Gold Futures Traders Breath Easy as Dovish Fed Powers the Next Major Rally
Gold futures surged sharply this week after the Yellen Fed yet again chickened out on raising its benchmark interest rate. Gold futures speculators’ irrational fear of Fed rate hikes has been a major drag on gold. And rate-hike risks just plummeted in the coming months, since the Fed can’t risk acting heading into this year’s critical US presidential election. So gold’s next major upleg was likely just unleashed by the Fed.
Oddly, Wall Street’s expectations for a rate hike at this week’s latest meeting of the US Federal Reserve’s Federal Open Market Committee were surprisingly high. The interest-rate target directly controlled by the FOMC is the federal-funds rate. Commercial banks are required to hold reserves at the Fed. They lend these reserves to other banks overnight in the federal-funds market, at the FOMC’s federal-funds rate.
This market is so important that federal-funds futures contracts trade on the CME. No one has more knowledge about federal funds than the hedgers and speculators trading in this market. Parsing their collective bets yields the implied odds of Fed rate hikes, which the CME conveniently calculates and summarizes in real-time with its FedWatch Tool. It revealed this week’s rate-hike expectations were totally wrong.
On Tuesday’s close before this latest Wednesday FOMC meeting, these futures-implied rate-hike odds were running just 18%. Thus any hike would have been a big surprise for the markets, almost certainly igniting a major stock-market selloff. Historically the FOMC hasn’t hiked before these odds are running 70%+. That only happens after top FOMC officials have spent months warning of an impending rate hike.
Before the Fed’s first rate hike in 9.5 years last December, these futures-implied rate-hike odds were way up near 80%! So it was strange to see many economists and analysts ignore federal-funds futures in expecting a probable rate hike this week. Given their strong gold buying after the Fed did nothing for the umpteenth time, gold futures speculators obviously also believed this week’s rate-hike risks were higher.
Even more perplexing, these American gold futures traders who dominate short-term gold price action have long believed Fed rate hikes are gold’s nemesis. Gold futures trading is exceedingly risky, so only elite and sophisticated traders participate in this market. At $1350 per ounce, each 100-ounce futures contract controls $135,000 worth of gold. Yet the maintenance margin required to trade it is merely $5400!
So the maximum leverage available in gold futures now is 25.0x, vastly higher than the decades-old legal limit in the stock markets of 2.0x. At 25x, a mere 4% adverse move in the gold price would wipe out 100% of the capital risked by a fully-margined trader! So you’d think that these guys would take the time to seriously study gold’s historical price action and drivers before taking such outlandish risks betting on it.
Historically gold actually thrives during Fed-rate-hike cycles! As I pointed out in depth last December just days before that first Fed rate hike in 9.5 years, Fed-rate-hike cycles are actually very bullish for gold prices. There have been 11 since 1971, and gold’s average gain across the exact spans of all was way up at +26.9%. Gold rallied in a majority 6 of these 11 Fed-rate-hike cycles, enjoying huge average gains of +61.0%!
And in the other 5 where gold retreated, its average loss was an asymmetrically-small 13.9% over their exact spans. The lower gold’s price entering Fed-rate-hike cycles, and the more gradual their hiking pace, the better gold performs as the Fed forces interest rates higher. So this newest Fed-rate-hike cycle couldn’t be any more bullish for gold. Gold entered it at major secular lows, and it is the most gradual ever.
Even if the goofy gold futures speculators can’t be bothered to spend a day digging into gold’s historical price action during Fed-rate-hike cycles, they should consider the last one. Between June 2004 to June 2006, the FOMC more than quintupled its FFR to 5.25% through 17 consecutive rate hikes totaling 425 basis points. Surely that slaughtered gold, right? Nope. Over that exact span, gold still powered 49.6% higher!
