Gold's Momentum Selloff

Gold has suffered unrelenting selling in the last couple months, hammering it and its miners’ stocks much lower.  Those outsized anomalous losses have left sentiment in tatters, with overpowering bearishness universal.  Gold’s thrashing had nothing to do with fundamentals, it was driven by cascading momentum selling in gold futures and gold-ETF shares.  But such dumping is finite, increasingly likely to exhaust itself.

Last summer, gold rocketed 40.0% higher out of last March’s COVID-19-lockdown-spawned stock panic.  That massive upleg left this metal extraordinarily overbought, guaranteeing a correction to rebalance both sentiment and technicals.  That came right on schedule, with gold dropping 13.9% over 3.8 months into the end of November.  That healthy selloff was in line with this bull’s precedent, leaving gold sufficiently oversold.

Gold’s three prior corrections during this secular bull had averaged 14.3% losses over 4.1 months.  And that was skewed big, with two of those earlier selloffs seriously exacerbated by unique anomalous events.  So the odds swung around to favor gold’s next bull upleg getting underway.  Indeed it soon started marching higher in a strong uptrend, carrying gold up 9.8% by early January.  Then gold went pear-shaped!

On Friday January 8th, gold was blitzed with extreme gold-futures selling.  That shattered its uptrend, blasting gold 3.5% lower that day alone!  That was pure technical selling, which accelerated after gold’s psychologically-heavy $1,900 level failed overnight.  From there it has been all downhill, with gold falling 12.0% by the middle of this week.  That extended its total correction to 16.8%, challenging the worst of this bull.

What the heck happened?  Gold investment demand should be strong if not massive given today’s super-bullish backdrop.  The Fed’s printing presses are spinning like crazy, with it monetizing a colossal $120b per month of US Treasuries and mortgage-backed securities.  Over the past year, the Fed’s total balance sheet and Treasuries held have skyrocketed an absurd 82.5% and 95.8% to a mind-blowing $7,590b and $4,845b!

This most-extreme monetary inflation in US history is happening with US stock markets trading way up at dangerous bubble valuations.  Exiting February, the elite S&P 500 stocks averaged extreme trailing-twelve-month price-to-earnings ratios of 35.8x!  Investors should be rushing to diversify their stock-heavy portfolios in gold, especially as rising yields threaten to slay stocks’ There-Is-No-Alternative rationalization.

The relentless and sometimes-heavy gold selling since early January had nothing to do with gold’s strong fundamentals.  Instead it was purely momentum-driven, snowballing gold-futures selling that triggered a cascading exodus from major-gold-ETF shares.  The lower gold fell, the more these traders either had to or wanted to sell.  Then their ongoing dumping exacerbated gold’s losses, forming a powerful vicious circle.

While tough to weather psychologically, this type of mindless herd momentum selling is inherently self-limiting.  At some point, everyone susceptible to being scared into selling low has already sold, leaving only buyers.  Then gold rallies sharply from the selloff nadir, resuming its next bull-market upleg.  The past couple months’ selloff was two-staged, a gold-futures primary igniting a far-bigger gold-ETF secondary.

Unfortunately and infuriatingly at times, gold-futures speculators punch way above their weights when it comes to the gold-price impact of their trading.  The extreme leverage inherent in gold futures gives these guys outsized influence over gold prices.  Back in early January before this selling avalanche started, the gold-futures margin requirements mandated just $10,000 cash held in accounts for each contract traded.

As gold was still up near $1,915 then, that meant each 100-ounce contract controlled $191,500 worth of gold.  That enabled gold-futures speculators to run extreme leverage as high as 19.2x!  For decades the legal limit in the stock markets has been 2x.  For every 1% gold’s price moved, these specs would gain or lose 19%.  Such an intense amplification of risks greatly compresses the time horizons for their trades.

On that early-January Friday when $1,900 gold failed, gold’s 3.5% plummeting leveraged 19x forced brutal 2/3rds losses on traders long at maximum margins!  Running extreme leverage, they are forced to sell or face imminent ruin when gold is falling.  Their focus is exceedingly-myopic by necessity, making buy-and-sell trading decisions exclusively on momentum.  Speculators’ herd futures dumping kicked off gold’s selloff.

