Gold stock selloff anomaly

The leading gold-stock benchmark and trading vehicle remains the GDX VanEck Gold Miners ETF. While it feels like an eternity ago, in mid-April the major gold stocks dominating GDX were faring quite well. At $40.87, this ETF had blasted 39.5% higher in just 2.6 months in a strong young upleg. This small sector was regaining favor, starting to win the attention of more-mainstream traders. Then it all went pear-shaped.

In less than a month into mid-May, GDX plummeted 26.2%. It started to recover into early June, but only rallied 10.5% before another crushing wave of selling hit. That slammed the major gold stocks another 24.3% lower by this week. GDX’s total losses over the 3.1 months between mid-April to this Wednesday were a soul-crushing 38.2%! As price action drives sentiment, it is no wonder this sector has grown loathed.

The gold stocks are now suffering their worst summer performance in all modern gold-bull-market years, running from 2001 to 2012 and 2016 to 2022! This chart is updated from my gold-summer-doldrums essay of a few weeks ago. Using the older HUI gold-stock index which is functionally-interchangeable with GDX, it indexes each gold-stock summer to May’s final close. This year’s deviation from norms is ugly.

As of this week, the major gold stocks have plunged a stunning 21.1% summer-to-date! Between 2001 to 2012 and 2016 to 2021, they averaged far-better 2.8% gains in this same span. So there’s no doubt recent months’ gold-stock death march lower is an exceptional anomaly. This severe drawdown is also unusual in its profile, proving gradual and remarkably-linear. Gold-stock selloffs are typically sharp and short-lived.

This relentless selling has felt like Chinese water torture, obliterating any residual bullish sentiment. The tiny fraction of traders still watching this left-for-dead sector are extrapolating this miserable downtrend into the indefinite future. They assume gold stocks are doomed to keep spiraling lower. Few contrarians are willing to try and catch these falling knives, so battered gold miners are seeing little bidding in this massacre.

But market extremes are never sustainable, neither technically nor sentimentally. Anomalous selloffs are almost always soon followed by symmetrical mean-reversion rallies higher. Bombed-out stock prices and suffocatingly-bearish psychology are inherently self-limiting. Once all traders susceptible to being scared into selling low have panicked and fled, that leaves only buyers. Their capital inflows fuel major reversals.

These hated gold stocks are overdue for an imminent monster rally higher. To understand why, traders need to look at the driving forces behind their anomalous selloff. They were gold getting hammered lower by extreme gold-futures selling on the US dollar rocketing parabolic. The gold stocks are leveraged plays on the metal they mine, with GDX generally amplifying material gold-price moves by 2x to 3x. That’s what happened.

A couple weeks ago I wrote a whole essay illuminating the euphoric dollar slamming gold. From mid-April to mid-May during GDX’s first 26.2% downleg, gold fell 7.8% on heavy gold-futures selling. That was spawned by a strong 4.0% rally in the dollar’s leading benchmark, the US Dollar Index. Then from early June to mid-July in GDX’s next 24.3% downleg, gold plunged 9.3% on a monster 5.2% parabolic USDX surge!

Overall between mid-April to the middle of this week where GDX collapsed that horrible 38.2%, gold was bludgeoned 14.2% lower by the USDX blasting 6.2% higher. That made for gold-stock leverage to gold of 2.7x, right in line with GDX’s long-established 2x-to-3x precedent. Both these enormous gold and USDX moves were more extreme when measured on their own timelines, helping explain gold stocks’ cratering.

From its earlier overbought topping in early March soon after Russia invaded Ukraine, gold has plunged 17.4% over 4.4 months as of this week. Speculators’ and investors’ confidence in this leading alternative investment was crushed as it collapsed from $2,051 to $1,695, a serious fall from grace. At best within that span from late March to mid-July, the USDX skyrocketed 11.1% to an incredible 20.1-year secular high!

