Gold stock head fake?

Gold started grinding lower after its own September 4th upleg zenith of $1554, capping a massive 32.4% run over 12.6 months. The gold stocks corrected with gold like usual, as these miners are essentially leveraged plays on gold. Since their earnings amplify gold-price changes, the major gold stocks dominating GDX generally leverage gold by 2x to 3x. So the gold stocks drifted lower over the next several months.

At worst GDX was down 15.4% over 1.3 months by mid-October, although it would narrowly miss new correction lows by pennies in both early and late November. Gold’s own selloff hit its correction-to-date nadir on Thanksgiving Eve, falling 6.4% over 2.8 months. Both of these corrections were really mild and short by their own bull-to-date standards. And neither GDX nor gold fell anywhere near their own 200dmas.

Gold-bull corrections after major uplegs almost always drag prices back down to their 200-day moving averages before giving up their ghosts. These key technical lines are major support within ongoing bull markets. 200dma approaches help corrections complete their missions of eradicating the excessively-bullish sentiment at previous upleg toppings. At worst in late November, GDX was still 4.7% over its 200dma.

Gold similarly appeared to evade a normal correction, retreating to 4.0% above its own 200dma in late November. Those were serious red flags technically that the corrective work hadn’t yet finished. And GDX’s 15.4% loss over 1.3 months was dwarfed by this bull’s prior two GDX corrections averaging 35.4% losses over 11.8 months. So technically gold stocks’ correction hadn’t ended cleanly heading into December.

Gold was in the same boat, with its 6.4% selloff over 2.8 months at worst very small and short compared to this bull’s prior corrections averaging 15.5% losses over 6.0 months. While gold’s improving sentiment on its first new bull-market highs in several years argued for a milder correction, it still should’ve proven bigger than 6%. That was after the largest upleg of this bull pushed gold to extremely-overbought levels.

Gold remained in its correction downtrend through most of December, but was crowding upper resistance which was mirroring gold’s 50-day moving average. But early last month GDX broke out above its own 50dma, emboldening gold-stock traders. Yet the major gold stocks still ground sideways after that until a Christmas Eve surprise. Nothing should’ve happened on that ultra-light-volume half-day holiday session.

Gold had climbed 0.5% to $1485 the day before, edging over its own 50dma. These 50dmas often prove upside resistance in correction downtrends. That piqued the interest of technically-oriented gold-stock traders, who bid GDX 2.4% higher to $27.77. Then out of the blue on Christmas Eve, gold surged 1.0% higher to regain $1500 on no news whatsoever! That decisive 1%+ breakout ignited gold stocks’ own.

Gold had surged back up through both its correction-downtrend resistance and 50dma, implying that its correction might be over. So GDX blasted another 3.2% higher in that usually-throwaway half-day Christmas Eve session. Closing at $28.66, those were the major gold stocks’ best levels since late September. That shattered the upper resistance of gold stocks’ own correction downtrend, igniting much excitement.

That surprise Christmas Eve breakout rally is readily evident in this chart, which shows GDX over this entire gold-stock bull since early 2016. The months-old correction downtrend was no longer holding this sector back. So gold-stock psychology shifted dramatically in the week or so since. Traders are mostly no longer apprehensive about a deeper correction, but believe gold stocks’ next bull upleg is underway.

As a long-time gold-stock speculator for decades now, I sure understand the allure of a breakout rally. Wealth multiples fast in major gold-stock uplegs, they are exciting events. As gold stocks power higher and greed mounts enticing in more traders, the fear of missing out grows great. Doubling your capital in 6 to 12 months is a super-seductive proposition, and it has happened plenty of times in modern gold-stock history.

Of course the markets were closed on Christmas Day, but gold’s breakout rally extended on Boxing Day with another 0.7% gain to $1511. So GDX climbed another 1.5% to $29.08. After a breather last Friday, gold climbed another 0.3% near $1515 this Monday. Gold-stock traders rejoiced at seeing gold’s best levels since late September, and piled into the miners to push GDX up another 2.1% to hit $29.49 on close.