So this popular belief in recent years that Fed rate hikes are going to crush gold is ridiculous, a totally-false myth. Yet gold futures speculators still hang on every word from the FOMC and its top officials. Whenever the Fed does something hawkish or jawbones about it, gold futures speculators flee in terror. Conversely when the Fed is perceived as more dovish, these traders rush to buy gold just like we saw this week.
Gold futures speculators chaining themselves to the Fed is readily evident in this gold chart of the past couple years or so. American futures speculators’ total long contracts, upside bets on gold, and short contracts per the CFTC’s weekly Commitments of Traders reports are also included. This year’s young new gold bull has been heavily influenced by how futures traders perceive the Fed’s stance on rate hikes.
On a lazy summer Sunday night in July 2015, gold was crushed to artificial lows by an extraordinarily-manipulative giant short sale. Within a single minute around 9:30pm Sunday July 19th, a gargantuan 24k-contract gold futures sell order was placed. That was so extreme that twice within that single minute 20-second trading halts were triggered! Gold was blasted $48 lower to $1086 in one minute, shattering support.
As I explained in depth at the time, this was obviously an extreme shorting attack. No long-side trader would dump so many contracts so quickly at such a low-volume time, as it would have a huge adverse impact on their exit price. Impressively despite the horrendous gold sentiment back then, this brazen attempt to manipulate gold lower failed. Soon after that gold entered a major new multi-month uptrend.
Between early August and mid-October 2015, gold powered 9.6% higher out of that shorting attack. It was carving a nice uptrend, until a hawkish surprise from the FOMC’s October 28th meeting last year. In its usual post-meeting statement, the FOMC warned of an imminent rate hike “at its next meeting” which was coming in mid-December. Consider this precedent before gold futures speculators’ kneejerk selling reaction.
In the 10.2 years since its last rate-hike cycle ended in June 2006, the Fed has only hiked rates a single time last December. And in the very FOMC statement from the meeting immediately preceding that one with the rate hike, the FOMC directly warned one was impending. Since the Yellen Fed didn’t warn again in this week’s FOMC statement, there is no chance it is planning to hike at its next early-November meeting.
Back to that late-October-2015 FOMC statement’s hawkish surprise, futures speculators dumped gold with reckless abandon. Their total long contracts shown above in green cratered, and their shorts in red skyrocketed. It was American futures speculators’ irrational fear of rate hikes that drove gold’s major 6.1-year secular low in mid-December. Gold actually bottomed the day after the Fed’s first rate hike in nearly a decade.
But rate-hike-cycle fears are not misplaced at all for the general stock markets. Still back in December, I looked at the benchmark SP 500 stock index’s performance during those same 11 Fed-rate-hike cycles since 1971. Its average gain in them was merely +2.8%, an order of magnitude less than gold’s. And considering these overvalued stock markets directly levitated by extreme Fed easing, rate hikes are a real threat.
During the first couple trading days after that mid-December rate hike, the SP 500 plunged 3.3%. But with a new tax year approaching in a couple weeks, most sellers waited until 2016 to exit in response to a tightening Fed. That would push the big taxes due on their realized gains out another entire year. The moment January 2016 arrived, the Fed-rate-hike-driven stock-market selling resumed with a vengeance.
During the first 6 weeks of 2016 in the wake of the Fed’s initial rate hike off that 7.0-year-old zero bound, the SP 500 plunged 10.5%! That was its biggest selloff in 4.4 years. So as I predicted on the final day of 2015 when gold languished at $1060, investors soon started to flock back. Gold is a unique asset that moves counter to stock markets, so investment demand soars when stock-market fortunes are deteriorating.
It was this gold investment demand that fueled 2016’s strong new bull market! Last week I discussed this in depth if you want to get up to speed on this essential foundation. Investment capital steadily returned to gold in the first half of 2016, before stalling out in the third quarter. While all this investment demand has overwhelmingly been this gold bull’s primary driver, futures speculators still drive major swings.
