Gold’s, Miners’ Stops Run
Adam Hamilton October 7, 2016 3489 Words
Gold, silver, and their miners’ stocks plummeted out of the blue this week, shattering their bull-market uptrends. Gold-futures speculators had been holding excessive long positions for months, weathering all kinds of selling catalysts. But once gold slipped through key support, long-side futures stop losses started to trigger unleashing cascading selling. Understanding this event and its implications is crucial for traders.
This week’s precious-metals carnage was a big surprise, erupting suddenly with no technical warning. Gold had been faring quite well after hitting its latest interim high of $1365 in early July. That was driven by heavy fund buying of gold-ETF shares in the wake of late June’s unexpected pro-Brexit vote. After those big capital inflows dried up, gold consolidated high. At worst by late August it had pulled back 4.1% to $1308.
Then gold spent all of September grinding higher along its bull-market uptrend’s support, which was an impressive show of strength. Speculators were holding large near-record long positions in gold futures. Since these bets are so hyper-leveraged, that greatly elevated the risks of a snowballing selloff. I wrote extensively about gold’s record selling overhang back in mid-July, and that threat has lingered ever since.
But despite all kinds of excuses to do so, the futures speculators never rushed for the exits. Every week their collective bets on gold are detailed in the CFTC’s famous Commitments of Traders reports. Back in late June, speculators’ gold-futures long contracts climbed above 400k for the first time in history. Then a couple weeks later in early July, they climbed to an all-time record high of 440.4k contracts as gold peaked.
That presents a big selling risk due to the extreme leverage inherent in futures trading. Every contract controls 100 troy ounces of gold, worth $135,000 at $1350. Yet back in July, the minimum cash margin speculators were required to deposit for each gold-futures contract they traded was just $6000. This week it is running $5400. That works out to maximum leverage to gold of 22.5x and 25.0x, insanely high!
For many decades the legal limit in the stock markets has been 2.0x, making gold futures more than an order of magnitude riskier. At extreme 10x, 15x, 20x, and 25x leverage, mere 10.0%, 6.7%, 5.0%, and 4.0% adverse moves in gold against speculators’ positions would wipe out fully 100% of the capital they risked! So when these guys are wrong, they have to be quick to exit their trades or risk total annihilation.
As late 2015’s huge gold-futures selloff battering gold to deep 6.1-year secular lows proved, there is nothing these speculators fear more than Fed rate hikes. Despite history proving in spades that gold actually thrives during Fed-rate-hike cycles, this group of traders wrongly views them as gold’s nemesis. So they tend to sell aggressively when data or news increases the likelihood of more rate hikes sooner.
Yet some remarkable events this past summer made it look like gold-futures speculators were coming around to gold’s historical strength in rate hikes. For 13 of the 15 CoT weeks since late June when their collective gold-futures longs first climbed over 400k, these same excessive 400k+ levels held. That was despite gold’s summer doldrums, new record stock-market highs, and a vastly-more-hawkish outlook on the Fed.
Fed-rate-hike odds at upcoming FOMC meetings are calculated in real-time based on federal-funds futures trading. The hedgers and speculators participating in this market are very sophisticated and the best-informed in the world on likely Fed policy. This market is so important that historically the FOMC has never hiked until these futures-implied rate-hike odds exceed 70%, in order to avoid shocking the markets.
Back on August 12th, these rate-hike probabilities had collapsed way down to 6%, 8%, and 39% at the FOMC’s next few meetings. Over the next couple weeks culminating with Janet Yellen’s highly-anticipated Jackson Hole speech on August 26th, these rate-hike odds rocketed to 36%, 41%, and 64%! That was without a doubt the most-hawkish couple-week span of economic data and Fedspeak seen in many years.
Amazingly in light of last year’s panicking precedent, gold-futures speculators held firm with their excessive longs. During those two CoT weeks closest to that rocketing-rate-hike-odds span, speculators only dumped a collective 9.8k gold-futures contracts! Thus gold only slid 1.2% lower. That was an incredible display of strength in the face of a soaring rate-hike threat, so speculators’ high longs looked durable.
Until this Tuesday, which started out rather unremarkably with no gold-futures-moving news at all. Gold had closed at $1313 on Monday, still above August 31st’s pullback low of $1308. Gold was trading right there when the US trading day rolled around. Those futures-implied rate-hike odds at Monday’s close ran 11%, 62%, and 64% for the FOMC’s next few meetings in early November, mid-December, and early February.
So there was virtually no chance of an imminent rate hike in early November right before the critical US elections. Provocatively, Fed hawkishness wasn’t a factor at all in Tuesday’s plunge. While there was some hawkish Fedspeak on Tuesday, it was nothing out of the ordinary for recent months. By the close Tuesday after gold had plummeted, those rate-hike odds had barely budged to just 13%, 59%, and 62%.
