Gold-futures speculators and/or American stock investors have to keep buying. If they don’t, gold will stall out and…
Gold dramatically surged to major new secular highs this past week, fueled by stunning geopolitical news. The US assassinated Iran’s top general, so Iran fired ballistic missiles at military bases in Iraq used by the US. That naturally ramped gold bullishness, spawning all kinds of predictions for much-higher prices. But geopolitically-driven gold spikes never last long, and the gold buying behind this surge is very precarious.
Geopolitics are fascinating, the modern intersection of centuries of history, politics, religion, and military actions. Growing up, geopolitics were my second passion after the markets. I read everything I could on that broad topic, both nonfiction and fiction. Tom Clancy’s masterful novels were my favorites, and I love that whole technothriller genre to this day. For decades I’ve eagerly followed and devoured geopolitical news.
And being a lifelong stock speculator, I’ve always had a special interest in how geopolitical developments affect markets. So this past week’s wildly-unexpected events were amazing to observe, and had major impacts on gold prices. Last Thursday January 2nd, gold closed at $1528. That was its best level since late September, but unremarkable with gold well under its last upleg’s peak of $1554 in early September.
Then overnight a US Reaper drone fired missiles at cars carrying Iran’s top general Qasem Soleimani at Baghdad International Airport in Iraq! He commanded all of Iran’s extraterritorial military and clandestine operations, which were often carried out by proxy foreign militias that Iran armed and supported. This targeted assassination was authorized by Trump because Soleimani was reportedly plotting to kill Americans.
Gold shot as high as $1550 on that shocking game-changing event, which risked snowballing into a full-blown war between the US and Iran. Last Friday the 3rd it closed up 1.4% to $1549, the highest it had been since that last upleg peak. Iran would have to retaliate over the killing of who was described as its second-highest official after its president. Over the weekend speculation of what that would look like ran rampant.
When US gold-futures trading opened up Sunday evening New York time, gold rocketed from $1552 to $1585 virtually instantly. It was able to hold some of those gains this Monday, rallying 1.0% to $1565. That was not only a new upleg high, but a major secular one as gold’s highest close in 6.7 years! Gold excitement was really building, leading to countless forecasts that a major surge higher was just starting.
Gold climbed another 0.4% to $1572 on Tuesday, with mounting anticipation for Iran’s revenge. I warned about gold being very overextended in our weekly newsletter that day, writing “Geopolitical rallies are seldom sustainable anyway. The initial fears from events always prove worse than realities. And once the geopolitical news fades from prominence in a matter of days, that gold-futures buying reverses to selling.”
At Tuesday’s US close I concluded that, “Given the extreme spec gold-futures positioning and a lack of investment-buying support, gold’s near-term outlook is for a sharp selloff.” That contrarian view sure wasn’t popular, like usual when greed is swelling with gold at major highs. Before I share the analyses that fed into that call, geopolitically-motivated gold rallies are always suspect since they never last for long.
After big geopolitical news flares, the airwaves are flooded with military experts commenting on what is going on. Without fail, they spin dire worst-case scenarios of what could happen next. While these are often plausible, history has proven they almost never play out. I first learned this lesson in high school as I tried to trade around the Gulf War from mid-1990 to early 1991, when the US invaded Iraq to liberate Kuwait.
Iraq invaded and annexed Kuwait in August 1990. Iraq’s military, considered the best in the region by far then, dug in and heavily fortified positions for months. As the US started shipping in an invasion force, pundits warned attacking Iraq’s army would take months resulting in thousands of American soldiers dying. But instead of fighting to the death, Iraqi soldiers mostly fled. The ground battle was largely over within days!
The retreating Iraqi military had a scorched-earth policy, setting fire to around 700 oil wells. Experts filled the media warning it would take years to extinguish those raging fires, and the entire planet faced cooling and crop failures as oil-fire smoke reflected too much sunlight. Yet most of those were extinguished in a few months, and all were put out within that same year! Geopolitical worst-case scenarios are always wrong.
More recently last September, a drone and cruise-missile attack took down one of the world’s largest oil-processing facilities in Saudi Arabia. Abqaiq removes hydrogen sulfide from 7m bpd of Saudi crude oil, making it safe to be shipped in tankers. About 5% of global oil capacity was taken offline, and experts warned repairs would take months! Yet that massive facility was back up to full capacity in a couple weeks.
