Gold should be soaring with red-hot inflation raging, but instead it is breaking down. This history-defying disconnect has devastated sentiment, leaving this leading traditional inflation hedge despised. Traders need to realize gold’s bizarre decoupling from all precedent is an extreme anomaly that will prove short-lived. It has been driven by a parabolic US-dollar surge fueling unsustainable heavy gold-futures selling.
As a professional speculator and financial-newsletter writer for the past 23 years, I’m deeply immersed in the markets. I eat, breathe, and sleep trading, watching and analyzing market action all day every day. In such a long span of time, I’ve seen plenty of irrational episodes where prices temporarily disconnect from reality. But recent months’ serious gold weakness may take the cake as the most absurd I’ve witnessed!
For millennia, gold has proven the greatest investment in inflationary times of monetary debasement. Its supply growth from mining is very-slow, constrained naturally by the rarity of economic gold deposits and the decade-plus timelines necessary to bring them to production. So when governments irresponsibly expand their money supplies at excessive rates, gold prices surge to reflect those depreciating currencies.
Relatively-way-more money is suddenly available to compete for relatively-much-less gold, bidding up its price levels. And the higher gold powers, the more investors want to chase it accelerating its upside. This logical gold-inflation dynamic has fueled legendary gains during past inflation super-spikes. The previous couple before today’s monster hit in the 1970s, and gold’s performances reflected how it should react.
From June 1972 to December 1974, headline year-over-year US Consumer Price Index inflation soared from 2.7% to 12.3%. During that 30-month span, conservative monthly-average gold prices blasted up an amazing 196.6%! After that serious inflation wave passed, another one soon followed. From November 1976 to March 1980, the YoY CPI prints skyrocketed from 4.9% to 14.8%. Gold was a moonshot in that span.
Over that 40-month inflation super-spike, gold shot parabolic with a stupendous 322.4% gain in monthly-average-price terms from trough to peak CPI! As the world’s aboveground gold supply is way bigger now than during the 1970s, gold probably won’t nearly triple or more than quadruple again in this first inflation super-spike since then. But surely it ought to at least double with red-hot inflation raging out of control.
Today’s soaring general prices are the result of the Federal Reserve flooding the world with a colossal deluge of new US dollars in recent years. Between the end of February 2020 just before the pandemic-lockdown stock panic and April 2022, the Fed mushroomed the US-dollar supply a ludicrous amount. In just 25.5 months, the Fed’s balance sheet which is the US monetary base skyrocketed 115.6% or $4,807b!
By effectively more than doubling the US money supply in just a couple years, the Fed conjured up vastly more dollars to compete for and bid up the prices on far-slower-growing goods and services. That’s why even headline CPI inflation, which is intentionally lowballed by the US government for political reasons, is soaring. Just this week the latest June CPI print blasted up 9.1% YoY, its hottest since November 1981!
This chart superimposes gold prices over the headline YoY CPI over the last few years or so. During the past 25 months, that leading inflation gauge has skyrocketed from a pandemic-lockdown anomaly down at 0.1% in May 2020 to last month’s crazy 9.1%. But monthly-average gold prices have only climbed a pathetic 6.9% in that span! Clearly gold is not yet reflecting this first inflation super-spike since the 1970s.
Fed money-supply changes take time to work their way through the massive US economy, so headline inflation lags them. Fed officials started panicking in mid-March 2020 after the flagship US S&P 500 stock index cratered 33.9% in just over a month! They worried pandemic lockdowns would force a severe recession, which could snowball into a full-blown depression with the negative wealth effect from plunging stocks.
So they started redlining their proverbial monetary printing presses, flooding the world with epic amounts of US dollars newly conjured out of thin air. Headline CPI inflation remained low until spring 2021, when that dollar deluge finally filtered down to normal Americans. In March, April, and May of that year, the YoY CPI surged to 2.6%, 4.2%, and 5.0%! Money-supply-growth-driven higher prices have intensified since.
