Gold Shorts Near Record! / Commodities / Gold and Silver 2018

Gold continues to driftnear summer-doldrums lows, feeding and intensifying bearish sentiment.  But an exceedingly-bullish event justhappened which will ignite a major new upleg. Speculators’ gold-futures short positions have soared near all-timerecord highs!  That means the recentheavy gold selling is exhausted, and massive proportional short-covering buyingis imminent.  That will catapult goldmuch higher.

Short-term gold priceaction is dominated by speculators’ gold-futures trading.  This is counterintuitive as this group oftraders and the capital they control are small compared to investors and theirvast funds.  But the futures guys stillwield wildly-disproportional outsized influence over gold.  It’s impossible to game short-term goldaction if you’re not watching and analyzing speculators’ collectivegold-futures trading activity.

The main reason this istrue is the extreme leverage inherent in gold futures.  Investors buy gold outright, using their ownmoney without any margin.  And if theychoose to buy gold in the form of exchange-traded funds like the leading GLDSPDR Gold Shares gold ETF, stock-market leverage has been legally limited to amaximum of 2x since 1974.  Futuresspeculation is an entirely different world shattering these norms.

Every gold-futurescontract controls 100 troy ounces of gold, worth $122,500 at $1225 gold.  But margin requirements, the cash speculatorsare required to keep in their accounts to trade, are vanishingly small.  This week COMEX only required cash margins of$3100 per gold-futures contract.  That isabout 1/40th the value of the gold controlled, equating to extreme leverage around 40x. This greatly distorts gold prices.

At 40x leverage, everydollar speculators deploy in trading gold futures has 40x the price impact on gold as a dollar investors use to buyoutright!  This enables gold-futuresspeculators to punch far above their weights in bullying the gold pricearound.  And 40x generates mind-bogglingrisks, as a mere 2.5% gold move against speculators’ positions will obliterate100% of their capital risked.  So theyhave to trade very differently.

While investors buygold gradually over months and years, that extreme leverage inherent in goldfutures forces speculators’ focus to hoursand days.  When a 1% move in golddrives 40% gains or losses, all that matters is the ultra-short-term.  By necessity gold-futures speculators’outlooks are incredibly myopic and their trading is very lumpy.  They all have to act at once when gold movesmaterially against their positions.

This herd effectamplified by extreme leverage running up to 40x can really move the goldprice.  Those resulting big and fastmoves heavily color investors’ sentiment, so they tend to pile on to whatever the futures guys are up to.  When speculators are heavy sellers poundinggold lower, investors start worrying and selling in unison.  That can really exacerbate and intensifywhatever gold’s short-term trend happens to be.

And this summer that iscertainly lower.  This first chart is anotherupdate from my latest research on gold’s summer-doldrums trading range published in early June.  Gold tends todrift sideways to lower in market summers in bull-market years, this is its weakest time of the year seasonally.  But this year’s gold actionis worse than usual, slightly below support in recent weeks.  Extreme gold-futures shorting is to blame.

This spilled-spaghettimess of a chart is simple conceptually. Gold’s summer action in every modern bull-market year is individuallyindexed to its final pre-summer close at the end of May, which is set at100.  Then all price action is recast offthat common base, making summers perfectly comparable regardless of prevailinggold prices.  An indexed level of 95 forexample simply means gold is down 5% summer-to-date.

Gold’s modernbull-market years ran from 2001 to 2012, skipped the intervening bear years of2013 to 2015, and resumed in the next bull from 2016 to 2018.  All this was explained in depth in my recentsummer-doldrums essay.  The yellow linesbelow show individual years’ indexed summer gold action from 2001 to 2012 and2016.  I rendered 2017’s in light bluethis week, because it is relevant and predictive for this year.

All those individualyears’ indexed gold prices are then averaged together in the red line, whichdistills out gold’s seasonal tendencies during market summers.  On average gold has slumped 0.2% in Junes, rebounded0.9% in Julies, and then surged 2.2% in Augusts as its major autumn rallies getunderway.  Finally the dark-blue lineshows gold’s indexed trading action this year, which has been weak even formarket summers.

As I warned in earlyJune when gold was still trading near $1300, gold tends to drift sideways tolower this time of year.  Market summersare simply devoid of the big recurring surges in outsized gold investmentdemand seen during much of the rest of the year.  With no major income-cycle or culturaldrivers of gold buying, gold languishes especially in the first halves of summers. It tends to meander within 5% of May’s close.

