Gold was just hammered lower after the latest FOMC decision. Heavy gold-futures selling erupted after a third of top Fed officials implied they saw a couple potential rate hikes way out into year-end 2023. While leveraged gold-futures speculators panicked, gold investors ignored these faint tidings of slight tightening way off in the distant future. Their resolve is bullish for gold, as investors control far more capital than speculators.
Gold has two dominant primary drivers, speculators’ gold-futures trading and normal investment capital flows. The interplay of these overwhelmingly determines gold’s price trends, so traders need to carefully follow them. The extreme leverage inherent in gold futures makes their gold-price impact bigger over the shorter term, while the vast pools of investment capital make it more important to gold over the longer term.
Last week I wrote an essay on the Fed gold-futures purge, analyzing that FOMC decision and the heavy gold-futures selling that pummeled gold in its wake. In a nutshell, 6 out of 18 top Fed officials think their federal-funds rate might be 50 basis points higher by the end of 2023! That may as well be an eternity away, and the so-called dot plot those individual outlooks came from is a notoriously-inaccurate forecaster.
But with the super-low margin requirements for gold futures, speculators could run insanely-high leverage up to 20.7x leading into that FOMC decision! That kind of amplification breeds extreme risks, as a mere 4.8% gold move against speculators’ positions would wipe out 100% of their capital deployed. So they had to exit fast after that hawkish Fed surprise goosed the US dollar, fueling self-feeding gold-futures selling.
The more gold-futures contracts dumped, the faster gold fell. The sharper gold’s plunge, the more other speculators were forced to liquidate longs or face catastrophic losses. That’s why gold plummeted 4.5% in just two trading days following those far-away dots creeping higher. While all this was covered in depth in last week’s essay, there wasn’t yet enough data to evaluate the FOMC’s impact on gold investment flows.
Now there is, and investors shrugged off those distant-future potential rate hikes so far. That’s very bullish for this battered metal in the coming weeks and months. Speculators’ gold-futures selling quickly exhausts itself, as these traders’ capital firepower is very limited. As long as the resulting gold plunge doesn’t scare investors into fleeing, this metal is nicely set up for a sharp mean-reversion rebound to new upleg highs.
Unfortunately comprehensive gold supply-and-demand data showing investment flows is only published quarterly by the World Gold Council. That compares to weekly for speculators’ gold-futures positioning. But thankfully a great proxy for global gold investment demand is available daily. That is the physical-gold-bullion holdings of the leading and dominant gold exchange-traded funds, which are both American ones.
They are the gargantuan GLD SPDR Gold Shares and IAU iShares Gold Trust. As of the WGC’s latest quarterly fundamental report covering Q1’21, GLD and IAU commanded 29.0% and 14.1% of all the gold held by all the world’s physically-backed gold ETFs! The next-largest competitor trading in the UK only weighed in at 6.3%. And gold-ETF capital flows are also increasingly dominating overall gold investment.
Q1’21 is a great example, as evident in the WGC’s latest fantastic Gold Demand Trends report. Overall world gold demand was quite week, plunging 23.0% year-over-year or 244.2 metric tons. Yet traditional bar-and-coin investment demand was very strong, blasting 35.5% or 89.0t higher. Gold’s only material demand category that plunged was gold-ETF demand, plummeting from +299.1t in Q1’20 to -177.9t in Q1’21.
And of last quarter’s 177.9t worldwide draw in gold-ETF holdings, GLD+IAU accounted for 154.4t or 87%! These American gold-ETF giants were responsible for nearly 7/8ths of the only gold-capital-flows shift that mattered last quarter. And that’s certainly no anomaly, many quarters have seen global gold ETFs overwhelmingly dominated by GLD+IAU command most of the relevant quarterly supply-and-demand action.
Consider Q2’20, the post-lockdown-stock-panic quarter in which gold soared 12.9% in a sharp mean-reversion rally. Bar-and-coin investment demand plunged 28.9% YoY that quarter as gold’s soaring prices retarded buying. Yet overall investment demand still rocketed 101.0% higher, fueled by gold-ETF capital inflows skyrocketing 478.7% YoY to 435.8t! GLD+IAU alone accounted for 63.5% of that, over 5/8ths!
The American stock markets are the largest and most-important in the world by far, dwarfing everything else. And American stock traders’ favorite gold trading vehicles are these giant US gold-exchange-traded funds. So it makes sense that vast amounts of American stock-market capital sloshing into and out of gold via GLD and IAU would often dominate this metal’s capital flows, and thus gold price action as well.
