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Gold’s Artificial Lows

With gold languishing near deep secular lows, its technicals look hopelessly broken. Sentiment is off-the-charts bearish, with traders universally convinced gold is doomed to spiral lower indefinitely. But gold’s weakness this year is very deceiving, as it wasn’t the product of global fundamental supply-and-demand forces. Extreme record shorting by American futures speculators spawned these artificial lows.

Gold’s price is its price, so how the metal got way down here may seem irrelevant. But nothing could be farther from the truth! Fundamentally-driven lows are righteous. If the world gold supply expands faster than demand, or demand contracts faster than supply, then the resulting lows are real. They will persist for as long as fundamentals remain unfavorable, as gold’s sellers have no obligations whatsoever to return.

And gold has certainly faced real fundamental headwinds this year. The elite researchers at GFMS, the group that supplies the World Gold Council with its comprehensive supply-and-demand data, recently reported global gold demand dropped 14% in Q2. Provocatively most of this was from plunging demand in China, as local investors were seduced into chasing that crazy stock bubble that subsequently burst.

But the massive year-over-year plunge of nearly a quarter in Chinese investment and jewelry demand for gold failed to impact its price. During that same Q2, gold merely slipped a trivial 0.9%. That means there were enough buyers elsewhere to offset China’s popular-speculative-mania-induced drop in demand. And ending Q2 at $1172, gold was just 2% under its initial deep June-2013 low from 2 years earlier.

Gold’s recent plunge that ignited a full-blown panic in the absurdly-undervalued gold stocks actually had nothing to do with global fundamentals. It was driven by American futures speculators’ extreme record shorting. Such lows are artificial, which is defined as “not arising from natural or necessary causes, contrived or arbitrary”. Even more importantly, they are never sustainable due to the nature of short selling.

Gold’s latest woes began several weeks ago on Friday July 17th. That day the Chinese central bank finally announced it had much bigger gold reserves than long reported. The People’s Bank of China declared its gold reserves were 1658 metric tons, a massive 57% jump from the previous figure which had been reported continuously since April 2009. China finally admitted it was accumulating reserve gold.

This was very bullish news, and probably just the tip of the iceberg. The Chinese government is very shrewd, and knows that if it reports the full extent of its gold buying speculators will pile in forcing it to pay higher prices in the future. So that disclosure was almost certainly only partial. Yet analysts had long been predicting the PBoC’s gold holdings were at least 3500t, so the 1658t reported was a disappointment.

So that Friday gold lost 1.0% to $1134, which was unfortunately below this metal’s major early-November low. So with gold slumping to a deep new 5.3-year low, it was very vulnerable technically. And American futures speculators’ enormous short-side bets on gold were already just 0.1% shy of their all-time record high of 179.0k contracts seen the week before. It was their sharp rise that had battered gold.

It’s hard to believe now, but back in late January gold was trading at $1303! Speculators’ gold-futures shorts were down near 70.4k contracts then, normal levels. But over the next 22 weeks, they would gradually balloon these downside bets by a mind-boggling 154% or 108.6k contracts. That shorting ramp was wildly unprecedented, nothing close had ever happened before. That’s why gold was weak.

Western investors have largely been missing in action in recent years, as capital fled gold to chase the Fed’s extraordinary stock-market levitation. With investors out of gold, American futures speculators have free reign to batter the gold price around with their hyper-leveraged bets. Gold’s price action since 2013 has been a tale of futures shorting, with the gold price strongly inversely correlated to speculators’ shorts.

Even though they borrowed epic amounts of gold futures contracts they didn’t own to sell them, and they were legally obligated to buy gold futures soon to pay back those massive debts, they were winning as gold slumped to that new low on Friday the 17th. So they decided to press their bets in a spectacular way as the following trading week opened. It was a devious and Machiavellian strategy that paid off big.

Provocatively, their extreme shorting attack on gold wouldn’t even have been possible just a few weeks earlier. Back in early July, the CME shut down its US open-outcry gold-futures trading pits after many decades. Their daily hours of operation had long run from 8:20am to 1:30pm EDT Monday to Friday. So that span is when the vast majority of gold’s meaningful price action took place. Shuttering the pits killed that.

The CME took all gold-futures trading electronic, with greatly-extended session hours. Starting in early July, gold futures would be traded from 6:00pm EDT to 5:15pm the following day, from Sunday to Friday. That gave American gold futures a 23.25-hour trading day. But that’s problematic, as American traders are asleep or not paying attention for most of that time. There’s good reason stock-market trading days are just 6.5 hours.

When most market participants aren’t watching, liquidity and volumes are low so it is far easier for a big player to execute buying and selling orders specifically crafted to manipulate prices. And that’s exactly what happened on Sunday night July 19th. In the initial hours of that Sunday-evening trading that had started at 6:00pm EDT, gold was stable at its Friday close like usual. Minutes before 9:30pm, everything changed.

Out of the blue, gargantuan gold-futures sell orders slammed the American gold-futures market. Within just over a single minute, someone dumped nearly 24k gold-futures contracts controlling around $2.7b worth of gold! This selling was so extreme that twice within that single minute 20-second trading halts were triggered. That magnitude of selling in such a short time blasted gold $48 lower to $1086 in one minute.

Even before the data confirmed, it was blindingly obvious that this was an extreme shorting attack on gold. A normal long seller would never sell so many gold-futures contracts so fast, as the devastating price impact would impair its own exit price. And no normal seller would unload so much gold at such an illiquid low-volume time in the markets. When I learned of this that very evening, I knew it was short sellers.

Their timing was exquisite. Not only were American traders relaxing late Sunday evening and not paying any attention whatsoever since gold rarely moves then, Japanese traders were gone for a public holiday. And the Chinese markets were due to open within minutes at 9:30pm EDT, so there’s no doubt these short sellers were hoping to spark a gold panic in China. $1086 was a fear-spiking new 5.3-year low!

But this extreme...