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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Market Euphoria Weighs On Gold

Gold

The great euphoria emanating from these near-record-high stock markets is breathtaking. Traders are again convinced stocks do nothing but rally indefinitely. That everything-is-awesome mindset has stunted gold’s latest upleg, since there’s no perceived need for prudently diversifying stock-heavy portfolios. But that psychology can change fast, as we saw a half-year ago. Gold investment roars back as stocks roll over.

The word “euphoria” is widely misunderstood, often confused with “mania”. The latter is when stocks rocket vertically in blowoff tops, and is defined as “an excessively intense enthusiasm, interest, or desire”. The US stock markets certainly aren’t in a mania. At its latest high last Friday, the flagship US S&P 500 broad-market stock index (SPX) had only edged up 1.2 percent over the past 14.5 months. That’s not parabolic.

The closest thing to a mania seen in recent years was the SPX’s 18.4 percent surge over just 5.3 months that led into its initial January 2018 peak. Traders were ecstatic about Republicans’ coming major corporate tax cuts, and aggressively piled into stocks. While euphoria accompanies manias, it is entirely different. It is simply “a strong feeling of happiness, confidence, or well-being”. That psychology is universal today.

Traders have fully persuaded themselves that these stock markets have virtually no material downside risks. Like all sentiment, that’s the direct result of recent price action. These beliefs were last seen in late September and early October. The SPX had just hit a dazzling all-time record high, extending its monster bull market to 333.2 percent gains over 9.5 years. That was the second-biggest and first-longest in US history!

Gold was deeply out of favor near that last SPX topping too.  s a rare counter-moving asset that tends to rally when stock markets weaken, gold investment demand wanes when stock euphoria grows extreme.  he whole discipline of portfolio diversification is based on acknowledging that stock markets rise and fall.  ince investors can’t know when the next major stock-market selloff will erupt, they keep some non-stock holdings.

But euphoria blinds traders to long centuries of financial wisdom.  hey tend to extrapolate present conditions out into infinity, assuming they will last indefinitely.  ut betting any trend will run forever is just plain foolish, as markets are forever cyclical.  Complacency” always accompanies euphoria, “a feeling of contentment or self-satisfaction, especially when coupled with an unawareness of danger or trouble”.

Soon after traders overwhelmingly believe major selloffs are extinct, the next one pummels them.  he endless stock-market cycles reassert themselves with a vengeance, punishing the scoffers.  he severe correction after late-September’s peak is a textbook example.  ver the next 3.1 months into Christmas Eve, the SPX plunged 19.8 percent!  hat was right on the verge of confirming a new bear at its -20 percent threshold.

Traders were confronted with the painful truth that stock markets don’t rally forever, that major selloffs are inevitable.  o gold investment demand surged as investors rushed to start diversifying their bleeding stock-dominated portfolios.  ajor stock-market plunges are always followed by big and sharp rebound rallies.  ust 5 weeks after those deep near-bear lows, the SPX had blasted 15.0 percent higher by the end of January.

That’s when euphoria and complacency started to return.  hese perilous herd emotions strengthened with every daily SPX rally over the past several months or so.  he higher the stock markets bounced, the more selloff fears faded.  hat left portfolio diversification and gold investment increasingly out of favor again.  he result is today’s extreme euphoria resembles late September’s, traders don’t have a care in the world.

While euphoria and complacency are ethereal and unmeasurable, they can be inferred.  he classic VIX fear gauge is the most-popular way.  t quantifies the implied volatility options traders expect in the SPX over the next month, as expressed through their collective trades.  hile a high VIX reveals fear, a low one shows the direct opposite which is complacency.  ast Friday the VIX slumped under 12.0 on close.

The SPX’s massive rebound rally had extended to 23.7 percent over 3.6 months, recovering over 19/20ths of the preceding severe-correction losses.  he SPX had soared back to within just 0.8 percent of its record peak of 6.7 months earlier!  he stocks-to-the-moon zeitgeist had returned in an extreme way.  he VIX hadn’t been lower since early October, when the SPX still lingered merely 0.2 percent under its unprecedented crest.

