Gold has faded from interest in the past couple months, overshadowed by the monster stock-market rally.  But gold has been consolidating high, quietly basing before its next challenge to major $1350 bull-market resistance.  A decisive breakout above will really catch investors’ attention, greatly improving sentiment and driving major capital inflows.  With gold-futures speculators not very long yet, plenty of buying power exists.

Last August gold was pummeled to a 19.3-month low near $1174 by extreme all-time-record short selling in gold futures.  The speculators trading these derivatives command a wildly-disproportional influence on short-term gold price action, especially when investors aren’t buying.  Gold-futures trading bullies gold’s price around considerably to majorly, which can really distort psychology surrounding the gold market.

The main reason is the incredible leverage inherent in gold futures.  This week the maintenance margin required to trade a single 100-troy-ounce gold-futures contract is just $3400.  That’s the minimum cash traders have to keep in their accounts.  Yet at the recent $1300 gold price, each contract controls gold worth $130,000.  So gold-futures speculators are legally allowed to run extreme leverage up to 38.2x!

That’s extraordinarily risky of course.  A mere 2.6% adverse move in gold against traders’ fully-leveraged positions would result in 100% total losses.  It’s amazing these guys can sleep at night.  For comparison, the stock markets’ legal limit has been 2x leverage since 1974.  10x, 20x, 30x+ is crazy, and has been very problematic for gold for decades.  It greatly amplifies gold-futures speculators’ impact on gold prices.

Every dollar deployed in gold futures at 30x leverage literally has 30x the influence on gold prices as a dollar invested in gold outright!  So even though gold-futures speculators have far less capital available than investors, it is way more potent amplified up to 38x!  Thus when gold investment demand is weak like recently with stellar stock-market complacency, gold-futures speculators utterly dominate gold price action.

Their collective trading effectively controls gold psychology too, since the American gold-futures price has become the world’s leading gold reference one.  Investors start feeling bullish on gold and buying usually only after gold-futures speculators push its price higher.  And gold-futures selling leaves investors bearish and worried, impelling them to exit gold.  Gold-futures trading is the tail that wags the gold-investment dog!

So everyone interested in gold has no choice but to follow what the gold-futures speculators as a herd are doing.  The US Commodity Futures Trading Commission publishes weekly data showing their collective positioning, the famous Commitments of Traders reports.  They are released late Friday afternoons, and show traders’ aggregate gold-futures long and short contracts held as of the preceding Tuesday closes.

Despite gold’s solid upleg since those deep mid-August lows, these traders still have lots of buying power left to push gold considerably higher.  This first chart superimposes the daily gold price in blue over specs’ weekly total gold-futures long and short contracts in greed and red.  The great majority of gold’s upleg-to-date gains have been driven by short-covering buying.  Very bullishly the larger long buying is still yet to come.

In mid-August when today’s gold upleg was born, speculators’ total gold-futures shorts rocketed way up to 256.7k contracts!  That was the highest witnessed in the 19.6 years since early 1999, almost certainly an all-time record.  That unprecedented orgy of extreme shorting hammered gold from roughly $1300 down to $1175 in a couple months or so.  That sharp futures-driven gold plunge naturally devastated psychology.

The gold-futures traders were effectively borrowing gold they didn’t own to dump in the markets, hoping to buy it back later at lower prices and profitably repay those debts.  They were doing it at extreme 30x+ leverage, proportionally amplifying their capital’s price impact.  That record shorting spree had nothing to do with fundamentals, it was a snowballing momentum thing.  Yet investors were spooked into selling in sympathy.

In mid-June when gold traded just over $1300, total spec shorts were only 100.3k contracts.  But over the next 10 CoT weeks they skyrocketed 156% higher to that record 256.7k.  The resulting gold carnage led American stock investors to sell shares in the leading GLD SPDR Gold Shares gold ETF much faster than gold was being sold.  That forced its gold-bullion holdings 60.1 metric tons or 7.2% lower in that short span!

Gold bottomed the very week gold-futures short sellers had exhausted themselves, reached the limits of their available capital.  Since then gold has powered nicely higher on balance, enjoying a 14.2% upleg over the next 6.2 months into mid-February.  Gold peaked near $1341 then and has been consolidating high ever since.  This upleg has been almost fully driven by gold-futures buying, which is totally normal.

To close gold-futures short positions and repay those debts, speculators have to buy gold-futures long contracts to offset them.  They bought to cover an enormous 112.3k short contracts in this upleg’s span, mostly unwinding last summer’s record shorting spree.  They also added another 46.8k long contracts, leveraged upside bets on gold’s price.  Despite all that gold-futures buying, there is still room for much more.

Major gold uplegs have three stages, each driven by distinctive buying from different groups of traders.  Uplegs are always born and initially fueled by gold-futures short covering, as speculators are motivated to buy to cover and realize their shorting profits.  Short covering quickly becomes self-feeding, as resulting fast gold-price gains force other short-side traders to rapidly buy to cover or face catastrophic leveraged losses.