The only way physically-backed gold ETFs can succeed in tracking their metal is if they act as conduits for stock-market capital. That’s because gold-ETF-share supply and demand is independent from gold’s own. If GLD+IAU shares are being bought faster than gold itself, their share prices will decouple from gold’s to the upside. So ETF managers have to quickly step in and offset any excess ETF-share demand.
They do that by issuing sufficient new gold-ETF shares to absorb differential demand. Then the cash they raise from those share sales is immediately plowed into physical gold bullion, boosting their holdings held in trust for shareholders. Thus rising GLD+IAU holdings reveal American stock-market capital flowing into gold. That is exactly what has happened on balance since last week’s FOMC-dot-plot hawkish surprise.
Had gold investors started fleeing as gold-futures speculators’ frantic selling hammered this metal sharply lower in the Fed’s wake, GLD+IAU would’ve seen big draws. Their shares would’ve been sold faster than gold, forcing ETF managers to buy back any excess ETF-share supply. The cash necessary to finance those gold-ETF buybacks would be raised by selling some of their underlying physical-gold-bullion holdings.
Again as explained in depth in last week’s essay, gold’s 4.5% plummeting in the 26 hours following that FOMC decision had to be driven by speculators dumping gold-futures contracts. Investment capital flows almost never bully gold around that fast. Unlike the hyper-leveraged gold-futures speculators, investors usually own gold outright with no leverage. At most in GLD+IAU, they can only run the 2.0x stock-market limit.
Any investor reaction to gold’s futures-driven plunge last week would show up in GLD+IAU holdings, but not instantly like that leveraged futures selling. Now we have six full trading days of GLD+IAU data since that hawkish FOMC surprise, giving a clearer picture of how gold investment flows are responding. And so far investors are ignoring the Fed, as GLD+IAU holdings have actually risen modestly on balance since!
This chart shows GLD+IAU holdings in dark blue superimposed over gold’s price action in recent years. Note that major gold uplegs and corrections are fueled by gold-ETF capital flows. Gold’s last extended correction of 18.5% over 7.0 months ending in early March was partially driven by GLD+IAU suffering a 10.9% or 192.8t holdings draw. That exacerbated gold’s downside, unleashing more gold-futures selling.
Gold investment capital flows as represented by GLD+IAU holdings usually lag major gold uplegs and corrections. Investors generally don’t start recognizing key trend reversals transitioning between uplegs and corrections until weeks or sometimes months after those turns. Investors need to see gold move far enough and long enough to confirm a trend change before they will join in. That process is now underway.
While gold’s last correction hit its nadir of $1,681 in early March, GLD+IAU holdings kept grinding lower on inertia until the end of April sinking to 1,512.8t. Gold had finally rallied long enough and high enough to convince investors to start riding its young upleg. By mid-June on FOMC eve, GLD+IAU holdings had climbed 2.3% or 34.8t. As they don’t change direction often, that proved a young gold upleg was underway.
Last Wednesday the FOMC did nothing, keeping both its zero-interest-rate policy and $120b per month of quantitative-easing bond monetizations in place. The official FOMC statement gave no hints of changes in either, this crazy-easy monetary policy would continue indefinitely. Yet unofficially just a third of the top Fed officials saw slightly-higher rates up to 2.5 years into the future by year-end 2023, that hawkish dot plot.
In his usual post-FOMC-meeting press conference, the Fed chair himself dismissed the dot plot warning it is “not a great forecaster of future rate moves.” Yet currency traders still bid the US dollar sharply higher, which frightened the gold-futures speculators into selling en masse hammering gold down 1.6% in just the couple hours between that dot-plot release and the US close. But that didn’t scare the unleveraged investors.
That FOMC day GLD+IAU holdings edged 0.1% higher, implying slight American-stock-market-capital inflows into gold despite the carnage. Unfortunately that hyper-leveraged gold-futures selling snowballed overnight, blasting gold another 3.0% lower to $1,774 last Thursday. Gold’s worst down day since way back in early January, shattering the psychologically-important $1,800 level, could have rattled investors’ resolve.
Yet GLD+IAU holdings only drifted a trivial 0.2% lower that day! And that slight selling reversed hard to sizable buying the very next trading day, last Friday. While gold slumped another 0.6% extending its post-FOMC losses on those distant hawkish dots, GLD+IAU holdings surged up 0.7% to hit a new gold-upleg high of 1,556.8t! Investors didn’t seem worried gold had plummeted 5.2% in just three trading days.
