Gold – A reverse bubble in search of a pin
The victim could quickly find itself the beneficiary

by Michael J. Kosares
(With special thanks to Michael J. Ballanger for much of the article’s content)

The current COMEX short position in gold is a computer-driven market bubble blown to enormous proportions. Now at a record level, it is a different kind of bubble, though, from the type we usually associate with the term – a reverse bubble brought to life and nurtured through excessive selling rather than buying.  Nevertheless, it is just as deadly and opportunistic as the proverbial kind – a bubble in search of a pin.

That pin could suddenly materialize from any one of a number of sources ranging from a slumping dollar to a global emerging country debt and currency crisis. It could also come from out of the blue as an unforeseen black swan event.  Last but not least, it could come from the COMEX market itself as speculators scramble to cover their substantial positions.  In such circumstances, gold, the victim, could quickly find itself gold, the beneficiary.

In a recent article under the headline Historical Repetition in the Precious Metals Arena, expert analyst and sector specialist Michael Ballanger explains how the current situation in the paper gold market evolved and how it might play out to bullion’s advantage in the weeks and months ahead. With permission, we quote his article extensively so that the full flavor and depth of his analysis is not lost in the translation:

“In 1998, I was first introduced to the concept of pattern-recognition algorithms that could trade stocks based upon the software’s uncanny ability to scan predictive movements and formations and execute buy or sell programs on such interpretation. The growth of computer-driven money management has now resulted in trading ‘floors’ nearly devoid of human interaction, with carbon units only present to make sure the machines don’t go berserk (which they have on multiple occasions).

In vast, highly liquid markets like Forex and bonds and stocks, these algobots can operate fairly effectively, but in thin markets like commodities (and especially gold and silver), the algobots have a habit of feeding off each other. Once a short-term trend has been established, the ‘bots pounce and, in fact, extend and exaggerate it to the point of insanity. Once the ‘bots get control of the near-term trend, all other life forms join the party and the meme-du-jour becomes status quo, and there is no economic, financial or geopolitical event that will reverse it. The ‘bots do not analyze; they simply react and execute.

For this reason, I refute the idea that the Chinese are rigging the gold market by pegging the yuan to gold via the USD/CNY exchange rate. For most of the 2014-2018 period, a number of the blogger-gurus chortled on about how gold mirrored the JYP/USD cross —and before that the USD/EUR cross—but all that was, IMHO, was the pattern-recognition software picking up a working correlation and reacting to it. The more it worked, the more the ‘bots did it, and the cycle repeats itself over and over and over until the algo-scanners detect a ‘new kid on the block’ of correlation. At that point, they run with it.

And because it is so completely warped in its extent and its intensity, the carbon-based trading units get on the keyboards and post accusatory rants about some sovereign entity rigging the price with all the fancy gold-yuan overlay charts being irrefutable ‘proof.’ All it really proves is that the ‘bots have detected a correlation trend, and they have hijacked it. If any trading platform can abuse the system with not even the slightest of regulatory repercussion, it is the computers.

So, driver #1 is the existence of the algobots, and while it is entirely possible they are the riggers of the precious metals markets, they do so not from anything sinister or policy-driven; they are simply following the code written for them by the programmers.”

Further on in the same article, Ballanger moves to the arena of COMEX trading and the weekly Commitment of Traders report:

“Just as I complete a thorough debunking of ‘all that has worked in the past,’ and having declared it obsolete, out comes the COT report. It is a wildly bullish report from a couple of perspectives. First, the Commercial aggregate short position is now within 5,000 contracts of the December 2015 bottom in gold at $1,045. Second, the net shorts for Large Specs* (dumb money) at 215,500 contracts is 45% higher than it was at the bottom in December 2015. . . .

