Contrary Gold Futures: A Bullish View

Futures speculators are extraordinarily bearish on gold today. Their short positions on it are extreme and unprecedented, the highest seen by far in gold’s entire dozen-year secular bull. They expect downside gold momentum to persist indefinitely. But despite their reputation for sophistication, futures speculators are notorious for betting wrong at extremes. Their bearishness is a very bullish contrarian omen for gold.

Given gold’s horrendous 2013 so far, you really can’t blame futures speculators for being so pessimistic on it. Down 16.2% year-to-date, gold has never suffered a worse calendar-year start in its secular bull. American stock traders spawned a fierce gold headwind that global buyers couldn’t overcome. To help raise cash to plow into the euphoric, levitating stock markets, they aggressively dumped gold ETF shares.

The epic differential selling pressure on the flagship GLD gold ETF forced it to sell massive quantities of gold bullion to keep tracking its underlying metal. Despite the lower gold prices sparking enormous physical demand, particularly out of Asia, the wildly unprecedented deluge of ETF gold overwhelmed all buying. As gold was pushed lower and lower, it ignited a vicious circle that slaughtered futures traders.

Futures are very different from any other market, they are a hyper-leveraged zero-sum game. Leading into mid-April’s unheard-of gold panic, American futures speculators could control 100 ounces of gold worth $156k for just over $5k. Their maximum leverage was an insanely-risky 29 to 1, radically beyond the decades-old limit in stock markets of 2 to 1. Just a 3.5% move against them would totally wipe them out!

Early on Friday April 12th, gold broke below critical multi-year support triggering a huge mass of futures stops. The metal started plunging, forcing futures brokerages to unilaterally liquidate their customers’ long gold positions at any price. This cascading gold futures forced selling annihilated speculators. Gold plummeted 13.8% in two trading days, causing devastating leveraged losses far beyond capital risked.

After that bloodbath of a magnitude never before witnessed, it is understandable futures speculators remain scared of gold. The sentiment damage wrought by extreme selling events is so overpowering that it takes a long time for traders to recover. The aftermath of 2008’s once-in-a-century stock panic is a perfect case in point. Stock traders were so scarred by that trauma that they remained bearish for years.

But the best time to buy stocks wasn’t years later when sentiment finally started recovering, but right at peak bearishness in March 2009. When no bulls are left, when everything looks bleakest, is exactly when bottomings happen as I wrote at the time. A similar extreme is happening today in gold, with futures speculators nearly universally convinced that the yellow metal is doomed to never rally again.

Thankfully sentiment in futures is far easier to measure than in general stocks. Every futures contract has a long and a short side. The trader betting long (buying) is bullish, and the trader betting short (selling) is bearish. So by tracking longs and shorts, we can learn where futures speculators as a group think gold is heading. And today they are overwhelmingly bearish, with speculators’ shorts hitting bull records.

As a zero-sum game, the total number of longs and shorts are always perfectly equal. Every dollar won by one trader is a direct dollar loss for a counterparty trader. But the US futures regulator, the Commodity Futures Trading Commission, has long broken down futures traders into three classes. The CFTC publishes a weekly report, the Commitments of Traders, that shows positions held by each trader class.

Formally called commercial traders, non-commercial traders, and nonreportable positions, these are more commonly known as hedgers, large speculators, and small speculators. Hedgers trading gold futures use this metal commercially in their own businesses, such as mining or jewelry manufacturing. Speculators take the opposite sides of the hedgers’ trades, simply betting on where gold’s price is heading next.

So while total longs and shorts among all three classes are always a wash, within each class net-long and net-short positions arise. This first chart looks at these class-specific net gold-futures positions over the past 8 years or so. The speculators, both large and small, have not been more bearish on gold for many years. And each past time their bearishness hit extremes, gold soon started rallying dramatically.


The CFTC releases its CoT report late every Friday afternoon, with data current to the preceding Tuesday. So these charts are current to May 28th, the latest data available when this essay was published. On that day, the gold net-long position among large speculators (including hedge funds) fell under 57k contracts. This was down 52% since the week before April’s gold panic, and down by 73% since early October.

Though it feels like an eternity ago after 2013’s brutal bludgeoning, gold was thriving and challenging $1800 again early last autumn. The carnage has been so great since then that futures speculators have slashed their net-long gold positions by nearly 3/4ths! Note they were very bullish (high net longs) when gold was high and topping, the exact wrong time. And now they are very bearish when gold is low.

