Topping Dollar Is Gold-Bullish
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.
The biggest beneficiaries of much-higher gold prices in coming months and years will be fundamentally-superior mid-tier and junior gold stocks. Their profits really leverage gold, enabling their stock prices to greatly amplify its gains. These ideal-sized gold miners are able to grow their outputs on balance while holding the line on costs, driving fat earnings. 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
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