That too was back to late-September levels, and not far from gold stocks’ last upleg peak of $30.95 hit on September 4th. In just 5 trading days straddling Christmas, GDX had ripped 8.7% higher! That amplified gold’s own 2.5% surge in that span by 3.5x, better than the usual 2x to 3x. Throughout that breakout-rally week, commentary on gold and its miners’ stocks became more and more bullish as excitement mounted.

The critical question now is whether gold stocks’ breakout rally is real and sustainable. Is it the early days of this sector’s next major bull-market upleg as widely assumed? Or do the shallow and short corrections after the last massive gold and gold-stock uplegs still have work to do? If they hadn’t yet erased enough greed to rebalance sentiment, new correction lows are still likely. That would make this rally a head fake.

Traders bristle at this latter contrarian notion. Yet this chart proves this bull’s prior corrections have seen powerful countertrend rallies within corrections. They shatter downtrend resistances, exceed 50dmas, and can even boost GDX all the way back up near prior-upleg highs. So the mere existence of breakout rallies offers no guarantee that corrections are over. Corrections persist until sentiment is finally rebalanced.

That didn’t appear to happen after those recent gold and GDX upleg peaks. I’ve been blessed to be in the financial-newsletter business for over two decades now. My job is studying the markets all day every day to better understand them, write about them, and make profitable trades for our subscribers. Their feedback pours in constantly from around the world, and collectively proves a great sentiment indicator.

Later in prior gold-stock corrections as sentiment was bottoming, everyone was depressed. People were giving up on this sector after it fell so hard in the preceding corrections. Doubt, fear, and despair were the common themes. Capitulation ran rampant, with virtually no interest in deploying more capital in this volatile contrarian sector. That’s the time to be super-bullish on gold stocks, when most others are bearish!

But gold-stock bearishness has remained subdued at worst ever since early September. Even in mid-October, early November, and late November as GDX was hitting and challenging correction lows, that didn’t fuel widespread worry. This gold-stock correction was simply too shallow and short to eradicate greed and stoke fear. People were mostly looking to keep buying, which is typical mid-correction psychology.

That wasn’t surprising given how little both gold and GDX had retreated since their upleg toppings in early September. As discussed earlier in this essay, the metal and its miners’ stocks hadn’t fallen anywhere near as deep or long as their own bull-market precedents. Relatively small and short-lived selloffs don’t do much to rebalance sentiment. So greed persists while fear fails to bloom, delaying the next upleg.

Since those recent uplegs peaked, sentiment has yet to be right to birth major new uplegs. They are always born in fear, not greed. While herd sentiment is ethereal and impossible to measure, there’s an easy way to infer it. Look up what your favorite market analysts were saying about gold and gold stocks in mid-October, early November, and late November as GDX was near correction lows. It likely wasn’t bearish!

But sentiment and correction-to-date technicals aside, one thing all gold-stock speculators and investors can agree on is as goes gold so go the gold stocks. Again the gold miners are leveraged plays on gold due to their great profits leverage to this metal’s price trends. If gold continues powering higher, then this recent gold-stock breakout rally is righteous. But if gold sells off materially again, gold stocks will fall hard.

As always, gold stocks’ fortunes from here depend on what gold does next. As I’ve analyzed, proved, and discussed in countless essays over the decades, gold itself has two primary drivers. They are what investors and gold-futures speculators are doing. When they buy or sell, gold climbs or falls respectively. So whether gold stocks’ breakout rally is real or a head fake hinges on what these traders are likely to do next.

Comprehensive data on global gold investment is only published quarterly by the World Gold Council, and the latest Q4 read won’t be released for at least a month yet. But there’s a great proxy for what investors are doing at a high-resolution daily read. That’s the holdings of the world’s leading and dominant GLD SPDR Gold Shares gold ETF. They accounted for nearly a third of the global-gold-ETF total at the end of Q3!