So per the leading approximation, traders’ current euphoria and fear have reverted right back to their very same high and low levels just before the last major SPX selloff! hat’s why gold has slumped in recent weeks.  nvestors forget about it when they come to believe stock markets’ downside risks have vanished.  hen they buy into that peaking delusion that stocks can rally indefinitely, there’s no perceived need for gold.

This psychology creates an inverse relationship between stock-market levels and gold.  t becomes most-pronounced when stock markets are near record highs generating great euphoria.  his chart shows how the SPX and gold have traded over the past several years or so.  ver since that mania-like SPX surge into late January 2018 on corporate-tax-cut hopes, gold has generally meandered in opposition to stock markets.

(Click to enlarge)

The greater stock-market euphoria, for the most part the weaker gold investment demand and thus gold prices.  nd of course euphoria is a direct function of how high the stock markets are.  he SPX has surged to record and near-record levels 3 times over the past 15 months or so.  t peaked at 2872.9 in late January 2018, 2930.8 in late September 2018, and has shot as high as 2907.4 so far in mid-April 2019.

These two confirmed major toppings along with today’s likely third averaged 2903.7, so call it 2900.  he SPX is now trading just slightly above January 2018 levels, despite last year being one of the greatest in history for corporate-profits growth.  he underlying earnings of the 500 elite SPX companies soared well over 20 percent in 2018!  he SPX should’ve surged proportionally on such strong underlying fundamentals.

But it didn’t, mostly grinding sideways to lower.  he US stock markets were already wildly overvalued, spending most of last year trading literally in bubble territory.  hat’s 28x+ in trailing-twelve-month price-to-earnings-ratio terms, twice historical fair value at 14x.  tocks were already far too expensive to bid to major new highs, a dangerous problem which persists in their latest quarterly results.  nd 2018 was one-off.

Its four quarters were the only ones comparing pre-tax-cut and post-tax-cut results.  hat unprecedented discontinuity is the only reason earnings growth was so enormous last year.  rofits are expected to stall out this year at best, and likely shrink.  ll quarterly comparisons going forward already include those big corporate tax cuts.  o if the SPX couldn’t materially rally even in 2018, it’s in a world of trouble this year.

In December 2017 just before the corporate tax cuts kicked in, the 500 SPX stocks traded at a simple-average TTM P/E ratio of 30.7x.  t the end of March 2019, that had merely retreated modestly to 26.3x which is still just under perilous bubble territory.  ithout strong double-digit earnings growth, such rich stock valuation levels won’t be sustainable for long.  hat’s great news for gold’s investment demand and prices.

The first time the SPX topped in January 2018, gold’s powerful upleg stalled just shy of breaking out to new bull-market highs.  old held those strong levels until the SPX started powering higher again, which quickly rekindled euphoria dousing portfolio diversification.  old suffered a major correction as the SPX challenged and exceeded new records into September 2018.  old languished near lows as the SPX peaked.

Gold investment demand didn’t flare again to force gold higher until the SPX decisively rolled over from those all-time record highs.  nce the stock markets started falling long enough and far enough to scare traders into remembering stocks can fall too, gold investment demand surged pushing this metal’s prices much higher.  old was nearing another breakout before stock-market euphoria grew extreme again.

That’s why gold’s latest upleg stalled in recent weeks, why its price has slumped after nearing another major bull-market breakout.  old has actually shown remarkable resiliency considering stock euphoria soaring right back up to early-October extremes.  ast Friday when the VIX fell under 12.0 on close, gold was trading near $1291.  hat was way better than early October’s $1198 the last time the VIX traded that low.

Stock-market psychology’s primary impact on gold is sentimental.  he higher stocks and the greater the herd belief they will keep rallying, the more gold interest and investment demand fade.  ut there’s also a way to measure capital flows into and out of gold from American stock investors.  hat is through the gold-bullion holdings of the world’s leading and dominant gold exchange-traded fund, the GLD SPDR Gold Shares.

