Sharp Gold Pullback Healthy

Sharp Gold Pullback Healthy

Adam Hamilton    
February 10,
2023     2481 Words

Gold
was just slammed hard in a sharp selloff, plunging over 4% in only
two trading days!  That really freaked out traders, gutting bullish
sentiment and leaving them worried about more serious downside.  It
didn’t have to though, as gold’s powerful young upleg was
increasingly due for a pullback.  These are essential periodically
to maintain uplegs’ health, keeping sentiment balanced to maximize
their ultimate gains.

One
of the great challenges of trading is overcoming our natural
immediacy bias.  When we formulate opinions on anything, we all
tend to weight recent events more highly.  Applied to markets, this
means we assume whatever price action has just happened will persist
into a new trend.  We make linear assumptions in a nonlinear world,
forgetting about markets’ endless cyclical flows and ebbs.  This
leads to bad decisions.

Traders as a herd generally buy high after big rallies generate
greed, then sell low after subsequent major selloffs spawn fear. 
That’s the polar opposite of the buy-low-sell-high strategy
necessary for success!  In my decades as a professional speculator,
I’ve found the best antidote for immediacy bias and the herd
groupthink it inevitably leads to is perspective.  All market
action should be viewed in the context of longer trends.

Gold
plunging 4.4% last Thursday and Friday was certainly a violent
selloff.  But considered within a six-month timeframe, it didn’t
do much technical damage.  Between late September to last
Wednesday, gold powered 20.2% or $328 higher in 4.2 months.  That
wasn’t just a strong young upleg, it boosted gold back into
formal-bull-market territory with 20%+ gains!  This is essential
perspective for the subsequent drop.

That
4.4% or $86 gold selloff was big and mean, but it only reversed
about a quarter of those major gains leading into it.  And
interestingly 4%+ gold plunges over two trading days aren’t even
particularly unusual.  There were actually nine over the last
several years since 2020 dawned, spread over six separate events! 
So these can happen a couple times a year or so.  They shouldn’t
surprise traders who are doing their homework.

After last week’s latest Fed decision and rate hike, I wrote an
essay on the Fed
gold anomaly unwinding.  It analyzed how the Fed is running out
of room to keep jacking its federal-funds rate higher, so its
ability to shock markets with big rate hikes is over.  That is
really bullish for gold, as last year’s monster rate hikes ignited
extreme US-dollar buying driving heavy gold-futures selling which
crushed gold through mid-2022.

I’ve
written 1,056 of these
weekly web essays since early 2000.  In order to publish them
early Fridays, I have to decide what to analyze then finalize any
charts late Wednesdays.  So that mid-week close is the data cutoff
for these essays, which I pen Thursday mornings then proof those
afternoons.  Gold closed at an impressive new upleg high of $1,951
on that Fed Day last Wednesday, surging 1.2% despite the latest
hike.

Gold’s 4%+ plunge last Thursday and Friday didn’t change that
analysis in any way, as it is based on that critical longer-term
perspective necessary to overcome the immediacy bias.  But man, the
feedback I got was sure hostile!  Traders didn’t care that gold had
just powered 20.2% higher in 4.2 months, they were shocked and
angered it had fallen 4.4% in two trading days.  Here’s an example
e-mail from one reader…

He
quoted my essay where I wrote, “Gold is finally being freed from its
extreme-Fed-rate-hike-cycle shackles to start reflecting this
underlying raging inflation.”  He replied, “Really? Smashed down
$100 once again, thus proving that gold is unstable crap and the
gold commentators such as you are always full of shit! How much
would you pay me to read your newsletter?”  Our subscribers weren’t
surprised at all.

In
addition to these weekly web essays, we publish separate weekly and
monthly subscription newsletters containing the meat of my
analytical work and actual stock trades based on it.  That very Fed
day last week where gold hit $1,951, I warned our weekly subscribers
that a large gold pullback could be ignited that afternoon by
the Fed chair’s press conference following its decision.  Before
gold’s sharp selloff I wrote…

“If
Powell proves hawkish enough, it could ignite a USDX countertrend
rally hitting gold.  During in-progress uplegs, 50dmas are often
major support zones for larger pullbacks.  Ominously gold’s is way
down around $1,831 today!  Odds are such a severe selloff won’t
happen, but even that wouldn’t mortally wound gold’s upleg.”  While
gold weathered the Fed chair fine, that large pullback started the
next morning.