I would also observe that in referring back to primary Driver #1, there is no rational human being, analyst or otherwise, who would allow a position in anything to grow as large as what we have witnessed in the Large Spec aggregate short position. Prudent portfolio management would prune down, but since the algobots are only reactive (to trends), they have simply followed the programming code and piled on. When the programming rules instruct them to cover, there will be a mad scramble to do so, and that is what will send this pendulum of doom in the opposite and welcomed direction.

* Also reported as “NonCommercials” in the COT statistics

The chart immediately below shows the NonCommercials’ net short position in gold and its price since late 2015, as Ballanger describes above. As you can see, in 2016 and 2017 when the net positions of non-commercial traders (large speculators like institutions and hedge funds) balanced or approached balance (bottom chart), it signaled both a low point in the price and that a breakout was about to occur (top two charts).  In 2016, gold appreciated more than 30% on the breakout during a roughly six-month period.  In 2017, it appreciated nearly 20% within a six-month period. Now the noncommercial COT numbers have actually crossed – an extreme not seen since the early 2000s and the formative stages of gold’s secular bull market. It may be signaling a new watershed for the paper gold market.

Chart courtesy of GoldChartsRUs/Nick Laird

One week after his initial analysis of the machine-driven COMEX short position, Ballanger came out with another analysis this time under the headline, Back Up the Truck. In it, he speculates what might happen next:

“These are across-the-board synchronized correlations and as I wrote about last week, the computer-driven ‘algobots’ exacerbate and exaggerate every short-term trend in virtually all markets around the globe and since they never sleep, when Chicago shuts down, London picks up the reins and when London retires for the day, Tokyo carries the mantle such that over and over and over again, the pattern-recognition-driven algorithms implanted into the brains of the algobots feed upon themselves and overshoot their marks every single time, as happened on August 15 and 16 in (again) ALL markets. Now these pulse-less, robotic vermin are trapped and quite possibly, in deep trouble.

I wrote last week that the August 14 COT Report was ‘wildly bullish’ and indeed the lows were seen immediately thereafter as we did indeed get that ‘massive reversal in volume to the upside’ that we were all praying for. Below I have posted the August 14 COT and beside it is the August 21 COT so you all can see just how ‘crowded’ the gold-short trade is right now. It is already nearly $50 off the August 16 lows and we aren’t even through August yet. What pleases me to no end is that the seasonality trade finally kicked in so if the Indian wedding season (Diwali) and the restocking by the Italian jewelry trade is the fuel and fan required to ignite this tinderbox of dry twigs, we may be about to witness one of the biggest short squeezes of the last 50 years. Mind you, those primary drivers I spoke of last weekend are still forces with which to be reckoned and while I am placing bets on the good guys, I want additional evidence that the algobots have flipped over to BUY mode, which means these idiot computers will keep covering until they have stretched the market into massively OVERBOUGHT territory.

Table courtesy of GoldSeek

At present, the net short position on the COMEX built-up since the beginning of 2018 is the largest since the CFTC (Commodity Futures Trading Commission) began keeping records. It has taken the price of the metal 12% lower at a time when many analysts believe[d] that circumstances should have taken it higher.  It represents, as you have just read, an extreme position with explosive upside potential.  To bring this article in for a landing, we will quote one more analysis – this time from Germany’s Commerzbank: “Covering of record-high short positions would cause the gold price to surge.  All it needs is a trigger, for example, a correction of equity markets or an end to U.S. dollar strength.” Or, we will add in closing, the pin that punctures the bubble could come from something not on the list of current concerns – a black swan event as in 2008 that no one saw coming.

For the full Michael J. Ballanger articles quoted above, please see Historical Repetition in the Precious Metals’ Arena and Back-up the Truck.

Also see Extraordinary Popular Delusions or the Madness of Machines, Michael J. Kosares, 2012

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Michael J. Kosares is the founder of USAGOLD and the author of The ABCs of Gold Investing – How to Protect and Build Your Wealth With Gold [Third Edition]. He is also editor and commentator for USAGOLD’s Live Daily Newsletter and editor of the News & Views monthly newsletter.