And they certainly shouldn’t have been. Two potential rate hikes over a couple years into the future, which wasn’t even a consensus view among top Fed officials, was meaningless. The dot plot has a long history of proving radically wrong on future rate-hike timing and magnitude. And heavy gold-futures selling is always very finite, quickly burning itself out. Gold investors knew that gold-futures drama couldn’t last long.
This Monday, gold finally bounced with a solid 1.2% gain. Gold-futures speculators were likely buying again, with the hawkish-dots US-dollar surge finally petering out. GLD+IAU holdings slumped another 0.2% that day, but that doesn’t mean investors were selling. When gold is surging on futures buying, and American stock investors aren’t joining in, the gold ETFs see draws to equalize supply-demand differentials.
In those scenarios, gold’s price is rising faster than gold-ETF shares’ prices. In order to keep them from decoupling from gold to the downside, the gold-ETF managers have to buy back additional shares. They raise the cash to do this by selling some of these ETFs’ physical-gold-bullion holdings. That drives draws on gold up days where investors aren’t participating. This Tuesday, GLD+IAU holdings edged back up 0.1%.
Since I write these weekly essays on Thursdays during the US session, their data cutoff is Wednesday’s close. That day GLD+IAU holdings slumped another 0.2% to 1,551.5t as gold drifted a trivial 0.1% lower. Overall in these latest six trading days immediately following that hawkish dot plot, GLD+IAU holdings climbed a modest 0.3% or 3.9t. That’s despite gold still languishing 4.5% lower. Investors are strong hands!
Had the FOMC officially warned rate hikes might be coming later this year, or said it was going to soon start slowing its QE bond purchases, investors may have had some justification for lowering their gold allocations. But two potential rate hikes way out into late 2023? Come on! Gold investors are prudent in ignoring that colossal Fed nothingburger. This hyper-easy FOMC is still vomiting vast amounts of new money.
While these six post-FOMC trading days have been encouraging on the gold-investment front, that isn’t long enough to get us out of the woods. As this chart shows, heavy gold-futures selling hammering gold sharply lower can trigger big differential gold-ETF-share selling in response. Two recent episodes of that are highlighted in this chart. But both happened during gold corrections, and gold-ETF selling started quickly.
Gold was in an indisputable young upleg when this latest hawkish-dots scare hit. And the lack of any notable differential gold-ETF-share selling since argues that investors aren’t worried. This profligate Fed is still pumping $120b per month of new QE money into the US economy, even after its balance sheet has ballooned an absurd 87.0% or $3,752b higher in just 15.2 months since March 2020’s stock panic!
The Fed has nearly doubled the US-dollar supply in just over a year, and its printing presses are still spinning hellbent for leather. If the Fed starts tapering QE late this year, and that slowing of QE lasts through 2022, that implies another $1,440b of money printing is still coming! And if the stock markets fall seriously in response to tapering, the Fed will quickly stop for fear of a stock bear spawning a depression.
As gold investors know, there’s simply no reason to be bearish on gold today given this crazy-inflationary monetary backdrop from this FOMC. A third of top Fed officials maybe seeing two quarter-point rate hikes years into the future in 2023 is nothing to fear today. And if gold investors hold strong and don’t join in the gold-futures-spawned selling, those latter speculators will soon return mean-reverting gold sharply higher.
The biggest beneficiary of gold rebounding and resuming its young upleg will be the stocks of its miners. The major gold miners of the leading GDX gold-stock ETF tend to amplify material gold moves by 2x to 3x, so they were crushed sharply lower in this hawkish-dots gold-futures carnage. Their gains as gold recovers will also amplify its upside, making this anomalous selloff a good time to load up on great gold stocks.
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The bottom line is gold investors have ignored their metal’s sharp plunge following last week’s hawkish FOMC surprise so far. The holdings of the dominant American gold ETFs, the best high-resolution proxy for overall gold investment demand, have actually climbed slightly in the wake of those latest dots. It is silly to fear a third of top Fed officials seeing slightly-higher rates way out into year-end 2023, an eternity away.
The FOMC doing nothing last week remains really bullish for gold. Both the Fed’s zero interest rates and $120b of monthly QE remain in place indefinitely, flooding the world with ever-more freshly-conjured US dollars. And the heavy gold-futures selling spawned by those hawkish dots is already exhausted, paving the way for a sharp mean-reversion rebound in the yellow metal. Investors are wise to stay deployed in gold.
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