I
analyzed the causal chain in depth in our latest weekly newsletter
as always, but in a nutshell early last Thursday the European
Central Bank was dovish.  While it did hike its own benchmark rate
by 50 basis points as expected, its monetary-policy statement said
it would likely only do one more 50bp hike at its next meeting and
then pause its hiking cycle.  That is much earlier than the
ECB president recently implied.

So
the euro fell, fueling buying in the competing US dollar.  Its
benchmark US Dollar Index had just made a new downleg low the prior
day after the Fed, as gold carved that new upleg high.  The USDX was
as oversold as gold was overbought, neither to major-trend-reversal
extremes but both enough to trigger big countertrend moves to
rebalance sentiment.  These take the form of healthy pullbacks
within ongoing uplegs.

Major price trends are never linear, they always take two steps
forward followed by one step back.  So the longer any upleg runs
without any material selloff, and the higher prices get stretched
above their baseline 200-day moving averages, the greater the odds
for a large pullback.  Gold hadn’t suffered any significant declines
since mid-November!  After powering higher for several
months, a rebalancing selloff was due.

Gold’s 2.0% drop Thursday after the ECB hammered the euro goosing
the USDX worsened Friday after another market surprise.  Early on
the US government released its latest monthly US jobs report, which
proved a statistically-impossible eight-standard-deviation beat. 
Wall Street economists were looking for 187k US jobs created in
January, yet the Bureau of Labor Statistics claimed an unbelievable
517k were!

Traders viewed that blistering headline jobs data as Fed-hawkish,
arguing for more rate hikes.  So the USDX blasted 1.2% higher, its
biggest up day since leading into late September’s euphoric
20.4-year secular peak!  That unleashed what looked like heavy
gold-futures short selling slamming gold another 2.4% lower to
$1,866.  While 4%+ two-day gold plunges aren’t rare, back-to-back
major market surprises are.

The
ironic thing about traders’ kneejerk reactions to that
highly-suspect jobs report was that headline beat was fabricated. 
The BLS’s underlying raw jobs data actually showed a record
2,505k US jobs lost during January!  An epic 3m+ job seasonal
adjustment was applied to get that +517k headline number, literally
conjured out of thin air in bureaucrats’ spreadsheets.  Neither the
dollar nor gold should’ve reacted on that fiction.

But
with the short-term-oversold USDX starting to rally the day before,
and short-term-overbought gold starting to pull back,
momentum-chasing trading intensified.  Thus gold was pummeled down
4.4% in two trading days, freaking out traders.  But had they looked
at a simple chart with a six-month-plus duration to regain
perspective, their immediacy bias wouldn’t have run roughshod.  Gold
is still looking fine technically!

As I
had warned in our weekly newsletter that Fed day, major pullbacks
within uplegs tend to find strong support near their 50-day
moving averages.  When gold’s upleg carved that latest $1,951
interim high after the Fed chair’s presser failed to be hawkish,
gold was stretched 1.096x above its 200dma.  That was still way
under the 1.160x+ levels where traders need to start worrying about
larger upleg-slaying corrections.

But
because gold was still short-term overbought, its 4.4%
two-trading-day plunge left it well above its key 50dma support. 
Last Friday that was running $1,840, well below gold’s $1,866
close.  And at this essay’s Wednesday data cutoff, that
steeply-rising 50dma had climbed further to $1,848.  A pullback in a
major upleg that hasn’t even retreated to its 50dma yet is
nothing to worry about, even if it happens to be violent!

Pullbacks within ongoing uplegs exist to rebalance sentiment. 
When prices surge for some time without any material interruptions,
popular greed flares.  Traders fixated on recent gains start to
expect prices to keep powering higher indefinitely, so they pile in
to chase that upside.  But excessive greed risks burning out uplegs
prematurely, attracting in too many traders too soon which exhausts
their capital firepower for buying.

So
countertrend pullbacks naturally erupt periodically to bleed off
excess greed and reinject some fear.  These selloffs last until
sentiment is sufficiently rebalanced for buying to resume.  Their
effectiveness in this essential mission is inversely proportional to
their sharpness.  Bigger and faster pullbacks kill greed much more
rapidly than slower and shallower ones.  Thus violent pullbacks tend
to run their courses fairly quickly.

In
order to game when and where this current sharp gold pullback is
likely to end, we need some key data on
speculators’
collective gold-futures positioning.  I wrote a whole essay
analyzing that in depth in mid-January if you need to get up to
speed.  Big gold selloffs erupting rapidly right after market
surprises are always driven by heavy gold-futures short selling. 
The extreme leverage inherent in futures really moves gold.

