Gold's Artificial Lows
By: Adam Hamilton
Fri, Aug 7, 2015
With gold languishing near deep secular lows, its technicals look hopelessly broken. Sentiment is off-the-charts bearish, with traders universally convinced gold is doomed to spiral lower indefinitely. But gold's weakness this year is very deceiving, as it wasn't the product of global fundamental supply-and-demand forces. Extreme record shorting by American futures speculators spawned these artificial lows.
Gold's price is its price, so how the metal got way down here may seem irrelevant. But nothing could be farther from the truth! Fundamentally-driven lows are righteous. If the world gold supply expands faster than demand, or demand contracts faster than supply, then the resulting lows are real. They will persist for as long as fundamentals remain unfavorable, as gold's sellers have no obligations whatsoever to return.
And gold has certainly faced real fundamental headwinds this year. The elite researchers at GFMS, the group that supplies the World Gold Council with its comprehensive supply-and-demand data, recently reported global gold demand dropped 14% in Q2. Provocatively most of this was from plunging demand in China, as local investors were seduced into chasing that crazy stock bubble that subsequently burst.
But the massive year-over-year plunge of nearly a quarter in Chinese investment and jewelry demand for gold failed to impact its price. During that same Q2, gold merely slipped a trivial 0.9%. That means there were enough buyers elsewhere to offset China's popular-speculative-mania-induced drop in demand. And ending Q2 at $1172, gold was just 2% under its initial deep June-2013 low from 2 years earlier.
Gold's recent plunge that ignited a full-blown panic in the absurdly-undervalued gold stocks actually had nothing to do with global fundamentals. It was driven by American futures speculators' extreme record shorting. Such lows are artificial, which is defined as "not arising from natural or necessary causes, contrived or arbitrary". Even more importantly, they are never sustainable due to the nature of short selling.
Gold's latest woes began several weeks ago on Friday July 17th. That day the Chinese central bank finally announced it had much bigger gold reserves than long reported. The People's Bank of China declared its gold reserves were 1658 metric tons, a massive 57% jump from the previous figure which had been reported continuously since April 2009. China finally admitted it was accumulating reserve gold.
This was very bullish news, and probably just the tip of the iceberg. The Chinese government is very shrewd, and knows that if it reports the full extent of its gold buying speculators will pile in forcing it to pay higher prices in the future. So that disclosure was almost certainly only partial. Yet analysts had long been predicting the PBoC's gold holdings were at least 3500t, so the 1658t reported was a disappointment.
So that Friday gold lost 1.0% to $1134, which was unfortunately below this metal's major early-November low. So with gold slumping to a deep new 5.3-year low, it was very vulnerable technically. And American futures speculators' enormous short-side bets on gold were already just 0.1% shy of their all-time record high of 179.0k contracts seen the week before. It was their sharp rise that had battered gold.
It's hard to believe now, but back in late January gold was trading at $1303! Speculators' gold-futures shorts were down near 70.4k contracts then, normal levels. But over the next 22 weeks, they would gradually balloon these downside bets by a mind-boggling 154% or 108.6k contracts. That shorting ramp was wildly unprecedented, nothing close had ever happened before. That's why gold was weak.
Western investors have largely been missing in action in recent years, as capital fled gold to chase the Fed's extraordinary stock-market levitation. With investors out of gold, American futures speculators have free reign to batter the gold price around with their hyper-leveraged bets. Gold's price action since 2013 has been a tale of futures shorting, with the gold price strongly inversely correlated to speculators' shorts.
Even though they borrowed epic amounts of gold futures contracts they didn't own to sell them, and they were legally obligated to buy gold futures soon to pay back those massive debts, they were winning as gold slumped to that new low on Friday the 17th. So they decided to press their bets in a spectacular way as the following trading week opened. It was a devious and Machiavellian strategy that paid off big.
Provocatively, their extreme shorting attack on gold wouldn't even have been possible just a few weeks earlier. Back in early July, the CME shut down its US open-outcry gold-futures trading pits after many decades. Their daily hours of operation had long run from 8:20am to 1:30pm EDT Monday to Friday. So that span is when the vast majority of gold's meaningful price action took place. Shuttering the pits killed that.
The CME took all gold-futures trading electronic, with greatly-extended session hours. Starting in early July, gold futures would be traded from 6:00pm EDT to 5:15pm the following day, from Sunday to Friday. That gave American gold futures a 23.25-hour trading day. But that's problematic, as American traders are asleep or not paying attention for most of that time. There's good reason stock-market trading days are just 6.5 hours.
When most market participants aren't watching, liquidity and volumes are low so it is far easier for a big player to execute buying and selling orders specifically crafted to manipulate prices. And that's exactly what happened on Sunday night July 19th. In the initial hours of that Sunday-evening trading that had started at 6:00pm EDT, gold was stable at its Friday close like usual. Minutes before 9:30pm, everything changed.
