Gold suffered a sharp pullback this past month, spawning bearish sentiment. Futures speculators fled on surging Fed-rate-hike odds and new stock-market record highs. That pounded gold lower despite strong investment demand. This healthy sentiment-rebalancing retreat has left gold ready to rally again. Both its technicals and seasonals are very bullish, and futures speculators’ selling overhang has considerably abated.
On September 7th, gold powered 1.1% higher to $1348. That was exactly a 1.0-year high, gold’s best level seen since before Trump’s surprise election victory and the resulting extreme Trumphoria stock-market rally. But since gold had surged 4.9% higher in less than two weeks, greed was mounting again. So a couple trading days later, gold started selling off sharply and birthed this past month’s pullback.
As is usually the case in gold, the pullback spark was multifaceted. When gold had peaked, futures-implied Fed-rate-hike odds for its mid-December meeting were under 32%. But they shot up to 42% on Monday September 11th, when gold’s initial 1.5% drop kicked off this pullback. That day saw a strong relief rally in the stock markets, following a weekend where North-Korea and hurricane-Irma fears failed to materialize.
North Korea didn’t launch another ballistic missile or detonate another nuclear bomb for its Founder’s Day holiday, the anniversary of Kim Jong-un’s grandfather founding the modern country in 1948. And Irma’s eye veered south over Cuba before slamming Florida, dissipating enough of its energy. Thus Florida was thankfully spared from being razed like some of the Caribbean islands that bore Irma’s full force.
So the S&P 500 surged 1.1% that day, hitting its first new record high in five weeks. That lifted perceived Fed-rate-hike odds. As the anti-stock trade that often moves counter to stock markets, gold fell sharply on heavy gold-futures selling. That was pretty much the whole story of this past month’s entire pullback, a parade of new stock-market record highs and higher Fed-rate-hike odds fueling big gold-futures selling.
Thus by this week, gold had retreated 5.7% to $1271 in less than a month. During that span, no fewer than 11 new all-time-record-high S&P 500 closes were witnessed. That’s actually the biggest cluster seen in the entire post-election Trumphoria rally! And futures-implied Fed-rate-hike odds for its December meeting skyrocketed from 32% to 83% in that gold-pullback span. No wonder gold suffered heavy selling.
Big pullbacks always weigh on sentiment, breeding bearishness. So traders are now naturally quite pessimistic on gold’s near-term outlook. But that’s the very reason pullbacks and corrections exist, to rebalance sentiment. That keeps bull markets healthy. The excessive greed seen at major interim highs threatens to suck in too many buyers too soon, exhausting near-term buying. That can prematurely kill bulls.
Major mid-bull selloffs work to bleed away this topping greed. This is especially true for the gold-futures speculators who dominate gold’s short-term price action. As a herd they tend to get excessively long in strong gold rallies leading to interim highs. Pullbacks and corrections force these momentum players to start unwinding those overweight upside bets. Their selling quickly feeds on itself in this hyper-leveraged market.
That ultimately generates fear, restoring psychological balance. This paves the way for buyers to return and drive gold’s next rally higher. That’s where we are today. The past month’s sharp gold pullback has likely largely run its course, close to a major bottoming. This is evident in gold’s technicals, the collective gold-futures positions held by speculators, and gold’s seasonals. Gold’s technicals keep this pullback in perspective.
While a sharp 5.7% drop in just 18 trading days feels miserable, it was no big deal in the grand scheme. Gold’s current bull was born in late 2015, fueled by huge investment demand following the first stock-market corrections in years. This gold bull’s first upleg powered 29.9% higher in just 6.7 months into July 2016. Then gold corrected, which is perfectly normal and expected after all uplegs in healthy bull markets.
But thanks to the extreme Trumphoria stock-market rally ignited by Trump’s surprise win, this gold bull’s first correction snowballed to monstrous proportions. Gold is often hostage to stock-market fortunes, as they effectively control gold investment demand. When stock markets are high, investors feel no need to prudently diversify their stock-heavy portfolios with counter-moving gold. Thus gold languishes in stock euphoria.