GLD is a behemoth, holding 752.9 metric tons of physical gold bullion in trust for its shareholders this week.  ccording to the World Gold Council, GLD is the world’s biggest gold ETF by far.  t the end of Q4’18 its gold holdings were 2.8x larger than its next-biggest competitor’s.  LD commanded nearly 3/7ths of the total gold bullion held by the world’s top-10-largest physical-gold-backed ETFs, a vast amount!

GLD’s mission is to track the gold price, to give stock traders easy access to gold exposure.  his is only possible if GLD can vent excess supply and demand for its shares directly into the global gold market, as the supply and demand for GLD shares is independent of gold’s own.  LD prices can’t mirror gold prices unless this ETF is able to buy and sell physical gold bullion to equalize supply and demand, which it does daily.

It also reports its total gold holdings daily, allowing traders to see whether American stock-market capital is flowing into or out of gold.  hen GLD’s holdings are rising, investors are buying gold.  hen they are falling, investors are selling gold.  he capital flows into and out of GLD are heavily influenced by stock-market fortunes, stunted when euphoria grows extreme.  old investment has suffered with the SPX so high.

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Understanding how this capital flows work is important.  hen traders buy GLD shares faster than gold itself is being bought, GLD’s price threatens to decouple from gold to the upside.  LD’s managers avert this by shunting that excess GLD-share demand directly into gold itself.  hey issue enough new GLD shares to offset that differential demand, and use the proceeds to buy more physical gold bullion to hold in trust.

Conversely, when GLD shares are being sold faster than gold, GLD’s price will soon break away from gold on the downside.  LD’s managers stave that off by buying back its shares to sop up that excess supply.  he capital necessary to finance those repurchases is obtained by selling some of GLD’s physical-gold-bullion holdings.  o rising and falling GLD holdings show stock-market capital migrating into and out of gold.

This chart superimposes GLD’s daily gold holdings in metric tons over the closing gold price.  hey are well-correlated with gold, showing American stock traders’ GLD trading heavily influences how gold is faring.  ach calendar quarter’s gold-price percentage change, and both the percentage and absolute changes in GLD’s holdings, are noted.  ver the past year in extreme SPX euphoria, GLD has driven gold.

(Click to enlarge)

Incredibly GLD’s and thus American stock traders’ huge impact on the gold price is often not understood.  verlooking it is a grave error, greatly hobbling chances of multiplying wealth in gold.  o show how dominant GLD is, consider some of the larger quarterly gold moves of this young bull born from deep 6.1-year secular lows in mid-December 2015.  LD’s holdings languished near 7.3-year lows at that same time.

In Q1’16 gold surged 16.1 percent after the first SPX corrections in 3.6 years made traders remember gold’s crucial role in portfolio diversification.  hey flooded into GLD shares at dizzying rates, catapulting its holdings 27.5 percent or 176.9t higher that quarter!  er the latest comprehensive fundamental data from the World Gold Council, GLD’s build accounted for 84 percent of the year-over-year growth in total global gold demand!

In Q2’16 that massive gold upleg continued, pushing gold another 7.4 percent higher.  LD’s holdings surged another 16.0 percent or 130.8t higher on heavy differential buying by American traders.  hat GLD build alone ran 106 percent of gold’s total YoY worldwide demand growth!  ad US stock-market capital not been flowing into gold via GLD, this gold bull never would’ve existed.  4’16’s gold plunge drove home that critical point.

After Trump won the presidency that quarter, stock markets surged on hopes for big tax cuts soon with Republicans controlling the US government.  uphoria soared with the SPX, leading investors to jettison gold and chase stocks.  old plunged 12.7 percent that quarter, driven by a huge 13.3 percent or 125.8t draw in GLD’s holdings.  hat selling was a whopping 112 percent of the total YoY decline in global gold demand that quarter!

While American stock traders certainly aren’t the only gold investors, they command vast capital that has really moved gold in recent years.  old’s price behavior in each quarter of this bull has generally been quite proportional with capital flows into and out of GLD.  hat’s certainly proven true in this past year as well, when SPX euphoria ran rampant other than deep in Q4’18’s severe near-bear correction in the SPX.

