Gold's early-October plunge on futures speculators' stop losses being run has naturally left this metal mired in battered technicals and bearish sentiment. But that sharp selloff has already accomplished its rebalancing mission. The excessive gold-futures trading positions that triggered that stop running have already reversed, and the investors fueling gold's bull are starting to buy again. Gold is green lighting its next upleg.
Gold's price action in recent years has been overwhelmingly dominated by just two groups of traders. Gold-futures speculators effectively control gold's short-term behavior, as futures' extreme inherent leverage gives their capital wildly-outsized influence. And investors, specifically American stock investors buying and selling shares in the flagship GLD SPDR Gold Shares gold ETF, have commanded gold's longer-term moves.
Plenty of traditional gold investors don't want to believe this, as it's seen as paper gold overpowering the real physical market. While the gold futures that unfortunately rule gold pricing are definitely paper gold, GLD truly isn't. This critical ETF acts as a conduit for the vast pools of American stock-market capital to flow into and out of real physical gold bullion. The interplay of gold-futures and GLD trading drives gold.
This dominant pair of primary drivers thoroughly explains everything that's happened to gold in recent years. That includes the brutal bear market between 2013 to 2015, 2016's young new bull, and even gold's early-October plunge. Speculators and investors who want to multiply their capital in precious metals need to study gold-futures and GLD-holdings action. Both are now green lighting gold's next major upleg.
While investors' GLD-share buying is far more important to this gold bull's ultimate size and longevity, the best place to start is speculators' gold-futures trading. It was these traders' excessive upside bets that spawned gold's early-October plunge, and it will be their buying that ignites and initially fuels this gold bull's next surge higher. Everything in gold-futures trading results from the extreme leverage inherent in it.
Each gold-futures contract controls 100 troy ounces of gold, which is worth $127,500 at $1275. Yet futures speculators are only required to deposit $5400 of capital for each gold-futures contract they are trading. That works out to extraordinary maximum leverage of 23.6x! For comparison, the legal limit in the US stock markets has been just 2.0x since 1974. Gold futures' leverage is an order of magnitude greater.
At minimum margin, fully-leveraged gold-futures speculators risk losing 100% of their capital bet on a mere 4.2% adverse gold move! If gold moves more than that against traders, their losses can quickly snowball beyond 100% as margin calls force them to contribute even more capital. This extreme and unforgiving leverage inherent in gold futures forces their traders to maintain an ultra-short-term focus.
Unlike investors who own gold outright and have no problem weathering normal and healthy mid-bull selloffs, gold-futures speculators can't afford to be wrong for long or they will be totally wiped out. The massive risk their extreme leverage entails greatly amplifies both their collective sentiment swings and trading action, leading to their decisions having a wildly-disproportionate short-term impact on the gold price.
This outsized influence makes speculators' total long and short positions in gold futures one of the best short-term indicators for gold prices. Their aggregate bets are published every Friday afternoon in the CFTC's famous Commitments of Traders reports, current to the preceding Tuesday. And the latest CoT read before this essay was published, last Friday's, reveals that gold-futures selling risk has radically abated.
The first chart looks at the collective gold-futures holdings of speculators, both large and small, from those weekly CoT reports. Their total long positions, which are upside bets on gold, are shown in green. Their shorts or downside bets on gold are rendered in red. Gold and some key technicals are superimposed over the top. The latest CoT data proved very bullish for gold, green lighting its next major upleg to get underway.
To understand this past week's super-bullish gold-futures development, it's necessary to first get some context. Back in early July, total spec longs surged to a staggering 440.4k contracts! Since every one controls 100 ounces of gold, that's the equivalent of an enormous 1369.7 metric tons. That works out to almost a third of total global gold demand in 2015, a freakishly-huge upside bet given futures' extreme leverage.
Our gold-futures CoT data goes back to early 1999, and specs' extraordinary massing of longs in early July was easily the highest seen in that 17.5-year span and almost certainly an all-time record. These elite traders had gotten caught up in gold's powerful post-Brexit-vote summer rally, which ran counter to its normal seasonal weakness. Their collective longs ballooned to records as they expected gold to keep surging.
Futures speculators as a herd make the same dangerous mistake as the vast majority of other traders, assuming already-mature trends can be extrapolated out into the indefinite future. They are the most bullish as evidenced by the highest long-side bets when gold hits major interim highs after strong rallies. Being bullish when everyone else is near greed-drenched toppings is exactly the wrong time to be way long.
So when gold starts moving against speculators' hyper-leveraged gold-futures bets, they are forced to sell rapidly to avoid full-on annihilation. The maximum leverage in gold futures usually runs between 20x to 25x as maintenance-margin requirements are periodically adjusted by the futures exchanges. At 20x and 25x, a mere 1% drop in gold multiplies to scary 20% and 25% losses. At 2%, they hit 40% and 50%!
So when futures speculators are excessively long and gold moves against them, they have no choice but to exit fast. And this selling quickly cascades, exacerbating the resulting futures-driven gold selloff. The more long contracts speculators sell to get their capital out of harm's way, the faster gold falls. And that triggers still more selling by other speculators, aggravating the downside in a powerful vicious circle.
