By Adam Hamilton
Gold has powered higher smartly over the past couple months, achieving big gains. But this gold buying is only starting, implying this young upleg still has a long way to run yet. Speculators’ gold-futures buying remains modest, while much-larger identifiable investment buying hasn’t even begun. Traders will have to increasingly chase gold’s upside momentum to restore normal portfolio allocations, really amplifying its gains.
Gold has been on a tear lately, blasting higher to major technical breakouts. Between late September to midweek, the yellow metal surged up 15.7% in 3.5 months! Nearly all those big gains accrued since early November alone, when gold carved a deep double-bottom. During this young upleg’s rapid ascent, gold shattered its downtrend resistance and 200-day moving average. Now it is flashing a potent buy signal.
A powerful Golden Cross is occurring in gold, with its 50dma crossing back above its 200dma from below! This is one of the most-effective and most-bullish indicators in all of technical analysis, arguing this young gold upleg is only getting started. More importantly, gold’s supply-and-demand fundamentals align with and corroborate this rosy outlook. Impressively the great majority of usual gold-upleg-driving buying remains!
Major gold uplegs are fueled by three progressively-larger stages, with the latter two ignited by preceding ones. Uplegs are born and initially driven by gold-futures speculators buying to cover short-side trades. That soon gives way to bigger spec gold-futures long buying, which really accelerates gold’s gains. They ultimately grow big enough to entice investors to return with their vast pools of capital, supercharging gold uplegs.
This specimen’s initial stage-one gold-futures-short-covering buying is about 3/4ths exhausted, which is what has driven gold higher so far. But the subsequent stage-two gold-futures long buying is likely only about 1/6th expended. And the all-important stage-three gold investment demand remains nonexistent in identifiable form in its primary indicator. All this argues the lion’s share of gold’s gains are still coming!
The gold-futures speculators control the first two stages because of the extreme leverage inherent in that realm. That enables their capital to punch way above its weight in terms of gold-price impact. Midweek, each 100-ounce gold-futures contract controlled $187,760 worth of gold. Yet traders were only required to keep $6,900 cash margins in their accounts per contract, allowing crazy maximum leverage of 27.2x!
That dwarfs the stock markets’ legal limit of 2x that has been in place since 1974. At 27x, every dollar of capital deployed in gold futures exerts 27x the influence on gold prices of a dollar invested outright! So this gold-futures trading utterly dominates gold’s short-term price action, especially when investors aren’t active. That has certainly been the case in recent months, with futures doing all of gold’s heavy lifting.
Unfortunately speculators’ collective gold-futures trading activity is only available weekly with a lag. It is current to Tuesday closes, but not published until late Friday afternoons in the famous Commitments of Traders reports. So the latest-available CoT data before this essay was published was merely current to January 3rd. Gold surged another 2.0% in the subsequent CoT week, so this buying is understated some.
This chart superimposes gold and its key technicals over specs’ total longs in green and shorts in red. It is current to Wednesday’s close, the data cutoff for this essay. While gold’s golden-cross buy signal had not quite flashed midweek, it is on track to trigger Friday after this essay’s release. Gold is powering higher with a vengeance, mean reverting strongly after mid-2022’s sharp selloff on anomalous events.
Between early March to late September last year, gold crumbled 20.9% in 6.6 months technically entering a bear market. But starting from an unsustainable geopolitical spike after Russia invaded Ukraine, gold’s selloff was overstated. Gold initially recovered from that into mid-April, when extreme anomalies sparked snowballing selling. That accounted for nearly 5/6ths of gold’s total mid-2022 selloff, the overwhelming majority.
The Fed embarked on its most-extreme hawkish pivot ever, launching the US dollar stratospheric. Top Fed officials aggressively hiked their benchmark federal-funds rate an astounding 425 basis points out of a zero-interest-rate policy in just 9.0 months! They simultaneously ramped quantitative-tightening bond selling to its highest levels ever dared by far at $95b per month! Such epic tightening was radically unprecedented.
