Gold’s Violent Breakdown

CPA, Principal & Co-Founder of Zeal LLC
October 6, 2023

Gold just suffered a violent technical breakdown, plunging even deeper out of favor.  Heavy gold-futures selling has cascaded following the FOMC’s latest hawkish surprise.  That pummeled gold sharply lower, shattering key support zones.  But big gold-futures selling quickly exhausts speculators’ capital firepower.  Then they rush to buy and normalize their excessively-bearish bets, catapulting gold proportionally higher.

Only two weeks ago, gold was looking solid heading into late September’s FOMC meeting.  After closing at $1,931 the day before, the yellow metal just drifted flatlined following Fed officials’ latest decision.  That proved a hawkish surprise, despite no rate hike.  Top Fed officials’ projections for their federal-funds rate at year-end 2024 were boosted 50 basis points, implying two rate cuts next year instead of the previous four.

That should’ve been a nothingburger for markets.  Traders had expected this latest dot plot to moderate to three rate cuts forecast in 2024.  And Fed officials’ FFR projections have proven notoriously inaccurate, as the Fed chair himself warns.  Divining the FFR 15.4 months into the future may as well be an eternity away, as the actual coming FFR trajectory will likely vary radically depending on how the US economy fares.

Gold-futures speculators’ initial meh reaction to such a highly-uncertain far-future FFR-forecast change was logical.  But somehow in the ten trading days since, that metastasized into serious higher-for-longer fears.  Gold sold off in fully nine of those, including sizable 0.8%, 1.3%, 0.9%, and 1.0% down days.  As of midweek, the yellow metal has collapsed a shocking 5.7% since the eve of that latest FOMC meeting!

This violent breakdown is rather dumbfounding considering gold’s pre-FOMC resilience.  In mid-July a US Dollar Index mean-reversion bear rally ignited.  That greatly accelerated a couple weeks later after a Fed-hawkish upside surprise in US Q2 GDP, much of which was revised away one month later.  Momentum-chasing US-dollar buying became self-feeding, blasting the USDX an enormous 5.4% higher into FOMC eve!

The dollar’s fortunes are the primary trading cue used by the gold-futures speculators dominating gold’s short-term price action.  They dump gold futures when the USDX is materially strengthening.  Yet during that 2.2-month span of big-and-relentless dollar rallying, gold merely slid 1.5%!  Gold was overcoming the dollar prior to the FOMC.  Normally gold inversely mirrors material dollar rallies, suffering proportional losses.

Leaving the past couple weeks’ carnage even more perplexing, gold’s 5.7% plummeting happened as the USDX only climbed another 1.5%.  Yet that did restore the usual gold-dollar symmetry over the entire span since mid-July.  During those 2.7 months where the USDX rocketed up a scorching 7.3% at best, gold dropped 6.9%.  Both moves are extreme, looking wildly overextended and overdue to mean revert sharply.

In gold-futures speculators’ defense, they weren’t the only ones who suddenly took Fed officials’ endless higher-for-longer jawboning more seriously.  In that same short post-FOMC span, the flagship S&P 500 US stock index plunged a sizable 4.1%.  And US Treasury selling was ferocious, more brutal than gold’s.  Benchmark 10-year yields soared from 4.36% on FOMC eve to 4.80% this week on that withering bond selling!

There’s only one thing that could crush gold 5.7% lower in just two weeks, massive gold-futures selling.  Those speculators punch way above their weights in bullying around gold prices, mostly because of the extreme leverage inherent in gold-futures trading.  Each contract controls 100 ounces of gold, worth $182,120 at mid-week prices.  Yet specs are only required to maintain $7,800 cash for each contract they trade.

Those low margins enable huge maximum leverage as high as 23.3x, which is actually on the lower side for gold futures!  That means every dollar deployed in them exerts up to 23x the price impact on gold as a dollar invested outright.  Farther amplifying specs’ short-term gold dominance, their gold-futures price is gold’s world reference one.  So how specs as a herd are moving gold really influences investors’ psychology.

This chart superimposes recent years’ gold action over speculators’ total gold-futures longs and shorts.  Unfortunately their positioning is low-resolution data, only published once a week in the Commitments of Traders reports.  That data updated to Tuesday closes is released late Friday afternoons.  So the newest CoT when this essay was published was only current to September 26th when gold closed at $1,900.

That latest spec-gold-futures positioning data covered the CoT week that straddled that FOMC hawkish surprise.  For fully five trading days starting with that market-rattling 2024 dot plot, specs merely sold a tiny 0.9k long contracts.  That left their total longs running 280.8k contracts, right around their tight nine-CoT-week average of 279.1k through most of the USDX’s blistering bear rally!  That was quite telling.