Out of the blue, gargantuan gold-futures sell orders slammed the American gold-futures market. Within just over a single minute, someone dumped nearly 24k gold-futures contracts controlling around $2.7b worth of gold! This selling was so extreme that twice within that single minute 20-second trading halts were triggered. That magnitude of selling in such a short time blasted gold $48 lower to $1086 in one minute.
Even before the data confirmed, it was blindingly obvious that this was an extreme shorting attack on gold. A normal long seller would never sell so many gold-futures contracts so fast, as the devastating price impact would impair its own exit price. And no normal seller would unload so much gold at such an illiquid low-volume time in the markets. When I learned of this that very evening, I knew it was short sellers.
Their timing was exquisite. Not only were American traders relaxing late Sunday evening and not paying any attention whatsoever since gold rarely moves then, Japanese traders were gone for a public holiday. And the Chinese markets were due to open within minutes at 9:30pm EDT, so there's no doubt these short sellers were hoping to spark a gold panic in China. $1086 was a fear-spiking new 5.3-year low!
But this extreme gold-price manipulation was so blatant that already-scared Chinese investors thanks to their stock bubble bursting didn't bite. Gold soon rebounded to regain nearly half of those shorting-attack-fueled losses. And this metal actually rallied in the Chinese session on Monday the 20th, with volume on the Shanghai Gold Exchange running 100x July's normal daily volume to that point!
By the time that old recently-ended 8:20am EDT US gold-futures open arrived that day, gold was already back up to $1115. It had gained back 60% of its extreme one-minute losses during first Chinese and then European trading. Considering the new secular gold lows and horrendous sentiment, this was a great show of strength. But then the Western financial media got involved, fanning the flames of panic.
Early on that Monday, all the major news organizations were soberly reporting that gold suffered heavy selling in China. They claimed Chinese investors were being forced to liquidate their gold holdings to meet stock-market margin calls, and implied that this Chinese selling could persist for a long time. But this was total rubbish, absolutely untrue! I was shocked at how false and deceptive that coverage was.
It wasn't Chinese selling, the Chinese actually bought gold that day. All that selling took place in a single minute in the American futures markets Sunday night! If something like the resulting flash crash had happened in the US stock markets, traders would have cried foul and immediately known it was an artificial manipulation attempt. But since no one follows gold anymore, they failed to look into the actual events.
Unfortunately Western traders started selling gold on the new secular lows and false threats of more Chinese forced selling. And gold continued slumping from there over the recent weeks, finally drifting back down to its original shorting-attack low just this week. Not only was the gold flash crash an artificial construct, so was the subsequent weakness. And the fact that short sellers were the culprits was soon confirmed.
Every Friday afternoon, the US Commodity Futures Trading Commission releases detailed reports on futures traders' positions current to the preceding Tuesday. Known as the Commitments of Traders, that week's proved gold's flash crash was a concerted extreme one-minute attack by American-market speculators. Their total shorts soared to a radically-unprecedented new all-time record high of 201.6k contracts!
That was a colossal 22.8k-contract jump in their total shorts in that CoT week, right in line with the 24k contracts that were dumped that Sunday evening. The magnitude of both that flash-crash-inducing short selling and the resulting record speculator gold-futures shorts is incredible. If investors and speculators understood how extreme and unsustainable this is, they would rush to flood into gold with a vengeance.
This first chart looks at American speculators' total long and short gold-futures positions in every CoT week over the past 15 years or so. And the extreme shorting that forced gold to flash crash is eye-popping in this critical chart. Our CoT data goes back to 1999, and speculators' gold-futures shorts had never been higher in that span. And I'm certain they've never been that extreme period, a new all-time record high!
American speculators' total shorts skyrocketing to at least a 16.6-year high, and almost certainly an all-time record, was astounding! This extreme short-selling ramp means 2015's gold weakness and the recent new secular lows are totally artificial. This critical knowledge changes everything on gold's outlook. Short selling is radically different from normal long selling, as it is guaranteed near-future buying.
Short sellers don't own the gold futures they hope to sell high and later buy back low for a profit. So they first have to borrow gold futures from other traders. These contracts must effectively be paid back and therefore repurchased. The actual mechanic employed to close a gold-futures short contract is to buy a long one to offset it. Short sellers are legally and contractually obligated to buy back all the gold they sold!
So exceptional or extreme levels of speculator gold-futures shorting always precede imminent major rallies in gold. This chart highlights many key examples with the red bars. When speculators borrow and sell gold futures so aggressively, they soon exhaust their selling. Short selling using the extreme leverage inherent in futures trading is among the most risky bets one can make in all the world's financial markets.
So there really aren't that many speculators willing to take on potentially-unlimited risk. After this group is already heavily short, only buyers remain. So gold soon starts rallying which forces the short sellers to quickly buy to cover to eliminate their enormous risks. Sentiment also plays a big role here, as the futures speculators get the most bearish right as gold is bottoming just like everyone else in the markets.
With that long perspective in mind of just how extreme American speculators' gold-futures downside bets have become, let's zoom in to the past several years or so. They really prove that even in the most hostile environment imaginable for gold, extreme speculator shorting soon leads to sharp gold rallies as they rush to cover as a herd. The higher speculator shorts, the more bullish gold is in the near term.
