The euphoric US dollar rocketing stratospheric to extreme multi-decade highs slammed gold this week! That vertical surge ignited heavy gold-futures selling, hammering gold into a serious technical breakdown. The resulting sentiment damage was severe, with traders now convinced gold is doomed to spiral much lower. But a major reversal is imminent in the radically-overbought dollar, which will catapult gold higher.
Gold has two primary drivers, investment demand and gold-futures speculation. Investment capital flows are much-larger and ultimately far-more-important. But because of the extreme leverage inherent in gold futures, speculators punch way above their weights in influencing gold price action. They totally dominate gold when investors are mostly missing-in-action. And the US dollar’s fortunes are their main trading cue.
Each gold-futures contract controls 100 ounces of gold, worth $180,600 entering this week. But traders are only required to maintain $7,200 cash margins in their accounts for each contract traded. That makes for maximum leverage of 25.1x, over an order of magnitude greater than the 2x legal limit in the stock markets. At 25x, each dollar traded in gold futures has 25x the gold-price impact of a dollar invested outright!
But that kind of leverage is exceedingly-risky, as a mere 4% gold move against speculators’ bets wipes out 100% of their capital risked. Always facing fast total ruin, these traders’ time horizons are forced to be ultra-short-term. They can only care what gold prices are doing in coming hours or days, even weeks are too distant. That extreme-leverage-necessitated myopia often leaves gold inversely slaved to the US dollar.
The leading dollar benchmark is the venerable US Dollar Index, which was birthed a half-century ago in March 1973. It is now dominated by the euro, which commands fully 57.6% of the USDX’s weighting! The Japanese yen, British pound, and Canadian dollar are way-less-consequential at 13.6%, 11.9%, and 9.1%. Normally the US dollar meanders gradually, but in recent months it has soared parabolic in a monster rally.
This first chart superimposes the raw US Dollar Index over a technical construct called the Relative USDX or rUSDX. It simply divides the daily USDX close by its 200-day moving average, yielding multiples that reveal how stretched this world reserve currency is in constant-percentage terms. This flags when the US dollar is really overbought or oversold, which greatly increases likelihoods for imminent major reversals.
This rUSDX flattens this benchmark’s 200dma to plane at 1.00x, which the dollar travels around tending to form horizontal trading ranges. Those are defined based on rUSDX action over the past five calendar years. This indicator’s current extremely-oversold support level is 0.95x, while its opposing extremely-overbought resistance zone starts at 1.04x. Normally the USDX doesn’t break these boundaries for long.
But since Q2 dawned several months ago, the euphoric US Dollar Index has rocketed parabolic defying almost all precedent. Astounding dollar buying blasted it to a mind-boggling 1.090x its 200dma in mid-May, and 1.091x this week! These are among the most-extreme dollar-overboughtness levels on record. This is neither normal nor sustainable, which guarantees the USDX needs to reverse sharply lower soon.
In early January 2021, the USDX birthed a major new upleg out of a deep 2.8-year low. Over the next 14.0 months into early March 2022, this currency gradually powered 10.9% higher in a perfectly-normal uptrend. Its moderate upslope was sustainable, as the USDX rarely grew overbought and mostly stayed between its lower support and upper resistance. That even included in the turmoil after Russia invaded Ukraine.
That normal gradual dollar rally wasn’t a problem for gold, which still climbed 4.2% over that exact span. And inside that over exactly one year leading into early March 2022, gold actually rallied to great 22.0% gains! Even a stronger dollar behaving normally usually doesn’t shake loose big gold-futures selling. The hyper-leveraged specs mostly respond to sudden big-and-sharp USDX moves, which force them to react.
Those flared from late March to mid-May, when huge anomalous dollar buying catapulted the USDX an amazing 7.1% higher in just six weeks! That parabolic dollar surge ignited when the USDX was already quite overbought based on the rUSDX’s trading range, at 1.033x. That overboughtness stretched to an off-the-charts-extreme 1.090x when the dust settled, which was truly extraordinary dwarfing most precedent!