This
week specs are only required to keep $6,900 cash in their accounts
for each 100-ounce gold-futures contract they are trading.  At
$1,875, that controls $187,500 worth of gold.  So these traders can
run crazy leverage up to 27.2x!  Thus every dollar deployed in gold
futures at those extremes exerts 27x the gold-price impact as
a dollar invested outright!  But at 27.2x, a mere 3.7% gold rally
wipes out 100% of capital risked.

So
there aren’t many speculators brazen enough to short gold at maximum
leverage, and their capital firepower is very limited.  Once we can
see how high their gold-futures shorts are compared to their
past-year trading range, we can get an idea of when their selling
will likely be exhausted.  Unfortunately there is a problem with
that data, which comes in the weekly Commitments of Traders reports
from the CFTC.

Usually released late Fridays current to preceding Tuesdays, last
week’s CoT still hadn’t been published as of midday this Thursday
nearly a week late!  The CFTC said it didn’t have the data
because a major futures clearing firm suffered a ransomware
cyberattack.  The CFTC said it would release that back data when it
was received and validated, but gave no timeline.  So we’re
unfortunately flying blind on gold futures.

But
as long as gold holds around that 50dma major-upleg-support zone,
technically this selloff is just a pullback and nothing to worry
about.  Gold’s powerful young upleg remains very much intact, with
nearly 3/4ths of its gains unscathed.  The same is true with gold
stocks, which amplify gold moves due to their big inherent
profits leverage to gold.  The leading
GDX gold-stock
ETF was also pounded lower as gold fell.

Last
Thursday and Friday when gold plunged 4.4%, the major gold miners
dominating GDX suffered big 7.4% drops per that popular benchmark. 
That actually wasn’t too bad given the gold situation, merely 1.7x
downside leverage.  GDX tends to amplify material gold price moves
by 2x to 3x.  In just 4.0 months into late January, GDX had
leveraged gold’s 20.2% upleg with strong 52.1% gains!  That was a
normal 2.6x.

Despite gold stocks soaring dramatically out of last September’s
exceedingly-oversold stock-panic-grade lows, traders remain
skeptical of their young upleg.  I explored this a couple weeks ago
in an essay on the
neutral
gold-stock sentiment.  While greed was mounting as they soared
in recent months, it hadn’t yet grown big enough to overpower all
the residual fear from last year’s huge selloff.  That left traders
quick to flee.

So
GDX’s plunge to $30.32 last Friday brought it closer to its $30.23
50dma than gold.  Still that major-upleg support zone has held
since, leaving only minor technical damage.  Like gold, only about
1/4th of the big gold-stock upleg of recent months was lost in this
latest sharp pullback.  These perfectly-normal countertrend moves
are essential in major uplegs to maintain their health by
keeping sentiment balanced.

With
inflation raging
out of control thanks to extreme Fed money printing, gold’s
fundamentals remain incredibly bullish.  Central-bank buying
skyrocketed to a stunning 55-year high last year according to the
World Gold Council!  And the usual big gold-futures buying and
investment buying that fuels major gold uplegs
is only just
starting.  Gold wasn’t extremely overbought before this latest
sharp selloff erupted either.

Thus
there’s no reason to expect this violent pullback to slay gold’s
young upleg.  Its technicals still look great, and recent mounting
greed has been quickly overwritten with new herd fear.  Traders
having the essential perspective are neither surprised nor worried
about these periodic healthy pullbacks.  They are actually eagerly
anticipated, offering the best buy-relatively-low opportunities
within ongoing major uplegs!

That’s why you ought to subscribe to our popular newsletters, to
stay informed which helps keep your greed and fear in check.  I’ve
studied the markets and traded full-time for decades, which most
people have neither the time, inclination, nor skillset to do.  You
can still greatly benefit from all my experience.  Staying abreast
of market developments driving gold and gold stocks is crucial for
buying low and selling high.

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The
bottom line is gold just suffered a sharp pullback, which is
healthy.  Markets naturally flow and ebb, taking two steps forward
before one step back.  Those countertrend selloffs within powerful
uplegs are essential for rebalancing sentiment, maximizing their
ultimate gains.  Before gold’s latest plunge, it had been stretched
and overbought after rallying for months without any significant
selling.  A pullback was due.

While gold fell violently on a couple back-to-back market surprises,
it remained well above uplegs’ major support zone.  No serious
technical damage was done, which is also true for major gold
stocks.  So the technical and sentimental evidence argues this
latest selloff is a mid-upleg pullback rather than a larger
upleg-slaying correction.  Thus traders should capitalize and use
this opportunity to buy in relatively low.

Adam Hamilton,
CPA    
February 10,
2023    
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