Three Signs Of Gold’s Bottom

In this article, Adam Hamilton from Zeal Research discusses three signs which point to gold’s bottom. First, he compares gold to the US stock market. Second, he looks at the mass exodus from the flagship gold ETF, the GLD. Third, he points to the the extreme selling by American futures speculators.

Sign 1: Gold vs the S&P500

Adam Hamilton explains that the Fed incuded stock market buying frenzy in the S&P 500 stock index (SPX) closed at new nominal record highs in 69 out of 252 trading days in 2013.  With the SPX melting up so relentlessly, stock investors aggressively dumped their gold in the form of GLD-ETF shares to shift that capital into general stocks.

These vexing gold-to-stock-market capital flows quickly became self-reinforcing.  The higher the SPX traveled the more investors wanted to buy in to chase the gains, and the lower gold fell the more wanted to sell to end the pain.  This dynamic was deeply manifested in 2013’s first half.  In a 5.1-month span between gold’s January peak and June low, it plunged 29.1% partially driven by the huge 8.2% SPX rally.

Though gold suffered a couple massive fast selloffs, the necessary sentimental foundation to trigger them was formed by the relentless SPX levitation day after day.  In April gold plummeted in a panic-like selloff after critical multi-year support was breached.  But this metal would’ve never even neared that support without the early-year selling sparked by that SPX melt-up.  And gold again plummeted in June.

Sign 2: Gold vs the GLD

Adam Hamilton explains how the SPX melt-up drove investor away from gold, in particular the GLD ETF, which in turn drives gold prices lower through the physical gold selling of the ETF.

When investors sell GLD shares faster than gold itself is being sold, this ETF’s custodians are forced to sell real physical bullion. Thus heavy differential selling of GLD shares leads to heavy liquidations of GLD’s gold bullion.  That flood of marginal new gold supply hitting the global markets last year was what fundamentally drove gold’s plunge.  This next chart looks at the gold price superimposed on GLD’s physical bullion holdings.  Once again despite GLD-selling headwinds persisting, gold showed remarkable resilience in 2013’s second half.

The record mass exodus by American stock traders from GLD hammered gold down 29.1% over that short span.  And unfortunately this flood of gold liquidations from stock capital being pulled out of GLD continued to be huge in 2013’s second half.  Over that 5.8-month span between gold’s June and December lows, GLD’s holdings fell by another 16.6%!  Another 160.8 tonnes of gold were dumped on the market.

Prior to 2013, that second-half GLD liquidation alone would have been a dominating all-time record!  Yet gold merely lost 0.8% over that span.  It remained flat on balance despite the screaming headwinds of extreme GLD differential selling persisting.  Again this was an incredible show of relative strength, and a vast change in the character of gold’s price action.  Despite the bearishness, it was in the process of bottoming.

Sign 3: Gold futures

The pressure on the gold price, driven by GLD ETF selling, resulted in futures speculators dumping the precious metal aggressively. It became a vicious circle from which gold has not recovered yet.

The aggregate gold-futures positions held by speculators in the US markets are reported once a week in the CFTC’s famous Commitments of Traders reports.  This last chart shows speculators’ total longs and total shorts, as well as the total deviation in these positions from their 2009-to-2012 average levels in normal market conditions.  I’ve explained this chart in great depth in past essays if you need a refresher.

In that January-to-June span where gold plummeted 29.1%, speculators’ long-side gold futures fell by 22.2% while their short-side contracts skyrocketed 154.7% higher!  That might not mean much to investors who don’t traffic in this wild realm, so let’s convert it into familiar gold terms.  Added together, the total deviation of spec longs and shorts from prior-years’ averages shot from 27.2k to 187.9k contracts.

That difference of 160.7k contracts of gold-futures selling from paring longs and multiplying shorts is the equivalent of 500.0 tonnes of gold!  That actually dwarfs GLD’s massive 366.4-tonne supply added to the market over that same 5.1-month span.  Add the blizzard of GLD and futures selling together, and it is no wonder gold plummeted 29.1%.  There’s no way 866.4 tonnes of new gold can be absorbed in just 5 months.

Fast forward to the tapering decision of the US Fed, in December 2013, where gold reached its double bottom. Adam Hamilton analyzes the futures positions at that time:

The day after the actual QE3-taper announcement hit in mid-December, by surprise no less, gold merely edged 0.8% under its brutal late-June low.  Like so many things in life, the simple fear of the taper was far worse than the actual event.  The futures speculators have started to realize how wrong they were in believing the bearish hype, and have been adding longs and covering shorts in recent weeks.

But their bearish bets against gold were so extreme last year that their new gold buying has a long way left to go.  Merely to mean revert their total gold-futures longs and shorts to their prior-four-year averages, they have to buy 177.9k contracts from here.  This equates to 553.2 tonnes of gold, a vast amount that will fuel gold’s new upleg for many months to come!  They have to unwind their bearish bets, which is very bullish.

Conclusion

A massive double bottom 6 months in the making in the most hostile gold environment imaginable is an incredibly bullish omen.  While gold was hated and loathed and expected to keep plummeting, it found a strong support zone.  While the US stock markets continued to levitate, stock-market capital continued to rush out of GLD, and futures speculators’ gold positions remained extreme, gold held strong and made a stand.

If the same howling headwinds that crushed it to its worst calendar quarter in nearly a century in 2013’s Q2 failed to make a dent in gold in the following two quarters, a major reversal is underway.  Gold is carving a major secular bottom, and we are seeing the very earliest vanguard of a major new upleg being born.  Gold is overdue for a massive mean reversion higher after 2013’s extreme selling, and it is starting.

Gold entered 2013 near $1675, and that’s where it would have to return to merely nullify last year’s once-in-a-lifetime selling anomaly.  That is another 35% higher from this week’s levels before gold even starts reflecting the extreme money-supply growth in the Fed’s quantitative-easing campaigns!  And given the ballooning of the Fed’s balance sheet, gold is highly likely to head a heck of a lot higher than that.

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