Gold has sure been a four-letter word lately, suffering one of its worst bull summers, and the primary culprit was…
by Adam Hamilton of Zeal LLC
Gold has sure been a four-letter word lately, suffering one of its worst bull summers. The primary culprit was heavy gold-futures selling on a parabolic US-dollar surge fueled by extreme Fed hawkishness. But the resulting gold technical damage really disheartened investors, spawning additional relentless selling from them. This investment bleeding has certainly exacerbated gold’s downside, but its days are numbered.
With inflation raging in its biggest super-spike since the 1970s, gold should be soaring today. Instead it has been bludgeoned 14.3% lower between mid-April to late July, defying long precedent. And at the mid-week data cutoff for this essay, gold had again been pummeled right back to those deep summer lows. Technically gold looks pretty broken, which has whipped up bearish sentiment to suffocating extremes.
Gold was trading near $1,977 in mid-April just before the US Dollar Index started rocketing vertically. In the past five months starting then, US headline CPI inflation has run red-hot blasting up 8.3%, 8.6%, 9.1%, 8.5%, and 8.3% year-over-year! That high-water June print was the worst witnessed since way back in November 1981, a 40.6-year high! It’s hard to imagine a more-irrational backdrop for a major gold selloff.
Gold skyrocketed during the last similar inflation super-spikes in the 1970s. In the first the CPI blasted from +2.7% YoY to +12.3% over 30 months into December 1974. Gold’s monthly-average prices from trough 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 a moonshot, up 322.4%!
In last week’s essay, I analyzed the recent heavy-to-extreme gold-futures selling that is still dogging gold. The crazy leverage inherent in futures enables those speculators to punch way above their weights in gold-price impact. The good news is their capital firepower available for dumping gold is quite finite and already mostly-spent. They will soon do massive mean-reversion buying which will catapult gold sharply higher.
But tragically temporary futures-driven gold-price distortions greatly affect investors’ psychology. They have seen gold floundering in recent months contrary to all history, fueling overwhelming bearishness. They assume gold has somehow fundamentally disconnected from inflation, so they are abandoning it. Their resulting selling hasn’t been massive, but it keeps on dripping and dripping like Chinese water torture.
Had gold-futures speculators not duped gold investors into thinking gold’s ultimate-inflation-hedge status has failed, gold’s recent price action wouldn’t have been as ugly. This chart is updated from my latest gold-summer-doldrums essay of early July. It indexes gold’s summer performances to May’s final closes in all modern gold-bull years. Gold has just suffered one of its worst summers in this multi-decade span!
Between mid-April before that massive gold-futures selling erupted to last week, speculators dumped the gold-futures equivalent of 541.3 metric tons of gold! Those hyper-leveraged traders are forced to have myopic ultra-short-term time horizons, and all they cared about is the soaring USDX. They dumped gold futures in lockstep with that leading dollar benchmark rocketing up to unsustainable 20.2-year secular highs.
That epic dollar strength was driven by extreme hawkish jawboning by Fed officials, monster rate hikes and wildly-unprecedented levels of quantitative-tightening monetary destruction from the FOMC, the European Central Bank dragging its feet on raising rates, and Europe’s severe energy crisis caused by its heavy reliance on Russian imports. The euro has long dominated the USDX at 57.6% of its total weighting.
Before that enormous gold-futures selling slammed gold, investment demand was growing. Unfortunately comprehensive global gold supply-and-demand data is only released once per quarter by the World Gold Council, in its fantastic Gold Demand Trends reports. But thankfully there is an excellent highly-correlated high-resolution proxy for overall world gold investment demand that is published daily, revealing real-time trends.
That is the combined holdings of the leading American GLD SPDR Gold Shares and IAU iShares Gold Trust gold exchange-traded funds. According to the WGC, at the end of Q2 their combined holdings of 1,560.5t accounted for fully 41.1% of all the gold held by all the world’s physically-backed gold ETFs! That dwarfed the distant third one at just 7.5%. GLD and IAU dominate because they are tied to US stock markets.
These mighty ETFs act as conduits for the vast pools of American stock-market capital to slosh into and out of gold. When their gold-bullion holdings are rising, investors are shifting capital into gold on balance. When they are falling, investors are pulling capital back out. In plenty of quarters in recent years, moves in GLD+IAU holdings alone accounted for the great majority of changes in overall global investment demand!
In Q2’22 for example when gold started rolling over on that heavy-to-extreme gold-futures dumping, the combined GLD+IAU holdings fell 47.5t. That was nearly 6/10ths of the 80.3t total drop in world investment demand last quarter per the WGC’s latest GDT. Some quarters have actually seen GLD+IAU holdings changes exceed global gold-investment-demand changes, these behemoths dominate gold capital flows!
Between late April when that parabolic US-dollar surge unleashed huge gold-futures selling to the middle of this week, GLD+IAU holdings have suffered a 172.8 metric-ton draw. While this was dwarfed by that colossal 541.3t of gold-equivalent futures selling in that span, the investment bleeding still boosted that marginal gold supply by almost a third! 714.1t of identifiable gold selling in under 5 months is gigantic.
