Loading ...Already having a heavily-bearish bias and forced by leverage to be short-sighted, American speculators jump on every opportunity to sell gold futures. And that is exactly what happened to gold and therefore silver over the past month or so. Gold would droop for a couple days, futures traders would rationalize that as confirmation of their bearish theses, so they would sell more gold futures and amplify its decline.
This creates a vicious cycle. And in the absence of normal levels of gold investment demand thanks to the Fed’s artificial stock-market levitation, there isn’t enough offsetting physical buying. So futures selling dominates the gold price, and it slumps towards lows. The funny thing is these extreme bets against gold by such sophisticated traders always prove wrong, as gold rallies right at their peak bearishness!
This first chart looks at American speculators’ total long and short positions in gold futures, which are reported each week in the CFTC’s famous Commitments of Traders reports. On top of these collective bets the gold price is overlaid, as seen through the lens of the flagship SPDR Gold Shares ETF (GLD) that stock traders prefer. The worst time to be bearish on gold is when futures speculators force it near lows.
And that’s exactly what’s going on today. Around $1250 gold isn’t far above its June 2013 low of $1199, its December 2013 low of $1190, and its June 2014 low of $1244. Seeing gold and therefore GLD shares heading towards the bottom of their 15-month consolidation trading range makes investors and speculators very nervous and bearish about gold’s prospects. It feels like gold is ready to fall off a cliff.
At times like this, nearly everyone is bearish except the hardcore contrarians. We humans have a natural tendency to extrapolate our present conditions out into infinity. We want to assume that trends in force today are going to persist indefinitely. This dangerous assumption is why the vast majority of traders lose money in the markets. They succumb to the herd groupthink and popular emotion near extremes.
That fails because the markets are forever cyclical. Once everyone is bearish, the selling has already happened and a reversal is imminent because only buyers remain. So it is foolish to sell low in the midst of extreme popular bearishness. Yet since nearly everyone wants to feel accepted by their peers, to believe markets move in the same direction forever, bearish calls abound right as prices are actually bottoming.
The elite and highly-respected Goldman Sachs is a prime example of this, reiterating its 15-month-old (and wrong) forecast that gold will fall to $1050 by the end of this year. Each time gold nears the lower support of its bottoming consolidation trading range, this high-profile bearish call gets much attention. But Goldman Sachs, along with all of Wall Street, is merely a weathervane extrapolating current trends.
Back in August 2011 when gold was skyrocketing and a few contrarians like me were warning that it was way overbought and due for a serious correction, Goldman Sachs was wildly bullish on gold. It came out with report after report upping its gold price targets over all time horizons. It declared that a year later, gold would be around $1860. But a year after that euphoria, gold had slid down near $1600!
Goldman Sachs is bullish on gold or stocks or anything when they are high and topping, the exact wrong time to be. And it is bearish on gold when it is low and bottoming, the smart time to be bullish. As a herd, American futures speculators are the same way. They are weathervanes that reflect prevailing sentiment, with no desire to fight the crowd to buy low and sell high. This is crystal-clear in this chart.
Note that the blue GLD-share price has a strong and nearly perfect inverse correlation with the total level of American futures speculators’ gold shorts. Just as this elite group of traders is the most bearish on gold as evidenced by their real-money bets, gold is bottoming and on the verge of a sharp rally. This happened in mid-2013, late 2013, mid-2014, and is almost certainly going to happen again soon here today.
After Q2’13’s epic once-in-a-century gold plunge, American futures speculators were so convinced that gold would spiral lower indefinitely that their bets against it surged to an at-least 14.5-year high. It may have even been an all-time record. But defying these guys, gold soon rallied sharply. Extreme gold-futures shorting is inherently self-limiting, as it sets the stage for massive and frantic short covering.
When everyone thinks gold is doomed to spiral lower forever, everyone who wants to sell gold futures has already done so. Traders with long-side bets who succumbed to the bearish groupthink are already out, and traders with the cojones or hubris to make hyper-leveraged short bets have already laid them in. And with essentially no futures sellers left, that leaves only buyers. So a minor gold rally can quickly explode.
At relatively-conservative-for-futures-traders 20x leverage, a 5% gold move against their bets will erase 100% of their capital risked. And it doesn’t take much at all to spark 1% to 2% up days in gold that will trigger nearly instant 20% to 40% losses for these speculators. A material stock-market down day, a worse-than-expected economic report, some geopolitical flare-up, many things can ignite a sharp gold rally.
And when leveraged futures speculators see 20%, 40%, 60% of their capital risked annihilated in a day or two, they have no choice but to cover. In the futures realm, shorts are covered by buying offsetting longs. So in terms of positive price impact, there is zero difference between adding a new long and buying one to offset and close a short. As speculators buy to cover, the gold-price gains naturally start accelerating.