Gold’s Dollar Risk

Gold’s massive record-shattering bull run over these past couple years has been epic.  Remarkably it has also been a single monster upleg suffering no correction-grade selloffs.  But gold has just rocketed back up into extreme-overbought territory.  That greatly ups the odds a considerable selloff is due to rebalance super-stretched technicals and sentiment.  The US dollar’s fortunes are a major risk factor for triggering one.

From early October 2023 to midweek, gold has soared an extraordinary 112.3% higher!  This colossal bull run first lifted gold to a new record close in early December 2023, and has now achieved a phenomenal 84 in total.  Gold’s performance over the past quarter-century or so has now nearly doubled the S&P 500’s.  Starting from each’s major secular low back in the early 2000s, gold has soared 1,405% to the SPX’s 764%!

Superlatives fail to do gold justice, it has been utterly magnificent.  But even the mightiest bull markets are never linear, they flow and ebb taking two steps forward before one step back.  The latter periodic selloffs are essential, keeping bulls healthy and maximizing their longevity.  They bleed off excess herd greed and normalize way-overextended technicals.  Gold is once again at one of those selloff-imminent junctures.

Two weeks ago I wrote an essay “Gold Pretty Stretched” analyzing its extreme overboughtness in the context of this colossal bull.  Overboughtness can be measured by how far gold surges above its baseline trailing 200-day moving average.  At that point the most stretched gold had been recently was 18.5% over its 200dma.  Unfortunately that has grown much worse since, with gold surging to 21.6% over midweek!

As discussed then, this is gold’s fourth episode of extreme overboughtness in this mighty bull run.  The first three all ended in high consolidations rather than corrections, which is remarkable.  Strong foreign gold demand blunted the usual selling forcing bigger retreats.  Sideways drifts can accomplish the same rebalancing mission as selloffs, but take much longer to do it.  And within those gold suffered sub-10% pullbacks.

This mighty gold bull’s bigger pullbacks within high consolidations have run 4.0%, 5.7%, 8.0%, and 7.1%.  So the best-case scenario out of this latest extreme overboughtness is probably a multi-month sideways drift interspersed with 4%-to-8% selloffs.  But having seen no corrections in two years, this selloff could prove much worse.  Technically any correction-grade selloff over 10% but less than 20% keeps gold’s bull alive.

While it would be great if gold consolidated high again like it did during this past summer, outside of this amazing bull that’s unusual behavior following extreme overboughtness.  So we have to prepare our portfolios and gird ourselves psychologically for a big-and-fast 10%+ correction.  That primarily involves tightening up trailing stop losses to preserve more of our massive unrealized gains in gold and its miners’ stocks.

Corrections out of extreme overboughtness are typically sparked by some catalyst.  And the fortunes of the US dollar are a leading candidate, because gold-futures speculators closely watch the US Dollar Index for their main trading cues.  Normally spec gold-futures trading is the primary driver of short-term gold price action, because of the extreme leverage inherent in this realm.  These guys punch way above their weights.

As of midweek, each 100-ounce gold-futures contract controlled about $386,000 worth of gold.  Yet the COMEX margins only required traders to keep $17,000 cash in their account for each contract traded.  That enables crazy leverage as high as 22.7x!  Way up there, a mere 4.4% gold move against specs’ bets would wipe out 100% of their capital risked!  That forces them to have myopic ultra-short-term time horizons.

Once gold starts selling off materially, speculators have to pile on or risk ruin.  Their additional leveraged gold-futures selling accelerates gold’s downside, pressuring more specs to dump their longs and add shorts.  This can result in cascading gold-futures-driven selling hammering gold.  And unfortunately spec gold-futures positioning today shows these living-on-the-edge traders have way more room to sell than buy.

It’s useful to consider total spec longs and shorts as percentages of their trading ranges in this mighty gold bull.  The most-bullish near-term setup for gold is when they are effectively all-out, with 0% longs and 100% shorts.  That leaves them massive room to add longs and buy to cover shorts, which catapults gold higher.  Conversely the most-bearish scenario for gold is the opposite, when specs near 100% longs and 0% shorts.

That means their probable capital firepower available for buying more gold futures is likely exhausted, they are effectively all-in.  They have vast room to dump longs and short sell, but little to keep buying.  On top of this, spec longs are proportionally more important than shorts in determining gold’s near-future direction.  Over the past 52 reported weeks, spec longs have outnumbered shorts by an average of 4.2x.

