fully-leveraged speculators can have 39x the gold-price influence as investment capital! Silver futures aren’t quite as crazy at 21x, but that’s still radically beyond the 2x legal limit in the stock markets since 1974.
This extreme leverage magnifies risks proportionally, forcing futures speculators to have an ultra-short-term focus in order to survive. At 39x leverage, a mere 2.6% gold price move against speculators’ bets would wipe out 100% of their capital risked! At 21x, a 4.8% adverse silver price move would drive a total loss of capital. So unlike investors, futures speculators’ entire worldview is condensed into hours, days, and weeks.
They are short-term trend riders by necessity, all piling on to whatever gold and silver happen to be doing regardless of fundamentals. And since mid-June, they’ve been aggressively crowding in on the short side of the trade in both gold futures and silver futures. On June 14th gold and silver looked way different, up at $1302 and $17.15 on close. It was looking like a decent summer until a sharp rally erupted in the US dollar.
Tacitly acknowledging that gold is money, gold-futures speculators look to the US dollar for trading cues. They sell gold futures when the dollar rises, and vice versa. On that lazy day in June, the US Dollar Index blasted 1.3% higher. The European Central Bank had released a huge decision that morning, to finally end its massive quantitative-easing campaign as expected. But that hawkish blow was mitigated by a last taper.
Instead of terminating its QE money printing at the end of September, the ECB announced it would be cut in half for one more quarter before ceasing at year-end. A final extension was widely discussed in trading circles before that ECB meeting, yet for some reason currency traders still interpreted it as some kind of dovish surprise. So they sold the euro hard, hammering it 1.8% lower that day which goosed the US dollar.
Overnight gold-futures speculators started aggressively selling on that surging dollar, crushing gold 1.7% lower to $1279 the next day. That unleashed heavy gold-futures short selling which slowly cascaded as summer wore on. And silver-futures speculators look to gold for trading signals. Thus as gold spiraled lower on surging shorting, silver suffered the same thing in sympathy. It would eventually snowball into a bloodbath.
Thankfully speculators’ gold-futures and silver-futures trading activity is tracked, so we can observe its impact on prices. Late every Friday afternoon, the US Commodity Futures Trading Commission issues a weekly Commitments of Traders report. These detail speculators’ collective futures positions current to the preceding Tuesday close. So the latest-available data when this essay was published was August 28th’s.
CoTs classically divided futures traders into commercials and non-commercials. Those are hedgers that use underlying commodities in their businesses and speculators simply gambling on prices without any intention of ever seeing those commodities. The speculators are divided again into large and small, or those that have to report their futures positions and those that don’t. This system is now called “Legacy” CoTs.
In September 2009 these many-decades-old CoT reports majorly changed, with a new “Disaggregated” format introduced. It separates out futures positions differently into four new categories which include money managers. But I still prefer the tried-and-true legacy format since its history is about 6x longer than the new disaggregated format. And what those classic CoTs now reveal in gold and silver is stunning!
These charts superimpose daily gold and silver prices over speculators’ weekly positioning in gold and silver futures per those legacy CoTs. The reason gold and silver prices were pummeled 9.9% and 15.8% lower between mid-June and mid-August was crazy-extreme all-time-record short selling in gold futures and silver futures! Speculators’ total long and short contracts are rendered in green and red respectively.
Gold was actually enjoying a solid resilient summer before mid-June. Remember that was when the supposedly-dovish ECB announcing the end of its huge QE campaign crushed the euro and thus boosted the US Dollar Index. The last CoT before that fateful day came a couple days earlier on June 12th. At that point speculators held 240.9k gold-futures long contracts and 100.3k short ones, perfectly-normal levels.
But for some strange reason, that 1.3% USDX surge sparking a 1.7% gold plunge the next day unleashed utterly-fierce gold-futures short selling. In the CoT week straddling that pivotal event, specs added a truly-astounding 35.5k gold-futures shorts! That ranked as the 2nd-highest ever witnessed out of 1026 CoT weeks since early 1999. That’s where our CoT dataset goes back to, encompassing the entire modern era.
And that excessive short selling fed on itself instead of abating. The more gold-futures speculators were effectively borrowing to sell short, the lower gold prices fell. That encouraged more traders to climb on to that gold-shorting bandwagon. In any single CoT week, any change in spec longs or shorts that’s larger than 20k contracts is considered huge. The subsequent summer shorting oscillated around that extreme level.
After that initial epic shorting blitz, 6 of the next 8 CoT weeks saw spec gold-futures shorting just keep on ballooning with 14.7k, 17.9k, 29.0k, 13.4k, 19.7k, and 19.7k short contracts added! Nothing like this has ever happened before, it was far beyond any precedent. That incredible extreme record shorting spree didn’t run its course until the August 21st CoT, forcing total spec shorts up to 6 new all-time records in the process!
I’m calling these all-time records because I’ve seen complete charts of the full history of CoT data, but again our dataset goes back to early 1999. Before the last couple months, the previous record of specs’ total gold-futures shorts was 202.3k contracts in August 2015. But between the CoT weeks ending on July 24th to August 21st, stunning new records of 209.7k, 211.4k, 231.1k, 250.8k, and 256.7k contracts were hit!
