Forget Stocks, The Gold Short Squeeze Is Intensifying

Summary

• Despite mass rioting, stocks keep climbing since there isn't much else for Fed money to land on, but this looks increasingly like the mirror universe version of the dotcom bubble.
• Retail investors are buying anything collapsing. 3% of all NYSE trades are for $2,000 or less, and 13% of all options trades are for 1 contract according to Goldman Sachs.
• They are doing this because they expect the Fed to support what they're buying. But when retail gets in on a trend, it usually means the trend is ending.
• Gold, on the other hand, looks, once it breaks back to all-time highs looks like it could start a fear trade that will only intensify once equities break lower.
• Large deliveries were being taken at the Comex, over 45,000 contracts in a week, 141 tons, meaning the gold short squeeze is on.
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Is what's happening now in equities the mirror universe of the dotcom bubble of 20 years? It looks that way to Jim Bianco, head of Bianco Research, interviewed by Jim Grant of Grant's Interest Rate Observer last week. Here's what he said on Grant's podcast:

"The amount of small retail that has been plowing into this market has been unprecedented. Goldman Sachs pointed out that 3% of all trades on the NYSE are now for an aggregate value of $2,000 or less...13% of all options trades in the United States are for one contract...We always thought that retail investors are chasers of momentum, but what we have seen is that in the month of March, when the stock market had one of its worst months in history, over 1,000,000 new accounts were opened by small investors...Not only are they buying into the decline, they are buying with reckless abandon into the decline, and further, they seem to be the most interested in anything that is collapsing."

Bianco is only very slightly wrong, in my opinion. Retail investors are indeed still chasing momentum. The only difference is that 20 years ago, retail investors were indeed chasing upside momentum in tech stocks. Now, they are chasing momentum to the downside. It appears even they are getting on in the "Follow the Fed" trend. It really is like the dark mirror universe of the dot-com bubble, it seems.

Some gold bugs think the bullish momentum here is just crazy, considering all the mayhem going on in both the real and financial economies all over the world. But it really does make sense if in a twisted way. After all, if you're a bank and you have all this new money from the Federal Reserve, where are you going to put it? In the real economy now rioting and destroying small businesses? Or back directly into financial assets being supported by the Federal Reserve?

So, yes, the S&P 500 and Nasdaq are rallying because there's nowhere else for the new money to go right now. Even so, I'm not keen on playing the indexes here as I have done in the past. I'd rather buy the recent weakness in gold. While the S&P 500 looks pretty good by momentum here, the precious metals sector has still been outperforming since the S&P 500 bottomed on March 23. This is despite gold stocks bottoming a week earlier and gold trading sideways to down for about two months now. Here's the comparison chart since the S&P 500 bottomed on March 23.

Data by YCharts

I believe the recent pullback in gold stocks is nearing its end, and I expect the outperformance in gold stocks to continue and intensify over the medium term, so to allocate some cash to a SPY position would be like taking a Ford Pinto with a nearly empty gas tank into a drag race when you could just as easily drive a Porsche or whatever race car is the best one (I'm not an authority on that.)

The Long View Strongly Vindicates Gold

Now, here's something quite interesting: We don't have to see this from just a short-term viewpoint either, counting just from this March. Here are two very long-term charts that, if you're on the fence, should convince you that the gold bull market since 2015 is only just getting started, and that is the way to go considering the wild uncertainties in the world today. (Gold in blue, S&P in orange.)

The chart above compares the growth rate of the M2 money supply with the S&P 500, gold, and absolute US GDP from 1980 to 2000, the great gold bear market. Gold fell sharply in terms of both dollars and stocks because the money supply grew slower than GDP did. That was thanks to Paul Volcker, the man who arguably single-handedly saved the US dollar from hyperinflation back in the late 1970s.

I'm not a fan of GDP as an accurate measure of the economy. Far from it. I'm just illustrating a broader point here, namely that in the context of money supply growing slower than even the GDP economy, that gold would fall in such a scenario, assuming GDP says at least some vague meaningful thing about economic growth rates, which I think it does on some obfuscated level at least.

Now, look at the same chart during the last gold bull market, 2000-2011. (This time gold in orange, S&P in dark red.)

It's precisely the reverse. Alan Greenspan takes the helm from Volcker and starts printing a whole bunch of money. Money supply grows at almost twice the rate of GDP at that time, the S&P falls, and gold skyrockets.