Trading near 108.7 last week, the USDX had soared to extraordinarily-overbought levels 10.3% above its 200-day moving average! Normal overboughtness in recent years started at just 4% over that baseline. This long-dollar trade has become exceedingly-overcrowded in recent months. Just like with gold and its miners’ stocks, traders now assume the US dollar’s blistering strength will persist forever. They’re dead-wrong.

The USDX soared on an amazing confluence of unrepeatable one-off events. They started with the Fed’s most-extreme hawkish pivot in its entire century-plus history in recent months! That included ending QE4 bond monetizations, launching an aggressive new rate-hike cycle, and starting to unwind the extreme money printing of recent years through QT2 bond selling. All this coming so fast was wildly-unprecedented.

Starting in mid-March, the Fed’s FOMC accelerated its rate hikes from 25 basis points to 50bp then 75bp at three consecutive meetings! The latter two big hikes were the first the Fed dared at those levels since way back in May 2000 and November 1994. The Fed is universally expected to hike another 75bp at next week’s coming FOMC meeting. These soaring US interest rates attracted currency traders into the US dollar.

In just 25.5 months into mid-April 2022, the Fed had mushroomed its balance sheet a truly-astonishing 115.6% or $4,807b! Functioning as the monetary base, that more than doubled the US-dollar supply in just a couple years. So QT2 to start unwinding these crazy monetary excesses was started at $47.5b per month in June, before doubling to $95b monthly in September. That dwarfs QT1 in both size and intensity.

It took an entire year to slowly ramp up to QT1’s own terminal velocity of $50b a month of bond selling. The Fed will probably never be able to execute another similar hawkish shock in our lifetimes. Reversing from a zero-interest-rate policy to big-and-fast rate hikes while simultaneously birthing the largest QT monetary destruction ever attempted is totally-unique! That extreme hawkish shift is pricing into the markets.

Adding to that Fed-fueled dollar surge’s uniqueness, the euro plummeted in that same span. Between late March to mid-July where the USDX soared 11.1%, Europe’s common currency dropped near parity with a huge 10.2% loss. The euro dominates the US Dollar Index at 57.6% of its weighting, leaving the Japanese yen a distant-second at just 13.6%. This monster euro drop was as unique as the dollar’s surge.

The European Central Bank dragging its feet on tightening compared to the Fed was a big factor. That gap is closing though, as the ECB finally surprised this Thursday with a big 50bp hike! Like the Fed, the ECB is fighting raging Eurozone inflation fueled by its own extreme money printing in recent years. The euro’s anomalous weakness was also exacerbated by Europe’s dependence on Russian natural gas.

Traders dumped the euro as worries mounted that Russia would severely curtail or even halt shipments to punish European governments for supporting Ukraine. But this one-off event risk has been priced-in. Another factor is Italy’s troubled government forcing its bond yields higher. The ECB is trying to address that inter-country yield-fragmentation risk with new Italy-specific QE bond buying announced this week.

All this happening together in just a few months is extraordinary, and unrepeatable! The problem for gold and thus its miners’ stocks is gold-futures speculators watch the US dollar’s fortunes for their primary trading cues. So that monstrous USDX surge ignited extreme gold-futures selling, slamming gold sharply-lower which the major gold stocks of GDX dutifully amplified like usual. But those big moves are exhausted.

After the US Dollar Index rocketed parabolic to some of its most-extreme overbought levels ever, this wildly-overcrowded trade has run its course. The resulting euphoria and greed have already sucked in the vast majority of capital willing to chase that unsustainable momentum. The euro selling fueling its recent plunging is also way-overdone. The euro isn’t going to zero backed by the Eurozone’s huge economy.

The overdue big symmetrical mean-reversion reversals in both the US dollar and euro will ignite big gold-futures buying. That will catapult gold sharply-higher due to the same extreme leverage that pummeled it lower in recent months. With gold near $1,700 mid-week, each 100-ounce gold-futures contract controls $170,000 of it. Yet margin requirements only make traders keep $6,500 cash per contract in their accounts.

