Gold has drifted out of favor in recent months, overshadowed by the glitzy AI stock-market bubble. Yet technically gold is holding its own, consolidating high just under nominal records. Gold has merely pulled back mildly despite heavy gold-futures selling, impressively resilient. Speculators’ frenzied long dumping has fully reloaded their buying capital firepower, portending big gold gains as they normalize positioning.
Since late November, gold has generally ground sideways in a tight trading range mostly between $2,000 to $2,050. Earlier in this high-consolidation span, gold’s young upleg born in early October achieved this metal’s first new nominal record high in 3.3 years! By late December, gold had powered 14.2% higher in 2.7 months. Big gold-futures buying fueled that, on a weakening US dollar as Fed-rate-cut odds mounted.
But with traders expecting more than double the rate cuts this year than top Fed officials projected in mid-December, they started pushing back. Between Fedspeak, FOMC decisions, and major-economic-data upside surprises, futures-implied rate-cut odds were driven back down. In mid-January traders expected 170 basis points of cuts this year, but by mid-week that had collapsed to 89bp not far from Fed officials’ 75bp!
Perceived Fed rate odds are the US dollar’s dominant driver. Currency traders bid it up when they expect the Fed to either hike its federal-funds rate, keep rates higher for longer, or cut less. And because gold-futures speculators look to the US dollar’s fortunes for their primary trading cues, the dollar throttles gold. So as the benchmark US Dollar Index rallied in January and February on falling rate-cut odds, gold sold off.
Gold’s sentiment-rebalancing retreat proved very mild, merely 4.2% at worst in mid-February. Normally that wouldn’t be big or sharp enough to quickly bleed off greed or ramp bearishness. But gold’s sentiment shift was exacerbated by US stock markets’ stunning advance. During the past month or so, the flagship S&P 500 has achieved 11 new record closes! Capital is flooding into the Magnificent Seven mega-cap techs.
Gold has always been an alternative investment, the classic portfolio diversifier. Investors forget about the wisdom of maintaining small gold allocations when surging, lofty stock markets are generating major greed and euphoria. So investors have been increasingly fleeing gold in the last few months, presumably to chase this AI stock-market bubble. Entering February, the elite S&P 500 stocks averaged 30.6x TTM P/Es!
Gold’s appeal always wanes during stock-market manias, overshadowed by the great excitement they generate. But inevitably those overvalued and overbought stock markets decisively roll over to face their mean-reversion reckonings. Then investors start remembering their stock-heavy portfolios need to be diversified, and gold begins returning to favor. We aren’t there yet, but gold futures are reloaded and ready.
This chart superimposes gold over speculators’ total gold-futures long and short contracts over the last few years or so. Their positioning is reported weekly in the Commitments of Traders reports. Gold’s major uplegs and corrections are marked, along with specs’ net buying and selling of longs and shorts during those exact spans. Speculators’ leveraged gold-futures trading usually dominates gold price trends.
Gold’s latest upleg again started powering higher in early October, after an 11.3% correction during the previous 5.1 months. That selloff was fueled by specs selling 36.3k long contracts while adding 69.3k shorts, for a 105.6k total. Note that when gold bottomed deeply out of favor then, spec longs were low and spec shorts high. Every major gold bottoming in recent years happened with some variation of that.
Over the next 2.7 months into late December, gold again powered 14.2% higher. Speculators were again responsible, doing 120.4k contracts of mean-reversion buying to normalize early October’s excessively-bearish bets. That included 64.2k of longs and 56.1k of short covering, way under what is likely before this gold upleg matures. Total spec shorts and longs have major secular support and resistance zones.
Those are readily-evident in this chart, about 95k contracts for shorts and 415k contracts for longs. And since spec longs really outnumber shorts, they are proportionally more important. Over the last 52 reported CoT weeks, spec longs averaged 2.7x spec shorts. The difference between specs’ positioning and those gold-upleg-killing thresholds reveal these guys’ probable remaining gold-futures buying firepower.