That’s far too much supply too fast for markets to absorb normally, even in the midst of the worst inflation super-spike since the 1970s. Given that level of bullion flooding the markets, gold actually looks pretty resilient only falling 14.3%. Gold-futures speculators fleeing aggressively on the soaring USDX scared gold investors into joining in on that selling, amplifying gold’s downside for dreadful summer performance.
This next chart superimposes GLD+IAU holdings over gold technicals during the past several years or so. The big draw in recent months spawned by that heavy-to-extreme gold-futures selling is painfully obvious. But interestingly just as gold-futures speculators have exhausted their capital firepower for selling, gold-ETF holdings are also near major lows. That implies investment selling will soon slow then reverse to big buying.
Like almost all investors, gold ones are momentum-chasers. They only want to buy when gold is rallying decisively, which generates bullish excitement that those upside gains will persist. Earlier this year as gold powered higher in another upleg, American stock-market capital flooded into GLD and IAU. Their holdings soared 141.4t in Q1, a strong 9.6% build! Over half of that came after Russia invaded Ukraine.
The vast hordes of Russian soldiers, armored personnel carriers, main battle tanks, artillery, helicopters, and supply trucks blitzed across the borders in late February. That biggest European war since World War II triggered great geopolitical uncertainty. So gold blasted from $1,898 just before Russia’s formal invasion to $2,051 in early March. That sharp 8.1% geopolitical spike over just a couple weeks wasn’t sustainable.
It left gold really overbought, which I warned at the time. Indeed gold soon reversed symmetrically lower as the initial shock of Russia’s war passed, leaving traders accepting it as the new norm. But even as gold corrected, investment demand remained solid and GLD+IAU holdings continued to rise. By mid-April gold had stabilized at $1,977, and American stock investors were still bolstering their meager gold allocations.
Gold investors’ resolve didn’t start wavering until after that massive gold-futures selling erupted as the US dollar soared. That day gold closed at $1,977, the USDX ran 99.9. By early September when the US Dollar Index hit that extreme 20.2-year secular high, it had soared a huge-for-a-major-currency 10.4% which hammered gold 14.0% lower in that same span! That persistent gold weakness scared investors.
They gradually fled as the yellow metal was pummeled lower by heavy-to-extreme gold-futures selling. That investor exodus evident in GLD+IAU holdings greatly accelerated in July after gold broke below the psychologically-important $1,800 level. Nevertheless, that identifiable gold investment selling accounted for just under a quarter of the total selling including that colossal gold-futures dump. Investors follow gold’s lead.
Though they command vastly more capital than the gold-futures speculators, the latter’s extreme leverage grants them outsized influence on gold prices. That often runs 25x or higher, enabling every dollar traded by these specs to exert up to 25x+ the impact on gold prices compared to a dollar invested outright! Thus the small gold-futures-trading tail often wags the far-larger gold-investment dog, which is endlessly infuriating.
As of Wednesday, there have been 101 trading days since GLD+IAU holdings peaked in late April soon after gold started getting pummeled. Fully 76 of those have seen GLD+IAU draws! Although they have mostly been small, between 0.0% to 0.2%, they have proven utterly relentless. Since gold’s ugly futures-driven $1,800 breakdown in early July, 44 out of 52 trading days have seen draws like Chinese water torture.
Almost every trading day sees American stock investors sell GLD and/or IAU shares faster than gold itself is being sold, forcing these ETFs to sell bullion. They have to do this to fulfill their mission of tracking gold prices. When gold-ETF-share supply exceeds gold’s, gold-ETF-share prices threaten to decouple from gold prices to the downside. So ETF managers have to step in and buy back shares to sop up excess supplies.
They raise the capital to make these purchases by selling some of their gold bullion. As gold crumbles on that anomalous gold-futures selling, investors are fleeing pulling their capital out of gold. But that should be running its course soon here for a couple reasons. Most importantly as I analyzed in my gold-futures essay last week, that selling is exhausted. Speculators have run out of room to keep dumping contracts.
Total spec longs have dwindled way down to a fresh 3.3-year low, while total spec shorts remain way up near their recent 3.7-year high! Once these hyper-leveraged traders have done all the selling they can do, that leaves only room for buying. So huge mean-reversion buying to normalize excessively-bearish bets soon erupts out of such extremes. That catapults gold sharply higher, enticing investors to resume chasing it.
After the last time specs’ gold-futures positioning was this lopsided in May 2019, their necessary buying blasted gold 21.5% higher over just 3.3 months into that September! Much like today, investors had been fleeing before gold’s futures-driven bottom pushing GLD+IAU holdings relentlessly lower. But soon after that gold-futures normalization ignited, investors flooded back in with a vengeance amplifying gold’s upside.