That enables extreme maximum leverage of 26.2x! Every dollar traded in gold futures at these levels has 26x the gold-price impact as a dollar invested outright! So when the enormous gold-futures selling of recent months gives way to proportional buying, gold is going to soar. Both speculators’ long and short bets on gold via futures are at unsustainable extremes with selling exhausted, which is super-bullish for gold.

This next chart superimposes gold prices over speculators’ overall gold-futures positioning, which gets released weekly in the famous Commitments-of-Traders reports. Specs’ massive long selling and huge short selling in recent months fully explains gold’s anomalous plunge that crushed the gold stocks. Both gold and the miners will soar proportionally to their recent declines when gold-futures buying reemerges.

Again gold plunged 17.4% between early March to mid-July on that confluence of anomalous events just described. That’s the only reason GDX plummeted 38.2% from mid-April to this week. The gold-futures selling pummeling gold lower was colossal. Speculators dumped 116.9k long contracts while adding 52.3k short ones. That total selling of 169.2k in 4.1 months was the equivalent of 526.1 metric tons of gold!

To put that into context, the World Gold Council’s latest fundamental data shows global gold investment demand in all of 2021 ran 1,006.4t. So gold-futures speculators alone puking out over half that in a third the time was way too much for markets to absorb. Considering that withering onslaught, gold really proved quite resilient until its 200dma, major-uptrend support, and $1,800 all failed in late June to early July.

The gold-futures speculators punching way above their weights bullying around gold prices with outsized leverage is bad enough. 26x+ is criminal and should be outlawed, brought in line with stock markets’ 2x legal limit since 1974! There’s no reason one small group of traders should unfairly dominate any global market. Unfortunately the technical price action their reckless trading drives unduly influences investor psychology.

Gold’s fundamental backdrop today is phenomenal, wildly-bullish! Thanks to the Fed’s crazy QE4 money printing, US inflation is raging in its biggest super-spike since the 1970s. During the pair of those plaguing that decade, monthly-average gold prices from trough to peak headline CPI nearly tripled during the first before more than quadrupling in the second! Gold investment demand should be soaring with red-hot inflation.

Stock bear markets also fuel major gold investment demand, to prudently diversify stock-heavy portfolios. Between early January to mid-June, the flagship US S&P 500 stock index fell 23.6% formally entering a new bear! And given US stock markets’ festering near-bubble valuations, this beast has a long ways to rampage. Investors should be flocking back to the leading alternative investment to protect their scarce capital.

Yet thanks to the serious technical damage inflicted on gold by indiscriminate myopic gold-futures selling recently, investors are exiting. The World Gold Council publishes comprehensive gold-investment-demand data quarterly, but the best high-resolution daily proxy for that is the combined holdings of the dominant GLD and IAU gold ETFs. Between late April to this week, those suffered a big 7.1% or 115.7t draw!

Investors love chasing upside momentum, so technical breakdowns spook them into fleeing. It doesn’t matter if they are righteous or not, fundamentally-driven or fueled by unsustainable gold-futures selling. This recent gold carnage driven by the gold-futures equivalent of 526.1t of selling shook loose at least another 115.7t of investment selling. That adds up to nearly two-thirds of 2021’s total investment demand!

While it’s been infuriating seeing gold artificially plunge in this most-bullish-environment-imaginable for it, the responsible gold-futures selling has exhausted. Weekly CoT reports are current to Tuesdays, but not released until late Friday afternoons. So the latest-reported CoT data before this essay was published is only as of Tuesday July 12th when gold was near $1,725. Even more gold-futures selling has happened since!

So all the following wildly-bullish gold analysis is understated. Total spec longs had fallen to just 303.7k contracts then, a 3.1-year secular low near levels not seen since mid-June 2019! Major secular support runs higher than that near 312k contracts. Spec longs aren’t likely to fall much lower, so their selling is spent. As longs outnumber shorts by 1.8x, the are proportionally-more-important for gold’s near-term direction.