The last time large speculators’ net-long positions had been so low was way back in January 2007, 6.4 years ago. Were they right to be so bearish then? Futures speculators, due to their willingness to take on extreme leverage that would shatter a mere stock trader like me, are often viewed as the smartest and most sophisticated of all traders. But look at what gold did after these guys bet against it en masse.

Over the next 14 months, it blasted 64.2% higher! While there are no doubt smart individual futures traders, as a herd their track record is dismal. They succumb to groupthink and buy into popular euphoria and despair, extrapolating current trends out into infinity even when they are overdue to dramatically reverse. This same extreme bearishness was seen once again during late 2008’s crazy stock panic.

In November 2008 as gold fell near $700, futures traders again abandoned this metal. If it couldn’t surge during a once-in-a-lifetime stock panic, it had to be dead right? The large speculators’ net longs fell to 64k contracts, not much above last week’s levels. Then, like today, everyone was utterly convinced gold could only keep falling. So futures traders eagerly joined the popular gold-hyper-pessimism bandwagon.

But again this was the absolute worst time to be bearish on the yellow metal. Just 13 months later, gold had soared 66.3% higher! Futures speculators as a group were dead wrong, betting against gold the most aggressively when they should have been the most bullish. And this damning pattern continues back throughout gold’s entire secular bull. Futures traders’ positions are a major contrarian indicator.

In the chart above, I used light-blue bars to highlight each time large speculators’ gold net-long positions fell to major lows. If you look at the gold price during each peak-bearishness episode and then in the year or so after, without exception the yellow metal rallied dramatically. The most sophisticated gold traders in the world, the large futures speculators that include hedge funds, are always wrong at lows!

So why on earth would they be right today for the first time in this mighty 12-year-old secular gold bull? Futures speculator net-long lows have always been very bullish. When these guys get scared enough to close longs and short gold en masse, soon everyone who is willing to sell gold has already sold. This leaves only buyers, so gold soon starts rallying dramatically. That is going to happen again today.

Small futures speculators have a similar track record. They get most bearish on gold as evidenced by their net-long positions right when the metal is poised on the verge of a major new upleg. As shown in red above, in early May these guys’ net-long position in gold futures actually fell to -1.7k contracts. They were actually net-short gold! How rare is this? It has never happened before in this entire secular bull.

The last time small specs were net-short was back in the winter of early 2001. You may remember those dark days at the very end of gold’s preceding secular bear, when this metal languished in the $250s! This means just a month ago small specs were as bearish on gold as they were just before gold’s current secular bull was born! This defies belief, revealing the most extreme bearishness of this entire gold bull.

The last time small gold-futures speculators even came close to being net-short was during late 2008’s stock panic. Once again that was the worst possible time to be bearish, as gold would soon start surging in an enormous rally that would run for years. Futures speculators as a group simply get it wrong at extremes. They wax the most bearish near lows when they should be bullish, and vice versa near highs.

Contrarian trading theory works because sentiment extremes are self-limiting and soon burn themselves out. At toppings, as we’ve recently seen in the stock markets, greed grows so extreme that all available buyers have soon already bought. That leaves only sellers, so prices start falling and the great sentiment pendulum starts swinging back the other way towards fear. Smart contrarians fight the crowd.

At bottomings, like we’ve witnessed in gold in recent months, fear flares to such extremes that everyone susceptible to being scared into selling has soon already sold. That leaves only buyers, so as prices start rising sentiment starts shifting back towards the greed end of the greed-fear spectrum. The only way to buy low and sell high is to buy when others are afraid and sell when others are brave.

The fear futures speculators are showing in gold today, as exhibited by their short bets, is extraordinary to unprecedented depending on the measure. Extreme bearishness and extreme fear don’t breed further selloffs, but major new uplegs. So the outlook for gold today is wildly bullish, contrary to the widespread belief it is doomed. Futures traders succumb to popular groupthink, leaving them dead wrong at extremes.

This final chart examines gold-futures speculator positions from another perspective. It adds up the total longs and shorts held by both large and small speculators. And as evidenced by the massive surge in these traders’ short bets and the sheer quantity of their short positions, they have never been more bearish on gold in its entire secular bull. This is another powerful contrarian indicator that gold will soon soar.

The red line chronicles total speculator short positions in gold futures, and it surged to an astounding 158k contracts last week. Since each contract represents 100 ounces of gold, we are talking about American futures speculators being short 15.8m ounces of gold! To put this into perspective, the massive record GLD holdings liquidation that crushed gold in 2013 is “only” at 10.9m ounces. This short is gigantic.