The last epic dollar surge erupted during March 2020’s pandemic-lockdown stock panic, when the USDX soared 8.2% in only two weeks! But even that merely left the rUSDX running 1.049x, and such extremely-overbought levels proved short-lived like usual. Through all of Q2’22, the rUSDX averaged 1.066x which is unbelievable! Such a sudden big-and-fast dollar spike slammed gold 5.7% lower during that six-week span.
So what the heck happened to fuel this blistering USDX soaring to such exceedingly-overbought levels? There were three drivers, the plummeting US stock markets, the most-extreme hawkish pivot the Federal Reserve has ever executed, and European Central Bank dithering crushing its euro. All of these events were incredibly-unusual, together they are totally-unique, and they are neither sustainable nor repeatable.
Burning stock markets ignite big safe-haven demand for the US dollar, as traders flee to cash. During that six-week span into mid-May where the US Dollar Index’s parabolic 7.1% surge erupted, the flagship S&P 500 US stock index collapsed an ugly 14.6%! This same dynamic is what launched the USDX 8.2% higher in less than two weeks in March 2020, as the S&P 500 cratered a brutal 16.1% in that same panic span.
But the US stock markets started sliding in early January 2022, and it wasn’t until later in mid-June when the S&P 500 formally entered bear-market territory ultimately falling 23.6% on close. So flight-capital buying wasn’t the sole driver of the USDX’s epic parabolic surge. The unprecedented extremely-hawkish Fed is definitely the primary reason the dollar soared stratospheric, driven by Fed-official jawboning and actions.
In mid-March 2022, the Fed’s Federal Open Market Committee deciding monetary policy ended its zero-interest-rate policy in place since March 2020’s stock panic with a 25-basis-point rate hike. In late March as the USDX started rallying, major Wall Street banks started predicting larger 50bp hikes at the FOMC’s coming meetings in early May and mid-June. The Fed indeed lifted its federal-funds rate another 50bp at the former.
That hike alone was really-hawkish, the first 50bp one the FOMC had dared since way back in May 2000! And the Fed chair predicted more 50bp hikes were coming, although he effectively took 75bp off the table after that early-May FOMC meeting. Adding to its extreme hawkishness, the FOMC released its plan for its second quantitative-tightening bond-selling campaign to start unwinding its epic QE4 money printing.
Between March 2020’s pandemic-lockdown stock panic and mid-April 2022, the Fed mushroomed its balance sheet a ludicrous 115.6% or $4,807b higher! That radically-unprecedented quantitative-easing money printing more than doubled the US monetary base and thus effectively the US-dollar supply in just a couple years! That’s why inflation is raging out of control, far more money bidding up prices on everything.
In early May the FOMC declared QT2 would start in June, then quickly ramp up to $95b of monthly bond selling in just three months! That monetary destruction would dwarf the failed QT1 in every way, which took an entire year to reach a far-smaller $50b-per-month terminal velocity. That combination of more big rate hikes and big QT coming proved the most-hawkish Fed pivot by far in its entire century-plus history!
Currency traders are heavily focused on yield differentials between countries, with higher interest rates driving capital inflows to chase better returns. In just a couple months the ultra-aggressive Fed had killed both ZIRP and QE4, and started reversing both by hiking fast and announcing QT2. Meanwhile the ECB was dragging its feet despite soaring Eurozone inflation, with its main interest rate actually below zero!
Since September 2019, the ECB’s deposit-facility rate has been negative 50bp. That left a gaping chasm between it and the Fed’s FFR running near a positive-88bp midpoint after early May’s meeting. So the euro was increasingly sold in favor of the US dollar, amplifying the latter’s gains. Remember the USDX effectively is the euro, since that common currency now accounts for over 4/7ths of its entire weighting.
Gold’s performance during those six weeks the dollar skyrocketed into mid-May actually proved quite resilient. The yellow metal only fell 5.7%, less than the USDX’s extreme 7.1% rally! During that March-2020 episode where the USDX soared 8.2% in under two weeks, gold had collapsed 11.2% on extreme gold-futures selling. And bottoming near $1,811 in mid-May 2022, gold held near major uptrend support.