The Fed panicked to fight the raging inflation unleashed by its own extreme money printing. In just 25.5 months into mid-April 2022, the Fed had recklessly ballooned its balance sheet by an absurd $4,807b or 115.6%! That effectively more than doubled the monetary base underlying the global US dollar supply in just a couple years. Relatively-way-more money was competing for relatively-less goods and services.
That grotesque monetary excess bid prices sharply higher, heavily debasing the US dollar’s purchasing power. But the US Dollar Index still started soaring, on the massive yield differentials the Fed’s hikes were opening up over other major currencies. From mid-April to late September, the USDX skyrocketed an astounding 14.3% to an extreme 20.4-year secular high! That loosed enormous gold-futures selling.
Those gold-futures speculators look to the US dollar’s fortunes for their primary trading cue, affirming that gold remains money. They do the opposite when the dollar makes material moves, selling futures when it is rallying. Their trading time horizons are compressed incredibly myopically due to that extreme leverage they run. Way up at that crazy 27x, a mere 3.7% adverse gold move wipes out 100% of their capital risked!
So over gold’s entire mid-2022-selloff span, speculators dumped 165.5k gold-futures long contracts while adding 66.0k short ones. That huge 231.5k contracts of total selling was the equivalent of a colossal 720.0 metric tons of gold! That was far too much too fast for markets to absorb, pummeling gold prices sharply lower. But gold-futures speculators’ capital firepower is quite finite, so their selling soon ran out of steam.
Gold finally bottomed at $1,623 on September 26th, literally stock-panic-grade levels. That was a deep and brutal 2.5-year low not seen since just emerging from March 2020’s pandemic-lockdown stock panic! In order to hammer gold that hard, specs’ total longs plunged to a 3.4-year low while their shorts soared to a 3.8-year high! Such extremes are never sustainable for long, guaranteeing big mean-reversion buying.
I analyzed that gold-futures puking stalling in mid-October while gold still languished at $1,644. Back then while gold sentiment remained super-bearish, I concluded “speculators’ extreme gold-futures puking over this past half-year is stalling. That heavy selling responsible for these anomalously-low gold prices has exhausted these hyper-leveraged traders’ capital firepower. … That guarantees big buying is coming.”
That indeed soon ignited in fast stage-one short-covering buying, triggered by the wildly-overbought US Dollar Index finally starting to roll over. When gold has just plunged to deep lows scaring the heck out of long-side traders, the short gold-futures specs are often the only buyers. With probabilities mounting for a gold V-bounce, they buy to cover and close their downside bets at fat profits which catapults gold sharply higher.
But that wasn’t enough to convince the crazy-bearish long-side specs, who continued selling down their overall positioning to a marginal new 3.6-year low in late November. So this young gold upleg suffered that double bottom. But with the USDX’s own overdue mean reversion lower really gathering steam, that gold-futures short covering resumed. As of that latest CoT data current to January 3rd, it hit 66.5k contracts.
That is the dominant driver of gold’s 15.7% surge, as spec long buying remained anemic at merely 18.1k contracts. Together that adds up to 84.5k contracts of total reported gold-futures buying in gold’s young upleg so far, the equivalent of 262.8t of gold. But that is still less than 3/8ths of the massive gold-futures selling that pummeled gold lower in mid-2022. That implies over 5/8ths of likely gold-futures buying remains!
While total spec shorts have already collapsed back down near their rising secular support line, total spec longs remain far below recent years’ resistance around 413k contracts. In order to climb back up to those levels which flagged the major gold peaks since 2020, specs would have to buy another 139.9k longs or 435.1t of gold! That kind of stage-two buying would catapult gold way higher, really growing this young upleg.