So why did gold plunge 3.3% lower on Tuesday, its worst daily loss in 3.3 years, after weathering all kinds of selling catalysts all summer? This first chart showing speculators’ collective long and short bets in gold-futures contracts helps illuminate that wild selling anomaly. This data comes from those weekly Commitments of Traders reports, which are published on Friday afternoons but current to preceding Tuesdays.
While gold had carved higher lows in September along its bull-market uptrend’s support, since its early-July peak its high consolidation had also suffered from lower highs. Thus hyper-leveraged gold-futures speculators were wary of a breakdown, so they set extensive stop losses right below late August’s $1308 low. There were a bunch of these contingent sell orders clustered around $1305, and even more near $1300.
Heading into Tuesday, speculators’ gold-futures longs remained near record highs. While the latest CoT data current to Tuesday’s selloff won’t be available until a few hours after this essay is published, total spec longs were way up at 412.1k contracts the week before. That was the 7th highest out of 926 CoT weeks since early 1999! So these near-record longs heading into Tuesday really exacerbated gold’s plunge.
This overwhelming gold bullishness also extended to short-side futures trades, bets gold would head lower. Total spec shorts were only running near 97.5k contracts in the latest CoT data, not far above their lowest levels of 2016’s young gold bull of 93.0k in late August. With gold-futures speculators heavily long and not very short, gold was at risk of suffering intense selling pressure with little buying to offset it.
Early on Tuesday as gold drifted below $1305, breaking late August’s low, the futures selling intensified as stops were hit. Stop-loss orders are very wise even for stock investors with no leverage or margin at all, and are absolutely essential for futures speculation given its extreme leverage. As these stop losses triggered, more automatic gold-futures selling piled on. This pushed gold even lower, tripping still more stops.
And with speculators so heavily long gold, there were tons of stops to trigger as gold broke through its key psychological support at $1300. Watching this all unfold in real-time, the selling looked orderly but relentless. I didn’t see any sense of panic, just mechanical forced selling cascading as stop levels were hit in succession. There was no apparent gold-futures shorting attack either, like the one perpetrated in July 2015.
Sometimes short sellers try to instantly force the gold price lower with the explicit intention of unleashing cascading futures selling from triggering enough long-side stops. Within a matter of seconds, a large short seller will dump 10k to 20k gold-futures contracts to hammer the gold price. I was suspicious of that kind of thing Tuesday morning, but didn’t see the telltale huge-volume-spike signature it generates.
The timing was excellent for a shorting attack as the Chinese markets are closed all week for a major national holiday. That means Western futures speculators playing gold downside wouldn’t have to fear Asian buying offsetting and nullifying their shorting. There were rumors of a large hedge fund stuck in a forced-liquidation scenario, but that only arose well after gold had already started plunging that morning.
We can’t know for sure what happened in speculators’ collective longs and shorts until this latest CoT week’s data is released late Friday afternoon after this essay is published. But I strongly suspect the data will show a sharp plunge in speculators’ long contracts due to forced selling as their stops were hit, along with a sizable but not major jump in short contracts. This new CoT report should illuminate much.
While I was well aware of the risk of cascading gold-futures selling due to speculators’ excessive longs, and have warned about it in all of our newsletters for several months, Tuesday’s running of the stops was still a major surprise. Since gold-futures speculators had weathered gold’s technical weakness and that enormous Fed-hawkishness ramp in late August, I figured the risks of them selling en masse were waning.
No such luck though. Tuesday’s surprise plunge was exceptionally damaging to sentiment, naturally spawning a vast surge in bearishness. And it definitely shattered gold’s bull-market uptrend. Still, the technical damage to 2016’s young gold bull is fairly modest. Gold was merely driven back to pre-Brexit-vote levels that were first seen in this bull in mid-March. That does nothing to invalidate or threaten gold’s bull.
As of Wednesday’s close, the data cutoff for this essay, gold’s total pullback since early July extended to just 7.2%. That’s still fairly mild, and vastly smaller than bull-slaying territory. In addition, gold’s plunge forced it back near its 200-day moving average. 200dmas usually prove strong support within ongoing bull markets. So odds are high gold will catch a bid very soon here and bounce right back up into its bull uptrend.
Obviously given futures speculators’ Fed-rate-hike obsession, this morning’s monthly US jobs report is a key factor in the timing of gold’s bounce. This essay draft was finalized Thursday after close, before that jobs data arrived. By the time you read this, you’ll know if jobs missed expectations which is dovish for Fed-rate-hike expectations fueling a gold rally on a futures bid. Or jobs could’ve beat, pushing gold the other way.
