By Adam Hamilton, CPA
The notorious gold-futures speculators just struck again, selling aggressively and pummeling gold sharply lower. Another red-hot inflation report goaded them into puking out more contracts, which is supremely irrational given market history. But their heavy selling since mid-April has exhausted their finite capital firepower. So that gold-distorting spewing is stalling out, and will soon reverse to huge mean-reversion buying.
The latest US Consumer-Price-Index inflation report was released this Thursday, again coming in hotter than expected. The headline print surged 8.2% year-over-year, off its +9.1% peak in June but ahead of economists’ +8.1% expectations. And the core number excluding food and energy soared 6.6% YoY, its biggest gain since August 1982! Inflation continues to rage out of control thanks to extreme Fed money printing.
For centuries if not millennia, gold has proven the ultimate inflation hedge. As its global mined supply can only increase slowly on the order of 1% annually, it has always been the go-to investment during times of currency debasement. Serious inflation rapidly erodes purchasing power, punishing investors with big real losses. With the worst inflation super-spike since the 1970s plaguing us, gold truly should be soaring.
That decade saw two similar inflation super-spikes where gold skyrocketed. 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%!
Yet immediately after this latest red-hot September CPI data, gold collapsed 2.0% within an hour. And that insane dissonant behavior is par for the course this year. Between mid-April to late September, gold collapsed 17.9% to levels not seen since just after March 2020’s pandemic-lockdown stock panic! During that span, monthly headline CPI inflation ran a scary +8.3%, +8.6%, +9.1%, +8.5%, +8.3%, and +8.2% YoY.
And real-world inflation is way worse, probably at least double the intentionally-lowballed CPI. What kind of traders see red-hot inflation data and experience even faster-rising prices in their own lives, then think they should dump gold? Those infuriating, hyper-leveraged, ultra-myopic gold-futures speculators! While they have managed to temporarily distort gold prices this year, they will be wiped out as it quickly normalizes.
Unfortunately these guys punch way above their weights in bullying around gold prices because of the extreme leverage inherent in gold-futures trading. With gold around $1,675 midweek before their latest incoherent puking, each 100-ounce contract controlled $167,500 worth of gold. But traders are merely required to keep cash margins in their accounts of $5,700 per contract, enabling maximum leverage up to 29.4x!
Running at that current 29x limit, each dollar gold-futures speculators trade has 29x the gold-price impact of a dollar invested outright! But that is exceedingly risky, with these traders facing 100% losses if gold merely moves 3.4% against their bets. That forces these guys to have ultra-short-term focuses, trading on time horizons measured in hours or days. So economic-data surprises moving markets is a big deal to them.
They’ve been relentlessly puking out heavy-to-extreme amounts of gold-futures long and short contracts since mid-April. Nearly all their big selling days happened after important economic data, top Fed officials talking hawkish, and Federal Open Market Committee meetings executing monster rate hikes along with quantitative-tightening monetary destruction. All this has catapulted the US dollar into a parabolic mania.
During mid-2022’s 5.5-month span where gold inexplicably defied all history by plunging 17.9% with an inflation super-spike raging, the benchmark US Dollar Index skyrocketed 14.2% higher! That proved a stupendous rally for a major world currency, off-the-charts extreme. Gold-futures speculators watch the US dollar’s fortunes for their primary trading cues, then do the opposite when the dollar materially moves.
Their epic puking done with extreme leverage has massively distorted gold prices. They are radically too low given this inflation-super-spike backdrop. The false price signals sent by all that gold-futures dumping have severely impaired gold psychology. As gold was pummeled ever lower, investors have increasingly fled assuming the yellow metal is broken or no longer an inflation hedge. This has been utterly maddening.
In coming years traders will look back on mid-2022 and marvel that anyone believed panic-level gold prices were righteous with inflation raging out of control. Sooner or later gold will normalize to reflect the vastly-expanded money supplies around the world. In just 25.5 months into mid-April 2022, the Fed more than doubled the US-dollar monetary base by ballooning its balance sheet a dumbfounding 115.6% higher!
The silver lining on these farcical gold prices is gold-futures speculators’ capital firepower available for selling is quite finite. They can only dump so many long contracts, and pile into so many short ones, before their funds are exhausted. Those limits are very close today, where selling has to stall out. After that these traders are forced to do massive symmetrical mean-reversion buying, which catapults gold far higher.
This chart mostly explains why gold prices are languishing so anomalously low despite this super-bullish inflation-super-spike backdrop. It superimposes gold prices over speculators’ total gold-futures long and short contracts as reported weekly in the famous Commitments-of-Traders reports. Specs have puked out enormous amounts of gold futures, which has left their positioning unsustainably exceedingly-bearish.
The lion’s share of gold’s absurd 2022 plunge indeed came since the US dollar started shooting parabolic in mid-April, on the Fed’s most-extreme hawkish pivot ever. But gold’s selloff was born before that in early March, from really-overbought levels at $2,051 driven by the sharp geopolitical spike after Russia invaded Ukraine. From there, gold has actually dropped 20.9% which is technically new-bear-market territory.
