The gold-futures and silver-futures short positions held by speculators have rocketed up to extremes in recent weeks. These elite traders are aggressively betting for further weakness in gold and silver prices. But history has proven extreme shorts are a powerful contrarian indicator. Right as speculators wax the most bearish as evidenced by their collective bets, gold and silver decisively bottom and birth major new rallies.
Futures trading has a wildly-outsized impact on gold and silver prices, especially over the short term. It is amazing how much volatility futures speculators’ collective buying and selling generates, often drowning out everything else. Two factors are responsible for this dominance. The extreme leverage inherent in futures trading and the unfortunate fact the resulting gold and silver prices are the world’s reference ones.
Normal investment capital flows occur with no leverage, the vast majority of stocks and bonds are bought outright. So buying and selling isn’t multiplied. Some stock traders use margin, which for many decades has been legally capped at 50% in the US. So they can borrow up to half their stocks’ purchase prices, or run 2x leverage. That gives any given capital flows, buying or selling, twice the price impact of outright ones.
But futures speculation allows truly extreme leverage, in a league of its own. US gold-futures contracts each control 100 troy ounces of gold. At $1250, that’s worth $125,000. But the margin requirement, the capital necessary in a trading account to hold that contract, is just $3950 this week. That enables traders to run leverage as high as 31.6x! That acts as a strong price-impact multiplier on all their buying and selling.
Silver futures are similar, with US contracts each controlling 5000 troy ounces. That commands $80,000 worth of silver at $16. But this week traders are only required to put up $5000 in cash to buy or sell each contract. That makes for maximum leverage of 16.0x, well under gold’s extremes but still enormous by normal-market standards. Futures effectively greatly amplify the price impact of relatively-small amounts of capital.
Every dollar of gold and silver buying and selling by outright investors has one dollar of price impact. But at 32x or 16x leverage, every dollar speculators move into or out of gold and silver futures has the same short-term price impact as $32 or $16 of outright investment! This extreme leverage grants these futures speculators wildly-outsized influence over price action. This is incredibly distorting and super-unfair to investors.
But unfortunately that’s the way the markets work these days. Compounding futures trading’s extremely-disproportional price impact, the resulting gold and silver prices have long been considered the world’s reference ones. So big gold and silver moves fueled by futures speculators can greatly affect universal sentiment, convincing other traders including investors to follow futures speculators’ lead exacerbating moves.
I sure wish this wasn’t the case. Without the extreme leverage inherent in futures speculation, gold and silver prices would be far less volatile and more closely reflect global physical supply and demand on an ongoing basis. But because futures traders’ capital flows are so radically multiplied, all investors and speculators interested in gold, silver, and their miners’ stocks have no choice but to closely follow futures action.
There’s one key way to do that, through the weekly Commitments of Traders reports published by the US Commodity Futures Trading Commission. Released late each Friday afternoon but current to the preceding Tuesday close, the CoTs detail speculators’ total long and short positions in gold and silver futures. Analyzing these weekly changes in collective bets and their trading ranges over time is very illuminating.
The CoTs break down all futures traders into three categories, hedgers, large speculators, and small speculators. The hedgers produce or consume physical gold commercially in their businesses, and use futures to mitigate gold-price risks to their operations. The speculators take the opposite side of hedgers’ trades, as futures are a zero-sum game. I lump both large and small speculators together for analysis.
This simple chart superimposes the daily gold price over the weekly total long and short gold-futures contracts held by speculators. Their long contracts, bullish bets that gold is heading higher, are rendered in green. And their short contracts, bearish bets that gold is going lower, are shown in red. It’s impossible to understand short-term gold and silver price action unless you closely follow this weekly data from the CoTs.
The reason I’m writing this essay is the past couple weeks’ gold-futures developments are exceedingly bullish! Speculators have taken on a massive new leveraged short position in gold as evidenced by the soaring red line. They are wildly-bearish as a group, totally convinced gold is heading lower in coming weeks and months. But after every past gold-futures shorting extreme, gold has instead blasted sharply higher!
Exiting June, gold was stable in the $1240s with typical dull summer-doldrums sideways trading action. But as July’s trading dawned on the 3rd, anomalous heavy selling slammed gold. During that holiday-shortened trading day when many if not most American traders were away on vacations, gold plunged 1.8% to $1219. There was no identifiable catalyst, like great US economic data or a big US dollar rally, to justify that.
Since the 4th was the Independence Day market holiday, that CoT week ended on the 3rd. So later that Friday when that CoT report was released, speculators’ extreme gold-futures selling was revealed. In a slow and dead holiday week, they jettisoned 14.9k long contracts while adding 27.7k short ones! In gold futures, any weekly swing in speculators’ collective bets over 20k contracts is considered very large and notable.
So seeing them dump 42.6k contracts out of the blue in one lazy summer CoT week was staggering. That is equivalent to 132.6 metric tons of gold, a vast amount. According to the World Gold Council, the definitive arbiter on global gold supply and demand, worldwide gold investment demand in Q1’17 totaled 398.9t. That averages out to 30.7t per week. That CoT week’s extreme gold-futures selling ran a colossal 4.3x that!