This dynamic is typical, as major gold uplegs have three stages of telescoping drivers. First speculators start buying to cover gold-futures shorts near major gold lows. That short covering is legally required to close out those downside bets, usually resulting in sizable realized profits. While that is quickly expended within a month or two, it pushes gold high enough for long enough to convince long-side specs to return.
Since gold-futures longs tend to outnumber shorts by 2x to 3x, long-side speculators have more capital. They flood back into gold to ride its upside momentum, amplifying its gains. That voluntary buying tends to unfold over three to six months. It drives gold higher still, leaving its uptrend decisive enough to attract back investors and the vastly-larger pools of capital they command. Their buying is ultimately the biggest by far.
Soon gold will inevitably V-bounce sharply higher after some economic data or market news sparks big mean-reversion gold-futures buying. That will eventually propel gold high enough for long enough to convince investors to start returning. The faster and bigger gold’s futures-driven surge, the quicker and larger gold investment demand will come back. And investors have massive room to reallocate back into gold.
GLD+IAU holdings have tumbled way back down to 1,453t mid-week. Those are deep lows last seen 2.4 years ago emerging from March 2020’s pandemic-lockdown stock panic. Gold rocketed 40.0% higher in just 4.6 months out of that last peak-despair anomaly, largely driven by a phenomenal 35.3% or 460.5t build in GLD+IAU holdings during that short span! They peaked up near 1,801t after gold started correcting.
So American stock investors easily have room to buy enough GLD and IAU shares to force a big 350t-ish holdings build. And with inflation raging out of control today thanks to extreme Fed money printing in the wake of that panic, today’s potential buying is far bigger. Between March to August 2020 as investors flooded into gold to chase its upside, headline CPI inflation was effectively nonexistent averaging up 0.8% YoY.
The US dollar’s purchasing power wasn’t rapidly eroding then, and the stock markets weren’t suffering a bear on extreme Fed tightening. So the investment case for gold today is radically stronger than it was in mid-2020. Eventually investors are going to realize they need to diversify more of their bleeding stock-heavy portfolios with counter-moving gold. During these past six months the CPI averaged scary 8.5%-YoY gains!
One of the most-famous stock-market books in history is Charles Mackay’s extraordinary 1841 study that all investors need to read, “Extraordinary Popular Delusions and the Madness of Crowds”. I was in high school the first time I digested it, which helped shape my future as a contrarian speculator and investor. Whenever investors as a herd come to believe some extreme is righteous and will last forever, it reverses hard.
The supremely-irrational gold-and-dollar situation today reeks of another extraordinary popular delusion. Even lowballed CPI inflation is running at its hottest since the 1970s, and real-world inflation is double or triple those headline numbers. Using 1970s CPI methodology, today’s watered-down CPI would be about twice as high. These soaring general price levels are rapidly debasing the US dollar’s purchasing power.
It takes many more dollars today to buy anything than it did a couple years ago! So it is madness for the US Dollar Index to be trading at multi-decade highs, the sole reason gold-futures selling has been so anomalously extreme. Unlike the global dollar supply which was foolishly more than doubled by the Fed in just a couple years after that stock panic, the world aboveground gold supply only grows about 1% annually.
So gold won’t lose its purchasing power as the dollar burns down around it. For centuries gold has been the go-to investment during times of serious monetary debasement, raging inflation. That won’t end now simply because of a temporary gold-price distortion fueled by unsustainable gold-futures selling that soon has to proportionally reverse. As gold comes roaring back, investors will return in droves accelerating its gains.
Gold will quickly mean revert higher as stage-one gold-futures short covering fuels stage-two gold-futures long buying which ignites stage-three investment buying. Within a few months of this getting underway, gold will rebound back into the $1,900s or even $2,000s! The biggest beneficiaries of gold normalizing to reflect this super-bullish inflationary backdrop will be the gold miners’ stocks, which have been brutalized.
While gold fell 14.3% between mid-April to late July on that extreme anomalous futures selling, the GDX gold-stock ETF plummeted a horrific 43.5% from mid-April to early September! Gold stocks are radically oversold compared to their strong fundamentals, and are overdue for colossal mean-reversion gains far exceeding gold’s. After that stock panic the last time GDX was this low, it skyrocketed 134.1% higher in 4.8 months!
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The bottom line is gold investment has been bleeding relentlessly since late April, exacerbating gold’s recent weakness. Investors fled as gold was bludgeoned lower by heavy-to-extreme gold-futures selling on the US dollar’s parabolic surge to lofty secular highs. Those investment-capital outflows in recent months accounted for just under a quarter of gold’s total identifiable selling, way behind the lion’s share of futures.
But that anomalous gold-futures selling has exhausted itself, reaching excessively-bearish levels that will fuel huge mean-reversion buying. That will catapult gold sharply higher, soon attracting back investors. They have vast buying to do to rebuild tiny gold allocations, especially with inflation raging out of control and a stock-market bear awakening. Prevailing gold prices are heading way higher after this distortion passes!
Adam Hamilton, CPA