That normal 5%summer trading range held strong this year until mid-July, when gold slumpedbelow its -5% support line.  The driverwas heavy gold-futures selling erupting on the release of Jerome Powell’sprepared remarks for his semiannual Congressional testimony on July 17th.  The Fed chairman stayed consistently hawkishin his outlook for continuing rate hikes. Gold futures speculators irrationally fear ratehikes.

But gold certainlydidn’t crater, at worst over the past couple weeks or so it was down 5.8%summer-to-date.  That’s on the lowerside, but still not significantly below trend. Not surprisingly this weaker-than-usual price action still reallytainted sentiment.  Speculators andinvestors alike are really down on gold, totally convinced it is doomed tospiral lower.  But they are wrong likeusual at extremes, a major rally is imminent.

Gold’s summer selloffthis year was driven by one thing, extremegold-futures short selling by speculators. They were shorting at near-record levels, catapulting their total shortcontracts to near-record extremes. Unfortunately the resulting gold-price weakness spooked investors, whohave sold heavily insympathy as I analyzed in last week’s essay.  But there’s nothing more bullish for goldthan extreme gold-futures shorts!

In order to short sellgold futures, speculators effectively have to borrow gold they don’t have.  They then sell someone else’s gold, hoping toprofit if they can buy it back later at a lower price to repay their debts.  Every contract sold short is legally obligatedto soon be closed by buying a long contract to offset it.  So gold-futures short selling literally guarantees proportional buying in thenear future, driving gold sharply higher.

Before we dig into thisyear’s near-record gold shorting, last summer offers a great example of what toexpect after extreme shorting.  A yearago last week, I wrote a similar essay pointing out the extreme gold-futures shorts.  Much like this year, they had pushed goldnear the lower support of its usual summer trading range as evident in thelight-blue line above.  That leftsentiment exceedingly bearish a yearago.

Being in thefinancial-newsletter business for a couple decades now, I have unique insightsinto how traders are feeling.  I receivecountless e-mails when they are dejected or euphoric.  A year ago and over the last couple weeks,I’ve been deluged with feedback telling me what a fool I am to be bullish ongold.  Clearly it’s heading muchlower!  Our actual newsletter sales alsorise and fall with the perceived gold outlook.

But when speculators’gold-futures shorts are extreme, an imminent sharp short-covering rally iscertain.  Between early July and earlySeptember last year, gold powered 11.2% higher on that dynamic!  That’s a big rally in just 2.0 months by anystandard.  Literally the worst andmost-foolish time to be bearish on gold is whengold-futures speculators are as evidenced by their extreme shorts.  Gold always surges from there.

This year’s majorautumn gold rally that will start powering higher any day now should proveconsiderably larger than last year’s. The next couple months’ gains in the dark-blue summer-2018 indexed goldline above ought to easily exceed the light-blue summer-2017 ones.  It’s a pity only hardened contrarians will enjoythese coming big gains, as most traders get mired in popular bearish sentimentand refuse to buy low.

Late every Fridayafternoon speculators’ collective gold-futures positions current to precedingTuesdays’ closes are detailed in the CFTC’s famous Commitments of Tradersreports.  The latest CoT read when thisessay was published is as of Tuesday July 17th. That was actually a couple days before gold’s latest summer-2018 lowunder $1223 was hit.  I was so excitedlast Friday when I saw speculators’ near-recordshorts.

This chart tracks theweekly total long and short contracts collectively held by gold-futuresspeculators per those CoT reports.  Goldis superimposed on top.  Nearly all ofgold’s short-term price action is explained by what these hyper-leveragedtraders are doing.  Gold rallies sharplywhen they are adding longs and/or covering shorts, and it falls sharply whenthey are dumping longs and/or adding shorts. They dominate gold!

Last Friday’s latestJuly 17th CoT report was utterly stunning. In that CoT week speculators sold short an enormous 29.0k additionalgold-futures contracts!  That wasnear-record shorting for a single CoT week, ranking as the 6th highest out ofthe 1020 CoT weeks since early 1999.  Andthat wasn’t even the first near-record shorting this summer!  The 2nd-highest shorting ever seen of 35.5kcontracts hit the June 19th CoT.

