Adam Hamilton – Zeal Intelligence | September 17, 2021 | 1:24 pm MarketsGold
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Gold continues to struggle to make headway, bogged down by skittish gold-futures speculators. They are loath to buy in quantity, because they fear serious downside from expected Fed tightening. For that same reason they are quick to flee as a herd, unleashing periodic bouts of heavy selling hammering gold. That feeds bearish psychology, ramping worries about the immediate threat of another gold-futures taper tantrum.
The original “Taper Tantrum” occurred back in mid-2013, and its brutal impact on gold is infamous. The Federal Reserve was getting ready to start winding down its third quantitative-easing campaign in early June that year. Total QE3 money printing had run $545b by that point, adding on to QE1’s epic $1,750b coming out of late 2008’s stock panic and QE2’s $900b. QE3 was still running full-bore at $85b per month.
In mid-June 2013, the Federal Open Market Committee met for one of its eight meetings each year. The actual FOMC statement that day pledged to continue monetizing US Treasuries and mortgage-backed securities at that $85b monthly pace. But in his post-meeting press conference, then-Fed-chairman Ben Bernanke laid out a vague timeline for gradually ending QE3. The taper tantrum resulted, crushing gold.
The US Dollar Index soared 2.9% over six trading days on the prospects of the Fed gradually slowing its blistering money printing. Gold cratered 10.4% during that exact span, and extended slightly to eight trading days gold collapsed 13.4%! It felt like the end of the world for this leading alternative investment. Gold limped out of that Q2’13 with a horrific 22.8% loss, making for its worst quarterly performance in 93 years!
That kind of plummeting was crushing even owning gold outright, but gold-futures speculators then could run extreme 21.3x leverage. A mere 4.7% gold move against their positions could wipe them out, destroying 100% of their capital risked. So they fled in terror as QE3-taper fears mounted between late May to early July that year. In seven weeks, they dumped 33.6k gold-futures long contracts while adding 31.5k shorts.
That added up to the equivalent of 202.4 metric tons of gold selling. The resulting gold free-falling sure scared investors too, so they piled on. The leading proxy for gold investment flows is the combined gold-bullion holdings of the dominant GLD SPDR Gold Shares and IAU iShares Gold Trust gold ETFs. Their holdings fell 7.7% or 93.8t on heavy differential gold-ETF-share selling during that same dark taper tantrum.
That extreme gold-selling episode was so traumatic that it forced a sizable fraction of speculators and investors out of the precious-metals realm forever. Traders’ interest has never fully recovered from that horrific Q2’13 capitulation rout. With the long bearish shadow that event cast, it’s not surprising that QE-tapering fears run deep. Leveraged gold-futures speculators simply can’t afford to be wrong on gold for long.
In the middle of this week, traders were required to keep $8,250 cash margins in their accounts for every gold-futures contract they held. But with gold trading near $1,794, each 100-ounce contract controlled $179,400 worth of gold. That allows speculators to run extreme leverage up near 21.7x, right where it was heading into the mid-2013 taper tantrum. So the gold-futures guys are scared of another one erupting.
Their fears of QE4 tapering starting soon, broadening out to general Fed tightening, are the whole reason gold has been struggling since mid-June 2021. The extreme leverage these guys run makes gold-futures trading the tail that wags the gold-price dog. At 21x, each dollar of gold-futures selling exerts the same downside gold-price impact as $21 of outright investment selling. So gold is often at the mercy of futures.
Prior to this latest taper tantrum, gold was enjoying a solid young upleg. The yellow metal rallied 13.5% between early March to early June. But accompanying the mid-June FOMC meeting, individual Fed officials’ future rate projections were slightly more hawkish than expected. A third of those guys looked to maybe see two quarter-point rate hikes way out into year-end 2023! That ignited extreme gold-futures selling.
Speculators’ gold-futures positioning is released weekly, current to Tuesday closes. Their trading trends are detailed in Commitments of Traders reports, defining CoT weeks. Over several CoT weeks straddling that hawkish Fed dot plot, speculators dumped 37.4k longs while adding 12.3k shorts. That made for the equivalent of 154.5t of gold selling. That big slug hammered gold about 7.0% lower, interrupting its upleg.
But much to their credit, gold investors weren’t fazed by gold-futures traders’ gross overreaction. Just a couple potential rate hikes 2.5 years into the distant future? Come on. So GLD+IAU holdings actually enjoyed a slight 0.7% build during that span, climbing 10.3t. Gold quickly started recovering out of that extreme selling episode, clawing back 3.9% by mid-July. Over half those rate-hike-fear losses were regained.
But then in early August, those hyper-leveraged gold-futures speculators again sold hard after a better-than-expected monthly US jobs report. Upside surprises on major US economic data, like the retail-sales print just this week, lead gold-futures traders to expect the Fed to start slowing its epic $120b-per-month of QE money printing sooner rather than later. So huge taper-tantrum gold-futures herd selling flared again.
