Massive PM-Futures Buying

Both gold and silver have enjoyed massive buying by American futures speculators in recent weeks.  It all started with Fed chair Janet Yellen’s cavalier dismissal of inflation, but the buying momentum persisted well after that.  Happening in the midst of the summer doldrums when global precious-metals investment demand is weak, this is an exceptionally-bullish portent.  It is setting up the PMs for a major autumn upleg.

A little over a month ago, I wrote an essay on the record shorting of gold and silver futures by American speculators.  This one group of traders utterly dominates gold and silver price action, and therefore the fortunes of stock traders’ flagship GLD gold ETF and SLV silver ETF.  Gold futures had just seen their biggest jump in spec shorts, and silver futures their highest levels of spec shorts, in at least 15.4 years!

As I said then with gold and silver loathed and languishing near ugly multi-month lows, extreme shorting is very bullish.  Futures shorts contractually have to be covered before expiration, and this is done by buying offsetting longs.  The higher speculators’ futures shorts get, the more near-future buying they guarantee.  And since futures are so hyper-leveraged, this buying to cover often happens quite rapidly.

In early June near the gold and silver lows, speculators merely needed to keep $6000 in their account to control a single 100-ounce gold contract, and $8250 for a single 5000-ounce silver contract.  But these contracts were worth a whopping $125,000 and $95,000 respectively at $1250 gold and $19 silver.  So that represented maximum leverage of an insane 20.8x in gold futures and 11.5x in silver futures!

In the stock markets, leverage has been legally limited to 2.0x ever since the Federal Reserve implemented its Regulation T in 1974.  At 20.8x leverage, a mere 4.8% gold-futures move in the opposite direction that speculators are betting will wipe out 100% of the capital they risked.  It was only a matter of time until some buying catalyst arrived that would unleash furious short covering, and it happened to be Janet Yellen.

On June 18th after the latest meeting of the Fed’s Federal Open Market Committee, the chair held one of her quarterly post-FOMC-meeting press conferences.  CNBC’s economics reporter Steve Liesman asked the first question, wondering if the Fed was “behind the curve on inflation” since its 2% target has already been exceeded recently.  Yellen’s response would prove the catalyst to ignite massive PM futures buying.

She replied, “So I think recent readings on, for example, the CPI index have been a bit on the high side, but I think it’s – the data that we’re seeing is noisy.”  This “noisy” word would get much play after, as the CPI had just seen its first back-to-back months of 2.0%+ year-over-year growth since early 2012 the morning before.  She seemed very out of touch with economic reality and super-tolerant of higher inflation.

She finished by saying the Fed expects to “continue to see a gradual pickup over the next several years toward our 2% objective.”  Inflation was already at 2%+ annually on multiple major indicators and the Fed thinks it is going to take “several years” to get there?  This shocking revelation to traders indicated the Yellen Fed will tolerate higher inflation far longer than previously thought.  Inflation is bullish for PMs.

The reaction that afternoon was rather muted, with gold and silver only up 0.3% and 0.6% on June 18th.  But it’s important to remember Yellen’s quarterly post-FOMC-meeting press conferences don’t start until 2:30pm, an hour after the closes of the main US gold and silver open-outcry futures trading days at 1:30pm and 1:25pm.  So reactions to FOMC decisions often arrive the next day when full trading resumes.

And futures speculators indeed came out in force early on June 19th.  They bought aggressively, catapulting gold and silver 3.4% and 4.8% higher!  These were the biggest up days in both gold and silver since the mid-September FOMC meeting where the Fed defied expectations to not start tapering its QE3 debt-monetization campaign.  Janet Yellen had managed to trigger the gold and silver short squeeze!

Though such big surges emerging out of record speculator shorting had to be short squeezes, we couldn’t be sure for over a week.  Speculators’ futures positions are only reported once a week by the Commodity Futures Trading Commission in its famous Commitments of Traders reports.  These are published Friday afternoons, current to the past Tuesday.  So we had to wait until June 27th to see what really happened.

And it was far more awesome than I imagined, not only massive short covering but massive new long-side buying!  This first chart looks at the GLD gold ETF superimposed over speculators’ total long and short positions in gold futures.  The heavy buying unleashed by Janet Yellen’s cavalier dismissal of inflation was incredible, and served to confirm the bullish outlook for gold and silver on multiple fronts.

You can clearly see Yellen’s June 19th gold surge above, though it is certainly overshadowed by gold’s wildly anomalous plunge in the second quarter of 2013.  But the futures buying behind that Yellen gold surge was truly remarkable.  As expected, there was enormous short covering.  American speculators bought to cover 25.4k contracts in the CoT week straddling that surge, the equivalent of 79.0 metric tons of gold!

