Gold’s Momentum Selloff

Gold has suffered unrelenting selling in the last couple of months, hammering it and its miners’ stocks much lower. Those outsized anomalous losses have left sentiment in tatters, with overpowering bearishness universal. Gold’s thrashing had nothing to do with fundamentals, it was driven by cascading momentum selling in gold futures and gold-ETF shares. But such dumping is finite, increasingly likely to exhaust itself.

Last summer, gold rocketed 40.0% higher out of last March’s COVID-19-lockdown-spawned stock panic. That massive upleg left this metal extraordinarily overbought, guaranteeing a correction to rebalance both sentiment and technicals. That came right on schedule, with gold dropping 13.9% over 3.8 months into the end of November. That healthy selloff was in line with this bull’s precedent, leaving gold sufficiently oversold.

Gold’s three prior corrections during this secular bull had averaged 14.3% losses over 4.1 months. And that was skewed big, with two of those earlier selloffs seriously exacerbated by unique anomalous events. So the odds swung around to favor gold’s next bull upleg getting underway. Indeed it soon started marching higher in a strong uptrend, carrying gold up 9.8% by early January. Then gold went pear-shaped!

On Friday, January 8th, gold was blitzed with extreme gold-futures selling. That shattered its uptrend, blasting gold 3.5% lower that day alone! That was pure technical selling, which accelerated after gold’s psychologically-heavy $1,900 level failed overnight. From there it has been all downhill, with gold falling 12.0% by the middle of this week. That extended its total correction to 16.8%, challenging the worst of this bull.

What the heck happened? Gold investment demand should be strong if not massive given today’s super-bullish backdrop. The Fed’s printing presses are spinning like crazy, with it monetizing a colossal $120b per month of US Treasuries and mortgage-backed securities. Over the past year, the Fed’s total balance sheet and Treasuries held have skyrocketed an absurd 82.5% and 95.8% to a mind-blowing $7,590b and $4,845b!

This most-extreme monetary inflation in US history is happening with US stock markets trading way up at dangerous bubble valuations. Exiting February, the elite S&P 500 stocks averaged extreme trailing-twelve-month price-to-earnings ratios of 35.8x! Investors should be rushing to diversify their stock-heavy portfolios in gold, especially as rising yields threaten to slay stocks’ There-Is-No-Alternative rationalization.

The relentless and sometimes-heavy gold selling since early January had nothing to do with gold’s strong fundamentals. Instead, it was purely momentum-driven, snowballing gold-futures selling that triggered a cascading exodus from major-gold-ETF shares. The lower gold fell, the more these traders either had to or wanted to sell. Then their ongoing dumping exacerbated gold’s losses, forming a powerful vicious circle.

While tough to weather psychologically, this type of mindless herd momentum selling is inherently self-limiting. At some point, everyone susceptible to being scared into selling low has already sold, leaving only buyers. Then gold rallies sharply from the selloff nadir, resuming its next bull-market upleg. The past couple months’ selloff was two-staged, a gold-futures primary igniting a far-bigger gold-ETF secondary.

Unfortunately and infuriatingly at times, gold-futures speculators punch way above their weights when it comes to the gold-price impact of their trading. The extreme leverage inherent in gold futures gives these guys outsized influence over gold prices. Back in early January before this selling avalanche started, the gold-futures margin requirements mandated just $10,000 cash held in accounts for each contract traded.

As gold was still up near $1,915 then, that meant each 100-ounce contract controlled $191,500 worth of gold. That enabled gold-futures speculators to run extreme leverage as high as 19.2x! For decades the legal limit in the stock markets has been 2x. For every 1% gold’s price moved, these specs would gain or lose 19%. Such an intense amplification of risks greatly compresses the time horizons for their trades.

On that early-January Friday when $1,900 gold failed, gold’s 3.5% plummeting leveraged 19x forced brutal 2/3rds losses on traders long at maximum margins! Running extreme leverage, they are forced to sell or face imminent ruin when gold is falling. Their focus is exceedingly-myopic by necessity, making buy-and-sell trading decisions exclusively on momentum. Speculators’ herd futures dumping kicked off gold’s selloff.

This first chart superimposes gold over specs’ total gold-futures long and short contracts held. These are reported weekly in the famous Commitments of Traders reports. Had the snowballing gold-futures selling by these hyper-leveraged traders not flared, gold would likely be back over $2,000 by now. But because of the extreme risks inherent in amplifying gold’s price action, heavy gold-futures selling often cascades.

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Monica Kingsley 1 month ago Contributor's comment

I agree that gold's travails had nothing to do with fundamentals, and the consolidation is getting long in the tooth. I've laid down in my writings two scenarios for support if we are to resume the bullish trend soon. And contrary to the (perma)bears, I think we're closer to that turning point than generally appreciated.