The serious near-term downside risk specs' record gold-futures longs presented to gold were very clear back in early July. In my first essay after gold soared to its $1365 bull-to-date peak back then, I warned in depth about gold's record selling overhang. As long as futures speculators are excessively long, the odds favor even minor gold selloffs snowballing into something serious as these traders rush for the exits.
Gold-futures long extremes are usually short-lived, lasting a week or two before the cascading selling necessary to reverse them kicks in. Yet incredibly, gold-futures speculators were so bullish on gold that they ignored many things including surging Fed-rate-hike odds to maintain those high positions for a wildly-unprecedented 12 more CoT weeks! Spec longs defiantly stayed above 400k contracts for 10 of those.
That's why gold consolidated high after early July's bull peak instead of correcting like normal after a major bull-market upleg. Without gold-futures speculators liquidating their longs en masse, there was no material selling pressure on gold. After spec longs stayed near record highs for an entire quarter in the weak summer season despite mounting hawkish Fed expectations, they were actually starting to look sustainable.
While I warned about specs' near-record selling overhang for weeks on end in our newsletters, after 13 consecutive weeks of them I was guilty of getting complacent too. But the necessary selling to reverse these excessive longs still finally arrived amazingly late in early October. As gold started to drift under its $1308 late-August pullback low for the first time on October 4th, gold-futures stop losses started to trigger.
In a realm as hyper-leveraged as gold-futures trading, maintaining automatic stop-loss orders on trades is essential for survival. Gold can move 2% fast, wiping out fully half of traders' capital if they bet wrong in gold futures. Futures stop losses started triggering at $1305 that day, exacerbating the selling which soon forced gold under major $1300 support. That tripped many more stop losses, leading to a mass liquidation.
Cascading gold-futures selling quickly blasted gold down 3.3% on Tuesday October 4th, hammering it to a deep new pullback low of $1270. It's critical to understand exactly what happened that day, so I wrote an entire essay on gold futures' stops being run that week. But unfortunately despite that extreme down day that looked and felt like a climaxing capitulation, specs' gold-futures longs remained far too high after it.
They were still way up at 379.1k contracts, which was still the 20th highest witnessed out of the 928 CoT weeks since early 1999. While specs had liquidated an enormous 33.0k gold-futures long contracts to drive that big down day, their longs still remained so high that they kept that vexing near-record futures-selling overhang largely intact. That implied the selling wasn't over, and indeed gold was soon pushed even lower.
The next CoT report following the 4th's was the 11th's that came out last Friday afternoon, the newest CoT before this essay was published. And it proved astonishing! Gold only retreated 1.3% during that latest CoT week ending the 11th, less than a third of the 4.3% plunge of the previous CoT week. Thus there was no reason to expect to see speculators' gold-futures long liquidation continue at any serious scale.
Yet incredibly despite gold's relatively-mild drift lower, these traders liquidated fully another 42.0k long contracts! That was immense, actually the 8th-largest spec long dumping witnessed in those 928 CoT weeks since early 1999. The only larger single-CoT-week long liquidation in recent years was a 49.5k one in late May 2016. And that capitulatory selling frenzy by futures speculators heralded a major gold bottom.
Last CoT week's epic long liquidation hammered specs' total gold-futures longs back down to 337.1k contracts. That's right under the 340k-contract major support zone this young new gold bull has enjoyed since April. So the record and near-record gold-futures selling overhang that has kept a lid on gold since early July has essentially fully reversed! It is no longer a threat, as speculators now have firepower to buy.
These elite traders now have room to buy over 103k gold-futures contracts just to push their collective bets back up near early July's levels! That's the equivalent of 321.3t of gold. The entire 29.9% gold bull so far between mid-December and early July was partially driven by futures specs buying 249.2k long contracts while covering 82.8k short ones. So now having room for 103k contracts of long buying is very bullish.
But it gets even better. Specs also added 8.0k short contracts last CoT week, taking their total to 115.9k. That's the highest since gold was bottoming in late May just before its sharp summer upleg. Support levels of spec gold-futures shorts have been running around 95k contracts in this young bull. So gold is also poised to enjoy another 21k contracts of futures buying on short covering as it inevitably starts rallying again.
So in just the last two CoT weeks, speculators' collective gold-futures positions have swung from a near-record selling overhang of longs and relatively-low shorts to about 125k contracts of near-term buying potential! Gold's bull-market uplegs are almost always initially sparked by spec futures short covering, which has the same upside impact on gold's price as new long buying. Then long buying accelerates the upleg.
The fact gold is now seeing its most-bullish gold-futures setup since late May just ahead of its last upleg is super-bullish. Futures are now green lighting gold's next major upleg. Technicals back this too, with gold holding near its 200-day moving average since its early-October plunge. 200dmas are always the strongest support zones within ongoing bull markets, with stellar probabilities of stopping selloffs cold.
With gold-futures speculators' collective bets no longer excessively bullish and holding back gold, that paves the way for major investment buying to resume. It is these investment-capital inflows, through that leading GLD gold ETF in particular, that have been responsible for the great majority of gold's new bull market this year. GLD acts as a direct conduit for stock-market capital to buy real physical gold bullion.