This first chart superimposes gold over specs’ total gold-futures long and short contracts held.  These are reported weekly in the famous Commitments of Traders reports.  Had the snowballing gold-futures selling by these hyper-leveraged traders not flared, gold would likely be back over $2,000 by now.  But because of the extreme risks inherent in amplifying gold’s price action, heavy gold-futures selling often cascades.

While gold-futures speculators wield excessive influence over gold prices, the capital they command is limited.  So though they can dominate short-term price action, that usually doesn’t last very long.  Both their total gold-futures longs and shorts have meandered in giant ranges during this secular gold bull, which are rendered here.  Usually heavy gold-futures selling is a primary driver of gold’s healthy bull corrections.

But surprisingly that didn’t really happen during gold’s initial correction running from early August to late November.  While the metal fell 13.9% in line with bull precedent, total spec longs merely edged down 3.6k contracts while total spec shorts actually fell 12.0k.  As long buying and short-covering buying have identical gold-price impacts, that netted to 8.5k contracts of buying equivalent to 26.4 metric tons of gold.

That unusual trading suggests gold-futures speculators remained bullish on gold during the early months of its latest correction.  They wanted to stay exposed to gold upside with long contracts, and their appetite for short selling this strong metal waned.  That is normal over the course of secular bulls.  The more years gold powers higher on balance, the more bullish traders grow increasingly expecting gains to persist indefinitely.

So specs’ total gold-futures longs have carved a rising support line in recent years, generally remaining above it.  And their shorts have gradually drifted lower forming an overhead resistance line.  If those held, that implied the risks of cascading gold-futures selling were fairly modest after gold’s original bottoming at the end of November.  That proved true until gold’s brutal 3.5% plummeting on markets’ first Friday of 2021.

Unfortunately the weekly CoT reports are low-resolution data, masking what happens within weeks.  The CoTs are current to Tuesday closes, but aren’t released until late Friday afternoons.  During that CoT week straddling gold’s initial plunge, specs dumped an enormous 35.7k gold-futures long contracts!  Anything over 20k in a single CoT week is huge, and that ranked as the 20th-largest long liquidation since early 1999!

Since that fateful ugly gold action on January 8th kicked off gold’s snowballing selloff, it is very important to understand.  Today it is fashionable to blame gold’s momentum selloff on rising yields, yet that day the benchmark 10-year Treasury yields were just 1.11% remaining well under traders’ radars.  Gold broke below that $1,900 level triggering stop-loss selling in overnight Asian trading, well before the US session.

Gold was already down 1.5% heading into that Jobs Friday, and that monthly US jobs report was actually gold-bullish.  It came in at a major miss with total US jobs falling 140k in December on new lockdowns, which was way worse than the already-poor +50k estimates.  Gold rallied after that weak data implied the Fed would have to up its easing.  3/7ths of that 3.5% gold plunge happened overnight before that jobs data.

There was no fundamental reason at all to dump gold that day.  But for gold-futures speculators running extreme 19x leverage, they had to flee or risk annihilation.  Suffering 2/3rds of your capital wiped out in a matter of hours is a crazy risk no one can afford to take.  The more traders amplify their gains and losses with leverage, the shorter-term their focuses are forced to become.  They simply have to sell when others do.

With that unsustainably-extreme gold-futures selling quickly exhausting itself, gold stabilized and drifted sideways for a few weeks.  But that gold-futures-driven gold plummeting had spooked a far-larger group of traders.  These are American stock traders, both speculators and investors, who gain gold portfolio exposure through trading its major exchange-traded funds.  Their capital dwarfs that of gold-futures specs.

Despite running no leverage up to the stock-market limit of 2x, the gold-ETF shareholders are also often momentum traders.  They love to pile in to chase gains when gold is rallying, then sell out to flee when gold is falling.  That means speculators’ gold-futures trading can become the tail wagging the much-larger gold-investment dog.  When frantic gold-futures selling crushes gold lower, it can ignite bigger gold-ETF exoduses.

The two dominant gold-exchange-traded funds are the venerable GLD SPDR Gold Shares and the smaller IAU iShares Gold Trust.  American stock traders have shifted some of their vast pools of capital into gold via these vehicles, making them overwhelmingly important for gold price action.  The best global supply-and-demand data for gold is published quarterly by the World Gold Council, showing these ETFs’ importance.

