Gold bull markets offer outstanding opportunities for traders to grow their wealth.  These bulls consist of series of alternating uplegs and corrections.  Naturally the best times to buy low within ongoing bulls are right after corrections when major new uplegs are being born.  Gold uplegs have three distinct stages that are evident in real-time in key datasets.  Understanding how gold uplegs play out leads to superior gains.

Bull markets in gold can be exceedingly profitable for investors and speculators.  The last secular gold bull ran between April 2001 to August 2011.  During that 10.4-year span, gold powered 638.2% higher!  That radically bested the general stock markets’ 1.9% loss per the S&P 500 over that same time frame.  Hardened contrarians willing to buy low as gold bottoms after long bears can ride all of gold’s big bull gains.

Unfortunately the great majority of investors lack the experience, discipline, and mental toughness to fight the herd to buy low when all hope seems lost.  So they end up buying into gold bulls later after they are already well underway.  Understanding the evolution of gold uplegs, what births them and fuels their growth, really helps later investors deploy capital at better prices.  Buying relatively low is still essential mid-bull.

Knowing gold uplegs’ three-stage anatomy is very valuable for speculators too.  By actively trading the upleg-correction cycles within ongoing bulls, traders can earn ultimate gains much bigger than buy-and-hold investors.  Speculators buy relatively low early in major uplegs, then sell relatively high when they mature.  This profitable trading cycle can continue as long as the bull persists, creating more effective upside.

Consider gold’s current young bull, which was stealthily born in deep despair in mid-December 2015.  As of this week, gold was up 22.1% bull-to-date.  But the gains possible actively trading its uplegs are much larger.  Gold surged 29.9% higher by early July 2016 in this bull’s first upleg, then plunged 17.3% by mid-December 2016 in its first correction.  Since then gold has rallied 19.5% in its second upleg as of early September.

That means traders had a shot at 49.4% total gains so far from this bull’s upleg-correction cycles, more than doubling buy-and-hold gains!  While precisely timing bull markets’ major interim lows and highs is impossible, traders can capture more of these upleg gains by understanding how gold uplegs unfold.  I’ve discussed gold uplegs’ three stages in our newsletters for years, but hadn’t yet put it all together in an essay.

Gold bull-market uplegs usually unfold in the same telescoping fashion.  They are initially ignited by gold-futures speculators covering shorts.  These traders are usually the only buyers at major lows following corrections when sentiment is hyper-bearish.  They buy offsetting gold-futures long contracts to close out their existing short contracts at profits.  This short covering is the spark that first kindles major gold uplegs.

That short covering soon burns itself out, as short-side traders have relatively-little capital compared to the other gold buyers.  But it often propels gold high enough for long enough to entice long-side gold-futures speculators to return.  They command much more capital than the shorts, and their buying soon becomes self-feeding.  The more gold-futures contracts they buy, the more their peers start chasing that momentum.

That long-buying second stage eventually evokes gold uplegs’ third stage, the primary one and largest by far.  All the gold-futures buying extends gold’s rally enough to get investors interested in returning.  They control vastly more capital than futures speculators, so once they start buying gold is off to the races in a major new upleg.  Unlike short-lived gold-futures buying, gold investment buying can run for many months on end.

Stage-one gold-futures short covering is the initial trigger that ignites stage-two gold-futures long buying.  And all that futures buying together eventually jump-starts stage-three investment buying.  As investors start to return to gold in a material way, gold’s upleg accelerates in a self-sustaining virtuous circle.  The more capital investors pour into gold, the more it rallies.  The more gold rallies, the more investors want to buy.

The neat thing about gold uplegs’ three stages is their distinctive buying is readily identifiable in real-time in a couple key datasets!  These are not widely followed either, which grants big advantages to traders who take the time to stay abreast.  The futures data to track gold uplegs’ first two stages comes from the weekly Commitments of Traders reports published late every Friday afternoon by the US government’s CFTC.

These CoTs slice gold-futures traders into commercial hedgers, large speculators, and small speculators.  Both speculator groups lumped together create this chart, showing their collective total gold-futures short contracts in red and long contracts in green.  With gold superimposed over the top in blue, the stage-one and stage-two gold-upleg buying is readily apparent.  That flags gold uplegs’ births and early gains as they happen.