In late December near gold’s latest record interim high of $2,077, total spec shorts and longs ran 105.5k and 337.9k contracts. Major gold uplegs are fueled by three progressively-larger stages of buying. The first is gold-futures short covering, the second gold-futures long buying, and the third investment buying. Each earlier stage needs to drive gold high enough for long enough to ignite the subsequent much-larger stage.
With spec shorts just 10.5k contracts above their 95k support in late December, that stage-one buying was largely exhausted. But note in this chart it had been the dominant driver of gold’s sharp bounce early in this latest upleg. And spec longs then were still a massive 77.1k contracts under their 415k resistance! So this young gold upleg still had lots of room to run in late December as specs continued normalizing their bets.
But gold uplegs flow and ebb, like everything else. Though gold had plenty gold-futures buying firepower left to keep rallying, the US dollar started surging on those falling Fed-rate-cut odds. Then the S&P 500 hit record highs, spawning big euphoria. So gold’s upleg took a healthy breather, a pullback serving to rebalance sentiment. Late December’s modest excitement was eradicated as gold drifted lower in recent months.
Most of the gold-futures selling necessary to drive gold’s modest 4.2% pullback into mid-February came on the long side. Over the seven CoT weeks since gold’s last record close, total spec shorts only edged up 3.1% to 108.8k contracts. That still leaves room for a sizable 13.8k of mean-reversion buying before hitting that 95k support line. So some modest stage-one short-covering buying firepower has been reloaded.
But total spec longs just collapsed in January, plunging a massive 75.3k contracts in just four CoT weeks! Two of those suffered huge long dumping, defined as 20k+ contracts in any single CoT week. All that slammed total spec longs way back down to 261.7k contracts as of the latest-reported CoT data, current to last Tuesday the 13th. That’s a whopping 153.3k under spec longs’ secular resistance around 415k!
So the gold-futures speculators dominating gold’s price action now have capital firepower to do enormous stage-two buying. Specs’ frenzied long dumping in January as the US dollar surged on falling Fed-rate-cut odds fully reloaded potential long buying. Last Tuesday’s total spec longs were actually a bit under early October’s 264.8k when this gold upleg was born! And gold was only running $1,860 that CoT day.
Way down at just 261.7k now, spec long selling is likely exhausted. That’s not far above spec longs’ deep 3.6-year secular low of 243.1k contracts in late November 2022! So no matter how hawkish Fed officials wax or how big upside surprises prove in major US economic data, the gold-futures guys are probably about done dumping longs. While they have room to short sell, shorts are again proportionally less important.
When spec longs are pounded this low, that reveals these traders’ collective bets on gold are excessively-bearish. Historically that has meant big proportional mean-reversion buying is imminent to catapult gold sharply higher. The last time spec longs were lower was in early March 2023 at 259.2k. So huge gold-futures buying soon erupted to normalize those positions, blasting gold 12.4% higher in just over five weeks!
Again last Tuesday’s 261.7k longs were a little lower than early October’s 264.8k. Of course that flagged a major gold bottoming, as big mean-reversion buying ignited out of those lopsided bets. So over the next seven weeks or so, gold powered 11.3% higher. Twice in this past year alone, low spec longs near today’s levels have immediately preceded sharp 12%ish gold surges in about six weeks! They are really bullish.
If gold’s Valentine’s Day close of $1,991 proves this latest pullback’s low, another 12% surge off there would catapult gold way up near $2,229 in its normal spring-rally timeframe! And there are lots of new nominal record closes between late December’s $2,077 and there. Seeing those mount will bring gold-record momentum into play, a powerful self-feeding dynamic that last fueled a couple monster gold uplegs.
Investors are apathetic on gold, mostly not thinking about it during this exciting AI stock-market bubble. But the more new record closes gold achieves, the more the financial media will discuss it. Analysts who are bullish on gold will be increasingly invited to opine on why it is heading much higher. The more financial-media coverage, the more traders will remember gold and want to jump in to chase its upside momentum.