When total spec longs first hit 282.2k on August 1st, the US Dollar Index had just surged 2.5% in several weeks.  While big, that was only just over a third of the total dollar rally since mid-July.  So during the last 2/3rds of those powerful gains, specs effectively ceased all long dumping!  That implies either their capital firepower for selling or will to sell was exhausted.  Overall for gold, spec longs are more important than shorts.

On average over this past year, total spec longs outnumbered shorts by 2.5x.  The green longs line above is always much higher than the red shorts one.  With longs stable as the dollar soared, it was shorting that fueled gold’s initial breakdown.  During that same FOMC-straddling CoT week, spec shorts surged 17.2k contracts.  That’s nearing the huge threshold for any single CoT week, a 20k+ move in either longs or shorts.

That propelled total spec shorts to very-high levels of 145.9k contracts.  In recent years they’ve only been a bit higher briefly in mid-2022.  That was when the USDX rocketed parabolic to extreme multi-decade highs on epic Fed rate hikes, including four 75bp monsters in a row!  The USDX blasted up a huge 16.7% in just 6.0 months on that, crushing gold 20.9% lower in that rough span.  But shorting extremes never last.

This latest enormous shorting spike ignited earlier in the dollar’s recent bear rally.  In mid-August, three consecutive CoT weeks saw specs pile on 10.9k, 29.2k, and 15.1k contracts of new shorts!  That middle number was exceedingly extreme, ranking as the 9th-largest CoT week of spec short selling out of then 1,285 CoT weeks since early 1999!  Yet despite that withering onslaught, gold remained in its upleg’s uptrend.

And here’s the kicker on gold’s violent breakdown.  Again the last-available CoT report is only current to September 26th, when gold had merely fallen to $1,900.  In the latest CoT week that will be reported this Friday afternoon, gold plummeted another 4.0% to $1,824!  Drops of that magnitude guarantee massive gold-futures selling was to blame.  I’ll analyze this new CoT data in next Tuesday’s weekly newsletter as always.

Again when gold was still at $1,900 a week earlier, total spec longs and shorts were running 280.8k and 145.9k contracts.  With gold collapsing technically, spec longs could’ve capitulated and fled.  To hammer longs back to late November 2022’s deep 3.6-year secular low would’ve required another 37.7k contracts of selling.  My best guess is specs dumped another 10k to 20k longs during this yet-to-be-reported CoT week.

That would’ve maybe forced gold down 1% or so, but definitely not 4%.  So odds are spec short selling flared again, with these super-leveraged traders piling on to ride gold’s steep downside momentum.  They had room to do another 39.4k contracts of selling before total spec shorts hit their 3.8-year secular high seen in late September 2022.  I’d bet spec shorting soared another 20k to 30k contracts in this latest CoT week!

Using the midpoints of these CoT-week estimates, total spec longs may have fallen near 266k contracts this Tuesday while total spec shorts soared near 171k.  If those are in the ballpark, gold is now enjoying its most-bullish setup since late September 2022!  That was when gold plunged to a deep 2.5-year low, its worst levels since March 2020’s pandemic-lockdown stock panic.  Gold soon exploded higher from both.

A year ago last week, massive gold-futures selling had crushed the yellow metal to just $1,623.  Traders had completely given up on it, bearishness was extreme with technicals so hopelessly broken.  Yet that marked the birth of a powerful gold upleg, which soared 26.3% higher over the next 7.2 months!  If spec gold-futures positioning is similar now, then gold is poised to enjoy a similar big surge on mean-reversion buying.

While gold-futures speculators dominate gold’s short-term price action, there aren’t many traders willing to run such extreme leverage.  At 23.3x, a mere 4.3% gold move against their bets wipes out 100% of their capital risked!  So despite their influence there aren’t many gold-futures specs, making their collective capital firepower quite finite.  Once they’ve exhausted all of that available for selling, all they can do is buy.

Gold’s powerful upleg between late September 2022 to early May 2023 was largely driven by spec gold-futures mean-reversion buying, which is normal.  Major gold uplegs are fueled by three telescoping stages of buying.  First specs buy to cover gold-futures shorts, which drives gold high enough for long enough to entice the bigger long-side specs to return.  Their much-larger buying accelerates gold’s gains.

Eventually stage-one gold-futures short covering then stage-two gold-futures long buying extend gold’s upside enough to attract back vastly-larger stage-three investment buying.  Yet gold can easily surge 20% to 25% out of excessively-bearish spec gold-futures positioning like today on stage-one and stage-two buying alone!  Proportional mean-reversion gold-futures buying is normal following extreme selling episodes.

Aggressively shorting gold futures near major price lows is exceedingly risky.  All it will take to really shift Fed-rate expectations is one major worse-than-expected US economic report.  A big miss in some key economic data would likely hammer the way-overbought USDX, unleashing big gold-futures short covering.  Such buying quickly snowballs, as additional shorts are forced to cover hastening gold’s gains.

