Gold Upleg Still Young

CPA, Principal & Co-Founder of Zeal LLC
December 23, 2022

Gold has been powering higher on balance for a couple months now, surging to major breakouts.  That upside momentum is improving sentiment, with traders growing more bullish on gold’s potential.  That is well-placed, as this upleg remains young.  Major gold uplegs are three-stage events, each having distinct drivers.  The first and smallest stage isn’t even finished yet, which bodes very well for gold and its miners’ stocks.

The yellow metal’s latest upleg was stealthily born at panic-grade lows in late September.  Over the next 2.8 months into this week, gold powered an impressive 12.1% higher!  Yet that remains small and young by recent-upleg standards.  Gold’s previous four uplegs in the last few years averaged way-bigger 28.8% gains over much-longer durations of 7.9 months.  This current upleg is likely only getting started, with a lot to prove.

Major gold uplegs evolve through three stages of specific buying from particular traders.  They are born when gold-futures speculators buy to cover short contracts, which is stage one.  After gold falls to deep lows, some catalyst spooks these guys.  So they rush to close out their risky hyper-leveraged downside bets, which is legally required.  That buying soon becomes self-feeding, catapulting gold sharply higher.

That fuels enough gold upside momentum to increasingly attract back stage-two gold-futures long buying.  Unlike short covering which is mandatory, long buying is voluntary.  Speculators seeing gold surging want to pile on and chase its gains.  Since their total gold-futures long contracts usually outnumber their short contracts by 2x to 3x, gold uplegs’ second stages are proportionally larger.  Mounting gains ignite stage three.

That is driven by investors returning to gold with their vast pools of capital dwarfing gold-futures specs’.  That makes gold uplegs’ third stages their biggest and longest by far, accounting for the lion’s share of their overall gains.  Stage-three investment buying can last well over a year, compared to a couple months for stage-one gold-futures short covering and a half-year at best for stage-two gold-futures long buying!

Despite surging 12%+ in several months, today’s young gold upleg hasn’t even exhausted stage one yet.  While this upleg is technically 2.8 months old, gold carved a deep double bottom in early November.  So well over 19/20ths of its total gains accrued in just the 1.5 months since, not enough time for specs to run out of gold-futures shorts to cover and close.  Stage-two and stage-three buying remain virtually nonexistent.

That all but guarantees this latest gold upleg has a long ways higher to run yet.  Speculators’ gold-futures positioning data is published weekly in the famous Commitments of Traders reports.  CoTs are current to Tuesday closes, but not released until late Fridays.  So the latest-available CoT data for this essay was December 13th’s.  This chart superimposes gold and its key technicals over specs’ total long and short contracts.

The sole reason gold blasted higher out of its recent deep lows was frenzied gold-futures short-covering buying.  Gold originally bottomed in late September, at levels last seen after March 2020’s brutal pandemic-lockdown stock panic.  Gold’s 2.5-year low was driven by total spec short contracts soaring to 185.3k, an extreme 3.8-year high!  In early November near gold’s second bottom, they had surged back up to 180.1k.

But by that latest-reported CoT week current to December 13th, they had plunged to 123.2k contracts.  So specs bought to cover a major 62.2k contracts, the equivalent to 193 metric tons of gold!  That is a lot of buying in such a short span of time.  That differs some from the 56.4k of short-covering buying in gold’s latest upleg noted in this chart.  That’s simply due to the mismatched low weekly resolution of those CoT reports.

Gold bottomed at $1,623 on Monday September 26th.  So technically the prior Tuesday’s CoT data was still current that day.  All the gold-futures-contract changes in this chart are taken from the precise days of gold bottoming and topping, even if they don’t exactly match CoT troughs and peaks.  The next CoT that was released for Tuesday September 27th better reflects specs’ gold-futures trading hammering gold that low.

Despite that recent gold-futures short covering, this stage-one buying still likely isn’t finished.  There are a couple ways to infer that.  Speculators’ hyper-leveraged gold-futures trading usually proves the dominant primary driver of gold’s short-term price action.  So I analyze every CoT report in our weekly and monthly subscription newsletters for clues on gold’s probable near-term direction.  I developed some indicators to help.

One recasts speculators’ total gold-futures long and short contracts as percentages of their past-year trading ranges.  As of December 13th in that latest-reported CoT week, total spec shorts were still running 34% up into their past-year range.  That implied spec short-covering buying was about 2/3rds done with the last third remaining.  Probable gold-futures short covering isn’t exhausted until this indicator falls to zero.