Since speculators’ gold-futures trading often dominates gold price trends, I analyze the latest CoTs in all our weekly and monthly subscription newsletters. In order to quickly convey specs’ overall positioning in gold futures and its near-term implications for gold prices, I developed an indicator. It simply looks at specs’ total longs and shorts as percentages of their past-year trading ranges, revealing how far up in they are.
As of that latest-available January 3rd CoT when this essay was published, spec longs were 17% up into their range while spec shorts were 24% up into their own. That implied 3/4ths of likely stage-one short-covering buying had been expended, but fully 5/6ths of stage-two long-side buying remained! The most-bullish setup for gold is 0% longs and 100% shorts, which shows specs have largely exhausted their selling.
But because spec longs really outnumber shorts, they are proportionally more important for gold’s near-term direction. On average over the past 52 reported CoT weeks, spec longs ran 2.5x higher than spec shorts. So total spec longs being just 17% up into their past-year trading range is much more significant for gold than spec shorts being 24% up into theirs. The great majority of stage-two long buying is still coming!
With way less gold-futures shorts, stage-one short-covering buying tends to run out of steam within a few months. And that short covering is mandatory, as specs are legally required to buy contracts to offset and close their downside bets. But that frenzied short covering drives gold high enough for long enough to trigger stage-two long buying. That generally lasts three to six months as speculators chase gold’s upside.
Again combining longs and shorts, something on the order of 3/8ths of specs’ likely gold-futures buying has passed. With over 5/8ths still coming, gold has good potential to double the 15.7% gains this young upleg has already enjoyed! That ought to prove enough gold upside momentum to start enticing investors to return. While they don’t run extreme leverage like the futures guys, they control vastly more capital.
So their stage-three buying is necessary to fuel the biggest gold uplegs, which can exceed 40% gains. Two such mighty gold uplegs driven by massive investment buying crested in 2020, at mighty 42.7% and 40.0% gains! Unfortunately global gold investment demand is much harder to track than specs’ futures buying, as it is only reported quarterly in the World Gold Council’s excellent Gold Demand Trends’ reports.
But the combined gold-bullion holdings of the dominant American GLD SPDR Gold Shares and IAU iShares Gold Trust gold ETFs offer a great high-resolution proxy for overall gold investment demand. Reported daily, they reflect American stock-market capital deployed in gold via these mighty ETFs. Considered over quarters, their holdings closely track and sometimes dominate the WGC’s global-gold-investment trends.
This chart superimposes GLD+IAU holdings over gold and its key technicals in recent years. Just like the previous gold-futures chart, buying and selling over gold’s uplegs and corrections is noted. But unlike the gold-futures speculators, American stock investors haven’t even started buying gold yet. Its young upleg hasn’t run high enough for long enough to convince them to return, so all their stage-three buying is still coming.
Gold-futures speculators’ dominance of gold price action extends beyond their extreme leverage, since the resulting gold-futures price is gold’s global reference one. That’s what all traders watch, including investors. So when heavy gold-futures selling bullies gold lower like in mid-2022, that gold weakness really taints investor psychology. Thus they joined in the heavy gold selling last year, even though it was irrational.
Gold again plunged 17.9% mostly on big gold-futures selling between mid-April to late September. The futures specs fled as the US dollar shot parabolic on extreme Fed tightening. But during those six calendar months, headline US Consumer Price Index inflation averaged blistering 8.5% year-over-year surges! That raging inflation proved the hottest seen by far since the last inflation super-spikes during the 1970s.
Gold skyrocketed during those even in conservative monthly-average-price terms, nearly tripling during the first before more than quadrupling through the second! Gold investment demand exploded as that hot inflation relentlessly eroded the US dollar’s purchasing power. While today’s third inflation super-spike of this modern monetary era will ultimately fuel massive gold demand, mid-2022’s extreme anomaly delayed that.
Instead of focusing on gold’s super-bullish fundamentals and staying the course, investors fretted about its plunging futures-driven prices. So they fled last year as gold was hammered lower, as was evident in GLD+IAU holdings. Between late April to early December, they collapsed 16.7% or 271.3 metric tons. Naturally investors fleeing from gold’s downside momentum exacerbated it, amplifying the overall selloff.