In my decades studying the markets and trading, I can’t recall a single major geopolitical event that proved worse than initial assessments. Gloom and doom drives viewers and thus advertising revenue, so the media looks for worst-case-type experts. When the aftermath of geopolitical events doesn’t prove as bad as first feared, the gold and oil spikes quickly reverse into proportional selling. This is all sentiment-driven.
Back to this week, on Tuesday evening US time Iran retaliated for Soleimani’s assassination. It launched at least 15 ballistic missiles targeting military bases in Iraq used by American forces. Fear exploded, with all kinds of talk about World War 3 getting underway! Gold rocketed from $1574 to $1610 within a couple hours, its highest levels since March 2013. Again excitement mounted for a major upleg getting underway.
While the headlines that night seemed scary, again the perceptions were far worse than the reality. As the dust cleared the next day, Iran declared it “took & concluded proportionate measures”. Then midday Wednesday Trump reported there were no American casualties so the US was also standing down. The Iranian missiles looked to be deliberately targeted at aircraft hangars and equipment instead of barracks.
Gold had already started retreating overnight way before that, back near $1573 when Wednesday’s US trading began. It quickly plunged from about $1570 to $1556 after Trump gave an address indicating there would be no further US military strikes unless provoked. So one of the biggest geopolitical shocks seen in decades ended with a whimper instead of a bang. Thankfully the US wasn’t going to war with Iran!
Gold had rocketed from $1528 before that assassination to $1610 at the perceived peak of the crisis, then had plunged back down to $1555 on Wednesday’s close. That geopolitical-event spike-failure pattern is typical. But regardless of what was happening in the Middle East, the gold buying was precarious and not likely to last. I explained most of the following to our newsletter subscribers last week before Soleimani’s killing.
Gold prices are driven by capital flows, which come from both speculators and investors. When they are buying, gold rallies higher. Heading into this latest stunning geopolitical event, speculators were tapped out and investors weren’t buying. That meant gold had little chance of seeing a major new upleg power higher, despite the endless groupthink momentum-following commentaries eagerly claiming otherwise.
Speculators’ gold-futures trading dominates gold’s short-term price action for two reasons. This market allows mind-boggling extreme leverage exceeding 30x! That greatly amplifies gold-futures trading’s price impact on gold. At 30x, every dollar deployed in gold futures literally has 30x the gold-price influence as a dollar invested outright. Thus this small group of traders’ capital firepower is greatly magnified to move gold.
Further upping their outsized influence, the resulting gold-futures price is gold’s world reference one. So the gold-futures-driven gold price action heavily affects investors’ psychology, indirectly driving far-larger investment capital flows into and out of gold. If you aren’t up to speed on why gold-futures trading is so darned important if not overpowering for gold’s fortunes, I explained it more deeply back in mid-September.
This chart shows specs’ total gold-futures longs and shorts during this secular gold bull over the past 4 years or so. Reported weekly, longs are rendered in green and shorts in red. Gold is superimposed over the top of that. Spec gold-futures positioning was literally at record extremes before that US Reaper took out Soleimani! The latest-released data is current to Tuesday December 31st, days before that strike.
In this data series’ last-reported week ending New Year’s Eve, gold continued rallying after its Christmas Eve correction-downtrend breakout rally. I discussed that in depth in last week’s essay, where I again took the contrarian side arguing the recent gold-stock surge was a head-fake rally. Since gold selling was far more likely than sustainable buying, the surging gold stocks actually “face major near-term downside”.
When traders are excited that any sector is high, they hate hearing that stocks both rise and fall. So I got a lot of flak for that call too. Yet it too is proving right so far. In the 4 trading days from just before that US drone strike to this Wednesday, the leading GDX gold-stock ETF fell 3.4%. That was far from what most greed-blinded gold-stock traders expected with gold surging to those geopolitically-driven major secular highs!
Heading into this wild past week, speculators’ total gold-futures longs and shorts ran 442.6k and 76.1k contracts. Each contract controls 100 troy ounces of gold worth $155,000 at $1550, but only requires that traders keep $4,500 margin in their accounts. That equates to crazy maximum leverage up to 34.4x! At such extremes, a mere 2.9% adverse gold move would wipe out 100% of the capital risked betting on it.
