Gold to Take off on 3rd Upleg

Markets often follow predictable patterns.  Gold and precious metals analyst Adam Hamilton talks of the three upleg pattern in gold bull markets.  He summarises as follows:

1. Gold uplegs within ongoing bull markets have three distinct stages of buying. They are first birthed by gold-futures speculators covering shorts.
2. That pushes gold high enough for long enough to convince long-side gold-futures speculators to return. Their larger buying eventually grows young gold uplegs big enough to rekindle investment demand.
3. Once investors start buying, gold uplegs are off to the races. Identifying these three stages and their transitions as they happen is essential to optimizing gold bull market buy and sell timing.

Referencing the following chart he points out the uplegs since that December 2015 bottom for gold.  Taking data from the CFTC’s weekly Commitment of Traders Report, the chart shows both large and small futures speculators combined as the red line for their short positions and green line for long positions.  The blue line shows the gold price.

Hamilton explains perfectly the cause and effect of the leverage and groupthink of the speculators in their impact on markets:

“Gold-futures trading is a surreal alternate reality due to the extreme leverage inherent in it. For decades in stock markets, margin has been legally limited to 50%. That makes for 2x maximum leverage, limiting risk. Futures trading is a radically different beast. Today speculators are only required to have $4,900 of cash in their accounts for each gold-futures contract they’re trading, so running maximum margin creates huge risk.

Every gold-futures contract controls 100 troy ounces of gold, which is worth $130,000 at $1,300 gold. So speculators can run leverage to gold up to 26.5x today, which is incredible. At 26.5x leverage, all it takes to wipe out 100% of the capital risked is a mere 3.8% adverse move in gold! That doesn’t leave much room for error, as 1% to 2% daily gold moves aren’t uncommon. Traders can literally be destroyed overnight.

Trading gold at such supremely unforgiving leverage greatly compresses the time horizons gold-futures speculators operate in. Since the present is so overwhelmingly dangerous to their capital, all they care about is short-term momentum measured in days on the outside. As a herd they pile on to whatever side of the trade is following gold’s short-term trend, exacerbating it. When gold is falling, they aggressively short it.

The resulting groupthink makes speculators’ collective gold-futures bets a powerful contrarian indicator. As gold plunges late in corrections due to heavy shorting, speculators’ selling firepower quickly exhausts itself. Once their short selling peters out, the downward pressure on gold prices evaporates. That marks the bottoms of gold corrections, and births major gold uplegs. That’s the optimum time for all traders to buy low.”

So that short covering rally describes his 1^st Leg scenario, and then the 2^nd as the longs return as well.  The following chart shows the ETF (via the GLD major proxy) dynamics for the 3^rd leg.  Rising GLD holdings, the blue line, happens when share market capital flows into gold via ETFs (their preferred means of buying gold because they love paper).  Again the price of gold is in the red line.  When the blue line rises consistently it is his 3^rd leg when the ETF’s take the baton from the futures speculators.

World Gold Council just yesterday released the September figures for ETF’s collectively confirming they rose by 22.4 tonne in one month to 2,357 tonne.  Tellingly, at the epicentre of the sharemarket bubble, north America, the rise was 36 tonne (with Europe and Asia collectively bringing the total back to 22.4 tonne).  Hamilton points out though that WGC figures are after the fact and you can miss the cue, so he looks at the GLD holdings published daily.  He concludes:

“The recent surge in GLD’s holdings in gold’s current upleg confirms investors’ stage-three buying is now underway. This will likely run for many months. If the stock markets finally seriously roll over under the ominous Fed quantitative tightening, that gold investment buying could last much longer than normal. So odds are gold’s current upleg has a long ways to run yet, both in terms of price and time. That’s very bullish.”