That should’ve been the end of both that anomalous dollar soaring and the resulting gold-futures selling slamming gold lower. Indeed the radically-overbought USDX retreated a sharp 3.0% into late May, helping gold rebound 1.7%. But gold-futures speculators weren’t interested in buying, and investors were missing-in-action heading into gold’s usual summer doldrums in June. Weak seasonals left gold’s bounce anemic.
Meanwhile the Fed’s extreme hawkishness continued to mount. In early June, May CPI inflation came in red-hot and worse-than-expected soaring 8.6% year-over-year! That was this lowballed-headline-inflation gauge’s hottest print since December 1981! Fed officials panicked again on that, shattering their forward guidance to float a 75bp trial balloon in the Wall Street Journal the next trading day. That soon came to pass.
At the FOMC’s mid-June meeting, they executed a colossal 75bp rate hike which was the first of those since November 1994! They nearly doubled their year-end-2022 FFR outlook from a 1.88% midpoint in mid-March to 3.38%! And the Fed chair himself said additional big 50bp or 75bp hikes were likely at the FOMC’s coming meetings. With the FFR near +1.63% compared to the ECB’s -0.50%, the euro plunged again.
Meanwhile the ECB kept dithering in June while Eurozone inflation raged from long years of the ECB’s own excessive money printing. Early last month ECB officials finally pledged to hike rates at their next meeting in late July, but only by 25bp. That would still be the ECB’s first hike since July 2011! The ECB also said it would finally end its QE as July dawned, several months after the Fed with no hint of any QT.
That propelled the US Dollar Index back up to multi-decade highs in both mid- and late June, though gold still held its own drifting between $1,806 to $1,856 in the second half of last month. The worst of the summer doldrums had passed, and gold was still mostly hovering near its own 200dma. Gold’s resilience through Q2’s monster USDX rally is evident in its own Relative Gold chart, using the same methodology above.
But the heavy gold-futures selling between mid-April to mid-May and then again in mid-June had left the yellow metal weak. The worst thing about speculators’ extreme gold-futures leverage is resulting outsized gold moves affect investors’ sentiment. With gold not yet reflecting this biggest inflation super-spike since the 1970s, investment selling started picking up in late June. Quarter-end window dressing played a role.
Investment funds have to report their holdings to their investors after each quarter. So they often sell a quarter’s losers and buy winners to make their picking look better. The best high-resolution daily proxy for global gold investment demand is the combined holdings of the leading and dominant GLD SPDR Gold Shares and IAU iShares Gold Trust gold exchange-traded funds. They started wilting in recent weeks.
From mid-April to mid-May during specs’ initial gold-futures puking on that skyrocketing dollar, GLD+IAU holdings fell 3.6%. But as gold stabilized into mid-June, they rebounded a decent 1.4%. Then heading into quarter-end with gold languishing seemingly oblivious to red-hot inflation, they shrunk another 1.8%. That left gold at $1,806 exiting June, near speculators’ gold-futures stop losses which cluster by round prices.
Gold was still holding its own last week despite lofty USDX heights. Those were partially driven by the ECB already welshing on ending QE in July. In order to fight yield fragmentation between well-run core countries and heavily-indebted peripheral ones, the ECB president pledged a new QE campaign starting in early July just weeks after the ECB said QE was ending! That left the euro reeling entering this new quarter.
The other side of quarter-end window dressing is fund managers’ herd chasing early in new quarters. These professional money managers are rarely contrarians, extrapolating current trends persisting for the indefinite future. So they love to pile into winners to chase upside momentum, and sell losers which they assume will keep spiraling lower. Thus the wildly-overcrowded long-US-dollar trade was aggressively joined.
So this Tuesday as traders returned from the long US holiday weekend, extreme US-dollar buying blasted the USDX a humongous 1.3% higher! That unleashed heavy gold-futures selling, likely shorting although we won’t know for sure until the latest weekly Commitments-of-Traders report released after this essay was published. So gold cratered 2.2% to $1,768 as gold-futures stop losses were triggered, devastating sentiment.