The gold-futures selling during that 6.6-month span has been enormous beyond belief. That weekly CoT data on spec gold-futures positioning is current to Tuesdays. Between the ones matching gold’s early-March high and late-September low, speculators dumped an astounding 165.5k long contracts while short selling another 66.0k! That adds up to 231.5k of puking, which is the equivalent of 720.1 metric tons of gold!
That gold-futures spewing was even worse from a couple weeks around this gold-selloff span. Specs’ total longs actually plummeted 173.1k contracts at most, while their shorts rocketed 94.6k. That adds up to 267.7k, or 832.7t in gold-equivalent terms! Even March 2020, when gold collapsed 12.1% in just eight trading days on stock-panic safe-haven dollar buying, only saw speculators sell 49.3k gold-futures contracts.
So this past half-year’s 250k-ish of dumping was astonishing. Gold actually proved resilient only falling 20%-ish in the face of such colossal withering selling pressure. And those artificially-depressed gold prices from this extreme gold-futures puking really depressed investors, who increasingly fled in response to these false price signals. That was seen in the best high-resolution proxy for global gold investment demand.
That is the combined gold-bullion holdings of the mighty world-dominating GLD SPDR Gold Shares and IAU iShares Gold Trust gold exchange-traded funds. Reported daily, their holdings’ quarterly changes often account for a large majority of overall global-gold-investment-demand trends reported by the World Gold Council. During that 6.6-month gold plunge, GLD+IAU holdings fell 9.0% adding another 140.9t of selling.
But that proved considerably worse expanded a bit around gold’s geopolitical-spike topping and recent panic-grade low. Investment capital flows tend to lag gold price trends, because investors don’t need to scrutinize gold like the futures speculators. With no leverage, their risks are radically lower. From mid-April to late September, GLD+IAU holdings actually plunged 12.7% or 207.2t at worst as investors fled gold.
So the identifiable gold selling in this past half-year from gold-futures trading and those mighty American gold ETFs alone totaled a mind-boggling 1,039.9t! For an idea of how ludicrously outsized that is, during all of 2021 total global investment demand per the WGC ran 1,007.4t. So mid-2022’s epic gold selling, which was 4/5ths gold-futures puking, exceeded all the prior year’s investment buying in about half the time!
This extreme anomaly isn’t sustainable, and will soon proportionally reverse catapulting gold way higher. One of the biggest mistakes traders make is assuming current market conditions will continue indefinitely, extrapolating the present into the future. That always proves wrong, as markets are forever cyclical. When 2022 dawned, traders figured the record-high US stock markets would keep powering higher this year.
Yet as of midweek, the flagship S&P 500 stock index has plunged 25.4% since then in a mounting bear! Back in mid-2020 soon after the Fed started redlining its monetary printing presses to flood the world with dollars, traders assumed that wouldn’t be inflationary. Yet even the politically-manipulated headline CPI has soared from +1.0% YoY then to +9.1% this past summer. Once markets hit extremes, they mean revert.
Today’s universal assumptions that gold is no longer an inflation hedge so it is doomed to keep grinding lower are just as wrong. Markets are like rubber bands, they can only be stretched so far before they snap back. Assuming market extremes can keep on worsening is like betting an already-taut rubber band can keep on lengthening. Speculators’ gold-futures selling has reached those limits where it will violently reverse.
A day after gold was slammed to that fundamentally-absurd $1,623 panic-level low in late September, another CoT was released. It revealed total spec longs at just 247.5k contracts had hit a new 3.4-year low, levels not seen since early May 2019. And total spec shorts surged to 185.3k contracts, their highest levels since late November 2018 fully 3.8 years earlier! These incredible extremes are evident in this chart.
Spec longs will never go to zero, because speculators technically exist to take the other side of trades offered by hedgers who produce or consume physical gold in their businesses. Over the past five years or so starting in 2018, total spec longs in all CoT weeks have averaged 331k. So late September’s 248k is super-low. While these longs could drift a little lower, nearly all of specs’ long-selling firepower is spent.
And spec shorting is even more limited, because it is exceedingly risky. Traders literally have to borrow gold-futures contracts to short sell them, creating a legal obligation to buy them back later to return those contracts. They technically face unlimited loss potential since gold can rally far higher, leaving fewer traders willing to traffic in them. Since 2018, total spec longs have outnumbered shorts by an average of 3.2x.
In late September as gold bottomed, that 185k of total spec shorts was far higher than their 118k five-year average. That was so extreme it immediately spawned a big short-covering-driven gold rally. Over the next CoT week, gold soared 5.9% higher to $1,725 mostly on a huge 29.2k contracts of spec short-covering buying! But with gold pounded lower since, spec shorts have almost certainly surged back up again.
So speculators’ capital firepower available for selling hyper-leveraged gold futures has been exhausted by all their heavy-to-extreme selling since early March. They might get spooked into shaking loose a few more contracts, but that shouldn’t be material in light of the colossal selling in this past half-year. And once specs have puked out all the gold-futures contracts they are able to, big mean-reversion buying erupts.