Point being, over the time frame of decades (the 2011-2015 correction shows the medium term is different) when the economy grows faster than the money supply, gold falls and stocks rise. That makes intuitive sense. Why hold gold when everything else is climbing? When the money supply grows faster than the economy though, gold rises and stocks fall in real terms. That makes intuitive sense, too. Well then, now that money supply growth rates are reaching Einsteinian relativistic speeds that require plugging in Lorentz transformations to calculate time dilation effects, and GDP, conversely, is falling into a black hole, it doesn't take Einstein to figure out what's going to rise faster in this time frame - gold or the S&P 500.

While in the short term, you'll probably make some nice paper gains by holding the indexes like SPY or QQQ, you'll be using up capital that could be better used buying up any remaining gold stock dips, plus you're driving a beaten-up Ford Pinto in a drag race. You're going to have to get out in time to keep nominal gains and, eventually, move them into gold anyway to keep real gains when price inflation becomes obvious. You'll probably miss the top as bullish sentiment will likely keep you holding on, which means you'll get frustrated with yourself as you play with fire. Why bother with all this?

The Gold Short Squeeze Could Soon Climax

Better to look at the metals markets, especially considering the recent weakness. A short squeeze is looking more and more obvious, and here's why. Reuters reports May 28:

Some bullion banks are no longer willing to hold large positions on Comex, the biggest gold futures market, after the coronavirus snarled the supply of gold bars, sending Comex prices vaulting above London rates in March.

The divergence wiped hundreds of millions of dollars off the value of trading books, according to industry sources, with HSBC reporting a $200 million paper loss in a single day.

Many banks have already reduced their day-to-day trading on Comex since the market disruption but they are worried that prices could diverge again and some now intend to reduce their open positions by between 50%-75%, sources at six lenders said….

HSBC, JPMorgan, UBS and other lenders use Comex futures to hedge their exposure to the gold market in London. Banks are the exchange's single biggest user group, accounting for more than a third of all Comex contracts.

At issue are contracts owned by the banks worth as much as $45 billion, equivalent to around 800 tonnes of gold, according to Comex data.

While I don't doubt that the price spread between New York and London gold is a real thing and it has something to do with this mess, this, in my opinion, is not the main point. The coronavirus lockdowns are ending, some ironically by virtue of mass rioting, gold refineries are back in operation, and transport and logistics problems are easing up.

What's happening is more likely deliveries are being taken faster now, and there isn't enough gold in New York to satisfy them, so they're begging for help from London to back their contracts. Over the last 6 trading days on the Comex, nearly 46,000 contracts have stood for delivery. Here is a compiled screenshot of Comex data up to June 3.

Add in June 4 and 5, and the total is 45,722 contracts. At 100 troy ounces per contract, that's over 142 tons.

According to Zerohedge, May 29, which you can see above at 28,375 deliveries, was the largest daily delivery notice in exchange data since 1994.

The problem for bullion banks isn't necessarily the spread between New York and London as Reuters tries to emphasize, but the fact that vaults are being drained and the bullion banks are still short $45 billion. So, they're trying to abandon ship.

The only way they can exit these short positions in gold would be to coordinate a huge attack on the gold market simultaneously, cover as fast as possible and get out. That may be why gold has been trading sideways since April. Honestly, I don't even know if this is possible at this point because attacking the gold market means issuing more contracts, which puts them even deeper into the hole.

Paper Gold Supply About the Shrink?

In the end, what this means longer term is that there will be fewer suppliers of gold futures contracts from here on out with bullion banks fleeing the scene. They don't want to touch these contracts anymore. It's too dangerous. Traders will have to bid higher to get them, and a lower supply of contracts means higher prices per contract anyway. My feeling is that the premium gap between the physical and paper markets is on the verge of closing in favor of physical, possibly within weeks now.

Not only that but now producers are also starting to hold back supply. First Majestic Silver (AG) last month held back 292,000 ounces of silver and 700 ounces of gold blaming COVID-19 but more likely waiting for higher futures prices. The bullion banks are now being squeezed by speculators demanding delivery, and miners withholding supply.

From here on out, I believe investors should take advantage of any brief pullback in gold stocks to add to positions, before supplies on the Comex dry up. The S&P 500 looks to me to be a red herring.

Analyst’s Disclosure: I am/we are long AAAU, GOLD, NEM, GDX, GDXJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.