Futures Still Dogging Gold Price / Commodities / Gold and Silver 2022

Gold continues tolanguish near major lows after a rough summer, deeply out of favor with traders.  Oddly this leading alternative investment seemsoblivious to the first inflation super-spike since the 1970s.  That should be driving big gold demand, fuelinga major upleg.  But that classic inflationaryresponse has been temporarily delayed by heavy-to-extreme gold-futures selling.  When that reverses to buying, gold will soar.

As everyone running ahousehold or business knows, inflation is raging out of control.  Not even lowballed government statistics canhide it.  The monthly US Consumer PriceIndex has averaged blistering 8.3% year-over-year gains so far in 2022!  That’s 4.6x 2019’s +1.8%-YoY monthly average,the last normal year before the pandemic-lockdown stock panic and its extensiveaftermath.  This June, the CPI soared9.1% YoY.

That proved its hottestprint since way back in November 1981, a staggering 40.6-year high!  That’s despite today’s CPI being waywatered-down compared to the 1970s one, extensively understating real inflation.  Americans sure wish prices were only climbing9%ish annually, but the grim reality out there is at least double to triplethat.  With such extreme inflation, gold shouldbe soaring on huge investment demand.

Gold skyrocketed duringthe last similar inflationsuper-spikes in the 1970s.  In thefirst the CPI blasted from +2.7% YoY to +12.3% over 30 months into December1974.  Gold’s monthly-average prices fromtrough to peak CPI months launched 196.6% higher!  During the second the CPI exploded from +4.9%YoY to +14.8% in 40 months climaxing in March 1980.  Gold’s monthly-average prices were amoonshot, up 322.4%!

If today’s CPI stillused its far-more-honest 1970s methodology, headline inflation would be aboutdouble reported levels.  Gold’s stunningdisconnect from today’s raging inflation is troubling, leaving the great majorityof traders forgetting about that 1970s precedent.  After suffering one of its worst summers inmodern bull-market years, gold has largely been left-for-dead.  Instead of flocking back, investors arefleeing.

This vexing goldimpotence is sure evident in this chart updated from my latest gold-summer-doldrums essay of early July.  It normalizes gold pricesduring modern bull-market summers, indexing price action to May closes.  Gold’s average summer performances between2001 to 2012 and 2016 to 2021 are rendered in red.  Superimposed in dark blue are 2022’sanomalously-weak technicals, which have been ugly.

Normally gold carves amajor seasonal low in mid-June, then starts marching higher as its autumn rally fueled byoutsized Asian gold demand accelerates.  Butinstead of bottoming, gold deviated wildly from that trend this year.  Down 7.7% summer-to-date in late July, thatwas gold’s worst performance during all these modern gold-bull years!  The yellow metal should’ve been surprising tothe upside with inflation raging.

Since price actiondrives herd sentiment, that fueled overwhelming bearishness that continues tofester.  Neither speculators norinvestors want anything to do with gold, because its momentum has been goingthe wrong way.  If not even the firstinflation super-spike since the 1970s can ignite big, sustained gold demand, whaton earth could?  Looking broken giventhis super-bullish backdrop, gold has been abandoned.

But the kicker is recentmonths’ dreadful gold underperformance isn’t fundamentally-righteous.  It is just a short-lived anomaly driven by heavy-to-extremegold-futures selling.  That’s what hasbeen dogging gold, and it is inherently self-limiting and mean-reverting.  Gold-futures speculators’ capital firepowerto sell is relatively-small and finite. Once that is expended, they will have to buy proportionally to normalizetheir bets.

The biggest problem in goldmarkets is the extreme leverage intrinsic in futures trading.  That enables a tiny group of traders to wieldwildly-disproportional influence over gold prices.  This week, each contract controlling 100ounces was worth $170,000 at $1,700 gold. Yet traders are only required to maintain cash margin in their accountsof $6,500 per contract, making for crazy maximum leverage way up at 26.2x!

Running at 26x, eachdollar traded in gold futures has 26x the price impact on gold as adollar invested outright!  Sogold-futures speculators punch way above their weights in dominating short-termgold price action.  This is a seriousstructural problem undermining gold fundamentals, as such extreme leveragecreates irresistible opportunities for price manipulation.  Recent US federal-court cases have proventhis out.