Examples of extreme gold-futures selling birthing big-and-fast gold uplegs are legion. Again the last time the more-important spec longs were so darned low was back in early May 2019. With their selling spent, specs soon resumed buying to normalize that excessively-bearish positioning. Gold rocketed 21.5% higher in just the next 3.3 months on that! A similar move today would catapult gold back up near $1,975 by year-end.
Super-low spec longs and super-high spec shorts are the most-bullish-possible setup for gold, guaranteeing massive mean-reversion buying is imminent. It is tragic more speculators and investors don’t understand this, that they are getting caught up in bearish herd sentiment to be duped into selling low. The extreme gold-futures selling of this past half-year is stalling, and will soon reverse to symmetrical buying.
Major gold uplegs are three-stage affairs born from excessively-bearish spec gold-futures positioning. The first stage is fueled by mandatory short-covering buying, which feeds on itself as gold starts surging off some news catalyst. We got a preview of that in late September when gold soared after the lofty US dollar started rolling over. That will soon happen again, probably on some unexpected Fed-dovish news.
The faster gold rallies, the more pressure on speculators to buy back and close out their shorts or face catastrophic losses. That initial short-covering buying tends to run for a month or two, pushing gold high enough for long enough to convince the larger long-side specs to return. Their bigger stage-two buying is totally voluntary, but they love chasing upside momentum. That fuels virtuous circles of buying begetting buying.
The more gold rallies, the more speculators want to add gold-futures longs. The more they buy, the faster gold climbs. It typically takes three to six months for specs’ total longs to mean revert and overshoot after extreme lows. All their buying leaves gold powering higher decisively in an unmistakable strong young upleg, which eventually entices investors to return. They command vastly more capital than the futures guys.
Their stage-three buying can run for a year or more, and ultimately catapults gold to huge gains. After that pandemic-lockdown stock-panic anomaly in March 2020, gold soared 40.0% higher in just 4.6 months on enormous investment buying. GLD+IAU holdings skyrocketed 35.3% or 460.5 metric tons in that short span as investors rushed to chase gold’s upside momentum. Something similar is likely coming today.
Remember monthly-average gold prices nearly tripled during the first 1970s inflation super-spike before more than quadrupling during the second! There’s no reason gold can’t at least double this time around with inflation raging out of control again. Since gold averaged $1,681 in September after that epic gold-futures puking, that implies it could eventually soar over $3,350 in coming years as investors inevitably return.
Inflation super-spikes are terrible for stock markets, as this year’s mounting bear is again proving. Higher general prices ravage corporate earnings, which hammer stock prices. Companies can’t pass along all their surging input costs in selling-price increases, which leave their customers less willing or able to pay. With general prices surging, corporate sales decline anyway as people are forced to divert spending to necessities.
As stock markets burn and inflation relentlessly erodes dollar purchasing power, gold overtakes cash as an essential portfolio allocation. It doesn’t matter how high the Fed hikes interest rates, this inflation isn’t going away until the majority of that vast deluge of QE4 money printing is unwound. That’s going to take years if the Fed has the courage. The Fed conjured up $4,807b of new dollars out of thin air into April 2022!
Yet so far the Fed’s new QT2 campaign to destroy that money has only shrunk the Fed’s balance sheet by $206b. That’s just 4.3% of the prior couple years’ extreme money printing. So high inflation is going to persist much longer than most expect. As investors start realizing this, their gold demand will soar to start diversifying their stock-heavy portfolios. But first huge futures mean-reversion buying will catapult gold higher.
Remember that total gold-futures selling since early March ran a staggering 267.7k contracts, or 832.7t. A mean reversion ought to reverse half that or about 416t into buying, while a more normal overshoot would do way more. But even the equivalent of 416t of gold-futures buying will work wonders for battered gold prices. When gold soared 40.0% in 4.6 months in mid-2020, gold-futures and GLD+IAU buying totaled 382t!
So while it is fashionable to believe the herd’s uber-bearish gold groupthink today and ridicule contrarian viewpoints, it is stupidly foolish. The extreme gold-futures puking responsible for today’s heavily-distorted gold prices not even starting to reflect raging inflation is exhausted. That epic selling has stalled, and will soon reverse to proportional massive buying. That will catapult gold sharply higher just like many times before.
The biggest beneficiaries of gold’s imminent next major upleg will be the brutalized gold miners’ stocks. After being bludgeoned to false panic-level lows, they started to sharply V-bounce with gold out of those spec-gold-futures extremes. While that was interrupted by resurgent gold-futures shorting over this past week, gold stocks’ powerful rally will resume with a vengeance with gold-futures mean-reversion buying.
The bottom line is 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. It has left their gold-futures positioning at unsustainable bearish extremes, with both longs and shorts stretched to levels not seen for several-plus years. That guarantees big buying is coming.
The specs will soon be forced to do massive short-covering buying to normalize their lopsided bets, likely on the euphoric US dollar rolling over. Gold’s resulting strong upside momentum will attract back larger buying from long-side specs, accelerating gold’s upside. Then investors will increasingly return to chase those big gains, and flee this raging inflation. That will fuel a mighty gold bull restoring righteous price levels.
Adam Hamilton, CPA