The euro collapsed 1.6% that day, nearing parity with the soaring US dollar! That herd rush into the dollar and out of the euro and gold continued this Wednesday, with another sizable 0.5% rally leaving the USDX way up at 107.1! That was an extreme 19.7-year secular high, and extraordinarily-overbought levels with it stretched way up to 1.091x its 200dma! The euro fell another 0.8%, while gold lost another 1.6% to $1,740.
As this rGold chart shows, that was a serious technical breakdown for the yellow metal. Its longstanding uptrend support was shattered in just two trading days this week, driven by these anomalous dynamics. Heavy gold-futures selling slammed gold lower on the euphoric long-dollar trade, which spawned another big 1.7% GLD+IAU-holdings draw in Q3’s opening few trading days. This was a total bloodbath for gold.
But these extreme moves aren’t sustainable, and have to soon reverse sharply given how stretched both the USDX and gold are. While the former is crazy-overbought at 1.091x its 200dma, gold is now deeply-oversold at just 0.944x its own! That’s nearing the 0.92x extremely-oversold zone in rGold’s own five-year trend. Neither super-overbought nor super-oversold levels last long, since they exhaust buying and selling.
Today’s extreme dollar greed has probably sucked in almost all traders willing to buy high. Conversely the extreme euro and gold fear has likely scared away nearly all traders susceptible to being frightened into selling low. That leaves nothing but sellers for the USDX and nothing but buyers for the battered euro and gold! Speculators’ gold-futures positioning was already excessively-bearish before this week’s selloff.
Every CoT week’s latest data on this is analyzed in our popular newsletters. CoT data current to Tuesday closes is released late Friday afternoons. The latest available before this essay was published was current to June 28th. Then speculators’ total gold-futures long and short contracts were running 1% and 71% up into their past-year trading ranges. Gold’s most-bullish-possible near-term setup is 0% longs and 100% shorts.
After gold plummeted 2.8% in this newest CoT week ending July 5th on heavy gold-futures selling, we’re likely looking at the most-gold-bullish spec-gold-futures setup in years! All it will take to ignite massive mean-reversion buying catapulting gold sharply higher is some news catalyst unleashing overdue big US-dollar selling. That will likely prove weaker-than-expected major US economic data, which is Fed-dovish.
Despite today’s anomalous gold prices driven by heavy gold-futures selling on an unsustainable monster USDX rally, gold’s fundamentals remain strong. It is destined to power far higher in today’s latest inflation super-spike. During the last couple in the 1970s, monthly-average gold prices nearly tripled during the first then more than quadrupled in the second! Gold prices will adjust much higher to reflect monetary excess.
Collateral damage from gold’s recent aberrant plunge crushed the gold miners’ stocks. While gold is down 15.2% at worst over 3.9 months since early March’s peak on Russia invading Ukraine, the leading GDX gold-stock ETF has collapsed 34.5% since mid-April! The gold stocks are even more oversold than gold, ready to reverse and soar in a massive mean-reversion higher as gold-futures buying resumes soon.
So for contrarian traders mentally-tough-enough to really walk the walk in buying low, these battered gold stocks are a phenomenal buying opportunity. As these unsustainable USDX, euro, and gold anomalies reverse, the gold miners’ stocks will soar amplifying gold’s upside. GDX typically leverages material gold moves by 2x to 3x, with the smaller fundamentally-superior mid-tier and junior gold miners doing far better.
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The bottom line is dollar euphoria just slammed gold. Currency traders stampeded into an already-wildly-overcrowded long-dollar trade to chase upside momentum. That catapulted the US Dollar Index up to unsustainable extraordinarily-overbought levels. New multi-decade dollar highs spooked gold-futures speculators into dumping even more contracts, hammering gold even lower into deeply-oversold territory.
But such anomalous technical extremes on both sides can never last long, and will soon reverse sharply. The likely catalyst is this extreme Fed hawkishness moderating on weakening US economic data. That will ignite snowballing USDX selling which will bludgeon it sharply lower. Gold-futures speculators will be forced to aggressively buy to cover their shorts, catapulting gold higher unleashing big long and investment buying.
Adam Hamilton, CPA
July 8, 2022
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