Sharp gold pullback healthy

Traders as a herd generally buy high after big rallies generate greed, then sell low after subsequent major selloffs spawn fear. That’s the polar opposite of the buy-low-sell-high strategy necessary for success! In my decades as a professional speculator, I’ve found the best antidote for immediacy bias and the herd groupthink it inevitably leads to is perspective. All market action should be viewed in the context of longer trends.

Gold plunging 4.4% last Thursday and Friday was certainly a violent selloff. But considered within a six-month timeframe, it didn’t do much technical damage. Between late September to last Wednesday, gold powered 20.2% or $328 higher in 4.2 months. That wasn’t just a strong young upleg, it boosted gold back into formal-bull-market territory with 20%+ gains! This is essential perspective for the subsequent drop.

That 4.4% or $86 gold selloff was big and mean, but it only reversed about a quarter of those major gains leading into it. And interestingly 4%+ gold plunges over two trading days aren’t even particularly unusual. There were actually nine over the last several years since 2020 dawned, spread over six separate events! So these can happen a couple times a year or so. They shouldn’t surprise traders who are doing their homework.

After last week’s latest Fed decision and rate hike, I wrote an essay on the Fed gold anomaly unwinding. It analyzed how the Fed is running out of room to keep jacking its federal-funds rate higher, so its ability to shock markets with big rate hikes is over. That is really bullish for gold, as last year’s monster rate hikes ignited extreme US-dollar buying driving heavy gold-futures selling which crushed gold through mid-2022.

I’ve written 1,056 of these weekly web essays since early 2000. In order to publish them early Fridays, I have to decide what to analyze then finalize any charts late Wednesdays. So that mid-week close is the data cutoff for these essays, which I pen Thursday mornings then proof those afternoons. Gold closed at an impressive new upleg high of $1,951 on that Fed Day last Wednesday, surging 1.2% despite the latest hike.

Gold’s 4%+ plunge last Thursday and Friday didn’t change that analysis in any way, as it is based on that critical longer-term perspective necessary to overcome the immediacy bias. But man, the feedback I got was sure hostile! Traders didn’t care that gold had just powered 20.2% higher in 4.2 months, they were shocked and angered it had fallen 4.4% in two trading days. Here’s an example e-mail from one reader…

He quoted my essay where I wrote, “Gold is finally being freed from its extreme-Fed-rate-hike-cycle shackles to start reflecting this underlying raging inflation.” He replied, “Really? Smashed down $100 once again, thus proving that gold is unstable crap and the gold commentators such as you are always full of shit! How much would you pay me to read your newsletter?” Our subscribers weren’t surprised at all.

In addition to these weekly web essays, we publish separate weekly and monthly subscription newsletters containing the meat of my analytical work and actual stock trades based on it. That very Fed day last week where gold hit $1,951, I warned our weekly subscribers that a large gold pullback could be ignited that afternoon by the Fed chair’s press conference following its decision. Before gold’s sharp selloff I wrote…

“If Powell proves hawkish enough, it could ignite a USDX countertrend rally hitting gold. During in-progress uplegs, 50dmas are often major support zones for larger pullbacks. Ominously gold’s is way down around $1,831 today! Odds are such a severe selloff won’t happen, but even that wouldn’t mortally wound gold’s upleg.” While gold weathered the Fed chair fine, that large pullback started the next morning.

I analyzed the causal chain in depth in our latest weekly newsletter as always, but in a nutshell early last Thursday the European Central Bank was dovish. While it did hike its own benchmark rate by 50 basis points as expected, its monetary-policy statement said it would likely only do one more 50bp hike at its next meeting and then pause its hiking cycle. That is much earlier than the ECB president recently implied.

So the euro fell, fueling buying in the competing US dollar. Its benchmark US Dollar Index had just made a new downleg low the prior day after the Fed, as gold carved that new upleg high. The USDX was as oversold as gold was overbought, neither to major-trend-reversal extremes but both enough to trigger big countertrend moves to rebalance sentiment. These take the form of healthy pullbacks within ongoing uplegs.