Most of the gold-futures selling initially crushing gold between mid-April to mid-May was a huge long liquidation. But with most speculators abandoning their upside gold bets then, there wasn’t much left to sell from mid-June to mid-July. So the great majority of gold-futures selling crushing gold to its recent technical breakdown was shorting. Total spec shorts rocketed way up to 165.9k contracts last week!

Those extremes were the highest levels witnessed since 3.2 years earlier in late April 2019. While gold-futures speculators’ ludicrous leverage gives them tyranny over short-term gold prices, their capital firepower is very-limited. There’s only a small group of traders playing the gold-futures game, as the risks are crazy-high. So there’s only so much long and short selling these guys can do before they reach limits.

And those have almost-certainly been hit with spec longs at extreme 3.1-year lows while spec shorts are at extreme 3.2-year highs! Once their collective bets get that lopsidedly-bearish on gold, they soon have to reverse them with massive proportional buying. That initially starts with a short-covering squeeze on some inevitable gold-bullish news catalyst, with traders legally required to close out those positions by buying.

The resulting gold upside momentum from short-covering soon attracts in new long buyers, which propel gold higher accelerating its gains. That soon entices back investors which command vastly-larger pools of capital. This three-stage buying dynamic fuels major gold bull-market uplegs. To see what happens after spec gold-futures positioning gets so extreme, all we have to do is look at the last time in summer 2019.

Between spec shorts narrowly exceeding today’s extreme highs in late April 2019 and spec longs slightly-lower than today’s extreme lows in mid-June 2019, gold bottomed at $1,271 in early May. That summer wasn’t particularly gold-bullish, with the S&P 500 climbing to a series of record highs while inflation was low averaging a mere +1.7%-year-over-year CPI. And there were no unusual events like 2020’s pandemic.

Yet solely because spec gold-futures positioning had grown so extreme and had to be unwound, over just 4.1 months into early September gold blasted 22.3% higher to $1,554! From the Tuesday CoTs closest to that span, specs bought 204.6k long contracts while covering another 44.8k short ones. That added up to a massive 775.8t of gold-equivalent buying! Gold’s resulting big upside momentum quickly attracted investors.

During that same gold-soaring-on-futures-mean-reversion-buying span in mid-2019, GLD+IAU holdings blasted 17.4% or 181.0t higher! Everyone waxes way more bullish on gold when it is decisively rallying, which always happens as speculators rush to reverse excessively-bearish positioning like today’s. And with their metal soaring, the gold stocks amplify those gains. GDX rocketed up 53.4% in that short span!

That was just perfectly-normal 2.4x upside leverage, nothing unusual. If gold and GDX could soar 22% and 53% in just 4 months after the last time speculators’ gold-futures positioning was as extreme as today’s, imagine how big the coming mean-reversion upside potential is. Unlike summer 2019, we are in the biggest inflation super-spike since the 1970s while stock markets roll over into a deepening bear market!

Market history has proven many times that there is nothing more bullish for gold’s and gold stocks’ near-term fortunes than excessively-bearish gold-futures speculators. Once their capital firepower available for selling is exhausted as seen in very-low longs and very-high shorts, gold decisively bottoms. Then as these hyper-leveraged traders normalize their gold-futures bets, gold soars on big mean-reversion buying.

The bottom line is this recent brutal gold-stock selloff is an extreme unsustainable anomaly. Gold stocks only collapsed because their metal was slammed lower by extreme gold-futures selling. That in turn was fueled by an extreme parabolic US-dollar rally on an unprecedented confluence of one-off events. But all that exhausted specs’ gold-futures-selling firepower, leaving their positioning at unsustainable bearish extremes.

That only leaves room for big mean-reversion buying to normalize these severely-lopsided gold-futures bets. That will catapult both gold and its miners’ stocks sharply-higher in massive symmetrical rallies. In just four months after the last time speculators’ positioning was similar in spring 2019, gold blasted 22% higher which GDX amplified to a 53% gain! Exceedingly-bearish gold futures are super-bullish for gold stocks.

(By Adam Hamilton)