In the CoT week straddling that headline US jobs beat in early August, speculators didn’t dump any longs but they piled into gold-futures shorts with a vengeance. The 35.7k contracts they short sold that week was the third-largest on record, utterly massive! Part of that was a textbook gold-futures shorting attack the following Sunday evening, some large trader instantly slamming through a huge short sale to hammer gold.
Speculators had puked out 35.6k contracts in that single CoT week, the equivalent of 110.9t of gold. But gold investors, who control vastly more capital than the gold-futures speculators, shrugged. Those total GLD+IAU holdings only slipped 0.3% or 5.1t during that miserable span where gold plummeted 4.5%. These recent bouts of extreme gold-futures selling are very important for the FOMC’s coming QE4 tapering.
This chart superimposes daily gold closes over speculators’ gold-futures positioning from those weekly Commitments of Traders reports. The latest CoT data available as of this essay’s publishing is current to Tuesday September 7th, well before this week’s US-retail-sales-beat gold-futures selloff. So realize all the following analysis would be considerably more bullish if we could account for this latest big selling bout.
Speculators’ total long and short contracts are rendered in green and red respectively. Because of recent months’ extreme-gold-futures-selling episodes in anticipation of Fed tightening, the likelihood of another taper tantrum on the actual FOMC announcement is much lower. These traders’ capital firepower is very finite, despite their crazy leverage which allows them to punch way above their weight bullying gold around.
Technically gold remains in a secular bull which was born way back in mid-December 2015. At best gold has powered 96.2% higher over 4.6 years into early August 2020. Interestingly this bull started the very day after the Fed’s first rate hike in 7.0 years kicked off a long nine-rate-increase hiking cycle. Extreme gold-futures selling slaughtered gold leading into that feared hiking cycle, an important lesson for today.
Between late October to mid-December 2015, speculators dumped an immense 84.5k longs while piling into 70.6k shorts. That added up to the equivalent of a mind-boggling 482.2t of gold selling in just eight CoT weeks! That blasted gold 9.8% lower, spreading enough worry to convince gold investors to sell GLD+IAU holdings to an 8.1% or 69.7t draw. Yet Fed rate hikes proved a sell-the-rumor buy-the-news event.
The gold-futures speculators had jettisoned so many longs and piled into so many shorts that their selling firepower was totally expended before the Fed actually ended its longstanding zero-interest-rate policy. So over the next 6.7 months into early-July 2016, gold actually powered 29.9% higher kicking off a new secular bull in the midst of a new Fed tightening cycle! Leveraged gold-futures selling is finite and limited.
So the more contracts these guys sell leading into any big FOMC decision, the less they have left to sell after it actually comes to pass. That makes recent months’ bouts of extreme gold-futures selling actually bullish for gold. Rather than having a taper tantrum after the announcement, these traders have largely fled in anticipation of it. So they have far less room to liquidate longs and add shorts after QE4 tapering is announced.
The next taper tantrum quite literally could have mostly already happened! This chart reveals the trends of speculators’ total longs and shorts during recent years. The longer secular gold bulls power higher on balance, the more traders believe these powerful runs are sustainable. So spec longs gradually climb in uptrends throughout gold bulls, while spec shorts slowly shrink. Leveraged bets against gold bulls aren’t wise.
As of that latest September 7th CoT report, total spec longs were running 355.2k contracts. That is very low within their secular uptrend, which is now running from about 325k lower support to 500k upper resistance. Within the context of this trend, speculators have massive room to buy gold-futures longs but little room to sell more. They’ve already been selling on balance in quantity throughout much of 2021 so far.
And total spec shorts at 119.4k contracts are actually above the upper resistance of their downtrend. In the wake of that gold-futures shorting attack following that US-jobs beat in early August, spec shorts hit a lofty 2.2-year high! So per their secular downtrend, there is now vastly more room to buy to cover existing shorts than add new ones. Speculators have already done major gold-futures shorting as this year unfolded.
With spec longs already relatively-low and spec shorts already relatively-high thanks to major gold-futures selling in anticipation of coming Fed tightening, the odds of another taper tantrum crushing gold are much smaller. Whenever the Fed chair lays out the QE-tapering timeline, maybe as soon as after next week’s FOMC meeting, there just isn’t much room left for extreme gold-futures selling on either the long or short sides!
Given speculators’ bouts of extreme selling in recent months, a strong case can be made that the next taper tantrum likely already mostly happened in slow motion. The last one in mid-2013 was so extreme, so traumatic, that traders exited in anticipation of QE4 tapering rather than in reaction. After people suffer terrible events, the next time a similar one looks to be looming they prepare in advance to minimize the pain.
Trading is a probabilities game, nothing is ever certain looking into the future. Another serious gold selloff on the QE-taper announcement is certainly possible, but much less probable given recent months’ huge pre-selling. That has left speculators’ gold-futures positioning so gold-bullish that another sell-the-rumor buy-the-news scenario could unfold. Gold has good odds of rallying strongly in the wake of tapering starting.
Slowing today’s colossal $120b per month of QE money printing aside, the general market environment is far more bullish for gold today than it was leading into that ugly June-2013 QE3 tapering. Let’s start with money-supply growth. In only the 18.0 months since the March 2020 pandemic-lockdown stock panic, this profligate Fed has ballooned its balance sheet an astounding 93.8% or $4,045b! Yes you read that right.
