Gold Exodus To Reverse

Investors have pulled much capital out of gold in recent months in a major mass exodus. Their sentiment waxed very bearish as gold was pounded lower by extreme record gold-futures short selling. The latest record stock-market highs also suppressed the perceived need for diversifying portfolios with gold. But this heavy investment gold selling is slowing and should reverse sharply once stock markets roll over again.

Not too long ago in mid-June, gold was trading at $1302. It looked fairly strong for the summer doldrums, its weakest time of the year seasonally. But selling would soon return with a vengeance, pummeling gold 9.9% lower over the next 2.1 months into mid-August. That major slide leading into a late-summer low of $1174 certainly cast a dark pall over psychology, fueling surging bearishness that remains ubiquitous today.

While investment selling wasn’t the primary driver, it ultimately contributed in a big way. This gold selloff that started normal before snowballing to anomalous proportions was initially sparked by a sharp rally in the US Dollar Index. It rocketed 1.3% higher in mid-June on a major European Central Bank decision.  It announced it was finally ending its massive quantitative-easing campaign at year-end, as widely expected.

But the ever-cunning ECB officials led by Mario Draghi sought to soften that hawkish blow with a side promise not to hike rates “at least through the summer of 2019”. The euro plunged 1.8% on that, goosing the US dollar. American gold-futures speculators took note, as they often make trading decisions cueing off of short-term dollar action. So they sold aggressively overnight, hammering gold 1.7% lower the next day.

That startling drop kicked off a self-feeding chain reaction that cascaded for a couple months. Extreme short selling of gold futures by speculators forced gold lower. The weaker prices convinced these same traders to keep piling on more shorts, which pushed gold lower still. This vicious circle of leveraged short selling ultimately catapulted speculators’ total shorts to a series of new crazy-extreme all-time record highs.

All gold investors and speculators need to understand this dynamic, and I explored it in depth in an essay just a couple weeks ago. That wildly-unprecedented gold-futures shorting is the primary reason gold fell so sharply from mid-June to mid-August. But it had an unfortunate side effect of spooking investors, so they too soon started selling in sympathy. Those heavy investment outflows exacerbated gold’s decline.

The resulting gold selloff was very anomalous even for the summer doldrums. This first chart is updated from my early-June essay warning about these then-imminent summer doldrums. It reveals how gold has performed during the summers of every modern bull-market year, from 2001 to 2012 and 2016 to 2018. To keep differing price levels comparable, every year is individually indexed to 100 as of May’s final close.

With all gold action recast off that common base, this year’s huge divergence from norms is very evident. The yellow lines show individual-year indexed gold action, which tended to drift in a +/-5% range from the last pre-summer close. All those yellow lines are averaged together in the red line. That shows gold is usually weakest in June, recovers in July, and then starts powering higher in its strong seasonal autumn rally.

But that usual summer script sure didn’t play out this year! The gold action was sideways like usual into mid-June, but then deteriorated sharply. Thanks to the extreme record gold-futures shorting on that dollar rally along with the investment selling it spawned, gold plunged 3.5% in June. That was far worse than the 0.2% average slide in June in these modern bull-market years. That heavily tainted sentiment in gold-land.

As selling fueled, even more, selling gold fell another 2.3% in July, also way behind its typical 0.9% gain that month. And the carnage didn’t end in August despite gold carving a mid-month capitulation low as speculators’ epic record gold-futures-shorting binge climaxed. Gold shed another 2.0% last month, way behind its 2.2% average August gain. So summer 2018 challenged 2008’s for the worst of this modern era!

There are two key points here. First, this recent action was incredibly anomalous even by gold’s weak standards in the summer doldrums. It’s not often that gold-futures speculators short sell at extremes that history had never before shown were even possible. And to have that epic shorting orgy coincide with new stock-market record highs was rotten luck. The resulting investment selling was very abnormal too.

Second, this frenzy of heavy gold selling opened up a huge divergence between where gold is now and where it ought to be this time of the year.  Normally gold’s major autumn rally is well underway by mid-September. The farther any market is dragged from norms by extreme unsustainable action, the greater the odds of an imminent mean reversion. Gold should surge fast as the recent wild selling inevitably reverses.

The primary driver of gold’s coming snap-back rally will be record gold-futures short-covering buying that is proportional to recent months’ explored it in depth. And investment buying will bolster and amplify that, just like investor selling did on the way down. The more gold rallies, the more investors are attracted to deploy capital back into it. The near-term upside alone is big given the huge seasonal divergence now.