Speculators’ gold-futures-positioning data is only reported once a week in the famous Commitments of Traders reports.  These are current to Tuesday closes, but not released until late Fridays.  Unfortunately the bureaucrats at the CFTC aren’t going to publish CoTs during this government shutdown, even though they will later get full backpay!  So the last-available CoT potentially for awhile was current to September 23rd.

At that point total spec longs and shorts were running 73% and 29% up into their gold-bull trading ranges, deep into that bearish-for-gold side at 100% longs and 0% shorts.  If that was gold’s sole headwind, it might be manageable given this bull’s strong foreign demand.  But couple bearish spec positioning with gold’s extreme overboughtness and the current US-dollar technical situation, and gold-futures-selling risks soar.

This chart superimposes gold over the US Dollar Index during the last several years or so.  It is divided into major USDX swings, noting how both gold and the dollar fared in them.  If the USDX was up near a major high today, it wouldn’t be likely to rally far minimizing the risk of it triggering cascading gold-futures selling.  But ominously the USDX is now grinding along near major secular lows, so it could surge big anytime!

Speculators’ gold-futures trading often driven by the US dollar’s fortunes certainly isn’t gold’s only driver.  Still even in this remarkable bull run in recent years, gold has tended to move in opposition to big USDX swings.  15 separate ones are marked off on this chart.  During fully 13 of those or almost 7/8ths, gold moved in the opposite direction of the US dollar!  It still holds considerable sway over short-term gold action.

The USDX’s latest big swing was swooning 3.4% over 1.5 months into mid-September, culminating in a deep 3.6-year secular low.  That happened on FOMC Eve, the day before the Fed resumed cutting rates with a 25-basis-point cut.  Gold wildly-outperformed in that latest dollar-weakness span, blasting 12.2% higher as it broke out of its summer high consolidation!  But again that has left gold extremely overbought.

For gold, extreme overboughtness starts at 1.18x its 200dma based on the last five years’ precedent.  For the US Dollar Index, extreme oversoldness starts at 0.94x its 200dma.  In mid-September at that secular low the USDX traded at 0.946x, and in early July it had plunged as low as 0.933x!  Again gold has just soared to 1.216x its own 200dma as of midweek.  So with gold exceptionally high, the USDX is exceptionally low.

For long years gold was mostly slaved to the dollar’s fortunes due to the outsized impact of that hyper-leveraged gold-futures trading.  Often gold versus the USDX was the former’s whole technical story.  This mighty gold bull has broken the dollar’s tyranny over gold, again due to strong foreign gold demand.  Despite that, in recent years gold still tended to rally when the USDX weakened and retreat when it strengthened.

If gold wasn’t extremely overbought today, this low dollar wouldn’t be much of a threat.  If speculators’ gold-futures positioning was very bullish for gold, this weak dollar wouldn’t be too concerning.  But with gold deep into extreme-overbought territory and specs’ collective gold-futures bets quite bearish for gold, this low dollar is now a serious threat.  Any material USDX rally is likely to spawn cascading gold-futures selling.

Technically the dollar is certainly long overdue for a strong mean-reversion bounce rally.  The USDX has generally ground sideways on balance in recent years, but has plunged way under support.  The middle of that secular trading range is up near 103.5, or 5.9% higher than midweek levels.  But after long periods out-of-trend, proportional overshoots the other direction often happen.  The USDX’s upper resistance is near 107.0.

That is a whopping 9.5% higher from current levels, a huge rally in major-world-currency terms!  And 107 wouldn’t be unusual at all, as the USDX recently spent the better part of several months above it straddling late 2024 and early 2025.  A mean-reversion dollar rally isn’t just probable technically, it will likely soon have some big fundamental support.  Part of that is the Fed’s expected federal-funds-rate trajectory.

The main reason the USDX was so weak into FOMC Eve was traders were gaming the resumption of Fed rate cuts.  The Fed delivered, cutting 25bp for the first time since mid-December 2024 while the top Fed officials collectively projected two more 25bp cuts at the FOMC’s two remaining meetings in 2025.  But more cuts this year are tenuous, as Fed guys’ FFR projections on the quarterly dot plot are notoriously inaccurate.

Of the 19 top Fed officials making FFR projections in mid-September, just a narrow majority of 10 saw two more rate cuts this year.  The other 9 expected one cut, zero cuts, or even a rate hike by year-end!  So if just a couple-few Fed officials change their minds, more rate cuts this year could dwindle.  Better-than-expected economic data could spur that, but so could other factors not dependent on financial newsflow at all.