This represented specs covering over 1/5th of their total short positions in that week alone!  Our CoT data goes back to early 1999, an 809-week span.  And only 6 of those weeks had seen short covering over 25k contracts, it is exceedingly rare.  Since today’s secular gold bull was born in April 2001, there have been only 2 other CoT weeks with such massive short covering.  Yellen’s epic dovishness terrified the speculators.

This decisive plunge in their total shorts cemented a critical downtrend in place for an entire year.  At each subsequent major gold low, speculators have been less and less willing to take on excessive shorts.  They peaked at an at-least 14.5-year-record 178.9k early last July near gold’s initial low, but only hit a substantially-less-extreme 150.0k in early December at gold’s next major low.  The zeal for shorting was waning.

And just over a week before Yellen’s short squeeze erupted, the latest peak near the latest major gold low was just 132.8k contracts.  This downtrend in peak shorting is very bullish, since major new gold lows are unlikely to be seen without excessive selling by futures speculators.  As gold has consolidated over this past year, they are slowly starting to realize the extreme bearish consensus outlook on gold is dead wrong.

That CoT week’s massive short covering straddling Yellen’s press conference was expected.  But the big surprise was massive long-side buying as well!  Speculator long buying is more important than short covering.  Traders contractually have to cover shorts, so that buying is purely mechanical often with no conviction about where gold is heading.  But buying new longs is voluntary and requires high conviction.

This is especially true in the hyper-leveraged world of futures trading where being wrong can wipe out traders in a matter of days.  During that same Yellen CoT week, American futures speculators added an astounding 27.9k long contracts.  This exceeded their short covering, and was the equivalent of 86.7 tonnes of gold buying in a single week!  They catapulted their long exposure fully 1/7th higher on Yellen.

Unlike the traders buying to offset and close shorts, the guys buying new longs were not obligated to buy gold futures.  They voluntarily chose to risk their scarce capital in a super-leveraged realm on a high-conviction belief gold was heading higher still.  While specs’ total longs have been gradually climbing since they bottomed at 170.2k contracts in mid-December, the Yellen buying was still very unexpected.

In the 809 weeks of CoT history since early 1999, only 36 have seen spec longs grow by over 25k contracts.  The last one happened back in August 2012, well before last year’s extreme gold selling anomaly.  So speculator gold-futures buying of that magnitude is pretty rare and special, something not witnessed very often.  Together that week’s long and short buying was the equivalent of a staggering 165.7 tonnes of gold!

Such buying is massive beyond belief.  According to the World Gold Council, global investment demand averaged 30.2t per week in 2012 and 14.9t in 2013.  The American speculators’ futures buying alone that was unleashed by Janet Yellen’s dismissal of inflation dwarfed that.  If it didn’t happen in the summer doldrums when precious-metals investment demand is so weak, gold would have surged far higher on it.

Now with the US stock markets still levitating on the Fed’s epic dovishness, and gold still being totally shunned as an investment class, I figured that Yellen CoT-week spike would be the end of the heavy futures buying for now.  So I was very surprised again when the following week’s CoT report was released last Friday.  It showed continuing heavy speculator buying momentum in gold and silver futures.

Speculators covered another 9.0k short contracts in this latest CoT week, but also added an incredibly strong 19.8k on the long side!  At just 83.9k total shorts in this latest read, these positions are back down to their support over the past year or so.  But they still remain well above their average level in the normal years of 2009 to 2012 before 2013’s extreme selling anomaly, which weighed in at 65.4k contracts.

The jump in total spec longs to 244.4k contracts was even more impressive.  This was the highest level by far seen since mid-April 2013, in the CoT week spanning gold’s panic-like plunge.  That extremely anomalous outlying event destroyed gold sentiment, but futures speculators are as bullish now as they’ve been ever since then.  This means they will likely continue buying new longs as gold marches higher.

And there’s a lot of buying left to do.  Between 2009 and 2012, average spec longs in gold futures were 288.5k contracts.  But after extreme anomalies, mean reversions almost always overshoot dramatically in the opposite direction.  So we’re probably going to see spec longs at least return to late 2009’s 376k level over the coming years.  All that speculator buying will accelerate gold’s upleg, enticing investors to return.

The yellow line above shows the total deviation of both spec longs and shorts from their 2009-to-2012 normal-year averages.  It has been the dominant driver of gold and therefore GLD shares over the past year and a half, with a very strong inverse correlation.  So as futures traders continue covering shorts and adding new longs heading into gold’s autumn strong season, gold and GLD will power higher.

