Gold Futures Looking Bullish

Gold Futures Looking Bullish

Gold has rebounded sharply higher in the past month, taking the early lead as 2017’s best-performing asset class. Normally such a big gold surge would require heavy gold-futures buying by speculators. But they’ve been missing in action, barely moving any capital into gold yet. Their collective bets on this metal remain very bearish. Since they are such a strong contrarian indicator, that’s a very-bullish omen for gold.

The sole mission of speculation and investment, and thus all the endless research that feeds into it, is to multiply wealth. Traders can’t effectively buy low and sell high unless they understand what drivesthe prices of their trades. For years now, gold has had two overwhelmingly-dominant drivers.  Their capital flows fully explain the vast majority of all gold’s price action, and thus are exceedingly important to study.

The first is the world-leading GLD SPDR Gold Shares gold ETF. This acts as a conduit for the vast pools of American stock-market capital to slosh into and out of physical gold bullion. Differential supply and demand for GLD shares relative to the underlying gold supply and demand is directly shunted into gold itself. GLD’s physical-gold-bar purchases and sales as its holdings grow and shrink greatly impact gold prices.

Nothing has been more important for gold over the past year than the American stock-market capital that flowed into then out of it via GLD. Speculators and investors can’t understand where gold has been or where it’s likely heading without studying and closely watching GLD’s gold-bullion holdings. Last week I wrote a comprehensive essay digging into this crucial GLD-and-gold relationship in depth, check it out.

But American speculators’ gold-futures trading often overpowers American investors’ GLD-share trading in bulling the gold price around over the short term. Futures speculators enjoy an outsized impact on gold prices wildly disproportionate to the capital they wield for a couple key reasons. First, the American gold-futures price is gold’s de-facto world reference price. It is the most-widely-followed and quoted gold read.

So when these traders buy or sell aggressively and thus rapidly force gold materially higher or lower, it has a big psychological impact on everyone else in the gold world. Gold futures are the speculation tail wagging the far-larger investment dog in gold. Investors controlling vastly more capital than gold-futures speculators get bullish or bearish, and change their trading behavior accordingly, based on gold-futures action.

Second, gold-futures traders enjoy a radically-inordinate influence on gold thanks to the extreme leverage inherent in gold futures. While investors buy gold outright or with at most 2x leverage through GLD shares, gold-futures speculators often trade gold with incredible 20x to 25x leverage! That means every dollar of capital bet on gold futures can have 20x to 25x the price impact of another dollar invested normally.

So futures speculators’ collective buying and selling can really distort gold prices over the short term, even though gold investment demand will always ultimately prevail as gold’s primary driver. There’s a critical interplay between GLD capital flows and gold-futures action. Parallel buying or selling on both of these fronts always drives gold higher or lower. Opposing buying and selling tends to offset and cancel out.

Unlike GLD-holdings data which is available daily, speculators’ collective gold-futures trading activity is only published at a fuzzier weekly resolution.  Late every Friday afternoon the CFTC releases its famous Commitments of Traders reports. These reveal what both hedgers and speculators have been doing in gold futures current to the preceding Tuesday. Watching them is essential to gaming gold price action.

This first chart looks at the aggregate gold-futures long and short positions held by both large and small speculators, in contracts. Each gold-futures contract controls 100 troy ounces of this metal. Total longs or upside bets on gold are rendered in green, while total shorts or downside bets are shown in red. The yellow line shows the deviation of both these bets from normal years’ average levels between 2009 to 2012.

Gold Futures Specs 2016-2017

This chart zooms in to the past year or so, but let’s start on Election Day.  That night as Trump pulled into a surprise lead in the biggest battleground state of Florida, gold futures rocketed 4.8% higher to $1337! A Trump win was universally assumed to be bad for stock markets and thus good for gold, which is the anti-stock trade since it tends to move counter to stock markets. As stocks rebounded, gold was sold hard.

This heavy post-election gold selling was universal, coming from both investors jettisoning GLD shares and speculators dumping gold futures. With capital rushing out of gold’s two primary drivers, it was just hammered. In the 5 weeks between Election Day and the day after the Fed’s second rate hike in 10.5 years in mid-December, gold plunged 11.5%! That was part of a larger 17.3% major correction since early July’s peak.

Gold’s two biggest plunges in its miserable Q4’16, one of its worst quarters ever, were fueled by heavy gold-futures selling by speculators. Since such extreme leverage exists in this market, traders have to set tight stop losses. If they are running 20x leverage, a mere 5% adverse move in gold against their bets would wipe out 100% of their capital risked! So even minor 1%ish gold moves are major for futures traders.

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