Topping Dollar is Gold-Bullish

Adam Hamilton    
June 17,
2022     2653 Words

 

The
US dollar has skyrocketed in a monster rally this year, fueled by
the Fed’s extreme hawkish pivot.  Panicking over raging inflation,
top Fed officials are aggressively hiking rates and starting to
reverse years of epic monetary excesses.  But resulting overcrowded
dollar buying has left it extraordinarily overbought at precarious
heights.  As this lofty currency inevitably mean reverts lower, big
gold-futures buying will be unleashed.

 

The
world’s reserve currencies led by the US dollar are so massive that
they usually move glacially.  But 2022’s wild dollar action has
shattered those norms, as evident in its leading benchmark US Dollar
Index.  Birthed way back in 1973, this USDX is now dominated by the
euro at a whopping 57.6% of its weighting.  Recently this
typically-meandering dollar metric has shot parabolic,
blasting higher on forceful Fed tightening.

 

Last
Friday the USDX soared 0.8% on a red-hot US headline-inflation
report.  The May Consumer Price Index print proved a dreadful upside
surprise, soaring 8.6% year-over-year compared to expectations for
an 8.3% gain.  That proved this popular inflation metric’s fastest
surge since way back in December 1981, a scary 40.4-year high! 
Realizing this would light a fire under the Fed, traders flooded
into the US dollar.

 

That
continued the following trading day this Monday, when the USDX
blasted another 1.0% higher which is a huge move for it.  US stock
markets were plummeting, with the S&P 500 cratering 9.9% in just
four trading days!  That formally hammered it into bear-market
territory, down 21.8% since its latest all-time closing high in
early January.  Serious stock-market selloffs spawn flight-to-cash
safe-haven dollar buying.

 

That
dollar rush accelerated after an apparent Fed trial balloon was
reported by the Wall Street Journal.  Instead of sticking to earlier
guidance for a 50-basis-point rate hike at this week’s Federal Open
Market Committee meeting, Fed officials were thinking of going
75bp.  That’s exactly what they did a couple days later, executing
the Fed’s biggest rate hike since November 1994!  The USDX
surged to 105.5 leading into that.

 

That
proved an extreme 19.5-year secular high, the USDX hadn’t
seen such lofty levels since December 2002!  Way back then dollar
fundamentals were vastly healthier, supporting higher prices.  Since
then the dollar’s monetary base of the Fed’s balance sheet has
mushroomed 12.4x higher, flooding the world with huge supplies.  And
with headline inflation now raging 3.6x higher, the dollar’s
purchasing power is rapidly eroding.

 

Still with the Fed aggressively hiking while the European Central
Bank wasn’t, currency traders dumped the euro and piled into the
stratospheric US dollar.  That catapulted it to
extraordinarily-overbought levels running 1.085x the USDX’s
200-day moving average this week and 1.090x in mid-May!  Normally
dollar rallies give up their ghosts near less than half that
stretched, around just 4% over the USDX’s 200dma.

 

Extreme overboughtness never lasts long, since the kinds of
parabolic moves necessary to spawn it are fueled by extreme popular
greed.  That seduces the great majority of traders into going
all-in, exhausting their capital firepower for buying.  That only
leaves room for selling, which soon pounds unsustainable price
extremes back down to normal levels.  That inevitable mean
reversion lower is imminent in the US dollar.

 

Peak
Fed hawkishness has certainly passed, after the FOMC hiked 25bp,
50bp, and 75bp at its last three monetary-policy meetings!  Even if
the Fed ups its federal-funds rate another 50bp or even 75bp in late
July, that can’t surprise traders now expecting aggressive hikes. 
And the FOMC has already transitioned its quantitative-easing money
printing to quantitative-tightening monetary destruction, so that is
baked in too.

 

The
Fed has never before attempted such an uber-hawkish hard pivot,
launching a big-and-fast rate-hike cycle in concert with reversing
QE through unprecedented levels of QT.  QE4’s ludicrous $5,016b of
total money printing is starting to be unwound with QT2 now
accelerating to $95b monthly in September!  So no matter what Fed
officials do next, this ultra-aggressive tightening will have little
shock value going forward.

 

That
means the multi-decade-highed and extraordinarily-overbought US
Dollar Index is increasingly likely to mean revert sharply lower. 
The bombed-out euro is about to start competing with the US dollar
again, as just last week the ECB warned it is launching its own
rate-hike cycle in late July and ending its colossal QE campaign
this month!  So this topping US dollar is likely to roll over hard,
which is super-bullish for gold.

 

This
chart superimposes the yellow metal, the world’s ultimate currency
for millennia, on top of the USDX over the last few years or so. 
Gold prices are generally inversely correlated to the US
dollar’s trends, as has certainly been the case in recent months. 
That’s because hyper-leveraged gold-futures speculators who often
bully around gold prices look to the US dollar’s fortunes as their
primary trading cue, doing the opposite.