That anomalously-large gold correction finally bottomed in December 2016 after a brutal 17.3% loss in just 5.3 months. Nevertheless that remained short of new-bear-market territory at -20%, so gold’s young bull remained very much alive and well. This gold bull’s second upleg has powered higher on balance all year, up 19.5% at best over 8.7 months in early September. This current upleg has proven very impressive.
Gold has carved a well-defined uptrend this year, despite major obstacles. They include the seemingly-endless parade of Trumphoria-fueled stock-market record highs, the Fed’s third and fourth rate hikes of its current cycle, and gold’s usual summer-doldrums low which I warned about in advance. Despite all that, gold kept marching higher. This second upleg’s uptrend is truly outstanding given 2017’s stiff gold headwinds.
As I discussed back in early August, gold usually enjoys a major autumn rally between mid-summer and late September. This year’s proved quite strong, with gold powering 11.2% higher in just 2.0 months by early September. That catapulted gold above its uptrend resistance, and generated plenty of greed. As of early September, gold’s 17.2% year-to-date gain trounced the S&P 500’s 10.1%. Gold is thriving this year!
Again mid-upleg pullbacks are essential to keeping sentiment balanced, ultimately both prolonging and enlarging uplegs. Pullbacks are sub-10% selloffs within ongoing uplegs. Corrections are 10%+ selloffs between uplegs within ongoing bulls. Bull markets without pullbacks and corrections, like these surreal stock markets today, are very dangerous. Suppressing selloffs only delays then later exacerbates them.
Despite gold’s sharp 5.7% pullback in the past month, this current upleg’s technicals are still very bullish. Gold remains well within its upleg’s strong uptrend, well above lower support. And other than the weeks straddling that early-September interim high, this week’s $1270s levels are still among the best seen this year. On top of that gold remains above its trend-defining 200-day moving average, which continues to rise.
So from a pure technical perspective, the bearish gold sentiment these days is totally unjustified. Rather than fearing gold is heading much lower, smart speculators and investors should be salivating at buying relatively low within a strong bull-market upleg. Sharp mid-upleg pullbacks nearing trend support offer the best buying opportunities seen within bull markets outside of the major-correction lows between uplegs.
Most if not nearly all of the gold selling driving this recent healthy pullback came from futures speculators. These traders run extreme leverage that can exceed 25x! Such vast risk forces them to be short-term momentum players. This is evident in this chart showing speculators’ total long and short contracts per the weekly Commitments of Traders reports rendered under gold. These guys have been heavy sellers.
Because of gold futures’ extreme leverage, their speculators punch way above their weight in terms of bullying gold’s price around. It’s impossible to figure out why gold’s price does what it does without first understanding what’s going on in gold futures. Last week I wrote an essay on gold uplegs’ three stages that dives into gold-futures trading in depth. You may need that background to understand this critical chart.
Speculators’ collective gold-futures positions are only reported once a week, current to Tuesdays. Gold peaked at $1348 on Thursday September 7th, which was part of the CoT week ending the next Tuesday the 12th. Total spec gold-futures longs had surged to 400.1k contracts that day, an 11.5-month high. 400k+ is high absolutely too, as the all-time record peak seen in early July 2016 was 440.4k contracts.
That left gold with a futures selling overhang in early September. With these traders largely fully deployed on the long side, they didn’t have much more room to buy. But they had lots of room to sell if something spooked them. And there’s nothing gold-futures speculators fear more than Fed rate hikes. So as the December rate-hike odds rocketed higher in September, these hyper-leveraged traders were quick to sell.
In the first CoT week after that peak, they dumped 23.2k long contracts. In the second CoT week, which is the latest as this essay is published, they jettisoned another 25.1k. Anything over 20k in a single CoT week is huge. So speculators’ gold-futures selling has been fast and furious. The 48.3k long contracts they cast into the markets were the equivalent of 150.2 metric tons of gold! That’s far too much to digest quickly.