Gold suffered a sharp selloff on heavy gold futures selling in mid-May. There wasn’t even an FOMC meeting that entire month, but 3 weeks after each meeting the Fed releases its minutes. While the FOMC’s statement from its late-April meeting had been considered dovish with no explicit hints of any potential rate hike at its next meeting in mid-June, those April minutes were more hawkish than expected.
So gold futures speculators again rushed to sell, their total longs plummeting, driving gold’s sharp May pullback. This metal didn’t start to recover until the first Friday in June, thanks to a colossal miss in the US-monthly-jobs data. Economists were looking for 164k jobs created in May, but the actual was just +38k! This was the worst jobs report in 5.8 years, so the data-dependent Yellen Fed couldn’t risk hiking in June.
Thus futures speculators flocked back into gold again, catapulting it higher on plunging odds of the next Fed rate hike. Indeed at its mid-June meeting, the FOMC held fire. There was do dissent among the FOMC members, and their future projections for federal-funds rates in the coming years dropped by about 50 basis points. Gold’s strong June rally came because futures speculators expected no rate hike.
Then on the last Friday in June, gold soared after the British people shocked the world by courageously voting for independence from their unelected, unaccountable, meddling EU overlords. Speculators and investors alike rushed to buy gold, so it shot higher. The futures speculators weren’t buying because of Brexit uncertainty per se, but because they believed Brexit uncertainty would stay the Fed’s hand on rate hikes!
See the pattern here? Gold surges higher when futures speculators aggressively add longs and cover shorts in response to lower perceived odds for near-future Fed rate hikes. I suspect this week’s latest FOMC meeting will prove a similar major buying catalyst for gold, igniting its next major upleg. While the federal-funds-futures traders didn’t expect a rate hike, they did expect the FOMC to talk a bit hawkish.
But that didn’t happen! There was no explicit hint for an imminent rate hike at the FOMC’s next meeting like its gold-crushing warning late last October. This week’s FOMC statement was actually shocking in that the Fed didn’t even offer up an excuse like usual for not hiking rates. It said even though the rate-hike case “has strengthened”, it simply “decided, for the time being, to wait”. Yellen just doesn’t want to hike.
On top of all this, at every other meeting the FOMC releases a summary of the FFR projections by each of the FOMC members and regional Fed presidents. These so-called dots got much more dovish again, with the FFR levels for the next couple years plunging another 50 and 75 basis points or so! This Fed led by uber-dove Janet Yellen is getting more and more dovish all the time, unleashing serious gold buying.
There were 3 regional-Fed presidents on the 10-person FOMC who dissented, the first time this has happened since December 2014. But due to the rigged nature of the FOMC, that’s no indication that a rate hike is coming anytime soon. The colorful regional-Fed presidents, God bless ‘em, have no power at all on the FOMC. They only occupy 4 of its 10 seats on a rotating basis, so Yellen’s cohort always outvotes them.
Yellen and 4 closely-allied Fed Board of Governors’ members always control 5 votes, and the president of the New York Fed has the only permanent voting seat for any regional Fed as the 6th. Naturally he is always very dovish too, since rate hikes hurt the financial markets that are so critical to his Fed district’s economy. Yellen’s dovish faction dominates the FOMC with iron fists, regional presidents be damned.
And this is super-bullish for gold futures in the next few months, because now the Fed’s hands are tied until after the early-November US elections. There is zero chance for a rate hike or even much hawkish talk until after all Americans cast their ballots on November 8th. The FOMC’s next meeting is right before that on November 2nd, so it can’t even warn in that statement about a hike at its following mid-December meeting.
So we have at least 3 months now before the Fed can even start getting hawkish again, a fantastic and long window for gold’s next major upleg to surge higher on heavy investment and speculation buying. Contrary to Janet Yellen’s feeble assertions otherwise, the Fed is highly political. The results of this upcoming presidential vote have huge implications for the Fed, and Yellen certainly wants Hillary to win.