This extremegold-futures short selling is readily evident in this chart, the vertical leapsin the red total-spec-shorts line in recent weeks.  That alone would be super-bullish for gold,as these excessive shorts soon have to be covered and closed by buying offsetting longs.  Note again last summer how sharply goldsurged when specs rushed to cover their shorts. Their extreme leverage makes short covering self-feeding.

I’ve been aprofessional speculator and investor for decades, blessed with earning afortune without any leverage at all. Personally I think running 40x leverage is ludicrously crazy.  It’s hard to be right on what prices will doin the next hours or days, and a mere 2.5% gold move doubling or obliteratingcapital risked is too much to bear.  Sowhen gold starts rallying, these speculators short gold futures have to scramble to buy.

When shorts are extremeit doesn’t take much of a catalyst to ignite a major short squeeze.  Oncea tiny fraction of speculators buy to cover, the resulting minor gold rallyforces their peers to follow suit.  Alittle 0.5% gold rally out of the blue drives nearly-instant 20% losses, at1.0% they double to 40%.  The morespeculators buy offsetting longs to close out their shorts, the faster goldrallies.  That forces everyone else tocover.

This short-coveringfrenzy continues until the extreme shorting spike leading into it is fullyerased.  That takes from a few weeks to acouple months or so, and gold surges strongly the entire time.  Early 2016, early 2017, and mid-2017 aregreat examples from today’s gold bull clearly evident in this chart.  Short-covering buying begets even morebuying, soon catapulting gold high enough to bring back long-side speculators.

They command way morecapital than the short-side guys, as evident in the green longs line aboverunning much higher than the red shorts line. That forced involuntary short covering soon ignites a new virtuouscircle of buying that larger voluntary long buying soon joins.  These are the first two stages of majorgold-bull uplegs, ultimately driving gold high enough to bring back investors in far-larger stage-threebuying.

Gold blasted sharplyhigher out of every past episode of extreme gold-futures shorting, and today’swon’t be an exception.  And not only waslast CoT week’s shorting at extreme near-record levels, it forced total specshorts to a rare extreme near-record high.  As of July 17th which was before gold’slatest summer-doldrums low, total spec shorts had rocketed to an incredible196.3k contracts!  That’s mind-bogglinglyhigh.

Out of those same 1020CoT weeks since early 1999, that ranks as the 5th-highest spec shorts ever seen!  And it’s so close to a new all-time record,as only one other episode saw marginally more shorting.  Back in July and August 2015 late in the lastgold bear, a continuous 4-CoT week span saw total spec shorts hit 201.6k,201.9k, 202.3k, and 198.6k contracts. That was in response to a rare gold-futures shorting attack.

Because of that extremeleverage inherent in gold futures, they are highly susceptible tomanipulation.  Very rarely, a massivetrader will attempt to bash gold lower by short selling a colossal amount ofgold futures virtually instantly.  Idefine gold-futures shorting attacks as 20k+ contracts dumped within a few minutes.  Their goal is simple, to force gold lowenough fast enough to run long-side stop losses to trigger more selling.

If it wasn’t for those summer-2015 gold-shorting-attack-spawnedrecord levels of spec shorts, this past week’s would be the highest everwitnessed!  196.3k contracts is still a2.9 year high, the most seen in this entire young gold bull.  These near-record shorts guarantee proportional near-term buying as they are covered bybuying offsetting longs.  That means gold’s usual autumn rally will power sharply higher in coming weeks.

When spec gold-futuresshorts hit near-record extremes, theirselling is exhausted.  Again thereare only a relatively-small number of traders willing to shoulder thepotentially-unlimited risks involved in short selling hyper-leveraged goldfutures.  When their finite capitalfirepower is fully deployed, there is no else crazy enough to short further.  With no material selling left, only buying ispossible which fuels short squeezes.

The gold-futures buyingabout to be unleashed is massive.  Overthis past year, total spec shorts have averaged 116.4k contracts.  Merely to mean revert back to that averagewill require specs to cover 79.8k contracts within a couple months on theoutside!  That’s the equivalent of 248.3metric tons of gold.  Say that takes 8weeks, it averages to 31.0t a week.  Thatwould more than double recent goldinvestment demand.