The most-important clue that a major new gold upleg is likely imminent is relatively-high or excessive gold-futures shorting by speculators.  Every major gold upleg in recent years, during bull and bear alike, started powering higher immediately after elevated spec shorts.  That is readily evident above in the red spec-short line.  Higher spec shorts coincide exactly with major bottoms in gold, the best times to buy low.

Gold-futures trading is a surreal alternate reality due to the extreme leverage inherent in it.  For decades in stock markets, margin has been legally limited to 50%.  That makes for 2x maximum leverage, limiting risk.  Futures trading is a radically-different beast.  Today speculators are only required to have $4900 of cash in their accounts for each gold-futures contract they’re trading, so running maximum margin creates huge risk.

Every gold-futures contract controls 100 troy ounces of gold, which is worth $130,000 at $1300 gold.  So speculators can run leverage to gold up to 26.5x today, which is incredible.  At 26.5x leverage, all it takes to wipe out 100% of the capital risked is a mere 3.8% adverse move in gold!  That doesn’t leave much room for error, as 1% to 2% daily gold moves aren’t uncommon.  Traders can literally be destroyed overnight.

Trading gold at such supremely-unforgiving leverage greatly compresses the time horizons gold-futures speculators operate in.  Since the present is so overwhelmingly dangerous to their capital, all they care about is short-term momentum measured in days on the outside.  As a herd they pile on to whatever side of the trade is following gold’s short-term trend, exacerbating it.  When gold is falling, they aggressively short it.

The resulting groupthink makes speculators’ collective gold-futures bets a powerful contrarian indicator.  As gold plunges late in corrections due to heavy shorting, speculators’ selling firepower quickly exhausts itself.  Once their short selling peters out, the downward pressure on gold prices evaporates.  That marks the bottoms of gold corrections, and births major gold uplegs.  That’s the optimum time for all traders to buy low.

The higher prevailing spec shorts, the faster they surged to that peak, and the sharper the resulting gold-price plunge, the greater the odds a major new gold upleg is imminent.  Traders diligent enough to follow the weekly CoT data regularly can see and recognize these spec-shorting extremes as they happen.  In December 2015 as gold languished near deep secular-bear lows, I forecasted “a mighty new gold upleg in 2016.”

As you can see on this chart, spec shorts had soared near all-time record highs.  That portended huge short-covering buying to reverse those overextended bearish bets.  A year later in December 2016 as gold was bottoming in despair ahead of another major upleg, I wrote another essay using this same spec-gold-futures analysis to explain why gold was soon going to surge dramatically higher on futures buying.

And then just recently in July 2017, another near-record spec gold-futures shorting spree marked another major gold bottom.  At the time I pointed out how spec shorts had spiked almost as high as back in late 2015 when they birthed this gold bull.  When speculators are heavily short gold futures by recent or all-time standards, it heralds an imminent big gold rally.  In bull markets that usually means a major new upleg.

Speculators short selling are effectively borrowing gold they don’t own to sell it.  They hope to sell high up front in hopes of later buying back lower to earn profits.  They are contractually obligated to repay those gold-futures debts.  Mechanically they are settled by buying offsetting long contracts to cover and close out shorts.  So all gold-futures shorting is guaranteed near-future buying as those shorts are unwound!

That drives the first stage of gold uplegs.  Short covering tends to be fast and furious, catapulting gold out of major lows rapidly.  Once speculators start to buy to cover, gold moves higher on that demand.  The rallying gold price quickly forces other speculators to cover, or risk catastrophic losses of capital due to their extreme leverage.  So gold-futures short covering is self-feeding until it largely runs its course.

Those initial sharp spec-short-covering-driven gold rallies out of major lows usually spark stage-two gold-futures long buying.  Unlike short-side speculators where gold-futures buying is mandatory to unwind those bets, long-side speculators have no obligation to buy.  But they start getting bullish after short covering pushes gold high enough for long enough.  So they soon take the gold-buying baton from the short guys.

Long-side speculators control much more capital than short-side ones, as evidenced in this chart.  Note how the green total-spec-longs line is usually way above the red total-spec-shorts line.  So once their buying kicks in, gold’s young upleg really accelerates.  The delay from initial short covering to sizable long buying tends to run several weeks or so.  Long-side gold-futures speculators don’t return until gold has rallied.