According to the World Gold Council’s latest fundamental data, global gold investment demand in the first half of 2017 totaled 699.6t. Divide that by 26 weeks, and it works out to 26.9t per week. So there’s no way the gold-futures speculators’ colossal 75.1t-per-week selling can be absorbed. That’s far too much gold too fast for investment demand to offset. Thus gold fell sharply as supply temporarily overwhelmed demand.
Such extreme selling rates are just as unsustainable from the futures speculators’ side. Out of 978 CoT weeks since early 1999, only 21 or 2.1% have seen spec long-side selling exceed 48.3k contracts in a 2-CoT-week span. Such extreme selling soon peters out, which helps gold bottom. There’s no way that 24k-contract-per-CoT-week spec-long-selling pace can be maintained for long, as long selling is self-limiting.
Speculators’ gold-futures longs are finite. Even in the deep gold despair of late 2016 following that epic Trumphoria-driven gold correction, they bottomed around 254k contracts. They were sitting at 351.8k back on September 26th, the latest CoT data when this essay was published. Since then gold fell still-another 1.8% at worst as of Tuesday this week. So the next CoT report Friday afternoon will show more selling.
If speculators dumped another 20k long contracts, that only leaves 78k over this gold bull’s rock-bottom support. And those levels are seldom seen within uplegs, only between uplegs at the bottoms of major corrections. So a case can be made that the lion’s share of the gold-futures selling that drove this past month’s pullback is likely over. While speculators could sell more, they’ve probably already dumped enough.
Total spec longs certainly aren’t low, but they don’t get low within bull-market uplegs. And spec shorts aren’t high, but they don’t get high without some super-bearish catalyst to drive risky short selling. With those December Fed-rate-hike odds already up at 83%, that eventuality is nearly fully priced in. Those futures-implied Fed-rate-hike odds seldom exceed the mid-80s until a week or so before a hiking FOMC meeting.
Another reason this past month’s gold-futures selling has likely largely run its course is investors are still aggressively buying gold. Futures speculators dominate gold’s short-term trends with their epic leverage, but investors with their far-larger pools of capital drive broader upleg and bull-market trends. While futures speculators rushed to sell last month, stock investors flooded into gold ETFs led by the GLD SPDR Gold Shares.
Again in last week’s essay on gold uplegs’ three stages I explained the crucial GLD mechanics and gold-price impact in depth. In a nutshell, when stock investors buy GLD shares faster than gold itself is rising it forces this ETF to shunt that excess demand and capital into physical gold bullion. In September while gold plunged 3.1%, GLD’s holdings surged 5.9% or 48.2t higher! That reveals very-strong investment demand.
GLD hadn’t enjoyed a bigger monthly holdings build, and thus seen more stock-market capital inflows, since June 2016. That was when gold was in favor as this young bull’s first powerful upleg was starting to top. So to see gold investment demand soaring back toward those levels despite rocketing Fed-rate-hike odds and the biggest Trumphoria cluster of stock-market record highs was remarkable and very bullish.
If investors are already flocking to gold despite these lofty stock markets, imagine how gold investment demand will soar when they inevitably roll over. Remember this entire gold bull was ignited back in late 2015 and early 2016 on the first stock-market corrections in 3.6 years. The next stock-market correction, which is long overdue, will lead to another scramble by investors to prudently diversify their stock-heavy portfolios.
Gold’s seasonals also argue that its pullback is likely largely over, with a major rally imminent. This chart individually indexes gold prices to a 100 baseline within each bull-market year from 2001 to 2012 and 2016. Then all these annual indexes are averaged together to discern bull-market seasonal tendencies. It’s perfectly normal and expected for gold to suffer a major seasonal pullback in late September and October.