Since investors own gold outright, they have no need to be as high-strung reacting to price moves as those hyper-leveraged gold-futures speculators. So toppings and bottomings in gold-ETF holdings lag those in gold itself. It takes some time after major peaks and troughs in gold to convince investors trend changes are underway. During gold’s actual precise 20.9% selloff last year, GLD+IAU holdings fell 9.0% or 140.9t.
Despite gold blasting 15.7% higher since late September, investors apparently haven’t been impressed. At best in late December, GLD+IAU holdings had merely recovered a tiny 0.9% or 12.8t off their deep 2.7-year low a few weeks earlier. That was also stock-panic-grade, American stock investors hadn’t owned less gold via their preferred trading vehicles since the dark heart of March 2020’s panic! Talk about irrational.
Because of an unsustainable gold-futures-driven anomaly, investors effectively abandoned gold during the biggest inflation super-spike since the 1970s. Frightened away by gold’s big mid-2022 selloff, their herd psychology waxed so bearish that they still haven’t started returning. The big stage-three gold buying that fueled those mighty uplegs peaking in 2020 hasn’t even started yet per GLD+IAU holdings!
American stock investors effectively have zero portfolio allocations in gold today, which is crazy given this backdrop. Not only is an inflation super-spike underway, but the Fed’s frantic reaction has forced stock markets into a deepening bear market. Yet exiting December, all the gold held by GLD and IAU was still only worth 0.2% of the market capitalization of the elite S&P 500 stocks! Investors have vast buying to do.
Just to mean revert GLD+IAU holdings back up to mid-April-2022 levels before that Fed-goosed-dollar anomaly, GLD and IAU shares would have to see enough differential buying to catapult their holdings 19.3% or 262.6t higher. That’s getting into big-gold-upleg territory, as GLD+IAU holdings soared 314.2t and 460.5t fueling 2020’s massive 42.7% and 40.0% gold uplegs. And that was with low and benign inflation!
With inflation now raging and stock markets burning, the ultimate stage-three investment buying in this gold upleg ought to prove much bigger. Just to return to October 2020’s record GLD+IAU holdings high of 1,800.5t which seems conservative in this super-bullish environment for gold, another 437.3t would have to be added. It wouldn’t surprise me to see double or triple that with this inflation super-spike raging.
So this young gold upleg’s stage-one gold-futures short-covering buying is about 3/4ths exhausted, with a quarter still left to go. The much-larger stage-two gold-futures long buying is only about 1/6th complete so far, with the lion’s share remaining. And the vastly-bigger stage-three investment buying hasn’t even started yet according to gold investment demand’s best daily indicator. All that is wildly bullish for gold prices!
The biggest beneficiaries will be its miners’ stocks, which really amplify gold’s gains due to their earnings leverage to its prices. As of midweek, the leading GDX gold-stock ETF has blasted 45.6% higher at best during gold’s parallel 15.7% upleg. That makes for good 2.9x upside leverage to gold, on the high side of GDX’s usual 2x-to-3x range. The bigger gold’s upleg grows, the more these gold-stock gains will accelerate.
The bottom line is the recent gold buying is only starting. Gold’s young upleg has so far mostly been fueled by stage-one gold-futures short covering, which still isn’t finished. The great majority of bigger stage-two gold-futures long buying is still coming. That will eventually drive gold high enough for long enough to convince investors to return with their vast stage-three buying, growing this gold upleg into the big leagues.
And it should prove a monster with inflation raging out of control in its first super-spike since the 1970s, which will supercharge gold investment demand again. During times of serious currency debasement, all investors need sizable gold portfolio allocations. That will require massive buying starting from virtually nothing. The gold miners’ stocks will amplify gold’s resulting gains like usual, earning fortunes for traders.
Adam Hamilton, CPA