 

 

While speculators and investors are sure down on gold today, it
enjoyed a strong 2022 into early March.  Partially goosed by Russia
invading Ukraine, gold had blasted up 12.1% year-to-date then to
$2,051!  That was despite a parallel big 3.6% USDX rally.  While a
strong dollar is usually bearish for gold, that certainly isn’t
always the case.  That’s because speculators’ gold-futures trading
isn’t gold’s only primary driver.

 

Gold
price trends are driven by a combination of that gold-futures
trading along with investment capital flows.  While specs
punch way above their weights in terms of gold-price impact due to
the extreme leverage inherent in gold futures, investors command
vastly more capital.  So big investment buying or selling can
override or augment whatever the gold-futures guys are doing.  That
happened during gold’s last upleg.

 

Over
5.3 months into early March, gold powered 18.9% higher despite the
US Dollar Index’s parallel big 4.9% rally on increasingly-hawkish
Fed-official jawboning!  The gold-futures speculators indeed bought
on balance during that run, chasing gold’s strong upside momentum. 
As the next chart shows, they added 81.9k long contracts while
buying to cover another 34.8k short ones mostly into the war-driven
end of that span.

 

But
sizable investment buying also helped fuel gold’s last bull
upleg, with investors naturally getting more excited about deploying
when gold is powering higher.  That was evident in the best
high-resolution proxy for global gold investment demand, the
combined holdings of the dominant GLD SPDR Gold Shares and IAU
iShares Gold Trust gold ETFs.  Reported daily, they climbed 5.5%
during that span on differential buying.

 

GLD+IAU builds reveal American stock-market capital migrating into
gold via these ETFs, forcing their managers to buy more physical
bullion.  Both of gold’s mightiest uplegs in recent years, which
peaked at massive 42.7% and 40.0% gains in 2020, were
fueled by
enormous investment buying!  Gold price trends are only
understandable and gameable by considering investment buying and
futures speculating in concert.

 

While the USDX was strong into early March when gold last peaked, it
has shot parabolic since igniting serious gold-futures selling. 
Over the last 3.2 months where gold plunged 11.9%, the USDX
rocketed up an extreme 6.5%!  While definitely excessive and
unsustainable, that exceptional US-dollar strength is easy to
understand given the Fed’s unprecedented uber-hawkish pivot.  Much
has happened since early March.

 

When
gold crested back then, the FOMC still hadn’t started hiking rates
yet.  Fed officials had guided to a 25bp maiden hike, which was what
the FOMC did mid-month.  In that meeting’s accompanying Summary of
Economic Projections showing Fed officials’ collective outlooks,
they expected the federal-funds rate to exit 2022 near a target
midpoint of 1.88%.  No projections were given on QT2’s launch date
or its monthly size.

 

In
the couple FOMC meetings since then, the FFR was hiked by another
50bp then 75bp.  And the latest SEP from this week showed Fed
officials’ expectations for this year’s ending FFR soaring to a
3.38% midpoint!  At the previous early-May FOMC meeting, QT2’s
ultra-aggressive schedule was laid out.  It would launch at $47.5b
monthly in June, then rapidly double to a terminal $95b per month
starting in September!

 

That
dwarfs QT1, which took an entire year to ramp up to just $50b
monthly.  With both much-faster rate hikes and much-larger QT
monetary destruction, it’s not surprising currency traders flooded
into the US dollar in recent months.  But that peak-Fed-hawkishness
shock has passed, leaving the US Dollar Index at unsustainable
extremes.  It can’t stay radically stretched above its 200dma at
multi-decade highs for long.

 

Interestingly the USDX started rolling over right after this week’s
FOMC decision, despite the Fed chair himself warning “either a 50 or
75 basis point increase seems most likely at our next meeting” in
late July.  So even if the Fed does go another huge 75bp in six
weeks, it won’t surprise currency traders.  With more big
hikes already priced in to the dollar and traders’ buying firepower
likely mostly-exhausted, they started selling.

 

That
is already snowballing, and it’s almost inconceivable the
FOMC will risk further accelerating its rate-hike forecast or upping
QT2 with stock markets already plunging into bear territory.  The
deeper they fall, the higher the odds of a
negative-wealth-effect-induced severe recession.  This week the Fed
chair also promised in his presser that the FOMC is “Not trying to
induce a recession now.  Let’s be clear about that.”

 

Jerome Powell also hinted fast hikes now could lead to slower hikes
later.  “I said the next meeting could well be about a decision
between 50 and 75, that would put us at the end of July meeting, in
that range, in that more normal range and that’s a desirable place
to be because you begin to have more optionality there about the
speed with which you would proceed going forward.”  This hiking
cycle is done accelerating.

 

That
means the extraordinarily-overbought USDX has to reverse
proportionally sharply-lower to rebalance sentiment.  That’s
super-bullish for battered gold, especially given speculators’
current positioning in gold futures.  This chart looks at specs’
total longs and shorts, as well as their swings during gold’s uplegs
and corrections in recent years.  These traders now have massive
room to buy back in and catapult gold higher.