That last happened in late March 2022, ahead of gold’s $1,977 mid-April high from which its miserable mid-2022 plunge erupted.  In the CoT leading into that, total spec shorts hit 105.4k contracts.  Specs had to add 80.0k to help pummel gold down to late-September’s panic-grade low.  Again 62.2k of those have been covered so far, leaving almost 1/4th left to go.  So a fourth to a third of likely stage-one short covering remains.

But stage one is small, mainly acting as a trigger to usher in larger stage-two gold-futures long buying.  That only starts mounting after stage one pushes gold high enough for long enough to fuel sufficient upside momentum to attract back long-side speculators.  They generally control way more capital than the short-side guys, making stage two proportionally more important.  That’s when gold uplegs really accelerate.

Over this past year, total spec longs have outnumbered total spec shorts by an average of 2.5x in those weekly CoT reports.  So this gold upleg’s coming second stage is likely to enjoy two-and-a-half-times the capital inflows as stage one!  And so far spec gold-futures long buying has barely begun, these guys have only started nibbling.  That should accelerate into early 2023, which is super-bullish for gold and gold stocks.

Total spec longs plunged to just 247.5k contracts in late September as gold bottomed.  They had clawed back a little to 254.9k in early November, but then retreated down to 243.1k at the end of that month.  That proved an extreme 3.6-year low!  Speculators hadn’t been more bearish on gold as evidenced by very low upside bets since early May 2019.  Then such lopsided positioning necessitated huge mean-reversion buying.

That catapulted gold a blistering 22.3% higher over the subsequent 4.1 months!  Similar gains are likely today as stage two kicks in.  Remember today’s 12.1% gold upleg is effectively just 1.5 months old, yet to really transition from stage one to stage two.  The lack of spec gold-futures long buying to this point is evident in similar metrics.  Total spec longs were up just 11% into their past-year trading range on December 13th.

Probable spec long buying isn’t exhausted until that nears 100%, which last happened in early March on Russia invading Ukraine.  Huge gold-futures long buying fueled gold’s unsustainable geopolitical spike.  So by that measure, over 8/9ths of likely stage-two spec long buying is still yet to come in this gold upleg!  Alternatively total spec longs were running 393.4k in mid-April before gold rolled over hard on big futures selling.

By late November specs had dumped 150.3k contracts, yet so far only 18.6k of those have been bought back as of that latest-reported CoT.  That is less than 1/8th of the total probable stage-two buying!  So somewhere around 7/8ths to 8/9ths of that big spec gold-futures long buying remains outstanding.  And these leveraged traders are increasingly paying attention, gold’s recent gains are starting to win them over.

In that latest-CoT-week data as of December 13th, specs added 12.5k long contracts.  That proved their biggest CoT week of long buying by far since mid-April, back before gold plunged when its psychology remained bullish!  So there’s no reason not to expect the much-larger stage-two spec gold-futures long buying to accelerate in the next few months.  That will supercharge gold’s young upleg, ramping its gains.

That should drive gold high enough for long enough to start enticing investors to return, unleashing their vastly larger stage-three buying.  Unfortunately global gold investment demand is only published quarterly by the World Gold Council in its outstanding Gold Demand Trends reports.  That seriously-low-resolution data is too infrequent to analyze in-progress gold uplegs.  Thankfully there’s a great daily proxy mirroring it.

That is the combined holdings of the dominant GLD and IAU gold exchange-traded funds.  As of the end of Q3’22, according to the WGC these American behemoths commanded a whopping 40.0% of all the gold bullion held by all the world’s physically-backed gold ETFs!  The trends in their collective holdings tend to closely follow overall global gold investment demand.  And they show virtually no stage-three buying.

GLD+IAU holdings peaked near 1,626 metric tons in mid-April 2022.  Investors increasingly fled after as heavy gold-futures selling slammed gold this past summer.  Dumping GLD and IAU shares faster than gold, that ultimately forced their holdings to plunge a major 16.7% or 271t by early December!  That big investor exodus from gold on downside momentum left those holdings running just 1,355t a few weeks ago.

With no leverage to worry about, investors follow gold price trends much more casually than those hyper-leveraged gold-futures guys.  So peaks and troughs in gold investment generally lag those in gold itself by a couple weeks to months.  Gold investors need to see evidence of major trend changes before they will start migrating capital out or back in.  While they finally started to nibble, their stage-three buying is trivial.

Those recent GLD+IAU holdings lows proved the worst since March 2020 just emerging from that stock panic, truly extreme.  Yet as of midweek, investors had only done enough differential GLD-and-IAU share buying to drive a trivial 0.7% or 8.9t build.  That is nothing, only about 1/30th of necessary capital inflows to restore GLD+IAU holdings to mid-April’s pre-gold-selloff levels.  Stage three hasn’t even started yet!