The World GoldCouncil’s latest definitive read on global gold investment demand covers Q1’18,which averaged 22.1t per week.  So addinganother 31.0t of gold-futures short-covering buying on top of that would temporarilyboost demand by 140% alone!  But that’sway too conservative, as it doesn’t account for mean-reversion overshoots afterextreme gold-futures shorting or the big long-side buying gold’s rallies drive.

It’s much more likelythis coming major gold short squeeze sees speculators buy down theirgold-futures shorts to at least this past year’s lows.  That was 82.5k contracts in late March.  That implies we could see a staggering 113.8kcontracts of short covering alone, the equivalent of 353.9t of gold or 44.2tper week over 8 weeks.  Gold would surgeso fast on anything like that that long-side speculators would rush back in.

Their total longs ran269.9k contracts in that latest July 17th CoT, up just 21% into their past-yeartrading range.  That implies they stillhave room to do 4/5ths of theirlikely near-term long buying!  Note inthis chart that after spec shorts hit extremes the resulting short-coveringfrenzies motivate long-side traders to buy longs back up near highs within thenext 3 to 6 months or so.  That portendsfar more gold buying coming.

Total spec longs’52-week high of 400.2k contracts came in mid-September 2017 after last year’sautumn gold rally.  Revisiting thoselevels would require another 130.2k contracts of long buying on top of all thatshort covering!  That’s the equivalent of405.0t of gold, or another 15.6t per week if it unfolds over a half-year.  If that is condensed into one quarterinstead, it works out to another 31.2t per week which is huge.

The potential goldupside coming with 113.8k contracts of short covering and another 130.2k of newlong buying is enormous.  There’sliterally nothing more bullish for gold than extreme near-record gold-futuresshorting leading to extreme near-record total spec shorts.  All that excessive shorting that first pushesgold lower is guaranteed proportional near-future buying.  Gold’s setup today is the most bullish seen in years!

So there are great oddsthis year’s imminent major autumn gold rally will easily exceed last year’s big11.2% in 2.0 months.  Gold stocksleveraged those gains by 2.0x with a 22.7% HUI rally in that same span.  That leading GDX VanEck Vectors Gold MinersETF surged a similar 20.2%.  And today’s dirt-cheapgold stocks have far-greater potential in the coming months, since gold’scoming rally should be bigger.

They are deeply out of favor, eitherdespised or totally ignored.  And theyare wildly undervalued, trading atlevels implying gold prices were radically lower than prevailing levels.  The gold miners are earning fat profits even at$1225 gold, and those will really amplify gold’s gains as it rebounds out ofthese summer-doldrums lows.  Now is thetime to get deployed into great individual gold stocks before they reboundsharply.

At Zeal we’ve literally spent tens of thousands of hours researchingindividual gold stocks and markets, so we can better decide what to trade andwhen.  As of the end of Q2, this hasresulted in 1012 stock trades recommended in real-time to our newslettersubscribers since 2001.  Fighting thecrowd to buy low and sell high is very profitable, as all these trades averagedstellar annualized realized gains of +19.3%!

The key to this success is staying informedand being contrarian.  That means buyinglow before others figure it out, before undervalued gold stocks soar muchhigher.  An easy way to keep abreast isthrough our acclaimed weekly and monthly newsletters.  They draw on my vastexperience, knowledge, wisdom, and ongoing research to explain what’s going onin the markets, why, and how to trade them with specific stocks.  Subscribetoday and take advantage of our 20%-offsummer-doldrums sale and see all our new trades!

The bottom line isspeculators’ gold-futures shorting just surged at extreme near-record rates to extremenear-record levels!  That’s what drovethis summer’s worse-than-usual weakness. But this is really rare and exceedingly bullish for gold.  Speculators’ gold-futures-shorting firepoweris finite, and once their outstanding shorts near records that selling isexhausted.  That leaves only buying,catapulting gold sharply higher.

All biggold-futures-shorting spikes are guaranteed proportional near-future buying, asthose effectively-borrowed shorts must soon be repaid by buying offsettinglongs to cover them.  This results infrenzied short squeezes that birth major new gold uplegs and even bullmarkets.  There is literally nothing morebullish for gold than near-record gold-futures shorts!  This summer’s weak gold will soon reverse sharplyhigher.

Adam Hamilton, CPA

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