 

 

The
sole reason gold plunged 11.9% over these past 3.2 months leading
into this week’s FOMC decision was major gold-futures selling. 
Speculators dumped at least 106.1k long contracts in that short
span, and likely considerably more.  Spec gold-futures positioning
is only reported once a week current to Tuesday closes, in the
famous Commitments-of-Traders reports.  Gold bottomed at $1,807 this
Tuesday before the Fed.

 

But
those weekly CoTs with Tuesday data aren’t released until late
Friday afternoons, which is well after this essay was published. 
There had to be more big gold-futures selling during this
latest CoT week, as gold plunged 2.7% this Monday to $1,821 after
that 75bp-imminent WSJ leak!  GLD+IAU holdings edged up a smidgeon
that day, so investors weren’t fleeing.  But as of a week earlier,
106.1k longs had been dumped.

 

Specs also added a trivial 0.9k shorts during that span.  Together
that made for the equivalent of 333.0 metric tons of gold selling,
simply too much to digest over several months!  That parabolic USDX
surge on extreme Fed hawkishness didn’t freak out investors like the
futures guys.  GLD+IAU holdings climbed a modest 0.5% or 8.4t during
that same span.  With gold’s upside momentum gone, investors stopped
chasing it.

 

But
all speculators’ heavy gold-futures dumping during that monster
US-dollar rally largely exhausted their selling firepower.  That
massive 106.1k-contract long liquidation as of Tuesday June 7th,
again the latest-available CoT data before this essay was published,
left total spec longs at just 314.4k contracts.  That is right at
their multi-year support line rendered in this chart!  Longs
haven’t fallen much lower since spring 2019.

 

That
leaves vast room for these hyper-leveraged traders to buy back into
gold futures to normalize their collective bets.  The upper
resistance of spec longs’ trading range in recent years is running
near 413k contracts, which has been hit multiple times.  So these
guys have room to buy at least 98.6k longs before their
upside bets on gold get excessive again!  And likely more as this
week’s CoT should reveal lower longs.

 

Gold
has big upside potential on 100k+ contracts of probable long
buying, as well as another 25k or so of short-covering buying before
hitting support in spec shorts’ own trend.  That 125k is even better
than the 117k of total spec gold-futures buying seen during gold’s
last upleg peaking in early March.  That proved an impressive one,
catapulting gold 18.9% higher in just 5.3 months despite a
much-stronger US dollar!

 

And
gold’s resulting upside momentum will almost certainly attract back
investors, especially with inflation raging. 
Big inflation
really spurs gold, as I analyzed in last week’s essay.  Today’s
inflation super-spike fueled by the Fed’s extreme QE4 money printing
is the biggest since the 1970s, which suffered two.  Gold prices
nearly tripled during the first before more than quadrupling in
the second!  Big inflation is gold rocket-fuel.

 

So
this secular gold bull’s next upleg that was probably just born this
week ought to power at least 25% higher.  That would propel gold to
$2,259.  And it could prove much larger given this dreadful
inflationary backdrop.  Gold prices ought to at least double
before this raging inflation runs its course, which would carry it
up around $3,450 sometime in coming years!  It’s hard to imagine a
more-bullish environment for gold.

 

Fed
rate hikes aren’t a problem either.  This is the thirteenth
Fed-rate-hike cycle of this modern monetary era since 1971. 
Gold thrived
through the prior dozen, averaging nice 29.2% gains during their
exact spans!  That’s because Fed tightenings are so bearish for
stock markets, where falling prices boost gold investment demand
for prudent portfolio diversification.  The Fed’s new stock bear
will increasingly drive that.

 

Yet
because gold corrected hard from $2,051 in early March to $1,807
this week, it has been forgotten by the great majority of
investors.  And it is deeply-out-of-favor with the ones who
remember.  They don’t realize that gold was pounded lower by
now-exhausted heavy gold-futures selling fueled by a monster USDX
rally on a unique uber-hawkish Fed pivot.  With that now over,
both the dollar and gold need to reverse.

 

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biggest beneficiaries of much-higher gold prices in coming months
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enabling their stock prices to greatly amplify its gains. 
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Their stock prices will soar as gold resumes powering higher.

 

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The
bottom line is this lofty extraordinarily-overbought US dollar is
super-bullish for gold.  The Fed’s most-extreme hawkish pivot ever
ignited a monster dollar rally in recent months.  That unleashed
massive gold-futures selling, bludgeoning the yellow metal into a
sharp correction.  But that overcrowded long-dollar trade is already
reversing after this week’s huge 75-basis-point rate hike, which
marked peak Fed hawkishness.

 

With
extreme Fed tightening already slamming the stock markets into a new
bear, Fed officials can’t risk further escalation.  They need to
back off their accelerating-rate-hikes jawboning or it will trigger
a severe recession that will be blamed on the Fed.  That coupled
with exhausted dollar buying will force it to mean revert lower,
unleashing big gold-futures buying to normalize specs’ positioning
which will fuel a new gold upleg.

 

Adam Hamilton,
CPA    
June 17,
2022    
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