But there’s one thing we can be absolutely sure of, speculators’ gold-futures trading was the sole culprit behind Tuesday’s gold plunge. While speculators drive short-term gold action, its new bull this year is the result of heavy stock-market capital inflows into physical gold bullion via shares in the leading GLD SPDR Gold Shares gold ETF. If investors played a role in Tuesday’s gold plunge, GLD’s holdings would reveal it.
This chart looks at GLD’s physical gold-bullion holdings held in trust for its shareholders, which this ETF reports daily. GLD is exceedingly important because it acts as a direct conduit for stock-market capital to flow into gold, driving it higher. In order to keep GLD achieving its mission of mirroring gold, this ETF’s managers have to quickly equalize any excess buying or selling pressure on GLD shares directly into gold itself.
GLD shares have their own supply-and-demand profile independent from gold’s. So when American stock investors bid up GLD shares faster than gold is being bought, this ETF threatens to decouple from gold to the upside. GLD’s managers must shunt that excess demand into gold to maintain tracking. So they issue enough new shares to offset the excess demand, and use the proceeds to buy more gold bullion.
Differential GLD-share demand is actually the whole story of 2016’s gold bull! In the first quarter of this year, the GLD holdings build of 176.9 metric tons represented a whopping 80.6% of the total worldwide gold-demand growth year-over-year. In the second quarter, the GLD holdings build’s share shot up to a staggering 93.6% of total global gold-demand growth! Differential GLD-share buying is gold’s dominant driver.
The reason gold’s young bull stalled out in the third quarter is because American stock investors’ GLD-share demand evaporated. The Q1, Q2, and Q3 GLD builds of 176.9t or 27.5%, 130.8t or 16.0%, and -0.2% or -2.1t fully explain why gold surged in the first half of this year before consolidating high last quarter. With stock-market capital inflows so dominantly critical to gold’s bull, they were a suspect in Tuesday’s plunge.
But the hard daily holdings data released by GLD’s managers conclusively proves that stock investors had nothing at all to do with Tuesday’s gold plunge! These holdings were dead flat at 948.0t the very day that gold plummeted 3.3%, indicating GLD shareholders were selling no faster than the gold-futures speculators. On Wednesday, GLD experienced an utterly trivial 0.0% draw taking its holdings to 947.6t.
This was a big relief too, and very bullish for gold. If Tuesday’s plunge had been driven by the investors who fueled gold’s new bull market, that could be the vanguard of more investor selling. And if investors abandon gold now, its young bull is doomed since their buying is the only thing that pushed gold higher this year. As of the data cutoff for this essay, thankfully investors remain strong hands and aren’t fleeing.
Unlike futures speculators’ ultra-short-term focus necessitated by their super-risky hyper-leverage, gold investors are long-term players. Their gold positions are held outright, so a 3% drop in gold is just a 3% unrealized loss, not orders of magnitude greater like futures speculators’ amplified losses. As long as investors don’t start dumping gold, its bull market remains alive and well and due for a major rebound higher.
But when investors are away, the speculators will play. Gold investment buying via GLD shares stalled in Q3 because stock markets soared to new record highs on hopes of more central-bank easing after that Brexit vote. Since gold generally moves counter to stock markets, investment demand wanes when stocks thrive. The lack of investor buying gives futures speculators an outsized impact on gold’s price.
Thankfully wild gold-price moves driven by extreme gold-futures trading are very short-lived. The great leverage inherent in futures necessitates that major position shifts occur rapidly. These traders can’t afford to react gradually to adverse gold moves, so they all act at once resulting in quick violent action that soon fades. Since Tuesday’s gold-futures stop running didn’t spill into Wednesday, it’s probably over.
The worst impact of that surprise mass liquidation of gold-futures longs came in the gold miners’ stocks. Since their profits amplify the gold price, gold stocks took a colossal hit on Tuesday. The leading gold-stock benchmark HUI NYSE Arca Gold BUGS Index plummeted 10.1% to gold’s 3.3% loss on Tuesday! While that 3.1x leverage was reasonable for such a sharp gold plunge, it was gold stocks’ worst day in 14.5 months.
The gold-stock carnage sparked by that futures-driven gold plunge was breathtaking. Any stock traders who prudently had stop losses to protect their capital, including us, watched their gold stocks plummet to their stops and get sold. This stop running was automatic forced selling just like that seen in futures, exacerbating the sharp gold-stock plunge. It made for an exceedingly-challenging day for gold-stock traders.
Just like in gold, this bull-market-uptrend-breaking gold-stock plummet was a total surprise technically. The gold stocks as measured by the HUI had already suffered a massive correction of 22.0% between their early-August bull-to-date high and the end of that same month. That looked like a durable bottom sentimentally and technically, as gold stocks spent all of September grinding higher along bull-uptrend support.