In just a year-and-a-half, the Fed has nearly doubled the US-dollar supply! In the similar 18.0-month timeframe leading into the June-2013 QE3 tapering, the Fed’s balance sheet merely grew by 19.0% or $554b. Gold is the ultimate inflation hedge, as its aboveground supply only grows about 1% annually via mining. So today’s wildly-unprecedented fiat-currency growth globally is fantastically-bullish for the yellow metal.
This vast flood of new money the Fed is spewing into the economy is why even lowballed government-reported headline inflation is running so hot. The latest producer-price read on US wholesale inflation at factory gates soared 8.3% year-over-year! And the latest US consumer-price index blasted up 5.3% YoY. With price inflation hot and mounting thanks to the Fed’s largesse, gold investment demand should soar.
The more gold investors buy, the more their vastly-larger pools of capital will overwhelm whatever the far-smaller leveraged-gold-futures speculators are up to. Headline inflation was nonexistent leading into that June-2013 taper, with the PPI and CPI up just 1.7% and 1.4% YoY! Back then just like today the Fed’s benchmark federal-funds rate was slaved to zero, so there isn’t any more room for the Fed to hike rates now.
Heading into June 2013 gold had just rolled over into a new secular bear, after its previous secular bull had powered a massive 638.2% higher over 10.4 years into August 2011. April 2013 actually saw a gold panic, on extreme gold-futures selling on Fed-tightening fears along with accompanying heavy investment selling. So gold psychology was far more bearish heading into that last QE taper, precipitating more selling.
Gold-futures speculators’ primary trading cue is the fortunes of the US dollar, which gold often moves in lockstep opposition of. Heading into the June-2013 taper tantrum the USDX was way lower near just 80.6, leaving it with lots of room to surge on slowing Fed money printing. Today this same leading US-dollar benchmark is way higher around 92.5, giving it less room to rally when the Fed chair announces QE tapering.
Gold is the ultimate portfolio diversifier since it tends to rally during stock-market selloffs. So any material stock-market weakness will boost gold investment demand, lowering the odds of another taper tantrum. Thanks to the Fed’s insane post-pandemic-lockdown-stock-panic money printing since March 2020, the S&P 500 has skyrocketed 102.8% at best! That Fed-QE-driven levitation has left it dangerously overvalued.
Entering September 2021, the 500 elite S&P 500 stocks averaged trailing-twelve-month price-to-earnings ratios way up at 34.1x! Formal bubble territory starts at 28x, which is twice the century-and-a-half average fair value around 14x. Compare that to the S&P 500 climbing 38.5% at best over a similar pre-June-2013 span, and trading at a much-milder 23.4x average TTM P/E leading into that last Fed QE tapering.
Interestingly the serious fragility of today’s lofty stock markets, driven to perilous bubble valuations solely by the Fed’s extreme QE4, has plenty of contrarians wondering if the Fed can even fully taper QE. The FOMC believes the stock-market wealth effect is instrumental in driving consumer spending and thus the entire US economy. So when stock markets sell off considerably, Fed officials panic and rush to ease.
At a 10% S&P 500 correction starting after and being blamed on QE4 tapering, the FOMC officials would be sweating bullets. Nearing a 20% bear, they’d likely cry uncle and scrap tapering altogether. So if the long-overdue major stock-market selloff erupts soon after tapering, the Fed likely won’t finish. If this $120b of monthly QE is slowed by $10 per month, it would take 11 months adding another $660b in money printing.
So another taper tantrum sledgehammering gold seems much less likely this time around. Speculators have already done huge gold-futures selling in anticipation of coming Fed tightening, exhausting much of their selling firepower. And the market conditions today are way more bullish for gold than ahead of that last taper tantrum in mid-2013. And a major stock-market selloff may stop this next taper dead in its tracks.
Gold actually has mounting odds of powering higher after this long-feared QE4-tapering announcement. This sell-the-rumor buy-the-news behavior happened after the Fed kicked off its last rate-hike cycle, birthing today’s secular gold bull. The next taper tantrum may have already happened in slow motion in recent months. That is really bullish for gold and its miners’ stocks, which leverage their metal’s upside by 2x to 3x.
The bottom line is gold’s much-feared next QE taper tantrum may have already happened in slow motion in recent months. Gold-futures speculators have done massive amounts of selling in anticipation of Fed tightening nearing. That has expended much of their selling firepower, leaving their longs relatively-low and shorts relatively-high. This bearish positioning slashes the odds of a big gold selloff on QE4 tapering.
Because of excessive gold-futures selling leading into it, the Fed launching a new rate-hike cycle actually birthed today’s secular gold bull. And general market conditions today are way more bullish for gold than they were leading into the June-2013 taper tantrum. This next QE tapering likely won’t last anyway if it spawns an overdue serious stock-market selloff. Gold’s outlook is way more bullish than most traders realize.
(By Adam Hamilton)