The 201.9k contracts American futures speculators were short gold in this latest CoT week is crazy-extreme. The only remotely-comparable episode was back in early July 2013 when they hit 178.9k after the worst quarter for gold in 93 years thanks to wildly-unprecedented market distortions courtesy of the Fed. When gold initially plunged to $1199 in June 2013, everyone was convinced it would keep on dropping.
Yet the futures speculators had such extreme short positions that they had to buy to cover. Over the next 16.0 weeks, they bought 95.3k long gold-futures contracts to offset their record-at-the-time shorts. And as a result, gold rocketed up 18.2% in just 8.6 weeks. That's not trivial. Even from this week's miserable new 5.5-year gold lows, a similar rally today would blast gold back up above $1280. That's a serious rally.
Once speculators start to cover shorts, this process quickly snowballs and feeds on itself. Leverage in gold futures exceeds 30x at max, compared to just 2x in the general stock markets. At 30x leverage, a mere 3.3% gold rally would wipe out 100% of the capital risked by short sellers! So once gold starts to rally, growing numbers of them are forced to rapidly buy to cover or face catastrophic losses far beyond capital bet.
Since every single contract shorted has to soon be offset by buying a long one, the larger speculators' total short position the greater the subsequent rally as they're forced to cover. Even in the recent Fed-distorted years where gold suffered howling headwinds, we've already seen four massive frenzies of short covering by American futures speculators. Each left their total shorts back down near 75k contracts.
That has been the normal level of gold-futures shorting in recent years. It's in line with the normal-year average of speculators holding 65.4k gold-futures short contracts between 2009 to 2012 before the Fed spun up QE3 which seduced most capital into the levitating stock markets. So it's a high-probability-for-success bet that even in this environment speculators will cover enough shorts to shrink them to 75k again.
And that is incredibly bullish for gold in the next few months here. This single group of traders is on the hook to purchase 126.9k gold-futures contracts to repay their excessive debts. And this won't take long, as the average short-covering frenzy since 2013 took just 10 weeks. Once gold starts rallying, these guys can't afford to mess around in light of their extreme leverage and risk. So short covering happens fast.
Now 126.9k contracts of gold-futures buying is the equivalent of a staggering 394.8 tonnes of gold! That equates to a monthly buying rate around 157.9t over 10 weeks. And that is utterly enormous. According to the World Gold Council, global gold investment demand averaged just 68.4t per month in all of 2014. So as futures speculators rush to cover, investment demand would skyrocket to 3.3x recent average levels!
Believe me, when gold investment demand effectively triples gold is going to soar. This has happened multiple times in recent years, even with investors largely absent thanks to the Fed's gross distortions. And with the biggest gold-futures shorting spree ever witnessed fueling such anomalously-extreme record short levels, gold's going to enjoy a far-larger rally than the recent-year average of 16.2% over 10 weeks.
Every major gold low of this surreal QE3 era has been driven by excessive shorting by the American futures speculators. And thus every one of those lows was artificial and short-lived. Shorting-fueled lows are not sustainable, as the very selling that fed them must always reverse into proportional near-future buying. Shorting-driven lows are never righteous, unlike legitimate supply-and-demand-driven ones.
So gold's extreme artificial lows in recent weeks are incredibly bullish. The groupthink consensus view that gold will keep plunging is totally wrong. Gold-futures short selling is finite, and soon burns itself out. Once only a tiny fraction of short sellers decide the risk of a rally is too great to bear so they cover, the resulting gold-price gains force the rest to cover too. Their buying amplifies and intensifies this short covering.
There's nothing more bullish in the markets than extreme record shorts. This guaranteed near-future buying in gold that will catapult it higher can be played in physical gold bullion itself, the leading GLD SPDR Gold Shares gold ETF, or in the extremely beaten-down stocks of the gold miners. I prefer the latter, as they are trading at fundamentally-absurd price levels and will really amplify gold's coming gains.
It amazes me so few people are bullish on gold today given the record extreme speculator gold-futures shorts. Sadly most traders are content to simply run with the herd, to succumb to popular consensus instead of doing their own research. That dooms them to never buying low and selling high, instead they are duped into doing just the opposite. So instead of multiplying their wealth, the markets bleed it dry.
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The bottom line is gold's deep new secular lows are totally artificial. They weren't driven by righteous fundamental gold selling, but by extreme record gold-futures short selling. Speculators seized a rare opportunity to foment a gold flash crash with a Machiavellian exquisitely-timed epic burst of shorting, and succeeded. This was falsely interpreted as legitimate selling, which greatly damaged psychology.
But short selling is anything but normal selling, as excessive shorts are guaranteed near-future buying. All those gold-futures contracts that were borrowed and sold have to soon be bought back and repaid. Thus after extreme gold-futures shorting events, gold always enjoys big and sharp rallies on proportional futures buying. And gold's imminent short-covering rally should be the largest ever, coming from record extremes.