After that initial SPX peak in January 2018 and the subsequent sharp-yet-shallow-and-short correction, gold investment demand grew as euphoria wavered.  etween mid-January to late April that year, GLD enjoyed a 5.1 percent holdings build.  hat wasn’t enough to push gold much higher, it only climbed 0.4 percent.  ifferential GLD-share trading isn’t gold’s only driver, gold-futures trading also plays a major role for different reasons.

But as the SPX powered higher out of that initial post-topping selloff, so did investors’ stock euphoria.  o they again started to pull capital out of GLD faster than gold was falling, forcing a major holdings draw.  etween late April to early October soon after the SPX’s second topping and new all-time record highs, GLD’s holdings plunged 16.2 percent.  hat gold-investment exodus pushed gold prices 9.0 percent lower in that span.

The relentless slump in GLD’s holdings reversed sharply on a very telling day.  merican stock traders finally started aggressively buying GLD again on October 10th, forcing a major 1.2 percent daily holdings build.  hat happened?  hat was the first day the SPX sold off hard after its recent record high, plunging 3.3 percent to shatter complacency.  hat budding sentiment shift was evident in the VIX, which soared 39.7 percent to 22.6.

The more that serious Q4’18 SPX selloff intensified, the greater gold investment demand grew.  his was most evident in December, when the stock markets plunged a brutal 9.2 percent alone!  hat pain really helped investors remember the wisdom of having gold allocations in their stock-heavy portfolios.  old surged 4.9 percent that month on a 3.4 percent GLD-holdings build.  old investment was strong with stock euphoria gone.

Investors’ interest in gold continued well after the SPX started rebounding, as GLD’s holdings peaked in late January 2019 about 5 weeks after the SPX had bottomed.  ut with the SPX already soaring 15.0 percent off its lows, euphoria was mushrooming rapidly.  etween early October to late January, GLD’s holdings surged 12.8 percent driving a parallel 9.7 percent gold rally with stock euphoria not stunting gold investment demand.

Though gold’s latest interim high of $1341 came a couple weeks later in mid-February, American stock traders’ capital outflows from gold were well underway.  s the SPX powered ever higher that month, GLD suffered draws on fully 13 of its 19 trading days!  hat differential GLD-share selling on resurgent stock euphoria continued to this week.  ince late January, GLD’s holdings have shrunk another 8.7 percent.

Though gold has been fairly resilient considering the lofty stock-market levels, it still slid 3.3 percent in that span.  old’s upleg was stunted by stock markets’ powerful rebound rally.  t rekindled the same levels of extreme euphoria and complacency seen near the SPX’s late-September record peak.  ith everyone once again convinced stocks can rally indefinitely with no material selloffs, gold investment demand withered.

While wearying for long-suffering contrarian investors, this is actually quite bullish for gold.  ack in early October GLD’s holdings slumped to 730.2t in extreme stock-bull-peaking euphoria.  old fell as low as $1188 as GLD’s holdings bottomed before the SPX started dropping again.  orced way back down to 752.3t this week, GLD’s holdings are only 3.0 percent above those deep early-October lows.  et gold was way higher.

At $1276, gold was fully 7.4 percent above its own early-October low!  his is a much-higher base from which to launch its next surge higher, with gold-investment buying potential via GLD shares almost fully reset!  hen these dangerously-overvalued stock markets inevitably roll over again, American stock traders will again remember prudently diversifying with gold.  heir big capital inflows will again drive gold much higher.

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That has real potential to fuel a major bull-market breakout for gold above its $1365 bull-to-date peak seen way back in July 2016.  his is even more likely because gold-futures speculators aren’t very long as I discussed in last week’s essay.  ust like American stock traders, they have lots of room to buy gold aggressively as it resumes marching higher.  old investment demand only grows as gold prices climb.