Our CoT data extends all the way back to January 1999, now encompassing 967 weeks. That’s certainly a big sample size over a long secular 18.5-year span. Specs’ extreme short selling in that CoT week ending July 3rd ranked as the 7th-largest witnessed over that entire span, and almost certainly ever! It was truly exceptional gold-futures short selling, which was disturbingly odd with no discernable catalyst.
Adding both that short-side ramp and the long-side liquidation together, that CoT week’s selling was the 15th biggest on record. While gold sentiment is almost always weak and bearish in the summer doldrums, such epic gold-futures selling didn’t make any sense. These speculators usually need some motivating news to get them to trade so aggressively, like major US-economic-data surprises or big US-dollar gyrations.
At that CoT report’s release a couple Fridays ago, I found this selling blitz very interesting. But one week doesn’t make a trend. For some unknown reason, gold-futures speculators were whipping themselves into a bearish frenzy right when gold usually sees major seasonal lows. Unfortunately that tainted the gold outlook for investors, who fell in line with futures speculators to start relentlessly selling GLD shares.
This American GLD SPDR Gold Shares gold ETF is the world’s leading and dominant gold-investment vehicle, acting as a conduit for the vast pools of US stock-market capital to flow into and out of physical bullion. After that anomalous July 3rd gold-futures selling bashed gold below its 2017 uptrend’s support, capital started fleeing GLD. GLD shares were sold faster than gold itself, fueling a series of substantial draws.
Thanks to the sentiment multiplier effect of that leveraged gold-futures selling, GLD’s holdings fell 0.7% on July 3rd, another 0.7% on the 5th, and 0.6% on the 7th when that CoT report was released. That was the worst cluster of investor gold selling since this year dawned. GLD’s managers had to liquidate some of their gold bullion to buy back the excess GLD shares for sale, exacerbating the weakness in gold prices.
But the gold selling still didn’t cascade and snowball like the futures specs expected. Gold stabilized in the $1210s, low enough to feed bearish psychology but not so ugly as to spawn real panic selling. With gold essentially flat in the subsequent CoT week ending July 11th, I didn’t expect much from the CoTs. So boy was I shocked when they showed speculators’ extreme gold-futures short selling persisting!
In this latest CoT week before this essay was published, speculators sold 6.0k long contracts while continuing short selling like madmen. They added another astounding 27.4k short contracts, which proved the 8th-largest on record out of those 967 CoT weeks. Over the two newest CoT weeks, specs dumped 55.1k gold-futures contracts. That was actually the second-biggest shorting spree ever over a two-CoT-week span!
With back-to-back weeks of epic short selling, something was definitely up. Maybe it was benign, as gold sentiment is almost always very bearish during the summer doldrums. The biggest gold down day in that latest CoT week came on Jobs Friday the 7th, a 1.0% loss. US jobs growth in June at +222k proved much better than the +179k expected, on top of +47k in past-month revisions. That is hawkish for Fed rate hikes.
There’s nothing gold-futures speculators fear more than Fed rate hikes, although history is crystal clear that is supremely irrational. Gold has actually thrived during past Fed-rate-hike cycles! But this totally-false rate-hikes-doom-gold mindset has driven many past episodes of major gold-futures selling. The fact today’s started an entire CoT week earlier when there was no economic-data catalyst implies something more.
For many years now, gold-futures speculators have wielded their extreme leverage like a weapon with the nefarious intent of actively manipulating gold prices lower. Seeing such epic gold-futures shorting in back-to-back CoT weeks in this quiet time of the year is highly suspicious. It really could’ve been a gold-futures shorting attack in slow motion, a sustained attempt to force the gold price lower than fundamentally justified.
Only the speculators who executed these trades will ever know their motivations. But the hard results are exceedingly bullish for gold. 55.1k gold-futures contracts, the equivalent of 171.2 metric tons of gold, sold short in two weeks merely pushed this metal 2.6% lower. That’s not much considering the deluge of selling, especially near gold’s major seasonal lows when sentiment and technicals are most vulnerable.
If I was short gold futures, I’d be sweating bullets after such near-record gold-futures shorting had such a modest downside impact on gold prices. There had to be huge buying somewhere in the world to offset that extreme futures supply. The only other two-CoT-week span in history with more short selling ended in November 2015, where gold plunged 4.3%. And that was in one of gold’s strongest months of the year seasonally.
This orgy of extreme short selling left speculators’ total gold-futures shorts way up at 189.2k contracts at the end of this latest CoT week. That’s huge! Out of those 967 CoT weeks since early 1999, that proved the 6th highest on record. The top four clustered around the all-time high of 202.3k back in early August 2015. Number five was 191.6k in December 2015, right before gold’s current bull market was stealthily born.
Speculators haven’t been so short gold futures since mid-December 2015 when gold slumped to a 6.1-year secular low on the Fed’s first rate hike in a decade. Right from those extreme lows, gold exploded almost 30% higher in the next half-year or so. Spec shorts this high are exceedingly-rare bull-birthing levels! After every major spike in gold-futures short selling in history, gold has rocketed higher in major rallies.
