Gold-Bull Breakout Potential

Gold has faded from interest in the past couple months, overshadowed by the monster stock-market rally. But gold has been consolidating high, quietly basing before its next challenge to major $1350 bull-market resistance. A decisive breakout above will really catch investors’ attention, greatly improving sentiment and driving major capital inflows. With gold-futures speculators not very long yet, plenty of buying power exists.

Last August gold was pummeled to a 19.3-month low near $1174 by extreme all-time-record short selling in gold futures. The speculators trading these derivatives command a wildly-disproportional influence on short-term gold price action, especially when investors aren’t buying. Gold-futures trading bullies gold’s price around considerably to majorly, which can really distort psychology surrounding the gold market.

The main reason is the incredible leverage inherent in gold futures. This week the maintenance margin required to trade a single 100-troy-ounce gold-futures contract is just $3400. That’s the minimum cash traders have to keep in their accounts. Yet at the recent $1300 gold price, each contract controls gold worth $130,000. So gold-futures speculators are legally allowed to run extreme leverage up to 38.2x!

That’s extraordinarily risky of course. A mere 2.6% adverse move in gold against traders’ fully-leveraged positions would result in 100% total losses. It’s amazing these guys can sleep at night. For comparison, the stock markets’ legal limit has been 2x leverage since 1974. 10x, 20x, 30x+ is crazy and has been very problematic for gold for decades. It greatly amplifies gold-futures speculators’ impact on gold prices.

Every dollar deployed in gold futures at 30x leverage literally has 30x the influence on gold prices as a dollar invested in gold outright! So even though gold-futures speculators have far less capital available than investors, it is way more potent amplified up to 38x! Thus when gold investment demand is weak like recently with stellar stock-market complacency, gold-futures speculators utterly dominate gold price action.

Their collective trading effectively controls gold psychology too, since the American gold-futures price has become the world’s leading gold reference one. Investors start feeling bullish on gold and buying usually only after gold-futures speculators push its price higher. And gold-futures selling leaves investors bearish and worried, impelling them to exit gold. Gold-futures trading is the tail that wags the gold-investment dog!

So everyone interested in gold has no choice but to follow what the gold-futures speculators as a herd are doing. The US Commodity Futures Trading Commission publishes weekly data showing their collective positioning, the famous Commitments of Traders reports. They are released late Friday afternoons and show traders’ aggregate gold-futures long and short contracts held as of the preceding Tuesday closes.

Despite gold’s solid upleg since those deep mid-August lows, these traders still have lots of buying power left to push gold considerably higher. This first chart superimposes the daily gold price in blue over specs’ weekly total gold-futures long and short contracts in greed and red. The great majority of gold’s upleg-to-date gains have been driven by short-covering buying. Very bullishly the larger long buying is still yet to come.

(Click on image to enlarge)

In mid-August when today’s gold upleg was born, speculators’ total gold-futures shorts rocketed way up to 256.7k contracts! That was the highest witnessed in the 19.6 years since early 1999, almost certainly an all-time record. That unprecedented orgy of extreme shorting hammered gold from roughly $1300 down to $1175 in a couple months or so. That sharp futures-driven gold plunge naturally devastated psychology.

The gold-futures traders were effectively borrowing gold they didn’t own to dump in the markets, hoping to buy it back later at lower prices and profitably repay those debts. They were doing it at extreme 30x+ leverage, proportionally amplifying their capital’s price impact. That record shorting spree had nothing to do with fundamentals, it was a snowballing momentum thing. Yet investors were spooked into selling in sympathy.

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