This rush-to-cover-or-face-ruin dynamic helped catapult gold 20.2% higher in just 4.2 months into early February 2023, then another 13.2% higher over 2.3 months into early May!  Anywhere you look on this chart, or similar charts going back decades, spec shorts soaring to very-high levels always soon spawn sharp gold surges on mean-reversion buying.  This latest one won’t prove an exception, gold is poised to soar.

While the igniting catalyst is never certain in advance, one is certainly imminent.  It may prove a big miss in monthly US jobs, or cooler-than-expected CPI, PPI, or PCE inflation.  Maybe retail sales will plunge as American consumers face increasing financial pressure.  But make no mistake, something big and Fed-dovish is coming soon.  It may simply prove these soaring 10-year Treasury yields, which are dangerous.

They risk breaking all kinds of things, which Fed officials don’t want to be blamed for heading into a very-contentious election year.  The US housing market could implode with 8%ish mortgage rates that few can afford.  The US government’s interest expenses are soaring with these higher rates, threatening to climb to unsustainable levels devouring much other spending.  The stock markets could plunge into a severe selloff.

The negative wealth effect from that alone could sharply curtail higher-income Americans’ consumer spending, forcing a deep recession.  Lower-income Americans have already been crushed by this raging inflation, while middle-income ones have exhausted their once-huge excess savings from all the pandemic stimulus payments.  The strutting hawkish Fed officials will change their tunes fast as recession threats mount.

Any meaningful shift from a hawkish higher-for-longer bias to a dovish rate-cuts-are-coming-soon one will slam the lofty USDX.  That will unleash that massive gold-futures mean-reversion buying to launch gold sharply higher.  And there is enormous room for that, as evident in this chart.  Note total spec longs’ upper-resistance line in recent years near 413k contracts, and shorts’ lower support running around 95k.

To mean revert and overshoot back to those gold-upleg-slaying levels, from September 26th’s CoT specs would have to buy a stupendous 183.2k gold-futures contracts!  That’s the equivalent of a staggering 570 metric tons of gold.  For some perspective on that, according to the World Gold Council global gold investment demand in the first half of 2023 ran 532t.  Gold would soar to new record highs on such buying.

Gold’s last nominal record close was August 2020’s $2,062.  Despite the last couple weeks’ carnage, that is only 13.2% higher from here.  Once gold’s inevitable mean-reversion rebound grows large enough to start challenging new records, bullishness will explode.  Widespread financial-media coverage will stoke great interest, and traders love chasing winners’ strong upside momentum.  New records will accelerate that.

And the coming spec mean-reversion gold-futures buying may prove even bigger, if my estimates of this latest CoT week’s selling necessary to pummel gold another 4% lower are close.  That would equate to an epic 223.2k contracts of room to buy, the equivalent of 694t!  Excessively-bearish gold-futures bets by speculators never last long, always soon mean reverting then overshooting in major proportional buying.

As always the biggest beneficiaries of this inevitable sharp gold rebound will be the gold miners’ stocks.  They’ve been chronically undervalued for years, but have started regaining ground relative to gold since September 2022.  The major gold miners dominating the leading GDX gold-stock ETF soared 63.9% over 6.5 months into mid-April 2023 as gold’s last big upleg surged.  Gold returning to favor will push them way higher.

Gold’s violent breakdown over this past CoT week finally forced it into formal correction territory, down 11.2% since early May.  Thus a new upleg is coming, which GDX will amplify by 2x to 3x.  So a typical 25% gold upleg would fuel 50% to 75% major-gold-stock gains from here.  A larger 40% one would blast GDX up 80% to 120%.  And smaller fundamentally-superior mid-tier and junior miners would fare much better!

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The bottom line is gold just suffered a violent technical breakdown, trashing sentiment.  But gold’s latest plunge was driven by massive gold-futures selling, leaving speculators’ positioning exceedingly-bearish.  These super-leveraged traders have probably about exhausted their capital firepower available for selling.  Their shorts in particular are likely challenging major secular highs, which are never sustainable for long.

That guarantees huge mean-reversion short-covering buying is imminent, which will catapult gold sharply higher.  As specs rush to cover or face financial ruin, the much-larger long-side specs will pile on to chase gold’s upside momentum.  The sparking catalyst for all this will be some Fed-dovish data shifting traders’ federal-funds-rate expectations, which could come any day.  Battered gold stocks will soar as gold recovers.


Adam Hamilton, CPA, is a principal of Zeal LLC, which he co-founded in early 2000 as a pro-free market, pro-capitalism, and pro-laissez faire contrarian investing and speculating Information Age financial-services company. Hamilton is a lifelong contrarian student of the markets who lives for studying and trading them.

The Federal Reserve Bank of New York holds the world's largest accumulation of monetary gold.
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