Top Fed officials continue to universally claim they are targeting 2% inflation, which is also mentioned in every FOMC statement.  The Fed guys like to measure inflation with the core-PCE metric.  In their latest Summary of Economic Projections in mid-September, they forecast that running 3.1% exiting 2025 which is still really hot.  So if inflation doesn’t come down soon or accelerates for any reason, there will be fewer cuts.

For decades top Fed officials have continued to make clear that they value Fed independence from the US government above all else.  Trump has immensely pressured the Fed to aggressively cut rates all throughout his second term, including ridiculing the Fed chair and trying to stack the Fed’s governors with Trump’s people.  The Fed guys could sour on cutting more simply to assert their independence from Trump.

If traders’ expected federal-funds-rate trajectory shifts higher for any reason, odds are this oversold and bombed-out US dollar will catch a big bid.  And once the dollar establishes some upside momentum, it will likely be chased accelerating the USDX gains.  That will almost certainly shake loose considerable gold-futures selling, potentially hammering gold lower.  An overdue dollar mean-reversion rally is a big risk for gold.

And while top-Fed-official machinations are the most-likely dollar-strength trigger, they aren’t the only one.  The US Dollar Index is utterly dominated by the euro at 57.6% of its weighting!  The Japanese yen at just 13.6% is a distant second.  For the most part, the USDX is and trades like a dollar-euro pair.  And like usual, Europe has endless problems which could weaken the euro automatically resulting in a stronger dollar.

Examples are legion including crushing debt burdens, sluggish economic growth, stifling overregulation, insufficient energy production, and weak export demand.  Europe also has a huge Russia problem, with Vladimir Putin itching for a broader war probing NATO defenses and resolve.  Yet Europe continues to buy vast amounts of energy from Russia directly funding Putin’s war machine.  This could all go pear-shaped fast

Putin is going to continue his brutal war against Ukraine as long as he can find soldiers to throw into that meat-grinder.  And he could very well launch covert or overt military operations against other European countries on Russia’s border.  He could threaten to choke off Europe’s natural-gas supplies this winter.  All kinds of bad things could happen over there, and most would likely weigh on the relatively-high euro.

Currency traders often look at interest-rate differentials between countries.  The Fed’s federal-funds rate is currently set at 4.13% after mid-September’s cut.  That is still more than double the European Central Bank’s main deposit rate now at 2.0%!  So even if the Fed cuts a couple more times, rates underlying the US dollar will still support much higher yields than those for the euro.  That also argues for dollar strength.

Considered alone this low-and-oversold US dollar might not matter much to gold.  But with gold deep into extreme-overbought territory with gold-futures speculators positioned for big selling, an overdue USDX rally could trigger snowballing long dumping.  That could hammer gold sharply lower, fueling a necessary big-and-fast selloff to rebalance its stretched technicals and sentiment.  Traders need to prepare for this risk.

For us at Zeal, that means ratcheting up the trailing-stop-loss percentages on our extensive newsletter gold-stock trades that have massive unrealized gains.  As of midweek, those were running as high as +106% even on young trades added since late June!  Tighter stops will protect more of our big gains if gold rolls over hard.  Later we’ll use that stopped-out cash to redeploy much lower after gold stocks correct.

But after a quarter-century intensely studying and actively trading gold stocks, I think the bigger risk is psychological.  With gold and gold stocks soaring to new records, legions of new traders are flooding in to chase their gains.  That’s great, as growing constituencies are long-term-bullish for gold and its miners’ stocks.  But if new guys jump in then soon get slammed with a fierce correction, that could break their spirit.

All speculators and investors are much better off knowing a gold correction is highly-probable here than being surprised when it unfolds.  Gold and especially gold stocks have always been volatile, which is a key reason they are so darned profitable to trade.  Realizing when market conditions favor selloffs rather than further rallying can really mitigate drawdowns’ psychological impact.  Forewarned is forearmed in the markets!

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The bottom line is gold faces a big risk today in the US dollar’s fortunes.  Now grinding along near major secular lows, the USDX is overdue for a strong mean-reversion rally.  Dollar strength has usually weighed on gold even during its mighty bull of the last couple years.  And gold’s downside risk now is compounded by its current extreme overboughtness coupled with speculators’ gold-bearish positioning in gold futures.

Any gold-futures selling sparked by a resurgent dollar would likely cascade, quickly slamming gold lower.  And there are plenty of reasons the USDX needs to bounce beyond oversold technicals.  The federal-funds-rate trajectory could soon rise as top Fed officials hesitate on continuing to cut rates with festering high inflation.  And the euro which is the other side of the USDX coin has many arguments why it should weaken.

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