In the 27 months since the Fed’s fateful March-2020 decision to hyper-inflate the US dollar, the YoY CPI has averaged 4.2%. That is skewed down by really-low reads during and after the lockdowns in 2020, but still double the 2.1% average CPI in the 27 months before that pandemic-lockdown stock panic. During the 17 full months Joe Biden has been president, the headline YoY CPI has been far worse averaging 6.2%.
This current raging inflation is literally unlike anything witnessed since the 1970s. And it sure should be after such radically-unprecedented money-supply growth by this profligate Fed. Yet gold is acting like the Fed never doubled the US dollars in circulation, like this latest inflation super-spike doesn’t even exist! That’s exceedingly-frustrating for contrarian speculators and investors, as well as students of market history.
Gold’s vexing disconnect from this red-hot inflation is fairly-new though, mostly emerging over just the last several months. During the initial year between March 2021 when the headline CPI first surged over the Fed’s 2% inflation target to March 2022, gold powered 22.0% higher. That way-more-normal behavior for mounting inflationary pressures was a good start. Gold marched higher like it should have in a solid uptrend.
Gold would’ve fared better in that span, but the US dollar was also strengthening. During that first real year of this inflation super-spike, the leading benchmark US Dollar Index climbed 7.2%. That is counter-intuitive, as inflationary debasement of currencies eroding their purchasing power eventually forces them lower. But the US dollar was bid higher on an increasingly-likely new Fed-rate-hike cycle to fight raging inflation.
Since currencies usually meander glacially, incredible leverage is available for currency traders as high as 50x to 100x! At those extremes, a mere 2% or 1% US-dollar move can double or wipe out traders’ capital bet. That forces them into a super-myopic ultra-short-term perspective. Currency traders often focus on yield differentials, shifting capital from countries with lower interest rates to others with higher ones coming.
The Fed launched its latest rate-hike cycle in mid-March 2022, ending its zero-interest-rate policy in place since March 2020’s pandemic-lockdown stock panic. Those rate hikes have really accelerated in the last three Federal Open Market Committee meetings, running 25 basis points, 50bp, and then 75bp in mid-June. The latter two hikes proved the biggest the Fed had dared since May 2000 and November 1994!
And the panicking Fed officials weren’t only jacking rates sharply higher, in early May they detailed how they would start unwinding that epic money-supply growth. The Fed would begin selling $47.5b of bonds each month in June, doubling to a terminal $95b-per-month pace in September. That dwarfed the Fed’s first quantitative-tightening campaign, which slowly ramped up to $50b monthly over an entire year into Q4’18.
Together that ultra-aggressive rate-hike cycle and big QT made for the most-hawkish Fed pivot by far in its entire century-plus history! So currency traders stampeded into the US dollar, further motivated by the weaker euro. Europe’s common currency dominates the USDX at 57.6% of its weighting, and the European Central Bank was dragging its feet in even starting to hike rates out of its own negative-interest-rate policy.
Crazy-leveraged currency traders love chasing momentum, so they increasingly piled into the soaring US dollar while dumping the cratering euro. That dynamic triggered gold’s inflation disconnect, which merely started three months ago in mid-April. Gold was still trading way up at $1,977 before the USDX rocketed parabolic and the euro collapsed. Their huge moves since then have been extraordinary and unsustainable.
As of this Monday the USDX had skyrocketed 8.3% in just 2.9 months, an exceedingly-extreme move for the world’s reserve currency. Epic Fed hawkishness fueled that, while helping the competing euro crater a brutal 7.7% in that same span. By major-currency standards, the dollar’s massive rally compressed into such a short timeframe was parabolic. It catapulted the USDX way up to an incredible 19.7-year secular high!
Such an anomalous surge attracted huge capital inflows, leaving the US dollar extremely-overbought and wildly-overcrowded. It also generated mania-like universal bullishness, leaving herd psychology for the USDX overwhelmingly-greedy. It was that euphoric dollar that slammed gold, as I analyzed in depth in last week’s essay. Gold’s apparent inflation disconnect resulted from an exceedingly-extreme dollar rally.