GLD acts as a conduit for the vast pools of American stock-market capital to slosh into and out of gold. When investors buy GLD shares faster than gold itself is being bought, their price threatens to decouple from gold’s to the upside. GLD’s managers must prevent this to keep their ETF tracking gold. So they issue enough new shares to offset that differential GLD demand, and use the proceeds to buy physical gold.

So when GLD’s holdings are rising, investment capital is flowing into gold. And when they are falling, it is moving back out. American stock investors dumping GLD shares faster than gold will lead to a downside tracking failure. So GLD’s managers have to sop up that excess supply from differential selling, by buying back GLD shares. They raise the funds to do this by selling physical gold. GLD’s holdings reveal all this.

During that 5-trading-day span straddling Christmas when gold and GDX surged 2.5% and 8.7% in their breakout rallies, GLD’s holdings only climbed 0.8% or 7.3 metric tons. While that was the best cluster of GLD-holdings builds since late September, it is still next to nothing. Historically GLD trends have mirrored global gold investment ones quite closely. Over this past week, investors weren’t materially buying gold.

And why would they with these extreme Fed-levitated stock markets at euphoric all-time-record highs? Gold is a contrarian trade, the ultimately portfolio diversifier. It generally isn’t in demand when stocks are high and complacency is overwhelming. And $1500+ gold may be exciting to gold-stock traders, but it isn’t high enough to drive considerable interest outside of contrarian circles. Investors weren’t buying gold.

To show how feeble this past week’s 0.8% or 7.3t GLD-holdings build was, consider the ones surrounding gold’s last upleg peak. From this metal’s bull-market breakout in late June to GLD holdings’ own peak in late September, its bullion soared 21.0% or 160.8t. During two separate 5-trading-day spans in late August and late September, GLD’s holdings surged 3.6% or 30.5t and 3.9% or 34.0t! That was big buying.

If investment capital isn’t flowing back into gold in a major way, and isn’t likely to start to, gold will have a tough time powering higher. And the single best gold-investment indicator is revealing weak investment demand at best so far in gold’s breakout rally. That’s a serious problem for gold stocks, arguing strongly for the head-fake case. But today’s precariousness in gold and GDX are really driven home by gold futures.

Unfortunately speculators’ gold-futures trading dominates gold’s near-term price trends. These guys can punch far above their weights in terms of capital deployed because of the extreme leverage inherent in gold futures. This week each single gold-futures contract controlling 100 ounces of gold worth $151,700 only required traders to keep maintenance margins of $4,500 in their accounts. That’s just mind-boggling.

These traders can legally run extreme leverage to gold up to 33.7x! At 10x, 20x, or 30x, every dollar that they deploy has 10x, 20x, or 30x the price impact on gold as a dollar invested outright. With that kind of leverage these guys can’t afford to be wrong for long or risk swift ruin. So their trading time horizons are necessarily compressed into days and weeks. They have to be short-term momentum followers to survive.

Upping their outsized influence on gold even further, the resulting gold-futures price happens to be the world’s reference one for gold. So gold-futures price action has far-reaching psychological impacts out in the much-larger investment realm! The gold-futures tail often wags the gold-investment dog. Gold’s breakout rally can only continue if specs buy gold futures. That’s highly unlikely as this sobering chart reveals.

Gold’s price in blue is superimposed over specs total gold-futures long contracts in green and total short ones in red. I explained this in depth in early December, but in a nutshell gold-futures buying drives gold higher while selling pushes it lower. Buying can happen two ways, adding new longs and buying to cover and close existing shorts. This latest weekly data on specs’ positioning reveals their buying is tapped out.