The total futures buying in the 2 CoT weeks since Yellen’s inflation dismissal saw new spec long-side buying of 47.7k contracts, and spec short covering of 34.4k contracts.  So speculators grew their total gold-futures longs by 24% over that little span while slashing their shorts by 29%!  Obviously the idea that the uber-dovish Yellen Fed will tolerate high inflation for a long time really resonated with futures traders.

And Yellen’s attitude on inflation isn’t going to change anytime soon, which is very bullish for the precious metals going forward.  Not surprisingly since gold drives silver, silver-futures speculators mirrored gold-futures ones with dramatic surges in short covering and new long buying following Yellen.  This last chart looks at the same CoT data for silver futures, with the SLV silver ETF superimposed on top.

The impact of Yellen’s comments and resulting gold surge spread into silver-futures trading as well.  Speculators bought to cover massive amounts of silver shorts, and added big new longs, over both of the two CoT weeks following Yellen’s press conference.  Together this buying added up to 17.1k contracts of short covering, and 12.0k of new long buying, for total silver-equivalent buying of a whopping 145.6m ounces!

This was over the latest two CoT weeks, so cut it in half to an average of 72.8m ounces per week.  The Silver Institute recently reported that global silver demand hit an all-time record of 1081m ounces last year despite the extreme selling.  That equates to just 20.8m ounces per week, showing how massive the buying by American futures speculators was after Yellen’s press conference.  It was truly enormous.

This buying worked wonders for silver and SLV too.  In just 4 CoT weeks, the greater-than-15.4-year-record spec silver shorts were cut in half!  And provocatively nearly half of that short covering happened in the 2 CoT weeks before Yellen, so it was already well underway before she goosed gold.  As I wrote a month ago, extreme spec shorts have to soon be covered.  They are guaranteed near-future buying.

But the new long buying didn’t start until Yellen, and it was massive too with speculators growing their long-side bets on silver by 1/6th in just two weeks.  This continued the strong uptrend in silver-futures spec long buying we’ve seen since last September.  Speculators haven’t been this bullish, had higher total longs, since back in February 2011 way before last year’s anomaly.  And that proved a wise bet.

Over the next couple months, silver would rocket 46% higher to $48 per ounce!  When futures traders start piling on to a long-side trade, prices rise which start enticing in the vastly-larger pools of investment capital.  And once investors follow futures speculators’ lead and start redeploying, the uplegs take on a life of their own and grow very large before failing.  This mid-summer spec silver-futures buying is very bullish too.

The past couple weeks look like a sea-change shift in sentiment among futures speculators!  For much of the past year, they remained very bearish on and wary of gold and silver after the extreme selling anomaly in the second quarter of 2013.  But Janet Yellen signaling inflation isn’t a concern even as it crosses the Fed’s longstanding 2% target changes everything.  Gold and silver are go-to assets in inflationary times.

As everyone who runs a household knows, prices are rising like crazy.  Our food, shelter, energy, and necessities for living are getting more expensive.  Our health-care, education, and tax costs are getting more expensive.  Eventually these relentlessly-rising prices will coalesce into high inflation expectations, which will lead investment capital to pour back into gold and silver to ride the Fed’s money-printing boom.

The massive gold-and-silver futures buying in recent weeks is only the earliest vanguard of the capital flows coming to the precious metals as inflation continues to mount.  These capital inflows should really accelerate during the autumn rallying season once we get beyond the usual summer doldrums.  Gold and silver, and therefore GLD and SLV, are likely to be among the best performers in the second half of 2014.

But as always, the gold and silver stocks will dwarf the gains in their underlying metals.  The profits for mining leverage the precious metals’ prices, rising much faster than the underlying gains in gold and silver.  The larger gold and silver miners should at least double the metals’ gains, the mid-tier ones quadruple them, while the smaller miners have the potential to see upside leverage even greater than that.

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The bottom line is the gold-futures and silver-futures speculator buying following Janet Yellen’s brazen dismissal of inflation was utterly massive.  American traders flocked back to gold and silver at incredible rates, not just covering shorts as expected but adding enormous new long positions.  And this all happened in the dark precious-metals sentiment wasteland of the summer doldrums no less, a very bullish omen.

This represents a sea-change shift in sentiment among the futures speculators who have so dominated the gold and silver prices over the past year and a half.  Gold and silver are vastly more attractive for broad investment when central banks are willing to let inflation run high for a long time.  And the Yellen Fed has fallen all over itself to telegraph just that, heralding a new era of rising gold and silver investment demand.

Adam Hamilton, CPA

July 11, 2014

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