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Adam Hamilton
“Gold is poised for a massive short-covering rally, almost certainly the largest one in recent years given the record extremes of shorts that have to be bought back. This is super-bullish!”
Yet even facing such howling headwinds with everything stacked against it, gold still saw sharp short-covering rallies after American futures speculators’ shorts grew too excessive. This created a trading range of these positions in recent years as you can see in this chart, running from about 75k-contract support up to 150k-contract resistance. Speculators’ shorts returned to support multiple times in recent years.
And right after episodes when these leveraged downside bets on gold exceeded 150k contracts like they are at today’s record, major short covering soon ensued. This led to sharp gold rallies blasting 16.2% higher in 10 weeks on average. These are big gains anytime, let alone when everyone is hyper-bearish on gold. And since speculators’ gold-futures shorts are so epic today, the next short-covering rally will likely be huge.
Even since 2013 in these surreal Fed-distorted markets, speculators have bought to cover their total shorts down to 75k contracts several times. The last short-covering spree ended in early February 2015 at 70.4k contracts, a buying frenzy that catapulted gold 14.2% higher in just over 10 weeks. So it is very conservative to expect speculators to once again buy down their short positions to return back to 75k support.
From their current record extreme of 179.0i, it will require a staggering 104.0k of long-contract buying to return to 75k. And since each contract controls 100 ounces of gold, this collectively represents 323.5 metric tons of buying on short covering alone by this single group of traders! That is a colossal amount of gold buying in a short period of time, several months on the outside. Short covering soon feeds on itself.
Today at $1150 gold, each futures contract is worth $115,000. Yet the minimum maintenance margin per contract is now only $3750. So futures speculators can run leverage up near 31x, astoundingly risky. At such levels, a mere 3.3% gold rally would wipe out 100% of the capital they risked! So once gold starts moving, these speculators have to rapidly cover to avoid catastrophic losses. So they buy aggressively.
And their very short covering accelerates gold’s gains, putting pressure on the rest of the speculators who are not running minimum margin and maximum leverage. So they are soon forced to buy to cover too, putting even more upside pressure on the gold price. So once even a minor gold rally ignites a serious bout of short covering, it rarely stops until it has fully run its course. And today we are in for a massive one!
That 104k contracts of short covering necessary to return to recent years’ support of 75k again is the equivalent of 323.5 tonnes of gold. And it will all hit over several months or so. Let’s call it 3, since the average duration of short-covering frenzies in recent years is 10 weeks. That is 107.8t of additional gold demand monthly that doesn’t exist now. And according to the World Gold Council, that is wildly bullish.
The WGC’s latest figures showed average global investment demand in gold of 92.9t per month in the first quarter of 2015. So for the several months it takes to unfold, American futures speculators’ short covering alone will increase worldwide gold investment demand by an amazing 116%! This will fuel a sharp gold rally as always. At the recent-year average of 16.2%, gold would surge to $1335 in 10 weeks.
But I strongly suspect that gold’s imminent short-covering rally will be significantly larger coming from such extreme record levels of short selling. The bigger the short positions, the more buying is naturally required to unwind them back to reasonable levels. So instead of gold looking utterly hopeless today as everyone believes, it has an exceedingly-bullish setup. Major lows fueled by shorting are artificial and short-lived.
There are a couple more key observations from this gold chart before we move on to silver. Note that the gold price has had an incredibly-strong inverse correlation with American speculators’ total level of gold-futures shorts in recent years. When this short selling is temporarily adding futures supply, gold falls. And when it reverses into buying, gold rallies. Speculators’ shorting is literally the whole story on gold recently!
With investors still missing in action thanks to the Fed’s gross market distortions, speculators are ruling the roost. But provocatively, gold has been relatively resilient despite their extreme shorting this year. Even in the midst of its worst time of the year fundamentally in terms of seasonal demand spikes, the gold price hasn’t fallen below its early-November-2014 lows despite speculators’ futures shorting being much higher.
That means there are buyers out there absorbing this excessive gold-futures selling. Imagine how much this latent demand will explode once gold rallies enough to convince these hardcore contrarians that things are finally changing. Gold is poised for a massive short-covering rally, almost certainly the largest one in recent years given the record extremes of shorts that have to be bought back. This is super-bullish!