Thus that stage-one short-covering buying quickly burns itself out after a couple months or so.  But it first pushes gold high enough for long enough to convince long-side gold-futures speculators to return.  They command way more capital than the short-side guys, as evidenced by the green long line in this chart usually being much higher than the red short line.  Spec gold-futures long buying is uplegs’ second stage.

That unfolds more gradually than short covering, typically 6 months or longer.  Long-side traders not only have lots more capital to deploy, but their buying is voluntary.  They have to really believe gold is heading higher to make such risky hyper-leveraged upside bets.  In contrast short covering is mandatory and often involuntary, as those effective debts must legally be repaid.  Stage-one buying directly ignites stage two.

Gold has real bull-market breakout potential in the coming months because this current upleg hasn’t yet seen much gold-futures long buying.  Stage two is underway, but the majority is likely still yet to come.  The green total-spec-gold-futures-longs line above proves this.  At best in mid-February near gold’s latest high, total spec longs peaked at 305.0k contracts.  And they have since retreated sharply to 243.8k as of last Tuesday.

Both levels are really low by bull-to-date precedent.  This young secular gold bull was born out of deep 6.1-year secular lows in mid-December 2015.  Its maiden upleg was big and fast, gold rocketed 29.9% higher in just 6.7 months in essentially the first half of 2016.  As that peaked in early July 2016, total spec longs hit an all-time record high of 440.4k contracts!  Gold-futures traders piled on, helping fuel big upside momentum.

Total spec shorts that same CoT week ran 100.2k contracts.  That upleg had been partially driven by the gold-futures speculators buying a monster 249.2k longs while covering 82.8k shorts.  Gold crested at $1365 in early July, which remains this bull’s best level today.  Over the subsequent years $1350 would repel gold multiple times, becoming major overhead resistance as gold kept failing to break out above it.

Speculators soon started to unwind their excessive long positions, helping hammer gold 17.3% lower by mid-December 2016.  That heavy gold-futures selling was greatly exacerbated by stock markets surging after Trump’s surprise election victory.  This gold bull’s second upleg emerged from the ashes, driven first by gold-futures short covering which soon ignited gold-futures long buying.  That was also the first upleg’s order.

Gold powered another 20.4% higher to $1358 by late January 2018, and once again gave up its ghost right near that key $1350 resistance.  Gold-futures speculators ultimately played a smaller role in that upleg as investors returned.  Gold investment buying is the third stage of gold uplegs, which can grow far larger than gold-futures-driven stages.  Futures buying is a two-stage ignition mechanism to attract investors.

Total gold-futures longs only climbed 80.6k contracts during that second upleg, while shorts only slipped 4.1k.  That’s somewhat misleading though, as the precise upleg dates mask the green long line trending higher while the red short line trended lower.  When that upleg peaked, total spec longs and shorts were running 356.4k and 121.9k contracts.  The former was still much higher than today’s levels, a very-bullish omen.

This gold bull’s first two uplegs failed with total spec longs far higher than today’s 243.8k, averaging 398.4k contracts.  Second-stage spec long buying has exhausted itself and killed uplegs between roughly 350k to 450k contracts in this gold bull.  So the sub-250k levels seen last Tuesday remained way too low to likely signal a mature gold upleg.  Speculators still have room to do the majority of their stage-two long buying!

This gold upleg is highly likely to see at least another 100k contracts of long buying, and potentially up to 200k if gold returns to favor!  That is the gold-futures equivalent to another 311 to 622 metric tons of gold.  That will almost certainly catapult gold much higher, just like during this bull’s prior uplegs.  Given where gold is today, this creates major bull-market breakout potential.  A concerted assault on $1350 is likely.

Throughout this entire gold bull, gold has never been higher with sub-250k spec longs than it is today near $1300!  Usually the yellow metal was only around $1250 at this kind of positioning.  So we are now witnessing gold’s highest basing in its bull market relative to spec longs.  $1350 isn’t much higher than $1300, just another 3.8%.  There’s a good chance the remaining stage-two buying will drive gold there.

While it’s certainly not exact, 50k contracts of gold-futures long buying in this bull’s other gold uplegs have often pushed gold $50 higher.  Again we are almost certain to see another 100k and potentially a best case of 200k.  So gold has never been better positioned in this bull market to surge up to and through its multi-year $1350 resistance!  A decisive breakout above $1350 would change everything in the gold market.

Gold-futures speculators are necessarily trapped in the short term by their extreme leverage.  They don’t care what gold does, they just want to ride its momentum.  Investors are way different, with no leverage at all they have a long-term focus.  There’s nothing that excites them more, and drives more capital inflows into gold, than new bull-market highs.  Higher highs prove gold is still marching, portending more future gains.