Just a month ago, theformer head of JPMorgan Chase’s precious-metals business and his top goldtrader were convicted of manipulating gold prices from 2008 to 2016!  They face decades in prison when sentenced.  They did this through leveragedgold-futures trading, including spoofing. That is unleashing huge bogus gold-futures sell orders to hammer gold,which are then quickly cancelled before execution.

During closingarguments in that trial, the federal prosecutor stated “They had the power tomove the market, the power to manipulate the worldwide price of gold.”  That brings the US Justice Department’ssecured convictions to ten former Wall Street traders at JPMorgan, Merrill Lynch,Deutsche Bank, Bank of Nova Scotia, and Morgan Stanley.  So there’s no doubt leveraged gold-futurestrading greatly affects gold prices!

Thus it desperately needsto be reformed dramatically to eliminate this extreme leverage that inevitablyattracts fraudsters.  20x to 30x should beillegal, like in the stock markets where 2x has been the limit since 1974.  Even for the vast majority of gold-futurestraders who aren’t criminals, such radical leverage is so exceedingly-risky thatit compresses their trading time horizons into a very-myopic ultra-short-term.

Running 26x, a mere3.8% gold price move against specs’ positions will wipe out 100% of their capitalrisked!  So all they can afford to do is chasehour-by-hour momentum, which is what they did this summer to slam gold.  They can’t care about gold’s globalsupply-and-demand fundamentals, nor inflation, nor prevailing trends in goldand broader markets.  All that matters iswhether gold is rising or falling each minute.

This chart superimposesrecent years’ gold technicals over speculators’ total positions in gold-futureslong and short contracts.  Those arereported weekly in the famous Commitments-of-Traders reports, current toTuesday closes.  Gold disconnected frominflation in recent months because gold-futures specs puked out enormous amounts of selling!  This short-term-momentumchasing had nothing to do with fundamentals.

Gold started 2022 quitestrong, surging 16.0% over 3.2 months into early March.  While Russia invading Ukraine was a bigcontributor to that fast spike to $2,051, that just extended a year-old uptrend.  Investors impressed by gold’s strong upsidemomentum were growing more bullish and increasingly deploying new capital.  Gold even consolidated high near uptrendresistance after that initial geopolitical shock passed.

But something changedin mid-April when gold was still running $1,977.  Over the next 3.2 months into late July, it collapsed14.3% to $1,695.  That was despiteheadline CPI inflation in April, May, June, and July coming in red-hot up 8.3%,8.6%, 9.1%, and 8.5% YoY!  It made no senseto flee gold with that kind of wildly-bullish backdrop, given the yellow metal’scenturies-long history of being the ultimate inflation hedge.

Gold crumbled contraryto fundamentals because gold-futures speculators started aggressively sellingand that snowballed.  From early March tolate July, they vomited out an enormous 116.9k gold-futures long contractswhile piling on another 52.3k short ones. That 169.2k contracts of spec selling dwarfed anything seen in recentyears, adding up to a massive equivalent of 526.1 metric tons of gold dumped!

That was way toomuch too fast for markets to absorb, so gold prices collapsed.  This huge gold-futures spewing was initially catalyzedand subsequently fueled by the US dollar rocketing parabolic to hit multi-decadesecular highs.  Gold-futures specs watchthe US Dollar Index for their primary trading cues, doing the opposite.  Within that span gold plunged, the USDX skyrocketedan utterly-enormous-for-it 8.8% at best!

Heavy gold-futuresselling and thus gold prices almost perfectly inversely mirrored the USDX’s fortunesduring that time.  That leading dollarbenchmark blasting to an extreme 20.1-year high in mid-July fueled greateuphoria.  Like always during big-and-fastsurges to lofty heights, traders’ greed flared to bullish extremes.  Despite that long-dollar trade being wildly-overcrowded,they assumed its upside would last indefinitely.