That fuels powerful virtuous circles of buying. The more capital that flows into gold, the faster it rallies. The higher gold goes, the more bullish financial-media coverage grows attracting more traders. So gold uplegs forging deeper into nominal record territory tend to grow quite large. We haven’t seen one since 2020, when two separate record-achieving gold uplegs crested at massive 42.7% and 40.0% gains!
No one knows how large today’s record-achieving upleg will grow, but odds are it will get much bigger than late December’s 14.2% gain. Powering up 20%, 30%, or even 40% off early October’s low would carry gold way up near $2,183, $2,365, or $2,547! Any of these scenarios would generate lots of greed returning gold to favor. Spec gold-futures buying alone could fuel 20%+, but 30%+ would need investment buying.
Again major gold uplegs have three stages of buying. Only about 17% of this upleg’s probable stage-one gold-futures short-covering buying remains, or 13.8k contracts equivalent to 42.8 metric tons of gold. Incredibly 153.3k contracts or 102% of much-bigger likely stage-two long buying is left, since total spec longs fell under their levels where this gold upleg was born! That’s the equivalent of 476.7t of gold, 11x larger.
And stage-three investment buying hasn’t even started yet. That’s easiest to estimate with the combined holdings of the world-dominant GLD and IAU gold ETFs. They command about 4/10ths of all the gold bullion held by all the world’s physically-backed gold ETFs, and have closely tracked overall global gold investment demand in past years. Shockingly from early October to mid-week, GLD+IAU holdings dropped.
During this young gold upleg, they’ve actually fallen a considerable 4.6% or 58.5t as investors fled to chase this AI stock-market bubble! During those last two record-achieving uplegs in 2020 seeing monster 42.7% and 40.0% gold gains, GLD+IAU holdings enjoyed massive builds of 30.4% or 314.2t and 35.3% or 460.5t! To see similar massive gains this time around, investors will need to return again sooner or later.
That will depend on how these lofty, euphoric stock markets fare. If their mania persists into a higher peak later, gold investment demand will remain weak. But once they decisively roll over and worries sufficiently mount, prudently diversifying portfolios with gold will be remembered. Given how extreme valuations are in the Mag7 mega-cap techs and how widespread popular greed is, this bubble looks long in the tooth.
But whether the S&P 500 soon tops and rolls over or not, speculators’ excessively-bearish gold-futures positioning on the important long side guarantees big mean-reversion buying is coming soon. That will easily be enough to propel gold well into record territory, which starts merely 2.6% above mid-week levels. Spec gold-futures longs are fully reloaded, which is really bullish for gold’s near-term outlook.
The biggest beneficiaries of higher gold prices ahead will be the battered gold miners’ stocks. Absurdly their leading GDX ETF just plummeted a hair under early-October levels in mid-February! Their gold-upleg gains were totally erased, despite gold remaining 9.4% higher that day. Typically the major gold stocks of GDX leverage material gold upside by 2x to 3x, so they have huge mean-reversion buying coming.
Gold stocks are deeply undervalued, with plenty trading at single-digit TTM P/Es. They are likely to report some of their fattest earnings ever in the Q4’23 earnings season just getting underway. And if this record-achieving gold upleg grows to monster status, the gold stocks should skyrocket. During mid-2020’s last 40.0% gold upleg, GDX soared 134.1% amplifying gold’s gains by 3.4x! Smaller gold miners fared even better.
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The bottom line is long gold futures are fully reloaded. Speculators did so much selling in January that their total gold-futures longs fell under early-October levels when this gold upleg was born! Right after the last couple times spec longs grew so excessively-bearish, gold blasted about 12% higher in six weeks or so. Similar big mean-reversion gold-futures buying is likely again soon to normalize specs’ lopsided positioning.
Yet gold only needs to climb 3%ish to forge into new nominal record territory, which ought to accelerate buying. Record closes generate bullish financial-media coverage, attracting in more traders to chase gold’s upside momentum. While this coming gold-futures buying alone will push gold much higher, this euphoric AI stock-market bubble should also soon roll over. That ought to really boost gold investment demand.
Adam Hamilton, CPA
February 23, 2024
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