Major price trends are never linear, they always take two steps forward followed by one step back. So the longer any upleg runs without any material selloff, and the higher prices get stretched above their baseline 200-day moving averages, the greater the odds for a large pullback. Gold hadn’t suffered any significant declines since mid-November! After powering higher for several months, a rebalancing selloff was due.

Gold’s 2.0% drop Thursday after the ECB hammered the euro goosing the USDX worsened Friday after another market surprise. Early on the US government released its latest monthly US jobs report, which proved a statistically-impossible eight-standard-deviation beat. Wall Street economists were looking for 187k US jobs created in January, yet the Bureau of Labor Statistics claimed an unbelievable 517k were!

Traders viewed that blistering headline jobs data as Fed-hawkish, arguing for more rate hikes. So the USDX blasted 1.2% higher, its biggest up day since leading into late September’s euphoric 20.4-year secular peak! That unleashed what looked like heavy gold-futures short selling slamming gold another 2.4% lower to $1,866. While 4%+ two-day gold plunges aren’t rare, back-to-back major market surprises are.

The ironic thing about traders’ kneejerk reactions to that highly-suspect jobs report was that headline beat was fabricated. The BLS’s underlying raw jobs data actually showed a record 2,505k US jobs lost during January! An epic 3m+ job seasonal adjustment was applied to get that +517k headline number, literally conjured out of thin air in bureaucrats’ spreadsheets. Neither the dollar nor gold should’ve reacted on that fiction.

But with the short-term-oversold USDX starting to rally the day before, and short-term-overbought gold starting to pull back, momentum-chasing trading intensified. Thus gold was pummeled down 4.4% in two trading days, freaking out traders. But had they looked at a simple chart with a six-month-plus duration to regain perspective, their immediacy bias wouldn’t have run roughshod. Gold is still looking fine technically!

As I had warned in our weekly newsletter that Fed day, major pullbacks within uplegs tend to find strong support near their 50-day moving averages. When gold’s upleg carved that latest $1,951 interim high after the Fed chair’s presser failed to be hawkish, gold was stretched 1.096x above its 200dma. That was still way under the 1.160x+ levels where traders need to start worrying about larger upleg-slaying corrections.

But because gold was still short-term overbought, its 4.4% two-trading-day plunge left it well above its key 50dma support. Last Friday that was running $1,840, well below gold’s $1,866 close. And at this essay’s Wednesday data cutoff, that steeply-rising 50dma had climbed further to $1,848. A pullback in a major upleg that hasn’t even retreated to its 50dma yet is nothing to worry about, even if it happens to be violent!

Pullbacks within ongoing uplegs exist to rebalance sentiment. When prices surge for some time without any material interruptions, popular greed flares. Traders fixated on recent gains start to expect prices to keep powering higher indefinitely, so they pile in to chase that upside. But excessive greed risks burning out uplegs prematurely, attracting in too many traders too soon which exhausts their capital firepower for buying.

So countertrend pullbacks naturally erupt periodically to bleed off excess greed and reinject some fear. These selloffs last until sentiment is sufficiently rebalanced for buying to resume. Their effectiveness in this essential mission is inversely proportional to their sharpness. Bigger and faster pullbacks kill greed much more rapidly than slower and shallower ones. Thus violent pullbacks tend to run their courses fairly quickly.

In order to game when and where this current sharp gold pullback is likely to end, we need some key data on speculators’ collective gold-futures positioning. I wrote a whole essay analyzing that in depth in mid-January if you need to get up to speed. Big gold selloffs erupting rapidly right after market surprises are always driven by heavy gold-futures short selling. The extreme leverage inherent in futures really moves gold.

This week specs are only required to keep $6,900 cash in their accounts for each 100-ounce gold-futures contract they are trading. At $1,875, that controls $187,500 worth of gold. So these traders can run crazy leverage up to 27.2x! Thus every dollar deployed in gold futures at those extremes exerts 27x the gold-price impact as a dollar invested outright! But at 27.2x, a mere 3.7% gold rally wipes out 100% of capital risked.