GLD's mission is to track the gold price, but its shares have their own unique supply and demand that is totally independent from gold's. So when American stock investors buy GLD shares at faster paces than gold itself is being bought, they will soon decouple to the upside. The only way GLD can keep on mirroring gold is if that excess differential buying pressure is equalized directly into the underlying gold market.
So when GLD-share demand exceeds gold's, this ETF's managers are forced to issue new GLD shares to offset this excess demand. Then the resulting proceeds are immediately used to buy physical gold bullion that is held in trust for GLD's shareholders. Thus GLD's holdings, which are published daily, reveal whether stock-market capital is flowing into or out of gold. They too are green lighting gold's next upleg.
Without 2016's massive buying of GLD shares by investors, there'd literally be no gold bull. And that is not hyperbole or exaggeration at all. Gold soared 16.1% in Q1'16 and 7.4% in Q2'16 almost exclusively because GLD's holdings skyrocketed 27.5% and 16.0% on heavy stock-market-capital inflows into this ETF's shares. The World Gold Council's global fundamental gold supply-and-demand data proves this.
Per the WGC's definitive research, worldwide gold demand surged 20.5% or 219.4t year-over-year in Q1'16. GLD's gargantuan 176.9t holdings build alone in Q1'16 accounted for a whopping 80.6% of that total global growth in gold demand! GLD's incredible dominance over gold grew even more complete in Q2'16, where world gold demand climbed another 15.4% or 139.8t YoY. GLD's Q2'16 build was 130.8t.
Thus differential GLD-share buying by American stock investors was responsible for a staggering 93.6% of the total global increase in gold demand in Q2'16! So truly without American stock investors buying GLD shares faster than gold was being bought, gold's bull would've never been born. The fundamental reason it stalled in Q3'16 is GLD's holdings actually fell 0.2% or 2.1t as stock investors' capital inflows ceased.
I wrote a whole essay on this GLD-driven gold-bull stalling in mid-September if you'd like more detail. In a nutshell, record stock-market levels retarded gold investment demand. As stock markets soared to new record highs after their sharp post-Brexit-vote selloff, investors' desire to own gold waned. Since it tends to move counter to stock markets, gold demand for prudent portfolio diversification temporarily evaporated.
On October 4th as gold plunged, I knew cascading gold-futures selling had to be the culprit as I wrote to our newsletter subscribers that very afternoon. But my biggest fear that day was such intense futures selling would scare investors into joining in. If they started fleeing, gold's bull would face serious risks of being snuffed out. So it was a big relief to see GLD's holdings dead flat on the 4th and the next couple trading days.
Instead of spooking investors, the sharply-lower gold prices from that gold-futures stop running actually encouraged them to buy! GLD's holdings surged by 1.2% just a few trading days after that plunge on the 7th. American stock investors were buying more gold via GLD shares than the futures speculators were dumping. That trend wonderfully continued this week, with more GLD builds despite gold lingering near lows.
Thus so far in young Q4'16, GLD's holdings have already climbed 2.0% or 19.3t despite the sentiment damage wreaked in early October. Amazingly this big early-Q4 GLD build is right on pace with Q1'16's 19.7t by this point, which proved a monster quarter of differential GLD buying catapulting gold higher. And Q4'16's quarter-to-date 19.3t build is vastly superior to Q2'16's 14.3t draw by this point in that quarter.
So American stock investors' differential GLD-share buying, the overwhelmingly-dominant force behind this year's young new gold bull, is resuming at a major scale! This has also green lighted gold's next major upleg, which is likely already underway. As today's fake Fed-levitated wildly-overvalued US stock markets inevitably weaken, and gold enters its strongest time of the year seasonally, investors are buying again.
Thus the forces that drove gold's high consolidation in Q3'16 followed by early-October's plunge have already reversed. Speculators' vexing near-record gold-futures selling overhang has finally just been eradicated, leaving them positioned to be aggressive buyers again. And investors' mid-year break from gold buying that stalled out this young bull appears to be over, as the critical GLD builds are resuming.
Gold's next upleg can certainly be played with GLD, but this ETF will merely pace gold's coming gains at best. Meanwhile the stocks of the elite gold miners will really amplify gold's upside due to their great inherent profits leverage to gold. And as I discussed in depth last week, the gold stocks are screaming buys today with gold's bull entering its next major upleg. The window to get deployed at relatively-low prices is closing.
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The bottom line is gold's overwhelmingly-dominant primary drivers are both green lighting a major new bull-market upleg. Futures speculators' excessive longs have been liquidated back down to bull-market support, while their shorts surged near bull-market resistance. That leaves these key traders with great buying firepower for the first time since late May, just before gold's last major bull-market upleg got underway.
Meanwhile American stock investors have started heavily buying GLD shares again, fueling this ETF's big early-quarter holdings build equaling Q1'16's massive jump that ignited gold's young new bull. If this resumption of investment-capital inflows into gold persists, they will again drive its next major upleg. Contrarian speculators and investors can still buy in relatively low before the rest of traders figure this out.