Gold’s Curious Sentiment

Gold is faring quite well today technically, though you sure wouldn’t know it from the rampant bearish sentiment. Gold’s price is in a strong uptrend over a year old, high in both its current upleg and young bull market. Gold isn’t far from breaking out to its best levels since September 2013, a really big deal. The stock markets even finally sold off after years of unnatural calm. Yet traders are still down on gold.

Across all markets price action drives psychology. When something’s price is rising, traders get excited and bullish on it. So they increasingly buy to ride that upside momentum, amplifying it. Of course, the opposite is true when a price is falling, which breeds bearishness and capital flight. Given gold’s great technical picture today, investors and speculators alike should be growing enthusiastic about its upside potential.

But they really aren’t, which is certainly curious. Gold’s current upleg was born right before the Fed’s last rate hike in mid-December. Everyone thinks Fed rate hikes are very bearish for gold, but history proves the opposite as I argued near gold’s recent interim lows.  In the 2.4 months since, gold has rallied 6.6% as of the middle of this week. That trounces the leading benchmark S&P 500 stock index’s mere 1.6%.

Gold’s rate of ascent since mid-December annualizes out to a 33% pace, which is pretty darned exciting! Yet gold’s two primary sentiment proxies, silver and the stocks of gold miners, show enthusiasm for gold is nonexistent. Over that same current-gold-upleg span, silver is only up 5.0% while the HUI gold-stock index clocked in with a dismal 1.8% gain. Normally silver and the gold stocks leverage gold upside by 2x to 3x!

As I discussed about a month ago, gold is on the verge of a major breakout that would greatly shift psychology back to bullish. Gold’s bull-to-date peak was carved in early-July 2016 at a $1365 close. For a variety of reasons, gold stalled at best since.  Just a month ago gold surged to $1358 though, and only a week ago it hit $1353. It wouldn’t take much of a rally to boost gold to new bull-market highs to catch the limelight.

Generally upside breakouts have to be decisive to really attract traders’ attention. I define that as 1% beyond the old level, so $1379 in gold’s bull-high case. That’s only a handful of good up days away, not far at all. And that’s close to $1383, which is gold’s best level in a whopping 4.5 years. Start pushing $1400 again, and even oblivious traders who’ve long forgotten about gold will realize something big is changing.

On top of these key technical upside-breakout levels so close, the sharp stock-market selloff is fantastic news for gold investment demand. The S&P 500 plunged 10.2% in just 9 trading days! That ended an all-time-record 405-trading-day span without a mere 5% pullback and is the first stock-market correction in 2.0 years. Stock selloffs are very bullish for gold, as investors remember the wisdom of diversifying portfolios.

So gold’s popularity should really be mounting now given its strong price action.  Yet that certainly hasn’t happened yet, gold’s sentiment is really curious.  The prevailing psychology remains quite bearish, which feels much more like a major bottoming. The fear, anxiety, and apathy somehow still plaguing gold is the polar opposite of the greed and excitement near major highs  Gold is still overlooked, ignored, and shunned.

This weird sentiment anomaly totally disconnected from technical realities can and will turn fast, likely as gold decisively breaks out to new bull highs. That could happen anytime in the coming weeks or maybe months, it is nearing. But for now, it’s useful to understand why gold oddly remains so out of favor.  The answer lies in the psychology of gold’s two primary driving forces, futures speculators and stock investors.

Gold-futures speculators exert inordinate influence on daily gold price action. This is primarily due to the extreme leverage inherent in futures trading. This week a single gold-futures contract that controls 100 ounces of gold has a maintenance margin requirement of just $3500. That’s all the capital traders need to buy or sell a contract. But at this Wednesday’s $1323 gold, each contract controls gold worth $132,300.

That equates to extreme maximum leverage of 37.8x, death-defyingly high! For comparison, the legal limit in stock markets for decades has been 2.0x.At 35x leverage, each dollar speculators deploy in gold futures has 35x the gold-price impact of another dollar used to invest in gold outright. Such ridiculous leverage allows futures speculators to collectively punch far above their weights, dominating gold-price action.

As if that’s not unfair enough to normal investors, gold futures’ extreme leverage necessitates an ultra-short-term focus. Again at 35x leverage, a mere 2.9% adverse price move in gold would wipe out 100% of the capital speculators risked! So these guys are forced to think in terms of minutes, hours, days, or sometimes weeks for their trading time horizons. The months and years of investors may as well be eternities.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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