In modern bull-market years, gold’s autumn rally tends to top in late September. Specifically it peaks on last month’s 15th trading day on average. That translates this year to Friday September 22nd. Instead gold’s seasonal peak came a couple weeks earlier last month. That may have simply been because gold was overbought, having surged 11.2% in 2.0 months which is much better than the 6.9% autumn-rally average.
After that autumn-rally interim high, gold tends to suffer a seasonal pullback in bull-market years ending in late October. That averages out to this month’s 16th trading day, or Monday October 23rd this year. But since this year’s typical seasonal pullback was pulled forward 11 trading days, it’s not unreasonable to expect it to end proportionally early. That would peg today the 6th as the potential seasonal bottom for gold!
This duration-shifted rationale is flimsy alone, but it gains weight due to the magnitude of gold’s seasonal pullback this year. Gold only tends to retreat 2.2% on average in this late-September-to-late-October span. But this year it has again fallen 5.7% in that rough timeframe, 2.6x the seasonal average. Selloffs generally have a size-and-time tradeoff. The bigger and sharper they are, usually the shorter their duration.
Remember selloffs within healthy ongoing uplegs exist to rebalance sentiment. Greed can be bled away slowly with a gradual shallow pullback, or blasted away rapidly with a sharp deep pullback. And there’s no doubt this past month’s one was the latter in seasonal terms. It should’ve done more than enough work to eradicate early September’s excessive greed and inject fear back into gold-futures speculators.
The really exciting thing is gold’s October seasonal bottom is the last one before this metal’s strongest seasonal rally of the year. On average gold’s winter rally propels it 9.5% higher in bull-market years by late February. That 9.5% winter rally well outguns the 6.9% average autumn rally that recently ended, and dwarfs the 3.8% average spring rally. We are right at gold’s most-bullish time of the year seasonally!
Gold has real potential to enjoy a monster winter rally this year, especially if these insane stock markets start to roll over under the Fed’s just-unleashed quantitative-tightening juggernaut. Just like back in early 2016, gold investment demand will skyrocket again when the long-overdue stock selloff starts generating some fear. This year has again proven gold can rally without weaker stock markets, but they really accelerate it.
And the Fed’s likely December rate hike is nothing to fear despite futures speculators’ paranoia. Gold actually thrives during Fed-rate-hike cycles. It averaged gains of 26.9% in all 11 since 1971 before this current one. During the last one between June 2004 to June 2006, gold soared 49.6% higher despite 17 consecutive rate hikes totaling 425 basis points! In the current cycle to date, this week gold was still up 20.1%.
Despite all the bearishness out there thanks to this past month’s sharp pullback, gold is readying to rally. Its technicals continue to look very bullish, gold-futures speculators’ extreme selling can’t be sustained, investors are still buying big, and gold’s biggest seasonal rally of the year is imminent. These coming major gains as this upleg resumes can be ridden in physical gold bullion or that leading GLD gold ETF.
But far greater upside is coming in the gold miners’ stocks with superior fundamentals. They enjoy big profits leverage that really amplifies rallying gold prices, starting at 2x to 3x for major gold miners and going even higher for smaller ones! The gold miners’ stocks have naturally fallen sharply with gold over the past month. They remain radically undervalued even at today’s gold prices, let alone where gold is heading.
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The bottom line is gold is readying to rally. The sharp pullback it suffered over the past month is normal and healthy, serving to rebalance sentiment. Despite the falling prices and resulting bearishness, gold remains well within its bull-market upleg’s strong uptrend channel. The futures speculators responsible for gold’s selloff can’t keep jettisoning long contracts at the extreme and unsustainable rate seen last month.
Meanwhile stock investors continued aggressively buying gold, driving GLD’s biggest monthly holdings build of this gold bull’s second upleg. Their investment demand will explode when these crazy stock markets inevitably roll over. On top of all that, gold is on the verge of starting its biggest seasonal rally of the year. This past month’s sharp pullback created a fantastic opportunity to buy low before gold starts surging again.
Adam Hamilton, CPA
October 6, 2017
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