Normally this weekly gold-futures-positioning data current to Tuesday closes is released late on Friday afternoons. But because of the Christmas holiday, the most-recent read current to Christmas Eve wasn’t published until late this Monday. In the week ending Tuesday Christmas Eve, speculators added a huge 23.1k gold-futures long contracts! Anything over 20k is massive, so this fully explains gold’s breakout surge.

Big gold-futures buying alone isn’t unusual or inherently unsustainable. What’s really important normally and crucial for today is where that left specs’ overall gold-futures positioning. That 23.1k contracts of long buying in the week ending Christmas Eve pushed specs’ overall total longs way up to 423.5k. That was deep into nosebleed extreme-high territory, the 7th highest seen out of all 1095 reporting weeks since 1999!

Because of the ludicrous risks inherent in hyper-leveraged gold-futures trading, there’s only a relatively-small group of speculators willing to do it. And though their bets are super-amplified, they only collectively command a relatively-small and finite pool of capital. Spec longs almost never get higher than about 425k contracts, that is near their effective ceiling. The all-time-record high was 440.4k back in early July 2016.

Whether specs want to chase gold higher or not is irrelevant when their buying firepower is effectively exhausted. I suspect they added more longs over this latest week ending New Year’s Eve, pushing their bets into even-more-extreme territory. That latest data will be out late next Monday afternoon. But with spec longs right up near record highs, additional sizable gold-futures buying to push gold higher is very unlikely.

These traders can also buy gold futures by covering short bets. But their short-covering potential is also very limited from here, with total spec shorts at 83.1k contracts as of Christmas Eve. That wasn’t much over their gold-bull-to-date low in late November. The gold-futures speculators overwhelmingly driving short-term gold price action have virtually no room left to buy, but vast room to sell and hammer gold lower!

In gold-bull-to-date trading-range terms, total spec longs and shorts were running 93% and 3% up into those ranges on Christmas Eve. The most-bearish-possible near-term setup for gold is 100% longs and 0% shorts, since that shows buying exhaustion leaving room for nothing but selling. Specs had room to buy just another 21.3k contracts per their gold-bull trading ranges after that key gold-breakout-rally day.

But they had room to sell 19.3x more way up at 410.4k on both the long and short sides! If necessary and normal spec gold-futures selling erupts soon here to normalize their excessively-bullish bets, gold is going to fall hard. Spec selling tends to snowball since the faster and farther gold falls the more it forces other specs to dump their longs to avoid ruin. If gold rolls over, the gold stocks will follow it lower like usual.

Gold’s dominant primary short-term driver argues its own breakout rally is a head fake within a broader correction. Spec gold-futures buying is hitting a wall, and has to reverse into big selling sooner or later. If that extends gold’s total correction to a reasonable 10% or $1398, GDX is likely to plunge 20% to 30% from its own upleg peak at 2x to 3x leverage. That’s a lot of downside to risk on a suspect breakout rally!

I’d be really excited about these gold and gold-stock breakout rallies if gold investors were buying and/or if gold-futures speculators had lots more room to keep buying. But neither is true today. Investors don’t seem to care, and futures specs are tapped out! And without ongoing gold buying to push gold higher, the gold stocks are in trouble up here. Their recent breakout rally looks like another mid-correction trap.

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The bottom line is gold stocks’ Christmas breakout rally looks like a mid-correction head fake. Gold’s own driving downtrend-breakout rally wasn’t fueled by sustainable investment buying. Instead speculators were aggressively piling into gold-futures longs. But since that catapulted those upside bets back up near all-time-record highs, their buying firepower is effectively tapped out. There’s little left to fuel further gold gains.

With investors not materially buying gold and gold-futures speculators no longer able to, odds are gold’s breakout surge is going to fizzle out and roll over. That’s going to unleash serious normalization selling in gold futures that will likely cascade. The resulting gold selloff will certainly yank the rug out from under the surging gold stocks. They face major near-term downside if gold’s shallow and short correction resumes.

(By Adam Hamilton)