So there aren’t many speculators brazen enough to short gold at maximum leverage, and their capital firepower is very limited. Once we can see how high their gold-futures shorts are compared to their past-year trading range, we can get an idea of when their selling will likely be exhausted. Unfortunately there is a problem with that data, which comes in the weekly Commitments of Traders reports from the CFTC.

Usually released late Fridays current to preceding Tuesdays, last week’s CoT still hadn’t been published as of midday this Thursday nearly a week late! The CFTC said it didn’t have the data because a major futures clearing firm suffered a ransomware cyberattack. The CFTC said it would release that back data when it was received and validated, but gave no timeline. So we’re unfortunately flying blind on gold futures.

But as long as gold holds around that 50dma major-upleg-support zone, technically this selloff is just a pullback and nothing to worry about. Gold’s powerful young upleg remains very much intact, with nearly 3/4ths of its gains unscathed. The same is true with gold stocks, which amplify gold moves due to their big inherent profits leverage to gold. The leading GDX gold-stock ETF was also pounded lower as gold fell.

Last Thursday and Friday when gold plunged 4.4%, the major gold miners dominating GDX suffered big 7.4% drops per that popular benchmark. That actually wasn’t too bad given the gold situation, merely 1.7x downside leverage. GDX tends to amplify material gold price moves by 2x to 3x. In just 4.0 months into late January, GDX had leveraged gold’s 20.2% upleg with strong 52.1% gains! That was a normal 2.6x.

Despite gold stocks soaring dramatically out of last September’s exceedingly-oversold stock-panic-grade lows, traders remain skeptical of their young upleg. I explored this a couple weeks ago in an essay on the neutral gold-stock sentiment. While greed was mounting as they soared in recent months, it hadn’t yet grown big enough to overpower all the residual fear from last year’s huge selloff. That left traders quick to flee.

So GDX’s plunge to $30.32 last Friday brought it closer to its $30.23 50dma than gold. Still that major-upleg support zone has held since, leaving only minor technical damage. Like gold, only about 1/4th of the big gold-stock upleg of recent months was lost in this latest sharp pullback. These perfectly-normal countertrend moves are essential in major uplegs to maintain their health by keeping sentiment balanced.

With inflation raging out of control thanks to extreme Fed money printing, gold’s fundamentals remain incredibly bullish. Central-bank buying skyrocketed to a stunning 55-year high last year according to the World Gold Council! And the usual big gold-futures buying and investment buying that fuels major gold uplegs is only just starting. Gold wasn’t extremely overbought before this latest sharp selloff erupted either.

Thus there’s no reason to expect this violent pullback to slay gold’s young upleg. Its technicals still look great, and recent mounting greed has been quickly overwritten with new herd fear. Traders having the essential perspective are neither surprised nor worried about these periodic healthy pullbacks. They are actually eagerly anticipated, offering the best buy-relatively-low opportunities within ongoing major uplegs!

That’s why you ought to subscribe to our popular newsletters, to stay informed which helps keep your greed and fear in check. I’ve studied the markets and traded full-time for decades, which most people have neither the time, inclination, nor skillset to do. You can still greatly benefit from all my experience. Staying abreast of market developments driving gold and gold stocks is crucial for buying low and selling high.

The bottom line is gold just suffered a sharp pullback, which is healthy. Markets naturally flow and ebb, taking two steps forward before one step back. Those countertrend selloffs within powerful uplegs are essential for rebalancing sentiment, maximizing their ultimate gains. Before gold’s latest plunge, it had been stretched and overbought after rallying for months without any significant selling. A pullback was due.

While gold fell violently on a couple back-to-back market surprises, it remained well above uplegs’ major support zone. No serious technical damage was done, which is also true for major gold stocks. So the technical and sentimental evidence argues this latest selloff is a mid-upleg pullback rather than a larger upleg-slaying correction. Thus traders should capitalize and use this opportunity to buy in relatively low.

(By Adam Hamilton)