Those spec longs even before this past week’s US-Iran shooting started were already at a new all-time-record high! The hyper-leveraged gold-futures traders had never been more bullish on gold as evidenced by their aggregate bets. The problem is they are always wrong at extremes, when herd psychology just runs rampant. The previous spec-longs record eclipsed on New Year’s Eve was 440.4k from early July 2016.
That didn’t work out so well for gold, heralding a brutal 17.3% correction over 5.3 months! Note above that this entire secular gold bull has closely tracked spec gold-futures longs. Gold powers higher strongly in major uplegs when they are being aggressively bought. But once specs run out of capital firepower to keep buying, gold soon rolls over and corrects. They were totally tapped out before geopolitics just flared up.
Extreme gold-futures buying inevitably soon leads to proportional selling. Gold futures are not only super-leveraged, but have expiration dates. Traders who buy longs are legally required to sell them sometime before they expire. Once spec longs climb to historic extremes, these traders’ finite buying is mostly exhausted. That makes imminent selling far more likely than material new buying, which is bearish for gold.
Gold futures are a zero-sum game, with each contract having a long and short side. So speculators also sell short to game gold downside. In that latest-available data, total spec shorts had sunk to an extreme 4.9-year secular low! That meant there was likely little room left to buy to cover and close existing shorts. The gold-futures buying necessary to push gold higher looked completely exhausted before this past week.
In terms of their gold-bull trading ranges, total spec longs and shorts were running 100% and 0% up into them! That’s the most-bearish-possible near-term setup for gold, since there’s virtually no room to keep buying but vast room to sell. If spec positioning didn’t grow even more extreme than this bull’s already record-extreme trading ranges, they had room to buy 0k contracts but room to sell a staggering 436.5k!
Still they did do more buying, as that’s the only explanation for gold’s sharp overnight surges driven by this past week’s shocking geopolitical news. That almost certainly leaves their positioning even more extreme today. The next weekly read on their positioning current to this Tuesday’s close, hours before Iran’s missile attack, will be published late Friday afternoon. That data could prove even more bearish for gold.
I’ve carefully analyzed all gold’s uplegs and corrections since 1999 relative to spec gold-futures longs and shorts. Had the US-Iran thing not happened, that would’ve been this week’s essay topic. But gold hasn’t climbed in uplegs unless gold-futures specs are buying, either adding new longs or covering to close existing shorts. And when they are selling, either closing existing longs or adding new shorts, gold sells off.
Since gold-futures speculators are at their limits of potential buying on both sides of the trade, they aren’t able to keep pouring capital into gold to drive it higher even if they want to. Far worse, their excessively-bullish bets are very precarious. When gold falls materially, gold-futures selling rapidly snowballs. These traders are forced to sell or they face quick ruin from their extreme leverage. That amplifies gold’s downside.
With the gold-futures speculators’ buying firepower more than fully expended, investment buying is gold’s only hope for powering higher still from here. Unfortunately global gold investment data is only available at a quarterly resolution. But the physical-gold-bullion holdings of the leading GLD SPDR Gold Shares gold ETF offer a fantastic daily proxy of investment-demand trends. This proves true for a couple reasons.
Gold ETFs act like conduits for the vast pools of stock-market capital to slosh into and out of gold. Their mechanics necessary to track gold prices reveal capital inflows and outflows, showing what investors are collectively doing. And GLD is the world’s most-important gold ETF by far, commanding nearly a third of all the world’s gold held in ETFs. GLD’s holdings also mirror and drive major uplegs and corrections in gold.
When they are rising, American stock-market capital is flowing into gold. As investors bid up GLD share prices faster than gold itself is being bought, this ETF threatens to decouple to the upside and fail its gold-tracking mission. So GLD’s managers have to offset and absorb that excess share demand. They do this by issuing sufficient new GLD shares, and then the resulting proceeds are used to buy more physical bullion.
As this chart of GLD’s holdings over gold’s secular bull shows, gold’s recent upleg that initially peaked in early September was also driven by strong investment buying. GLD’s holdings surged with gold, showing big investment-capital inflows. But ominously investors aren’t buying gold’s latest sharp rally to new upleg highs. Geopolitical spikes are always driven nearly exclusively by gold-futures buying, not investment demand.