Realize gold’s big problem right now is universal stock-market euphoria at extreme stock-bull-peaking levels.  ut that won’t last, it never does.  nce the SPX inescapably starts sliding again in its next material selloff, gold demand will surge back.  hese lofty overvalued and overbought stock markets near record highs look exhausted.  hey are likely to turn back south any day, bleeding away euphoria and rekindling gold.

The biggest beneficiaries of gold uplegs are the gold miners’ stocks, which tend to leverage gold’s gains by 2x to 3x.  ack in essentially the first half of 2016 when gold surged 29.9 percent higher in response to back-to-back SPX corrections, the leading GDX and GDXJ gold-stock ETFs soared 151.2 percent and 202.5 percent higher in roughly that same span!  hen gold starts powering higher again, the coming gold-stock gains will be big.

The bottom line is stock-market euphoria has stunted gold’s upleg.  ith US stock markets once again back up challenging all-time-record highs, traders have forgotten the hard lessons from late September’s peak.  hey’ve deluded themselves into believing stocks can rally indefinitely, that near-bubble valuations don’t matter.  hus gold investment demand has withered, which is normal when stock markets are topping.

But once these lofty stock markets inevitably roll over decisively again, gold demand will come roaring back just like in Q4.  nvestors will remember the wisdom of prudently diversifying their stock-dominated portfolios with counter-moving gold, and start shifting capital back in.  hat will push gold prices much higher, with real potential for a major bull-market breakout.  he gold stocks will amplify those gains like usual.

By Adam Hamilton

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  • Geo on April 22 2019 said:
    "They are well-correlated with gold, showing American stock traders’ GLD trading heavily influences how gold is faring."

    Adam, you've made the same claim many times already in your past articles. This still heavily contradicts data and even your own charts. In your current and previous charts comparing GLD's holdings with the gold price, you can see numerous periods where the gold price leads GLD's holdings rather than the opposite. So which data leads which data again? In Jan 2017, there was a 7.6% rise in the price of the GLD, which means people have been buying. Yet, since gold bottomed, GLD's holdings have fallen another 4.5%. It fails as both a leading and a lagging indicator. There are countless other examples outside of this January example as well. This indicator is very useless as proven by its track record. Also, the gold exchanges completely dwarfs GLD's movements. GLD's movements are so very insignificant compared to the overall gold market.
  • Robert on April 22 2019 said:
    "It also reports its total gold holdings daily, allowing traders to see whether American stock-market capital is flowing into or out of gold. When GLD’s holdings are rising, investors are buying gold. When they are falling, investors are selling gold."

    "GLD’s holdings slumped to 730.2t"

    "GLD is a behemoth, holding 752.9 metric tons of physical gold bullion"

    Daily, even in great detail, doesn't mean much when there is absolutely no way to verify any of it. GLD makes the claim that it is completely supported by physical gold yet it denies your every day investors the right to exchange for any of their listed 'gold'. This alone means GLD shares are just paper by the day's end. Moreover, GLD's prospectus is loaded with weasel clauses that lets the trust get away without the promised gold backing. A good example of this is in the section of the prospectus that states GLD has no right to audit subcustodial gold possessions. Why does this audit loophole exist?

    I remember there was a well documented visit by CNBC's Bob Pisani to GLD's gold vault. This visit was organized by GLD's management to prove the existence of GLD's gold but the gold bar held up by Mr. Pisani had the serial number ZJ6752 which did not appear on the most recent bar list at that time. It was later discovered that this "GLD" bar was actually owned by ETF Securities.

    Note that even on the subject of GLD's insurance, they are not at all straightforward about it. Their representatives will not confirm nor deny the existence of GLD's insurance. I recommend anyone curious about this to confirm via calling GLD's publicly listed number for general inquiries at 866 320 4053 and ask about this clause from the GLD prospectus: "The Custodian maintains insurance with regard to its business on such terms and conditions as it considers appropriate which does not cover the full amount of gold held in custody." Exactly how much of the fund is insured? They will not give you a straight answer and might even throw in some bizarre excuse which I've experienced. Why hide this information from investors? The people behind GLD certainly do not seem like the most honest types.

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