In this chart check out how short covering and long buying evolved out of the major gold lows seen in December 2015 and July 2017.  The red total-spec-shorts line started dropping immediately out of gold’s lows, showing short covering underway.  But the green total-spec-longs line didn’t start rising until a few weeks or so after that initial short covering.  Stage-one short covering ignites stage-two gold-futures long buying.

While spec short covering usually largely fizzles out in a month or so, spec long buying can persist for months.  That continues to propel young gold uplegs higher.  As gold’s gains driven by futures buying mount, both technicals and sentiment really improve.  The bearishness rampant at the preceding major bottom before the short covering bleeds away.  The longer and higher gold rallies, the more bullishness grows.

Almost without exception, all major gold uplegs are initially birthed by spec gold-futures short covering.  Then they grow from the resulting spec gold-futures long buying.  So speculators and investors alike should closely follow the weekly gold-futures CoT data.  In real-time it flags when gold is likely to bottom and when major new uplegs are likely to ignite.  Then subsequent long buying confirms they are the real deal.

What the gold-futures speculators are collectively doing as a herd is so important to gold’s fortunes that I always analyze the latest weekly CoT data in depth in every issue of our weekly newsletter.  There’s little chance of successfully buying gold relatively low and selling relatively high within ongoing bulls unless you are following these CoT reports.  Their absolute levels and trends are the best gold indicators available.

But ultimately gold-futures speculators are a small group of traders.  Even their long-side buying nears exhaustion after a couple months or so, their capital firepower exhausted.  That stage-one and stage-two gold-futures buying needs to catapult gold high enough for long enough to get investors interested again.  Their stage-three buying is what drives the lion’s share of major gold uplegs.  But futures buying needs to ignite it.

Investors’ stage-three buying was historically far harder to track than the preceding futures buying.  Good gold investment data was only available quarterly from the World Gold Council.  That was far too seldom to catch major correction bottoms and upleg tops.  Thankfully there’s a great proxy for gold investment demand that’s published daily, the physical-gold-bullion holdings of the leading SPDR Gold Shares gold ETF.

Stage-three gold-upleg buying data comes from GLD’s holdings.  As I explained a couple weeks ago in an essay on gold investment resuming in our current upleg, GLD capital flows dominate gold trends.  Rising GLD holdings indicate stock-market capital is flowing into gold via that ETF conduit, which bids it higher.  Conversely falling GLD holdings reveal stock-market capital is exiting gold, which pushes it lower.

This last chart looks at GLD’s daily gold-bullion holdings in blue superimposed over the gold price in red.  When GLD’s holdings start rising consistently after a major gold low, it means investors are returning to gold.  Major gold uplegs are only possible if stage-three investment buying takes the baton from the gold-futures speculators.  And GLD’s holdings are the key dataset that enables that to be observed in real-time.

The first massive upleg of this young bull propelled gold 29.9% higher from mid-December 2015 to early-July 2016.  Differential buying of GLD shares was its major driver.  GLD shares have their own supply and demand independent from gold’s.  So when stock investors buy GLD shares faster than gold itself is being bought, this ETF’s share price threatens to decouple from gold to the upside and fail its tracking mission.

That can only be averted by shunting that excess demand into the underlying gold market.  So GLD’s managers issue new shares to offset that differential buying.  Then the capital raised from those sales is immediately plowed into physical gold bullion, boosting this ETF’s holdings held in trust for shareholders.  GLD is effectively a conduit for the vast pools of stock-market capital to flow into and out of the gold market.

In early 2016 gold entered a new bull market out of a deep 6.1-year secular low because stock investors flooded back into gold via GLD shares.  The stock markets were plunging in their worst correction since mid-2011, rekindling interest in prudently diversifying stock-heavy portfolios with gold.  It’s a rare asset that tends to move counter to stock markets, so investment demand soars when stocks materially weaken.

Over the next 6.7 months, American stock investors poured so much capital into GLD shares that its holdings surged an epic 55.7% or 351.1 metric tons!  That GLD buying alone accounted for nearly all of the total increase in world gold demand in the first half of 2016.  That on top of the 82.8k contracts of gold-futures short covering and 249.2k contracts of gold-futures long buying fueled gold’s new bull market.