In its latest numbers from the end of Q4’20, GLD and IAU accounted for a staggering 31.2% and 14.0% of all the gold held in all the world’s physical-gold-bullion-backed gold ETFs!  And the ETF component of global gold investment demand has grown into the wildly-swinging wildcard usually overpowering every other gold-demand category quarter to quarter.  Again the WGC’s Q4 data really drives home this critical point.

As gold’s last upleg surged into early August’s dazzling all-time-record high, stock traders flocked to gold ETFs to chase those fast gains.  So in Q3, ETFs added 272.2t of gold demand globally.  But in Q4 as gold corrected, the momentum capital flows reversed hard with ETFs suffering a 130.0t draw.  That huge negative 402.1t swing in gold demand quarter-on-quarter via physical ETFs bashed overall demand 116.6t lower!

Gold ETFs act as conduits for the vast pools of stock-market capital to flow into and out of gold.  When stock traders sell GLD and IAU shares faster than gold itself is being sold, these ETFs’ share prices will disconnect to gold’s from the downside failing their tracking mission.  GLD’s and IAU’s managers prevent this by buying back any excess gold-ETF-share supply beyond gold’s own selling on any particular day.

These buybacks are financed by selling some of the physical gold bullion held in trust for shareholders.  So when gold-ETF holdings are suffering draws and falling, it reveals stock-market capital flowing back out of gold.  The gold-ETF managers’ necessary bullion sales add to selling pressure, exacerbating gold selloffs already underway.  Like gold-futures selling, gold-ETF-share selling can cascade into vicious circles.

This next chart superimposes GLD+IAU physical-gold-bullion holdings in metric tons over the gold price.  Heavy differential gold-ETF-share selling forcing holdings draws began right after sharp selloffs in gold futures.  Like a thermonuclear bomb, the relatively-small gold-futures selling acts like a fission primary that ignites a much-larger fusion secondary.  Gold-futures selling scares gold-ETF shareholders into joining in.

The gold price is highly correlated with major-gold-ETF holdings.  A colossal 460.5t combined build in GLD and IAU is the only reason gold soared 40.0% higher last summer in that massive upleg out of those stock-panic lows!  Over that span specs actually sold a modest 25.4k gold-futures contracts, netting out to the equivalent of 78.9t of gold.  American stock traders played a big role in gold’s subsequent correction.

When gold fell 13.9% into late November, that was largely driven by GLD+IAU holdings falling 42.2t.  The timing of that differential gold-ETF-share selling is really important.  Note above that after gold peaked American stock traders kept adding gold on balance into mid-October, well after gold’s early-August top.  They didn’t start fleeing until gold-futures selling forced gold sharply lower in late October and early November.

With gold’s correction bottoming and a strong young upleg getting underway in December, American stock traders started returning.  GLD+IAU holdings started rising again on differential buying pressure.  As these shares were bought faster than gold, the ETF managers had to issue new shares to meet that excess demand.  They used the proceeds from those share sales to buy more physical gold bullion to hold.

But that nascent build in GLD+IAU holdings that would’ve likely accelerated, amplifying gold’s upleg, suddenly died.  The trigger is crystal-clear in this chart.  It was gold plummeting 3.5% on January 8th as gold-futures speculators aggressively fled when $1,900 failed.  That sharp single-day gold selloff was the event that radically changed sector psychology.  The bearishness flaring then has mostly intensified since.

After that gold plunge, American stock traders shifted from net gold-ETF-share buyers to sellers.  The more GLD and IAU shares they dumped, the weaker gold got as those gold-bullion sales added to selling pressure.  The more gold sold off, the more gold-ETF shareholders fled.  Like the parallel gold-futures selling, this was totally momentum-driven.  This intensifying gold-ETF dumping had nothing to do with fundamentals.

Since January 8th, the Fed’s insane money printing hasn’t slowed a bit.  And super-inflationary monetary injections will surge again when Democrats’ $1.9t of pandemic-stimulus money is soon unleashed into the US economy.  That vast deluge of new money competing to bid up prices on far-slower-growing goods and services is going to force price inflation much higher.  Gold has always been the ultimate inflation hedge.

Some think bitcoin has usurped gold in that role, but bitcoin is in a speculative mania today.  In just 5.4 months, it skyrocketed an epic 458.4% higher!  Regardless of bitcoin’s long-term prospects, such extreme gains guarantee a post-bubble collapse.  After bitcoin’s last speculative mania climaxing in December 2017, its price crashed 63.6% in just 1.6 months!  Bitcoin is far too volatile for an investment inflation hedge.