While the USDX skyrocketed 8.3% since mid-April, gold plunged 12.3% from that $1,977 to just $1,733 this Monday. Since I write these weekly web essays on Thursdays, their data cutoff is Wednesdays. As I’m penning this essay, gold has been hammered even lower near $1,700 as the USDX soars to new secular highs around 109.3! But this unsustainable USDX parabolic rally is doomed to reverse hard soon.
Exceptionally-big-and-fast surges to lofty heights inevitably generate overwhelming herd greed. Traders rush to chase the upside momentum, which temporarily becomes self-feeding. But that soon sucks in all-available near-term buyers, leaving only sellers. So vertical rallies soon peak with sentiment growing universally-bullish, then quickly fail in symmetrical plunges. Selling begets selling, accelerating the downside.
Any day now, the radically-overbought US dollar and equally-oversold euro are going to start violently mean reverting in the opposite directions. The catalyst could prove unexpected economic data out of the US or Europe which is less-hawkish for the Fed or more-hawkish for the ECB. Or it might be central-bank officials changing their jawboning, implying slower tightening in the US or faster tightening over in Europe.
Regardless of news flows, vertical parabolic rallies resulting in mania-like exuberance never last long. The universal bullishness for the US dollar on extreme Fed tightening reminds me of herd psychology for bitcoin back in early November. Traders collectively expected it to keep soaring indefinitely, with endless arguments to rationalize that sentiment. But since that extreme greed bitcoin has collapsed 71.9% at worst!
The mighty dollar won’t share that ugly fate, but its blistering 8.3% parabolic spike since mid-April should be symmetrically unwound over a few months. That would work wonders for gold, as that extraordinary dollar surge is the sole reason gold plunged since mid-April. That’s because the gold-futures speculators who dominate gold’s short-term price action watch the US dollar’s fortunes for their primary trading cues.
While the leverage inherent in gold futures doesn’t rival that in currencies, it is still extreme running near 25x in recent months. At those levels, a mere 4% gold move against speculators’ bets would wipe out 100% of their capital risked! That forces them into myopic short-term focuses as well, with time horizons in days to weeks on the outside. They aren’t even thinking about inflation, all they care about is the US dollar.
So specs aggressively dumped both long and short contracts since mid-April as the USDX skyrocketed. This chart reveals that heavy selling, which is reported weekly in the famous Commitments of Traders reports showing specs’ overall gold-futures positioning. Current to Tuesday closes, these weekly CoTs aren’t released until late Friday afternoons. So the latest-available data for this essay was only July 5th’s.
Despite traders’ swelling paranoia that gold is somehow no longer the ultimate inflation hedge, the dominant reason it collapsed 15.9% between early March to this Tuesday is heavy gold-futures selling. From the nearest CoT Tuesday closes matching that span, speculators dumped a huge 108.8k gold-futures long contracts while ramping their shorts by 32.5k! That 141.4k total contracts jettisoned is a lot of selling.
That’s equivalent to 439.7 metric tons of gold cast into global markets, with nearly 7/8ths flooding in during that mid-April to early-July timeframe where the USDX shot parabolic! Heedless of way-more-important broader trends like raging inflation, the myopic gold-futures specs have long been the villains of the gold world. Their frenetic leveraged trading bullying around gold prices also affects investors’ psychology.
The longer heavy gold-futures selling slams the metal lower, the more investors assume that gold must have some real fundamental problem justifying lower prices. So they join in the selling, amplifying downside. Between mid-April to early July, the best high-resolution proxy for global gold investment demand saw another 98.9t of selling. That’s the combined holdings of the huge dominant GLD and IAU gold ETFs.
So in just the last three months, gold suffered about 480 metric tons of identifiable selling! Fully 4/5ths of that was on the gold-futures side, in response to that parabolic US Dollar Index. But just as the dollar’s blistering rally is unsustainable, so is that heavy gold-futures selling. While specs wield outsized influence on gold prices due to their extreme leverage, their capital firepower is very finite. They can only sell so much.