Putting all this together, between late September to this week gold powered a nice 12.1% higher.  That was fueled by stage-one gold-futures short-covering buying equivalent to 193t of gold.  There’s likely at least another 56t of stage-one buying left.  Other specs have started nibbling on the long side, doing about 58t of gold-equivalent gold-futures long buying.  But that is merely around 1/8th of their likely total.

That implies another 410t+ of spec gold-futures long buying coming in the next few months!  After that drives gold high enough for long enough to bring back investors, they should have at least another 262t of buying to do per that GLD+IAU-holdings proxy alone.  This young upleg’s ultimate stage-three buying ought to prove way larger though, as this raging inflation and mounting stock bear are super-bullish for gold.

But sticking with these conservative numbers, this young upleg’s total stage-one, stage-two, and stage-three buying should shake out around 988t of gold.  Yet so far only about 260t have been bought, just over a quarter of that estimated total.  That means nearly three-fourths of this upleg’s likely buying is still coming!  That is almost certain to drive gold much higher in coming months, making for a great gold new year.

Speculator gold-futures mean-reversion buying will really accelerate on the lofty US Dollar Index’s sharp mean reversion lower.  The primary reason gold plunged 17.9% on heavy futures selling in the middle of this year is the USDX rocketed parabolic with an epic 14.3% gain to an extreme 20.4-year high in that span!  That was driven by the most-extreme tightening the Fed has ever attempted, led by monster rate hikes.

But the Fed’s ability to hawkishly surprise has waned dramatically, as I argued back in early November when gold hovered just above those panic-grade lows.  Indeed the USDX has collapsed 9.2% since its lofty heights, with fully 9/10ths of that since early November!  That ongoing dollar mean reversion lower as the Fed runs out of room to keep hiking will continue to spark big gold-futures buying, driving gold higher.

Its resulting strong upside momentum alone will be enough to increasingly attract back investors, who love chasing gains.  But this raging inflation unleashed by the Fed’s extreme money printing in recent years will supercharge gold investment demand.  During the last inflation super-spikes of the 1970s, gold nearly tripled during the first then more than quadrupled during the second in monthly-average-price terms!

Gold is heading much higher on remaining stage-one and still-coming stage-two gold-futures buying, which will be accelerated by the US dollar returning to earth after parabolic extremes.  The resulting strong gold upside momentum will entice back much-larger stage-three investment buying, itself amplified by raging inflation hammering stock markets and eroding purchasing power.  Yet gold won’t be the biggest beneficiary.

That will prove the gold miners’ stocks, which leverage material gold moves.  This next chart overlays gold with its miners’ leading benchmark, the GDX gold-stock ETF.  It is already outperforming its metal’s young upleg, surging 37.4% at best since late September.  That has amplified gold’s gains by 3.1x, on the high side of the major gold miners’ typical 2x-to-3x range.  The gold stocks will fly as this gold upleg grows!

Remember gold’s last four uplegs averaged 28.8% gains in 7.9 months.  GDX’s last four averaged 70.2% gains in pretty much the same timeframe, leveraging gold by 2.4x.  And the last two uplegs of both gold and gold stocks were prematurely truncated by anomalous heavy gold-futures selling on extreme Fed hawkishness.  The prior two normal gold and GDX uplegs averaged massive 41.4% and 105.4% gains!

Given today’s backdrop of the first inflation-super-spike since the 1970s ravaging investments, gold could easily blast another 40%+ higher before this latest young upleg gives up its ghost.  A 40% gain off its deep late-September low would catapult gold up near $2,275!  All the excitement that generated would blast gold stocks stratospheric with life-changing gains, especially in smaller fundamentally-superior miners.

Researching and trading the better mid-tier and junior gold stocks has been our specialty at Zeal for over two decades now.  We aggressively added new trades at fire-sale prices in recent months surrounding gold’s bottoms, filling our newsletter trading books.  Their unrealized gains are already running as high as +73.2% mid-week!  All speculators and investors need gold-stock portfolio allocations given gold’s bullish outlook.

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The bottom line is gold’s upleg is still young.  Gold’s strong recent gains were mostly driven by stage-one gold-futures short-covering buying, which isn’t even finished yet.  The much-larger stage-two gold-futures long buying and stage-three investment buying has barely started.  Around three-fourths of the probable gold buying likely to fuel this upleg remains, all but guaranteeing the lion’s share of gold’s gains are still coming.

And that’s not even considering extreme market events that should supercharge gold demand.  Those include the lofty US dollar mean reverting much lower and the first inflation super-spike since the 1970s raging.  They will almost certainly fuel much larger gold-futures buying and investment demand than usual.  The resulting powerful major gold upleg will catapult battered gold stocks far higher, an epic opportunity.

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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.


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