And the stock markets remain deep into dangerous bubble territory valuation-wise, ripe for a major selloff any day.  And although 10-year Treasury yields have soared, even at 1.51% last week real inflation-adjusted yields still remained very negative.  The Fed can’t afford to let this suppressed rate normalize, as the added interest payments on the US government’s staggering $27.8t of debt would threaten to bankrupt it!

The relentless gold selling since early January had no fundamental basis at all.  Given these conditions, gold investment demand should’ve surged.  All this gold selling was purely momentum-driven, forming an ugly negative feedback loop.  The more gold-futures and gold-ETF-share selling, the lower gold’s price was forced.  The lower gold fell, the more gold-futures and gold-ETF-share traders were motivated to flee.

The great majority of speculators and investors are not contrarians, but herd-following momentum traders.  They love to buy high when prices are rallying strongly, and are easily scared into selling low when prices are falling.  The latter is the dynamic that has played out in recent months, fueling that vexing cascading selling in both gold futures and gold-ETF shares.  The good news is that momentum selloffs are self-limiting.

As the tail wagging the larger gold-investment dog, gold futures are the key.  Speculators can only dump so many longs, and add so many shorts, before they run out of available capital firepower to keep selling.  The latest-available Commitments-of-Traders report before this essay was published was current to Tuesday February 23rd.  At that point gold was at $1,806, still way above the capitulation carnage seen since.

Even then, total spec longs had collapsed back down to 339.8k contracts.  They hadn’t been lower since early last summer.  Gold was trading at $1,727 then in mid-June, on the verge of rocketing 19.4% higher over the next seven weeks to that last upleg topping of $2,062!  Now already well below their climbing bull support line, total spec longs aren’t likely to plunge considerably under today’s probably-well-lower levels.

In last March’s stock panic, gold plummeted 12.1% in just eight trading days.  That forced enormous gold-futures selling as leveraged specs fled in terror.  These traders dumped a colossal 141.8k longs in just seven weeks straddling that!  Their total longs bottomed out and stabilized around 330k contracts.  At some point soon, all the specs leveraged enough to be forced out will be gone.  Then gold reverses hard.

Something catalytic will emerge in the markets, either price action or news.  That will motivate the specs sitting on the sidelines in cash to flood back into gold futures.  As that blasts gold higher, their peers will flood in to chase that upside momentum.  The resulting gold surge will motivate stock traders to rush back into gold-ETF shares, amplifying gold’s gains.  All that self-feeding buying will fuel gold’s next bull upleg.

So like all momentum-driven gold selloffs in the past, this one too shall soon pass.  Momentum selling is finite and self-limiting, and soon exhausts itself.  And once buying returns reversing that momentum to the upside, gold’s strong fundamentals should fuel massive capital inflows.  Between the colossal monetary inflation and super-risky bubble-valued stock markets, all investors should be prudently diversifying into gold.

While gold’s recent beat-down has been miserable, the collateral damage in gold stocks has been brutal.  The gold miners, which also have very-strong fundamentals, have been bludgeoned back down to deep new lows.  Major gold stocks will leverage gold’s coming upleg by 2x to 3x, with smaller fundamentally-superior ones faring even better.  So we are actively redeploying in great gold-stock trades in our newsletters.

The bottom line is gold’s vexing selloff in recent months was totally momentum-driven.  It had nothing to do with fundamentals, which remain strong for gold.  Extreme gold-futures selling erupted in early January after a key technical level failed, hammering gold lower.  That plummeting scared American stock traders, who started dumping major-gold-ETF shares.  Both gold-futures and gold-ETF-share selling cascaded since.

The longer and deeper gold’s festering selloff persisted, the more traders were motivated to join the herd selling.  The more they sold, the more gold fell.  The resulting negative feedback loop has hammered the entire precious-metals complex sharply lower, fueling soaring bearishness.  The good news is the gold-futures selling that ignited all this is finite, and is likely nearing exhaustion.  After that, gold should rally hard.

At Zeal we walk the contrarian walk, buying low when few others are willing before later selling high when few others can.  We overcome popular greed and fear by diligently studying market cycles.  We trade on time-tested indicators derived from technical, sentimental, and fundamental research.  That’s why all 1178 stock trades recommended in our newsletters since 2001 averaged hefty +24.0% annualized realized gains!

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Adam Hamilton, CPA

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