Gold, silver, and their miners’ stocks plummeted out of the blue this week, shattering their bull-market uptrends. Gold-futures speculators had been holding excessive long positions for months, weathering all kinds of selling catalysts. But once gold slipped through key support, long-side futures stop losses started to trigger unleashing cascading selling. Understanding this event and its implications is crucial for traders.
This week’s precious-metals carnage was a big surprise, erupting suddenly with no technical warning. Gold had been faring quite well after hitting its latest interim high of $1365 in early July. That was driven by heavy fund buying of gold-ETF shares in the wake of late June’s unexpected pro-Brexit vote. After those big capital inflows dried up, gold consolidated high. At worst by late August it had pulled back 4.1% to $1308.
Then gold spent all of September grinding higher along its bull-market uptrend’s support, which was an impressive show of strength. Speculators were holding large near-record long positions in gold futures. Since these bets are so hyper-leveraged, that greatly elevated the risks of a snowballing selloff. I wrote extensively about gold’s record selling overhang back in mid-July, and that threat has lingered ever since.
But despite all kinds of excuses to do so, the futures speculators never rushed for the exits. Every week their collective bets on gold are detailed in the CFTC’s famous Commitments of Traders reports. Back in late June, speculators’ gold-futures long contracts climbed above 400k for the first time in history. Then a couple weeks later in early July, they climbed to an all-time record high of 440.4k contracts as gold peaked.
That presents a big selling risk due to the extreme leverage inherent in futures trading. Every contract controls 100 troy ounces of gold, worth $135,000 at $1350. Yet back in July, the minimum cash margin speculators were required to deposit for each gold-futures contract they traded was just $6000. This week it is running $5400. That works out to maximum leverage to gold of 22.5x and 25.0x, insanely high!
For many decades the legal limit in the stock markets has been 2.0x, making gold futures more than an order of magnitude riskier. At extreme 10x, 15x, 20x, and 25x leverage, mere 10.0%, 6.7%, 5.0%, and 4.0% adverse moves in gold against speculators’ positions would wipe out fully 100% of the capital they risked! So when these guys are wrong, they have to be quick to exit their trades or risk total annihilation.
As late 2015’s huge gold-futures selloff battering gold to deep 6.1-year secular lows proved, there is nothing these speculators fear more than Fed rate hikes. Despite history proving in spades that gold actually thrivesduring Fed-rate-hike cycles, this group of traders wrongly views them as gold’s nemesis. So they tend to sell aggressively when data or news increases the likelihood of more rate hikes sooner.
Yet some remarkable events this past summer made it look like gold-futures speculators were coming around to gold’s historical strength in rate hikes. For 13 of the 15 CoT weeks since late June when their collective gold-futures longs first climbed over 400k, these same excessive 400k+ levels held. That was despite gold’s summer doldrums, new record stock-market highs, and a vastly-more-hawkish outlook on the Fed.
Fed-rate-hike odds at upcoming FOMC meetings are calculated in real-time based on federal-funds futures trading. The hedgers and speculators participating in this market are very sophisticated and the best-informed in the world on likely Fed policy. This market is so important that historically the FOMC has never hiked until these futures-implied rate-hike odds exceed 70%, in order to avoid shocking the markets.
Back on August 12th, these rate-hike probabilities had collapsed way down to 6%, 8%, and 39% at the FOMC’s next few meetings. Over the next couple weeks culminating with Janet Yellen’s highly-anticipated Jackson Hole speech on August 26th, these rate-hike odds rocketed to 36%, 41%, and 64%! That was without a doubt the most-hawkish couple-week span of economic data and Fedspeak seen in many years.
Amazingly in light of last year’s panicking precedent, gold-futures speculators held firm with their excessive longs. During those two CoT weeks closest to that rocketing-rate-hike-odds span, speculators only dumped a collective 9.8k gold-futures contracts! Thus gold only slid 1.2% lower. That was an incredible display of strength in the face of a soaring rate-hike threat, so speculators’ high longs looked durable.
Until this Tuesday, which started out rather unremarkably with no gold-futures-moving news at all. Gold had closed at $1313 on Monday, still above August 31st’s pullback low of $1308. Gold was trading right there when the US trading day rolled around. Those futures-implied rate-hike odds at Monday’s close ran 11%, 62%, and 64% for the FOMC’s next few meetings in early November, mid-December, and early February.
So there was virtually no chance of an imminent rate hike in early November right before the critical US elections. Provocatively, Fed hawkishness wasn’t a factor at all in Tuesday’s plunge. While there was some hawkish Fedspeak on Tuesday, it was nothing out of the ordinary for recent months. By the close Tuesday after gold had plummeted, those rate-hike odds had barely budged to just 13%, 59%, and 62%.