Investors haven’t seen a new gold-bull high since way back in early July 2016, which feels like forever ago in these markets.  As the months and years paraded by and gold kept failing to best $1350, most investors gradually lost interest in gold.  While its bull-market lower-support zone has gradually risen, the horizontal upper resistance really tainted psychology.  Gold has been viewed as consolidating, not in a bull.

But 100k to 200k contracts of spec gold-futures long buying starting near $1300 has real potential to blast gold back above $1350.  A decisive breakout is 1%+ beyond that, or $1364.  Once gold climbs back over $1365, it will start hitting new bull-to-date highs.  That will bring gold back into the financial news in a big way, rekindling investor interest and capital inflows.  The resulting bullish sentiment becomes self-feeding.

Major stage-three investment gold buying gets way more likely the higher gold forges above $1350.  It’s ironic that although investment is all about buying low when assets are out of favor, the great majority of investors instead prefer to buy high.  They love chasing winners, and increasingly crowd into positions the higher their prices climb.  There’s no doubt new bull-market gold highs will fuel big excitement in this metal.

Gold’s bull-market breakout potential in the coming months is amplified by a couple other major factors.  Gold is in a seasonally-strong time of the year, enjoying its seasonal spring rally.  That provides a solid sentimental tailwind that should help motivate gold-futures speculators to continue rebuilding their low gold-futures long positions.  Their buying also becomes self-feeding the higher and longer gold runs.

Far more importantly, gold-investment levels are really low thanks to the monster stock-market rally since late December.  With the US stock markets skyrocketing from ugly near-bear severe-correction lows to nearly regaining September’s all-time highs, complacency and euphoria are epic.  Stock investors have virtually no fear of a major stock-market selloff, which like usual has greatly retarded gold investment demand.

But these lofty stock markets are dangerously overvalued and overbought, heading into a Q1’19 earnings season which is looking to be the weakest in years.  When the stock markets roll over again, investors will again remember the wisdom of prudently diversifying their stock-dominated portfolios with gold.  It tends to rally when stock markets weaken, a rare and desirable quality.  The next material stock selloff will goose gold.

Back in December when the flagship US S&P 500 stock index plunged 9.2%, gold surged 4.9% higher.  Any material stock-market selloff, regardless of the reason, will quickly rekindle gold investment demand.  And if investors start buying even before gold-futures speculators’ stage-two long buying is complete, a decisive breakout back above $1350 is all but certain.  This gold bull’s upside breakout potential is very real.

The biggest beneficiaries of higher gold prices reviving interest in its bull market will be the gold miners’ stocks.  The major gold miners of the GDX VanEck Vectors Gold Miners ETF usually amplify gold’s own moves by 2x to 3x.  So a 10% gold rally will often translate into 20% to 30% GDX gains.  But when gold really shifts back into favor among investors, the upside can be far greater.  We’ve already seen that in this bull.

This GDX gold-stock-bull chart is updated from last week’s essay, where I explained the bullish gold-stock situation in depth.  So check that out if you need to get up to speed.  But for our purposes today, note the last time gold powered to new bull-market highs exciting investors was during this bull’s first upleg largely in the first half of 2016.  GDX skyrocketed 151.2% higher in essentially the same span of that 29.9% gold upleg!

That made for outstanding 5.1x upside leverage to gold from the major gold miners.  The smaller mid-tier and junior gold miners of the GDXJ VanEck Vectors Junior Gold Miners ETF did even better.  With their superior fundamentals and lower market capitalizations, mid-tier upside is much better than the majors.  Even if gold merely challenges $1350 again, the gold stocks will surge dramatically higher as traders flock back.

So while the lack of interest in gold and its miners’ stocks these days is understandable, it is unfortunate.  The biggest gains are won by buying relatively low before everyone gets excited about an asset or stock sector.  Once gold and the gold stocks start surging again as $1350 nears, speculators and investors alike will have to buy much higher.  Deploying aggressively before new bull highs should yield impressive gains.

One of my core missions at Zeal is relentlessly studying the gold-stock world to uncover the stocks with superior fundamentals and upside potential.  The trading books in both our popular weekly and monthly newsletters are currently full of these better gold and silver miners.  Mostly added in recent months as gold stocks recovered from deep lows, our unrealized gains are already running as high as 76% this week!

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The bottom line is this gold bull now has the highest major-upside-breakout potential of its entire lifespan.  This latest gold upleg fueled by gold-futures buying hasn’t matured yet, as speculators’ long positioning remains quite low.  For the first time in this bull, gold is already consolidating high around $1300 before most of the likely gold-futures long buying has run its course.  That makes an assault on $1350 very likely.

If gold can break decisively above that multi-year resistance and start forging new bull-market highs, its psychology will greatly improve.  Investors will take notice and start buying again, driving gold higher and fueling mounting bullishness.  The gold miners’ stocks will be the biggest beneficiaries of new bull-market gold highs.  Their stocks soared the last time investors were excited about this gold bull, rapidly multiplying wealth.

Adam Hamilton, CPA

April 15, 2019

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