But unfortunately they were just below that support line when Tuesday’s cascading gold-futures selloff hit. So the resulting capitulation-like snowballing selling fueled by stop losses being triggered in rapid succession also shattered the gold stocks’ young-bull uptrend. The HUI was battered back down to mid-April levels, extending this sector’s total correction to an enormous 28.4% over 2.0 months! It was brutal.
Naturally this calamity wreaked tremendous sentiment damage among gold-stock traders that will take some time to repair. Nevertheless, just like in gold Tuesday’s plummet did nothing to put the new gold-stock bull in jeopardy. While its uptrend was reshaped, this sector was still up an astounding market-dominating 83.1% year-to-date at Tuesday’s close. And it left the HUI right at its 200dma, major bull support.
So once gold inevitably catches a bid again soon here, likely on the Fed-levitated stock markets rolling over, gold stocks are going to surge higher again. Despite the technical damage, the core fundamentals of this sector remain very strong. Remember that in the second quarter, the latest data available, the elite gold miners of GDX and gold juniors of GDXJ had average all-in sustaining costs of just $886 and $887!
So the gold-mining sector remains very profitable at $1250 gold or even lower. And interestingly, the gold miners’ third-quarter operating results coming out in the next 5 weeks or so are going to prove way better than the second quarter’s. Q3’s average gold price powered 6.0% higher quarter-on-quarter, so the next batch of quarterly gold-miner results are going to be very appealing to investors and drive much buying.
If you suffered a mass stopping this week, you’re not alone. Such an extreme gold-stock down day that erupted from just over correction lows had to trigger the vast majority of stops out there. While it is certainly discouraging seeing much or most of your gold-stock and silver-stock portfolio stopped out, it is merely a setback on the road to huge major-upleg gains. They are well worth suffering an occasional selling anomaly.
Here’s the math. Assume the capital you have invested in gold stocks for the next upleg has an indexed value of 100. Even if all your positions are stopped at 20% losses, that takes the value to 80. But the key is remembering uplegs in gold-stock bulls are massive. In early 2016 the HUI blasted 131.8% higher in just 3.3 months for example! 50% to 100%+ upleg gains within gold-stock bulls are totally normal and common.
Take that 80 indexed portfolio value after the mass stopping and redeploy into the resulting capitulation lows, and 50% to 100% upleg gains will catapult it back up to 120 to 160. Those are total portfolio gains of 20% to 60%, typically in well under a year! While suffering a stopping is suboptimal and frustrating, it doesn’t great impede capital growth and wealth multiplication if redeployed since gold-stock uplegs are so big.
Tuesday’s anomalous futures-driven stop running hammering gold, silver, and their miners’ stocks truly changed nothing whatsoever on the fundamental front. The precious metals remain in strong new bulls almost certain to mean revert radically higher from here following their extreme secular lows of late 2015. This sector is extremely oversold, and due for a sharp rebound higher kicking off the next major uplegs.
Investors and speculators can play them in the leading gold and gold-stock ETFs of GLD, GDX, and GDXJ. But as always the greatest gains will come in the individual gold stocks and silver stocks with superior fundamentals. While they were slammed this week on snowballing stop-loss selling, they are going to come roaring back with a vengeance once gold inevitably catches a bid. Today’s buy-low opportunity is fleeting.
At Zeal we too suffered a mass stopping on this week’s improbable anomalous plunge. But decades of experience have taught me that extreme gold-stock selloffs late in bull-market corrections have to be quickly bought to ride subsequent sharp V-bounces higher. So even on Tuesday afternoon before the dust settled, we already started aggressively redeploying in the beaten-down gold stocks at amazing prices.
We bought 10 fundamentally-superior gold stocks and silver stocks in our acclaimed weekly newsletter published Tuesday afternoon, with more buying to come. That along with our monthly draws on our vast experience, knowledge, wisdom, and ongoing research to explain what’s going on in the markets, why, and how to trade them with specific stocks. This expertise is most valuable and essential when traders are most scared, since that’s when the best bargains are found. Subscribe today for just $10 an issue!
The bottom line is gold suffered an anomalous futures-driven selloff this week. As the gold price drifted lower through key support levels, futures stop losses were triggered. This automatic mechanical selling forced gold even lower, tripping more stops so futures selling cascaded. The resulting plunges in gold, silver, and their miners’ stocks shattered their young-bull-market uptrends and greatly damaged sentiment.
But these bull markets are very much alive and well despite this technical carnage. Investors weren’t dumping gold, and extreme gold-futures selling is always short-lived. So the precious metals are due for a sharp rebound higher out of deeply-oversold conditions, likely fueled by gold catching a bid on stock-market weakness. This will ignite these bulls’ next major uplegs, yielding huge gains for brave contrarians.
Adam Hamilton, CPA October 7, 2016 Subscribe at www.zealllc.com/subscribe.htm