I’ve written entire essays on the powerful inverse relationship between gold prices and spec shorting. Excessive or extreme gold-futures short selling is so immediately bullish for gold for a couple reasons. Like all traders, futures speculators’ capital is finite. By the time they ramp their collective shorts back up near historical extremes, their selling is largely exhausted. They don’t have the firepower to short much more.
Short selling itself is very risky. Normal sellers first have to own something before they sell it. But short sellers effectively borrow gold-futures contracts from other traders in order to sell them. Short selling is selling something that isn’t owned, which creates legal obligations to soon repay those debts. In futures this is accomplished by buying long contracts to offset and close short ones, which is very bullish for gold.
All gold-futures short selling is soon followed by proportional offsetting buying. So that 55.1k contracts of shorting in the past couple CoT weeks guarantees 55.1k contracts of imminent buying! Gold’s upside price impact is identical from short-side speculators buying longs to close their positions and long-side speculators adding new longs. While normal long buying is voluntary, short-covering long buying is mandatory.
And once short covering gets underway, it quickly feeds on itself due to that extreme leverage inherent in gold futures. At 30x, a mere 3.3% gold rally would wipe out 100% of the capital risked by fully-leveraged gold-futures speculators! So once gold starts powering higher again, they have to cover fast or face truly-catastrophic losses. Their short-covering buying pushes gold higher, triggering even more buying which snowballs.
The faster gold surges on short covering, the more other speculators are forced to buy to cover their own shorts. Long-side speculators jump in to buy aggressively when gold rallies too, and they control much more capital. Their buying amplifies gold’s upside and puts even more pressure on remaining shorts to buy back their shorted contracts to get out of harm’s way. Nothing’s more bullish for gold than excessive shorts!
So coming out of near-record gold-futures shorting over the past couple CoT weeks driving near-record spec shorts, a major gold rally is almost certain. With spec longs relatively low now and gold moving out of its usual summer-doldrums weakness into August, this rally ought to prove quite powerful. Near-record short selling always leads to massive subsequent gold-futures buying, which tends to unfold fairly rapidly.
Gold’s 30% rally confirming a new bull market in the first half of 2016 was driven by speculators adding 249.2k long contracts while covering 82.8k short ones. Today’s buying potential is similar. To get back to last summer’s 400k-contract long levels when gold was in favor, speculators would have to buy 136.9k long-side contracts. To return their shorts to normal levels between 2009 to 2012, 123.8k need to be covered.
That adds up to 260.7k contracts of gold-futures buying possible if not likely in the second half of 2017! That’s the equivalent of 810.9 metric tons of gold. As usual this will start out with short covering, but the resulting gold rally will entice back much more capital from long-side speculators. This could drive gold another 20% higher from this summer’s levels, which is up around $1500! That’s seriously-impressive upside.
Interestingly silver’s situation today is even more bullish than gold’s! Silver has been beaten like a rented mule this year, pummeled lower while gold remained relatively high. That underperformance was driven by the biggest surge in silver-futures short selling ever witnessed! That catapulted silver shorts way up to a stunning new all-time record high of 93.6k contracts in the latest CoT week before this essay was published.
All the gold-futures shorting analysis above applies equally to silver-futures shorting. When these guys are forced to cover their absurdly-massive shorts, silver is going to soar. Normal levels of silver-futures shorts from 2009 to 2012, the last normal market years, ran 21.5k contracts. That means buying to cover is way up at 72.1k potential contracts! That’s the equivalent of 360.5m ounces of silver, vast beyond belief.
According to the venerable Silver Institute, total global silver demand last year was 1027.8m ounces. So, we are talking about imminent near-term short-covering potential exceeding a third of annual worldwide demand! Silver shot up about 50% in roughly the first half of 2016 on 55.6k contracts of long buying and 30.0k of short covering. Over 5/6ths of that silver-futures buying is likely coming again in short covering alone!
The short-covering-fueled silver-price gains will entice in heavy silver-futures long buying as usual, really amplifying silver’s upside. So another 50% gain isn’t a stretch at all, which would blast silver up above $23 from its recent lows. Gold’s own short-covering rally will spark big silver buying too, as gold has long been silver’s dominant driver. Silver is wildly bullish today given the record shorts in highly-leveraged futures!
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 at near-record and record levels today, gold and silver look exceptionally bullish. We are likely on the verge of major if not massive new bull-market uplegs in these precious metals, which will yield big gains for smart contrarian traders.
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 wildly undervalued and incredibly out of favor today, so their upside potential is truly vast as gold and silver mean revert higher on huge short covering.
The bottom line is speculators’ gold-futures and silver-futures short positions have soared to near-record and 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 of gold futures and silver futures. The resulting sharp short-covering rally soon entices in new long-side futures speculators and later investors with their vastly-larger pools of capital. Excessive and record futures shorts are the best gold and silver buy signals available.
By Adam Hamilton, CPA