Gold’s secular bull was born in April 2001, so I haven’t bothered pulling CoT data before 1999. And in that entire span from 1999 to today, we’ve never seen gold speculators’ total short positions get anywhere close to 158k. The previous bull record was only around 108k in early 2005, again just before gold started powering higher in a mighty upleg. Even in the summer of 1999, peak secular-gold-bear despair, they never exceeded 135k.

So we’re definitely at a decisive secular-bull high far beyond anything witnessed before in the past 12.2 years. And back in February thanks to a GLD-selling-sparked gold capitulation, speculators’ total short positions rocketed higher by almost 90% in just 4 weeks. This was their biggest monthly surge in 9.4 years! So there is no doubt that futures speculators’ bearishness on gold right now is epically extreme.

When speculator short highs are coupled with speculator long lows, it marks bearish extremes from which gold will soon surge higher. I highlighted these combinations above in light blue again. Gold futures speculators have relatively-low long positions and relatively-high short positions at exactly the wrong times, right when gold is the most bullish. And the magnitude of today’s shorts is staggering.

The main reason high gold shorts are so bullish is because they signal an unsustainable sentiment extreme. But a secondary reason is more mechanical, short covering. Due to the extreme leverage inherent in futures, shorting them is vastly more risky than shorting stocks. Relatively small moves higher quickly ignite a frenzy of buying as futures shorts rush to move their capital out of harm’s way.

Thanks to April’s futures-forced-liquidation-driven gold panic, margins on gold futures have been raised from $5400 per contract before to $6400 now. So at $1400 gold, a speculator can control $140k worth of gold for just above $6k. This represents still-insane 22-to-1 leverage, which means a mere 4.6% move in gold can totally wipe out the capital of traders betting the wrong way. This is a very unforgiving game.

Once gold starts rallying, speculators shorting gold futures have no margin for error. They have to buy to cover their short positions as soon as possible, which quickly feeds on itself. More buying forces gold higher, making the race to close shorts even more frantic. That’s why short-covering rallies are the biggest and fastest ever seen in any market. This alone nearly guarantees a coming sharp gold surge.

No matter what gold does, some speculators will still short it. So all 158k contracts won’t be covered. But with futures speculators’ total shorts so staggeringly high today, their buying will still be incredible. Between 2009 and 2012, the average spec shorts in gold futures were 65k contracts. So merely buying gold futures until shorts are back down to the post-stock-panic average represents 93k contracts of buying.

That is about 9.3m ounces of gold, or nearly 6/7ths of the total GLD bullion liquation so far in 2013! So as gold starts moving higher, there is going to be short covering on a scale never before witnessed in this secular bull. The unwinding of any extreme futures position is usually equally as extreme, as these hyper-leveraged traders can’t waste any time once a price starts moving rapidly against their bets.

So from a pure futures standpoint, gold has never looked more bullish in its dozen-year secular bull than it does today! These futures speculators as a group always bet wrong at extremes. They stubbornly ride momentum, popular greed or fear, even when it has already peaked. They fail to see the major reversals coming because they are not contrarians who’ve trained themselves to fight prevailing market emotions.

But being a contrarian, fighting the crowd at sentiment extremes, is the only way to buy low and sell high. You want to buy when everyone is the most bearish, because that’s when prices are the lowest. That describes gold today perfectly. And you want to sell when everyone is the most bullish, because that’s when prices are the highest. And that too should sound familiar, just like the stock markets in May.

I’m not a futures trader, and I built up the physical-gold foundation of my portfolio well over a decade ago. My trading interest lies in stocks. And across the entire stock markets, there is no more contrarian sector than gold stocks. Because gold is hated and traders are hyper-bearish on it, gold stocks have been sold down to fundamentally-absurd panic levels. There is no harder-core contrarian play on earth today.

And among gold stocks, none are more loathed than the juniors. Their stock prices have been obliterated this year, no one will touch them with a ten-foot pole. This extreme bearishness means their prices will rally much faster than other gold stocks when gold’s next upleg really starts moving. As gold and gold stocks inevitably return to favor, the best of these despised gold juniors should see gains exceeding ten times.

The bottom line is futures speculators have never been more short gold in its entire secular bull than they are today. Their gold bearishness is epic, off the charts. But despite their willingness to make hyper-leveraged bets, these guys have always proven wrong at gold’s extremes. Their gold pessimism peaks right as this metal is bottoming before embarking on a major new upleg. This time is no different.

Extreme fear is never sustainable, it soon burns itself out and only buyers remain. And the futures speculators short gold are going to play a major role in this. As gold starts rallying again, they will have to buy aggressively to cover their record shorts. This may very well cascade into a short-covering frenzy, a buying panic. Today’s incredible gold bearishness means another massive gold upleg is imminent.