Yellen is a hardcore lifelong Democrat appointed by Obama. One of her governors with a permanent FOMC vote is Lael Brainard. She served in Obama’s Treasury department, and earlier this year actually made multiple donations to Hillary Clinton’s presidential campaign up to the personal limit! Democrats who love easy money dominate the FOMC, and they know a rate hike or enough talk of one will tank stock markets.
Almost since the FOMC made the unprecedented move to force the FFR to zero in December 2008, the Fed has been under heavy if not withering attack from Republican lawmakers. They hate the fact the Fed has grossly distorted the economy, and decided to subsidize debtors and Wall Street by robbing blind hardworking American savers. Congressional Republicans want to drastically limit the Fed’s power.
Remember soon after last December’s initial rate hike, the stock markets plunged dramatically. Given how fake today’s lofty Fed-goosed stock markets are, there’s no doubt another rate hike or sufficient threat of one will do the same thing. And it turns out that US stock-market performance in the final two months leading into early-November elections is exceedingly important for their outcomes. The Fed knows this.
Since 1900 there have been 29 US presidential elections. When US stock markets rally in Septembers and Octobers leading into these early-November elections, the incumbent party has won the presidency 16 of 17 times! But when stock markets sell off in those final couple months before the elections, the incumbent party has lost 10 of 12 times. Stock-market fortunes have 90% odds of predicting election results!
Why is this the case? 40% to 45% of voting Americans will always vote Republican, while an opposing 40% to 45% will always vote Democrat. But in the middle are 10% to 20% of swing voters with no strong party affiliation. They often vote based on how they perceive their own economic prospects. Higher stock markets have always bred optimism, making them more likely to vote for keeping the status quo.
Any Fed hawkishness at all risks pushing stock markets lower heading into the November 8th US elections, including at the FOMC’s next meeting on November 2nd. As I’ve been telling our newsletter subscribers for months now, there is absolutely no way the heavily-Democrat Yellen FOMC will risk doing anything at all that ups the chances of a hostile-to-Yellen Donald Trump winning the presidency!
So not only just unleashed by the Fed again, gold is entering a few-month-or-longer period where there is virtually no risk of anywhere-near-enough Fed hawkishness to spook gold futures speculators. Gold futures just got the green light for a major new upleg driven by investment and speculation buying. Every major gold selloff in the past year was driven by Fed hawkishness’s impact on futures trading, and that risk has vanished.
Thus I strongly suspect this week’s FOMC meeting will soon prove to be the catalyst igniting the next big upleg in gold’s strong young bull. Investors can certainly play this with physical gold coins or by buying shares in that flagship GLD SPDR Gold Shares gold ETF. Provocatively nearly all the capital fueling gold’s bull market this year has come from American stock investors aggressively buying GLD shares.
But at best GLD will merely pace gold’s coming gains. Meanwhile the stocks of the best gold miners will really amplify gold’s gains due to their great inherent profits leverage to gold. Gold-mining stocks have been 2016’s best-performing sector by far, and that dominance will once again accelerate as gold’s next major upleg gets underway. The elite gold stocks still remain very undervalued relative to prevailing gold levels.
The bottom line is this week’s dovish FOMC likely just unleashed gold to start powering higher in its next major upleg. For years, futures speculators’ perceptions of the likelihood of imminent Fed rate hikes has battered gold around. That’s proved very true in this year’s young gold bull too. But with the critical US presidential election rapidly approaching in early November, the Fed can’t risk sending any hawkish signals.
The heavily-Democrat ruling dovish faction of the FOMC won’t risk doing anything that could incite a stock-market selloff. US history has proven abundantly that weak stock markets leading into presidential elections greatly lower the incumbent party’s chances of winning. With the Fed bowing out, gold is just starting to enjoy a rare multi-month window devoid of Fed hawkishness to retard buying or spark selling.
Courtesy: Adam Hamilton
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