Running from the weekly CoT reports current to Tuesday closes, gold dropped 7.8% over that incredible 10-CoT-week span where total spec shorts skyrocketed from 100.3k contracts to 256.7k. That 156.4k-contract surge in gold-futures shorts was the largest ever witnessed, an insane orgy of short selling. And it bears the full futures blame for gold’s fall, as speculators actually added 17.5k gold-futures longs in that span.
On the last CoT Tuesday before this epic shorting, gold closed at $1295. When the dust had settled, it was pummeled to $1194 on the CoT Tuesday spec shorts peaked. So gold fell about $100 on the most-extreme gold-futures short selling in history by far. That really discouraged traders not paying attention to why gold fell, leading them to assume poor fundamentals must be to blame. But it was really just shorting.
Extreme gold-futures short selling is exceedingly bullish for gold! Relatively-high spec shorts mark major gold bottoms right before major new uplegs or even entire bull markets are born. Today’s gold bull birthed in December 2015 ignited out of near-record shorts. And ever since gold has soon rallied sharply out of relatively-high spec shorts, which spark major uplegs. These recent episodes are highlighted in red above.
There’s nothing more bullish for gold than extreme spec shorts because of how short selling works. Most trading attempts to first buy low then later sell high. But short selling reverses this normal order, starting with selling high before later attempting to buy low. Speculators can’t sell something they don’t have though, so they have to effectively borrow gold futures to short them. These debts must soon be paid back.
Mechanically gold-futures shorts are effectively repaid and closed by buying offsetting long contracts. So excessive spec shorts are literally guaranteed proportional near-future buying! These traders are legally obligated to cover their shorts in the near future. They are usually the only buyers out of major gold lows, and that buying to cover is mandatory. And just like shorting, that covering soon becomes self-feeding.
In gold-futures trading, the downside gold-price impact of selling a long contract owned or shorting a new contract is identical. So is the upside impact of buying a new long contract or buying one to offset and close a short. The more buying to cover speculators do, the faster gold’s price rises. And the sharper gold’s climb, the more other speculators are forced to cover their own shorts or face catastrophic leveraged losses.
Thus short-covering gold-futures buying quickly snowballs, catapulting gold sharply higher. Gold uplegs actually have three major stages, and futures short covering is the first one. This involuntary mandatory buying pushes gold high enough for long enough to encourage other futures speculators to return on the long side in stage two. Eventually gold’s gains grow large enough to entice back investors in stage three.
The scale of this summer’s extreme gold-futures shorting was off the charts, which means the inevitable coming short-covering will be proportionally huge. Again over that 10-CoT-week span from mid-June to late August, total spec shorts skyrocketed 156.4k contracts. That works out to a 15.6k-contract-per-week shorting rate. In the standard metric-ton terms gold fundamentals are usually discussed in, that’s 48.6 tonnes.
The definitive arbiter of global gold supply-and-demand data is the World Gold Council, which publishes awesome Gold Demand Trends reports quarterly. Q2’18’s was released in early August. In the first half of this year, total global gold investment demand ran 570.1t. That averages out to 21.9t per week. Yet in that wild 10-CoT-week summer-shorting-spree span, futures specs were puking out 48.6t of new supply weekly!
So it’s no wonder gold prices fell so sharply with futures supply more than doubling the normal investment demand. While gold futures are nearly completely paper gold, not traded physically, the world reference gold price is based on gold-futures action. So it plunged on that extreme gold-futures short selling. But gold will bounce right back up in symmetrical proportional fashion when the short covering gets underway.
To mean revert back down to mid-June levels of 100.3k, total spec shorts need to collapse by 156.4k contracts from their epic all-time-record high of 256.7k on August 21st. Short-covering rallies unfold fast out of extremes, over a couple months or so. Speculators can’t afford to hold on to their shorts for long as gold rallies against their hyper-risky leverage. This implies buy-to-cover rates of 19.5k contracts weekly for 8 weeks.
That’s the equivalent of 60.8t of gold per week, or nearly triple the average H1’18 global gold investment demand! And gold-futures short-covering buying is on top of normal investment demand, so overall it is poised to quadruple. Gold will rocket higher on such heavy buying. And that’s conservative, as after past extreme shorting episodes total spec shorts tended to not only mean revert but overshoot to the low side.
That would at least slash them back to their 52-week low of 82.5k contracts seen back in late March. If you run the numbers, that implies 174.2k contracts of short-covering buying which is the equivalent of a massive 67.7t per week over that typical couple-month short-covering span! And short-covering buying doesn’t happen in isolation, again the resulting sharp gold-price gains bring back other long-side traders.
They control way more capital than short sellers, as evidenced by the green total-longs line above being much higher than the red total-shorts line the vast majority of the time. Total spec longs are quite low today given the extreme bearishness in gold, just 252.9k contracts in the latest August 28th CoT. That’s just 10% up into their past-year trading range. Getting back to the top would require another 147.3k of buying!