That deluge of capitalinto the extraordinarily-overbought US dollar was in turn driven by the Fed’smost-extreme hawkish pivot ever.  Thatincluded aggressive official jawboning on coming rate hikes, multiple massive50- and 75-basis-point ones executed, and ramping up the biggest-and-fastestquantitative-tightening monetary-destruction campaign ever attempted!  The dollar soared with the Fed blasting rateshigher.

It was boosted by acratering euro, as that dominates the USDX at 57.6% of its weighting.  Just like the Fed, the European Central Bank hadredlined its monetary printing presses since March 2020’s scary pandemic-lockdownstock panic.  So inflation was raging inthe Eurozone too, but the ECB was dragging its feet on hiking rates.  With American yields soaring way faster thanEuropean ones, the euro was sold hard.

Exacerbating thatlong-dollar short-euro trade, Europe is facing a severe recession if not a depressiondue to its heavy reliance on Russian natural gas.  European countries joined the US insanctioning Russia extensively for its brutal war on Ukraine, so Russiaresponded by slashing its natural-gas exports to Europe.  Thus electricity prices have shotstratospheric, threatening increasing social unrest and political turmoil.

These dynamics have leftthe USDX extraordinarily-overbought while the euro is extraordinarily-oversold.  But extreme trades can only move in onedirection so long before they have sucked in everyone willing to buy orsell.  With available capital firepower exhausted,they soon reverse sharply in proportional mean reversions and overshoots in theopposite direction.  The parabolic US dollaris overdue to plunge back to earth.

That unsustainable extreme euphoric dollar surge is what sparked, fueled, and intensified that huge gold-futures selling inrecent months.  That also provedanomalously-extreme, leaving specs’ positioning exceedingly-bearish and overdueto reverse.  To normalize theircollective bets, these hyper-leveraged traders will soon have to do enormousproportional gold-futures buying.  Thatwill catapult gold sharply higher.

Speculators’ totalgold-futures long and short contracts have their own trading ranges, which are renderedon this chart.  Since spec longs now outnumbershorts by 1.9x, they are proportionally more important for gold’s near-futuredirection.  As of the latest-reported CoTweek ending last Tuesday, total spec longs had collapsed to a 3.3-year low of 274.2k contracts!  They hadn’t beenlower since way back in late May 2019.

Specs can only do somuch selling until their capital firepower is spent, their longs will never go tozero.  The original purpose of futuresmarkets was hedging for actual producers and consumers of real physical commodities.  Speculators take the opposite sides of thosehedging trades.  So once extreme bearishsentiment has driven spec longs down to major multi-year lows, massivemean-reversion buying soon erupts.

After that last timespec longs fell this low, gold blasted 21.5% higher in just 3.3 months asthese traders normalized their gold-futures positioning!  A similar mean-reversion blast out of late July’sdeep low would catapult gold up near an all-time high around $2,060.  That would work wonders for psychology, restoringgold’s strong uptrend and enticing back speculators and investors in droves.  Gold’s fortunes really turn fast.

In addition to today’sunsustainable extreme bearish positioning in speculators’ gold-futures longs,their shorts soared to their own in late July. That CoT week gold bottomed, total spec shorts rocketed up to 176.1kcontracts.  That was their highest in 3.7years, since late November 2018!  Thatmean-reversion buying already started, which is why gold rallied into earlyAugust before more uber-hawkish Fedspeak.

After that priorextreme, gold surged 10.4% higher over the next 2.8 months.  A similar normalization rally today would powergold back up near $1,872.  Even thatwould easily slay this bearish sentiment, starting to bring speculators andinvestors back to gold.  Just likedownside momentum, upside momentum soon becomes self-feeding.  Buying begets buying as traders chase gains, amplifyinggold’s upside as they return.

Gold uplegs unfold inthree stages.  They are ignited andinitially fueled by gold-futures short covering, which is legally required toclose out those bets.  That pushes goldhigh-enough for long-enough to fuel larger gold-futures long buying.  That accelerates gold’s upleg to decisive-enoughgains to start attracting back investors with their vastly-larger pools ofcapital.  Their far-bigger buying eventuallydrives major uplegs.