Without that stage-three investment buying taking the lead from the igniting gold-futures buying, gold probably wouldn’t have rallied 20%+ to officially enter bull territory.  And just recently investment buying started returning which confirms this gold bull’s second major upleg is well underway.  Unlike the gold-futures buying which exhausts itself in a few months at most, investment buying tends to run for many months.

Investors love chasing winners, nothing drives buying like higher prices.  The more investors bid up gold through differential GLD-share buying, the more its price rallies.  The more gold rallies, the more other investors want to join in to ride the momentum.  Buying begets buying.  That’s true for all forms of gold investment, not just gold ETFs.  But the daily reporting of gold-ETF holdings makes their buying more visible.

Each of gold uplegs’ first two stages of buying drives gold high enough to trigger the next larger stage.  And each stage transition yields important signals to speculators and investors.  Understanding where gold is in these three stages is essential to gaming where it is likely heading.  With the data necessary to track these stages available in real-time, traders following it can really boost their odds of buying low and selling high.

New gold uplegs start at major lows driven by excessive speculator gold-futures shorting.  That selling soon exhausts itself, then these traders have to buy proportionally to reverse and close out their shorts.  That stage-one short-covering buying launches new gold uplegs, and drives gold high enough for long enough to get the long-side gold-futures speculators interested.  They soon take the gold-buying baton.

Between peak spec shorts and spec long buying starting as evidenced by rising longs is the best time to buy into gold in an ongoing bull market.  Those events are unambiguous, as once spec shorts start falling from highs they rarely reverse.  Total spec longs are relatively low when short covering starts too, and they don’t start rising materially for a few weeks.  So if you know what to look for, those buying signals are clear.

Later on the young gold upleg is confirmed first by sustained spec long buying and later by sustained investor buying.  Once stock investors’ differential GLD-share buying starts pushing this leading ETF’s holdings consistently higher, the gold upleg is fully verified.  By that point it’s pretty much unstoppable barring some weird anomaly, totally self-feeding.  Nothing drives gold investment demand like rallying gold!

The recent surge in GLD’s holdings in gold’s current upleg confirms investors’ stage-three buying is now underway.  This will likely run for many months.  If the stock markets finally seriously roll over under the ominous Fed quantitative tightening, that gold investment buying could last much longer than normal.  So odds are gold’s current upleg has a long ways to run yet, both in terms of price and time.  That’s very bullish.

This bull market’s latest upleg can certainly be played with GLD, but that will merely pace gold’s gains.  Far greater upside will come in the gold miners’ stocks with superior fundamentals.  Their profits really amplify rallying gold prices, fueling leveraged stock-price gains relative to gold.  Despite their major breakouts in recent months, gold stocks remain deeply undervalued relative to gold.  Their upside potential is vast.

The key to riding any gold bull to multiplying your fortune is staying informed, both about broader markets and individual stocks.  That’s long been our specialty at Zeal.  My decades of experience both intensely studying the markets and actively trading them as a contrarian is priceless and impossible to replicate.  I share my vast experience, knowledge, wisdom, and ongoing research through our popular newsletters.

Published weekly and monthly, they explain what’s going on in the markets, why, and how to trade them with specific stocks.  They are a great way to stay abreast, easy to read and affordable.  Walking the contrarian walk is very profitable.  As of the end of Q2, we’ve recommended and realized 951 newsletter stock trades since 2001.  Their average annualized realized gain including all losers is +21.2%!  That’s hard to beat over such a long span.  Subscribe today and get invested before this young gold upleg matures!

The bottom line is gold uplegs within ongoing bull markets have three distinct stages of buying.  They are first birthed by gold-futures speculators covering shorts.  That pushes gold high enough for long enough to convince long-side gold-futures speculators to return.  Their larger buying eventually grows young gold uplegs big enough to rekindle investment demand.  Once investors start buying, gold uplegs are off to the races.

Identifying these three stages and their transitions as they happen is essential to optimizing buy and sell timing within gold bull markets.  So following speculators’ gold-futures data in the weekly Commitments of Traders reports, and the daily GLD-holdings data revealing stock-investors’ gold capital flows, is truly essential.  Investors and speculators greatly increase their odds for success by staying informed on this.

Adam Hamilton, CPA

September 29, 2017

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