Those limits are being reached, which is super-bullish for battered gold! In that latest-reported CoT week before this essay was published current to July 5th, total spec longs and shorts ran 311.7k and 146.2k contracts. And given gold’s weak price action since then on the USDX soaring ever-higher on early-quarter momentum buying, speculators’ longs are almost certainly even lower and shorts even higher this week.
Both are already near extremes as this chart reveals. Spec longs are right at major multi-year support, from which gold has surged dramatically higher on mean-reversion buying. So these traders likely have little additional room to keep selling, but massive room to buy back longs to normalize specs’ excessively-bearish bets. Since longs outnumber shorts by 2.1x, they are proportionally more important for gold’s direction.
Adding to evidence spec long selling is mostly-exhausted, longs have stabilized around that 312k support line for six CoT weeks in a row since late May despite much-lower gold prices. Most of gold’s weakness since then has been fueled by surging short selling. While total spec longs only fell a small 4.4k contracts since late May, spec shorts have surged 30.1k! That propelled them up near unsustainable multi-year highs.
Total spec shorts are above their uptrend resistance, nearing the same extreme levels that birthed gold’s last upleg in late September 2021. Gold was trading way down near $1,725 then, driven by gold-futures selling on a stronger US dollar fueled by hawkish-Fed expectations. But despite gold being universally despised then much like today, it powered 18.9% higher over the next 5.3 months on big gold-futures buying!
Since speculators’ hyper-leveraged gold-futures trading dominates gold prices when investment capital inflows wane, I always analyze the latest CoTs in our weekly and monthly newsletters. I like to recast total spec longs and shorts as percentages of their past-year trading ranges. As of that latest July 5th CoT, spec longs and shorts were running 0% and 96% up into those ranges. This is great news for gold.
That’s right at the most-bullish-possible near-term setup for gold of 0% longs and 100% shorts! That reveals spec selling on both sides of the trade is effectively spent, leaving room for nothing but big mean-reversion buying. So despite gold’s ugly selloff in recent months and technical breakdown in early July, its outlook remains incredibly-bullish. Gold has not disconnected from inflation, this is a temporary anomaly.
Fortunes are won in the markets by buying low then selling high. The former requires betting on sectors when they are deeply-out-of-favor, like gold and its miners’ stocks today. It is never easy maintaining a contrarian worldview and fighting the herd, which is always wrong at price extremes. But market history has long proven that’s the best way to generate life-changing wealth. This anomalous gold selloff is a gift.
The radically-overbought euphoric US dollar is soon going to roll over hard, as the wildly-oversold euro rebounds. That dollar weakness will drive gold higher, forcing gold-futures specs to quickly buy to cover their shorts or face catastrophic leveraged losses. That will accelerate gold’s gains, attracting back long-side gold-futures buyers then later investors with their vastly-larger pools of capital. Gold will soar on all that!
The biggest beneficiaries of higher gold prices are gold miners’ stocks, which are far-more-oversold than their metal. The larger gold stocks of GDX tend to amplify gold upleg gains by 2x to 3x, while the smaller fundamentally-superior mid-tiers and juniors well outperform even that! Before this inflation super-spike runs its course and gold fully reconnects, the better smaller gold stocks should see order-of-magnitude gains.
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The bottom line is today’s apparent gold-inflation disconnect is a temporary unsustainable anomaly. Gold powered higher on balance like normal during the first year of this inflation super-spike. But a few months ago, the US dollar started shooting parabolic on incredible Fed hawkishness. That spawned heavy gold-futures selling, hammering gold into a serious technical breakdown. But both extremes are exhausting.
The extraordinarily-overbought, euphoric, and wildly-overcrowded long-dollar trade is overdue to reverse sharply. And speculators’ capital firepower to sell gold futures is largely tapped-out based on multi-year trends. So when the USDX inevitably rolls over on a less-hawkish Fed or more-hawkish ECB, gold will soar on massive mean-reversion gold-futures buying. That will attract back investors, accelerating the upside.
Adam Hamilton, CPA
July 15, 2022
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