Gold’s latest upleg was the most powerful of this secular bull, clocking in at 32.4% gains in 12.6 months as of early September. And this past week’s geopolitical spike has further stretched that to the current 33.9% gain over 16.7 months. Had the US-Iran situation not flared, odds are these newest gold highs wouldn’t have happened. They are a temporary anomaly from sentiment driving gold-futures extremes.
This chart shows strong gold investment demand for most of gold’s original upleg that peaked back in early September. Over that exact 32.4%-rally span, GLD’s holdings climbed 15.8% or 122.5 metric tons. Of particular interest is the post-gold-breakout phase of this upleg. That came after late June’s first new gold-bull highs seen in several years. GLD’s holdings were running 764.1t before that enticed investors back.
Investment buying is much-slower-moving than gold-futures buying, tending to lag gold’s major swings a bit. So GLD’s holdings peaked in late September a few weeks after gold crested. They soared 21.0% or 160.8t higher in just 3.2 months! That’s what a righteous gold upleg looks like, investors joining their vast pools of capital with spec gold-futures buying to drive gold higher for months on end with big weeks seen.
For example in late August and late September, GLD enjoyed two separate 5-trading-day spans where its holdings blasted 3.6% or 30.5t and 4.7% or 41.3t higher! Massive gold investment demand at that scale can overpower whatever the gold-futures specs are doing. In order for gold’s recent breakout rally to new upleg highs to be sustainable, investors have to join in. Especially with spec gold-futures buying exhausted.
In mid-December when gold was still very much in correction mode, GLD’s holdings slumped to 880.7t. That was down 4.8% or 44.3t from their late-September peak. Then this leading gold ETF started to see some slight differential buying pressure. Over the next several weeks into this one, GLD enjoyed fully 7 holdings-build days showing American stock-market capital flowing into gold. But they were all small.
Note in this chart how tiny the growth in GLD’s holdings was surrounding gold’s breakout surge, it has barely registered! At best over 12 trading days ending this Monday, after Soleimani’s assassination but before Iran’s retaliatory missile strike, GLD’s holdings grew just 1.8% or 15.5t. That’s virtually nothing in context of gold’s surge. And this Wednesday after Iran’s attack on those US-used bases, much of that reversed.
GLD suffered a major 1.0% holdings draw that day as investors fled on gold’s geopolitical spike collapsing again. That unwound over 60% of the entire investment buying in recent weeks! So at this point GLD’s total build over the last several weeks is just 0.7% or 6.2t. That is trivial, a rounding error. Investors are not materially buying gold, and are unlikely to with Fed-conjured stock-market euphoria stunting gold demand.
So today’s gold price near 6.8-year secular highs exciting traders is actually really precarious. The gold-futures speculators have stretched to record extremes of buying, leaving their bets excessively-bullish. They are very unlikely to have much capital firepower left to buy materially more. With their buying all but exhausted, they can’t buy more gold futures. The risk of a cascading selloff from such extremes is very high.
Meanwhile investors have shown they likely won’t buy more gold. Despite gold rocketing almost $100 higher in just several weeks to its best levels since early 2013, investors haven’t been motivated to buy much. Gold is the ultimate portfolio diversifier, and is rarely in favor when stock markets are near record highs and euphoria runs rampant. Investors are much more likely to continue recent months’ net selling.
All this leaves gold in a precarious place today. Gold needs continuing capital inflows to keep pushing it higher still. Gold-futures speculators and/or American stock investors have to keep buying. If they don’t, gold will stall out and roll over. And that will likely ignite the vast pent-up selling from this ominous record gold-futures-selling overhang. If gold’s correction resumes like it ought to, gold stocks will get hammered lower.
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The bottom line is the recent gold buying driving secular highs looks really precarious. Gold broke out to new upleg highs in a geopolitical spike. But historically these soon reverse into proportional selling, as the initial event-driven fears always prove overblown. Spec gold-futures positioning was already way up at record extremes even before the US and Iran started shooting, so traders’ buying firepower is exhausted.
At the same time gold-futures speculators can’t buy materially more, gold investors aren’t interested in buying. GLD’s holdings, the leading daily proxy of gold investment demand, have barely budged even as gold blasted higher in recent weeks. Record-high euphoric stock markets leave gold out of favor for diversifying portfolios. Without material capital inflows from speculators or investors, gold can’t keep climbing.
Adam Hamilton, CPA