Stage-two spec gold-futures long buying generally unfolds over 3 to 6 months. In tonnage terms that would add another 35.2t to 17.6t of weekly buying on top of normal gold investment demand as well as the initial short-covering frenzy! The resulting coming gold gains ought to be big and fast coming from today’s crazy-extreme all-time-record levels of spec gold-futures shorting. Consider the precedent here.
Back in early December 2015, total spec shorts neared then-record levels at 191.6k contracts. Gold was hammered to a 6.1-year secular low on irrational Fed-rate-hike fears. But as specs were forced to cover which unleashed huge mean-reversion long buying, gold soared 29.9% higher in just 6.7 months! Gold sentiment was even worse in late 2015 than it has been in recent weeks, universal bearishness flags lows.
Fast-forward to summer 2017, when gold plunged on extreme gold-futures shorting once again on those historically-baseless Fed-rate-hike worries. That July I published an essay with a similar analysis and contrarian bullish outlook as today’s called Gold/Silver Shorts Extreme. In it I explained that the near-record extremes in gold-futures and silver-futures shorts were incredibly bullish over the near-term.
Spec gold-futures shorts soared to 189.2k contracts in mid-July 2017, closing in on an all-time record at the time. That certainly wasn’t sustainable, a spark to ignite the guaranteed proportional short-covering buying was soon inevitable. And indeed it blasted gold 11.2% higher in just 2.0 months. A similar rally today off of mid-August’s deep 19.3-month gold low of $1174 would drive it back up to $1305 by mid-October!
But with total spec shorts a whopping 35.7% higher this time around, the resulting gold rally driven by mandatory short covering should be at least proportionally larger. We’ve never before witnessed a short squeeze as frantic gold-futures speculators attempt to unwind at least 156.4k excessive short contracts as rapidly as they can. It wouldn’t surprise me at all to see gold surge 20%+ over the next few months or so.
That would catapult it to $1408 off those mid-August lows, which would yield the long-awaited major bull-market breakout above $1350. New bull highs nearing $1400 would motivate investors with their vastly-larger pools of capital to flood back into gold, kicking off stage three early. And they have a lot of buying to do to reestablish positions. Since mid-June, GLD’s physical gold-bullion holdings have dramatically plunged.
Because that gold-futures-driven price is gold’s dominant reference one, particularly-one-sided trading by the gold-futures speculators can drag investors in. The price action resulting from speculators’ short-term gold-futures machinations can overpower investors’ normally-rational psychology. This summer they sold aggressively in sympathy, pummeling GLD’s holdings 9.9% or 81.8t lower. That’ll be bought back as gold recovers.
The situation in silver futures is even more bullish, with spec shorts way up at an even-more-extreme all-time-record high of 120.2k contracts in late August! That is mind-bogglingly epic, so all this gold-futures short-covering analysis applies to silver futures too. Just like gold, silver is on the verge of its biggest short-covering frenzy ever witnessed. Silver’s coming mean-reversion rebound rally ought to well outstrip gold’s.
I won’t rehash all the gold analysis for silver, but consider silver’s numbers. The 52-week low in specs’ silver-futures shorts was 41.5k contracts in mid-September 2017. Getting back there would require an astounding 78.6k contracts of short-covering buying. That’s the equivalent of 393.3m ounces of silver! If that short-covering buying unfolds over 8 weeks, it would boost global silver demand by 49.2m ounces a week.
According to the venerable Silver Institute, in 2017 total global silver demand ran 1017.6m ounces. That is the equivalent of 19.6m weekly, which includes everything not just investment demand. The coming silver short-covering frenzy has the potential to boost this by 251% for a couple months or so! There’s no way silver wouldn’t soar on such proportionally-extreme silver-futures buying. Silver too looks wildly bullish.
Over and over again history has proven the worst time to be bearish on gold and silver is when futures speculators are, as evidenced by high shorts and low longs. And with their shorts just rocketing up to crazy-extreme all-time-record highs in recent weeks, gold and silver look exceptionally bullish today. We are likely on the verge of massive new uplegs in these precious metals, yielding big gains for smart contrarians.
These can be played in the metals themselves, their leading GLD and SLV ETFs, or the stocks of their miners. The latter offer the greatest potential gains by far, as their profits really leverage higher gold and silver prices. The stocks of the elite gold and silver miners are radically undervalued today, having just suffered a rare capitulation plummet as gold and silver plunged on that record shorting. They’re screaming buys!
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The bottom line is speculators’ gold-futures and silver-futures short positions have soared to crazy record extremes in recent weeks. These elite traders are hyper-bearish, and betting heavily for more precious-metals downside. But gold and silver soon soared on short-covering buying following all past episodes of excessive and record short selling. There’s nothing more bullish for gold and silver than extreme shorts!
All futures sold short must soon be offset by proportional near-term buying to close out those trades. It quickly feeds on itself thanks to the incredible leverage inherent in gold futures and silver futures. The resulting sharp short-covering rallies soon entice in new long-side futures speculators and later investors with their vastly-larger pools of capital. Record futures shorts are the best gold and silver buy signals available.
Adam Hamilton, CPA