In one of those recent federalcases against traders illegally manipulating gold prices with futures trading,a prosecutor made a profound argument about why that is so damaging.  Investors look to price trends for clues onhow gold is actually faring fundamentally. So spoofing, or even leveraged selling snowballing like recently, sabotagescrucial price signaling.  Gold doesn’treflect underlying real-world supply and demand!

The greatest tragedy ofthis irresponsibly-extreme leverage allowed in futures trading is it heavilydistorts gold prices.  That greatlyaffects investor psychology, greatly impacting capital flows necessary tobalance global supply and demand. Because of recent months’ unsustainable hyper-leveraged futures dumping,investors have abandoned gold thinking it is totally broken disconnecting fromthis raging inflation super-spike.

While global goldinvestment-demand data is only published quarterly, an excellenthigh-resolution daily proxy is the combined holdings of the world’s largest anddominant gold exchange-traded funds.  Theseare the mighty American GLD and IAU.  Accordingto the World Gold Council, at the end of Q2 their massive gold-bullion holdingsaccounted for 41.1% of those in all the world’s physically-backed gold ETFs!

The distant-third-placeETF ranks just 7.5%.  The quarterly swings in GLD+IAUholdings alone are often responsible for most if not all of thechanges in overall world gold demand!  During that 14.3% gold plunge between mid-Aprilto late July, GLD+IAU holdings fell 6.9%. And that was part of a worse 9.9% total draw from late April just afterthat gold-futures selling erupted to this week, pounding them back to 1,465.0t.

Because extremegold-futures selling on an even-more-extreme parabolic dollar surge has doggedgold so hard in recent months, investors have fled.  They assumed the false gold-price signaling drivensolely by colossal unsustainable gold-futures selling was fundamentally-righteous.  They worried gold really had decoupled fromthis raging inflation.  Watch what happensonce they figure out all this was just an illusion!

Even with crazy leverage,the relatively-small gold-futures-trading tail can only wag the vastly-largergold-investment-demand dog for so long.  When massive gold-futures mean-reversionbuying inevitably erupts out of spec-positioning bearish extremes, resultingsharply-higher gold prices soon attract back investors.  Their self-feeding buying greatly amplifiesand extends young gold uplegs, growing them to major sizes.

Speculators’gold-futures longs can’t stay near extreme 3.3-year lows for long, suchexcessively-bearish herd bets never last. Soon some news or market catalyst arises that ignites big proportionalmean-reversion buying.  Another one iscoming, likely the radically-overextended US Dollar Index falling from itsunsustainable multi-decade highs.  Oncethat futures buying gets underway, gold will be off to the races again.

As stage-one specgold-futures short covering fuels stage-two spec gold-futures long buying whichin turn drives stage-three investment buying, gold will rapidly power higher.  Within a few months of this getting underway,it will be back into the $1,900s or even $2,000s!  The biggest beneficiaries of gold normalizingto reflect this super-bullish inflationary backdrop will be the gold miners’stocks, which have beenbrutalized.

While gold fell 14.3%at worst between mid-April to late July on that extreme futures selling, theleading GDX gold-stock ETF plummeted a horrific 43.5% from mid-April into last week!  The sentiment damage from the false gold-pricesignals was so severe that the entire gold-mining sector collapsed.  So the gold stocks are in for a colossalmean-reversion rally far exceeding gold’s as fundamentally-righteousprices return.

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The bottom line isheavy-to-extreme gold-futures selling has really dogged gold prices in recentmonths.  Speculators dumped massiveamounts of hyper-leveraged gold-futures contracts since mid-April, whichslammed gold prices sharply lower.  That fueledincreasingly-bearish psychology, scaring investors into fleeing in concert exacerbatinggold’s selloff.  They worried it had disconnectedfrom this raging inflation.

But the resulting lowgold prices are a temporary futures-distorted anomaly, not fundamentally-righteous.  The huge gold-futures selling driving themhas already been exhausted.  Gold blasteddramatically higher on proportional mean-reversion buying after similar pastbearish extremes of spec gold-futures positioning.  That inevitable normalization unfolding againcould easily catapult gold 20%+ higher within a few months.

Adam Hamilton, CPA

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