Fed Tests Gold Upleg

By Stanley Graham On Dec 20, 2024

The Federal Reserve somehow surprised traders with a hawkish rate cut this week. While that had been expected, apparently the Fed’s projected rate-cut trajectory slowed even more than feared. So market reactions were violent, including the US dollar blasting higher unleashing heavy gold-futures selling. This is the latest in a long line of Fed-spawned tests of gold’s resilience, challenging its current monster upleg.

From early October 2023 to late October 2024, gold skyrocketed 53.1% higher achieving a rare 40%+ monster-status upleg! Gold powered to 43 new nominal record closes in that remarkable span, despite massive uplegs’ usual driver being missing-in-action. Enamored with the AI stock bubble, American stock investors weren’t chasing gold’s upside momentum at all. That’s evident in the dominant gold ETFs’ holdings.

During that 12.9-month span, the combined holdings of the mighty GLD and IAU gold ETFs unbelievably slumped 0.4%! Big global demand catapulted gold higher while Americans ignored it, led by Chinese investors, central banks, and Indian jewelry buyers. Despite gold pulling back since the elections, this monster upleg remains alive and well. Amazingly it has yet to suffer a single upleg-slaying 10%+ correction.

Gold’s latest pullback surrounding Election Day clocked in at 8.0% total losses by mid-November, leaving it at $2,562. The gold-futures selling forcing gold lower was fueled by the US Dollar Index surging, with traders figuring the Fed would slow its rate-cut cycle under Trump. Sound familiar? That’s exactly what happened mid-week after this latest FOMC decision. Given that backdrop, markets’ sharp reactions were perplexing.

Back in mid-September leading into elections, the FOMC not only executed its first rate cut in 4.5 years but made it a crisis-level 50-basis-point one. Top Fed officials meet eight times per year to decide what to do with monetary policy, and every-other FOMC meeting is accompanied by their economic projections. The most-important facet is the dot plot, where individual Fed guys see their federal-funds rate in coming years.

Three months ago they forecast 100bp of total cuts in 2024 including that maiden one, followed by yet another 100bp in 2025. That benchmark USDX was pretty low then at 101.0, just 0.4% over a 13.3-month low several weeks earlier. Yet despite the political Fed officials trying to meddle with elections with that economically-unjustified outsized cut to goose stock markets, Trump’s chances of winning started rising.

Over the next five weeks, the USDX surged 3.4% along with Trump’s betting-market odds of victory. That trade assumed the Fed would really slow its rate-cut trajectory if Trump won. Something over 90% of the 400ish PhD economists working at the Fed are registered Democrats, the FOMC has a long history of being looser under Democrat presidents, and Republican lawmakers have challenged the Fed over the years.

Top Fed officials claim their decisions have nothing to do with politics, so they cited inflationary pressures under Trump. Extensive tariffs will raise import prices, and big tax cuts extended will leave Americans with more money to keep bidding up prices on goods and services. Whether much-different monetary policies under Trump instead of Harris are political or righteous, traders universally expected a tighter Fed.

So that huge US dollar bear rally accelerated after Trump won, the USDX blasting up another 3.9% to 107.5 over the next several weeks! That extended its total gains since late September to 7.1%, an enormous move in such a short span for the world’s reserve currency. The FOMC cut another 25bp at its next meeting two days after elections, but that was one of the off meetings not including FFR projections.

Traders actively speculate on and hedge for coming federal-funds-rate moves in futures. Those imply what markets are expecting the Fed to do. Between the FOMC’s maiden outsized cut in mid-September to FOMC Eve this week, those cuts collapsed. The day before the FOMC cut another 25bp for its third cut of this cycle, those futures implied traders were already expecting exactly 50bp of additional cuts in 2025!

Again that was down from 100bp next year in the previous dot plot three months earlier. So rationally if top Fed officials projected two or more 25bp cuts in 2025, markets shouldn’t have reacted much. That was priced-in, and the USDX had already surged sharply on yields staying higher for longer. On Tuesday the USDX closed at 107.0, while gold ran $2,644. Traders universally expected the FOMC to prove hawkish.

And it did, but merely aligned with shifted expectations after Trump’s decisive victory! Exactly on script, the FOMC again cut its FFR another 25bp to 4.38%. That made for 100bp of cuts in 2024, exactly what the previous dot plot predicted in mid-September. The FOMC only made one minor change to its statement, qualifying “additional adjustments to the target range” with considering “the extent and timing of” more cuts.

The Fed chair was expected to come across as more hawkish in his usual post-decision presser, and he did. I watched it live as always, and exactly as expected Jerome Powell’s opening statement declared more restraint on further cuts. Right upfront he warned, “With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive.”

“We can therefore be more cautious as we consider further adjustments to our policy rate. We know that reducing policy restraint too fast or too much could hinder progress on inflation. … If the economy remains strong and inflation does not continue to move sustainably toward two percent, we can dial back policy restraint more slowly.” Importantly those press conferences start a half-hour after FOMC decisions.

Powell’s expected hawkishness wasn’t what fueled those violent market reactions, as they immediately ignited on that FOMC decision. And with that expected quarter-point cut and the FOMC statement barely changed from the prior meeting’s, the quarterly Summary of Economic Projections’ dot plot had to be the culprit. It is released at the same time as FOMC decisions, 30 minutes before Powell takes the podium.

Back in mid-September, top Fed officials had projected the federal-funds rate being 3.38% exiting 2025. This week they raised that 50bp to 3.88%, exactly as futures were pricing in the day before! The 100bp of cuts forecast next year three months ago were lopped in half to 50bp. Again the USDX already soared for much of that intervening span, on expectations for fewer Fed rate cuts under Trump leaving higher yields.

So it was shocking to see the US Dollar Index immediately soar on that dot plot, closing up a huge-for-it 1.0% to 108.1! That was the biggest USDX up day by far since the day after elections when Trump’s big win was already fully apparent. And it left this leading dollar benchmark at a 25.3-month high. How in the heck were currency traders surprised by the FOMC doing exactly what they had expected and priced in?

After decades of analyzing every FOMC decision, I have no idea what traders were thinking this week. Top Fed officials did up their PCE inflation forecasts for 2025 by 0.4% on a headline basis and 0.3% core, both to 2.5%. Maybe the currency guys figured a hotter inflation forecast implied even fewer than two total cuts next year across eight FOMC meetings. Maybe they worried the “Longer run” FFR edged up 0.1% to 3.0%.

The ironic thing is speculators sophisticated enough to trade super-leveraged currency futures should know the dot plot is notoriously inaccurate in predicting where the FFR will actually go! The Fed chair himself often warns about this in his post-FOMC-meeting press conferences. Examples are legion, as top Fed officials constantly change their outlooks based on the latest trends in jobs and inflation data.

The dollar inexplicably rocketing higher Wednesday unleashed intense gold-futures selling. Leverage in gold futures is extreme, and speculators in that hyper-risky arena look to the dollar’s fortunes for their primary trading cues. They are quick to dump gold futures when the dollar surges dramatically, which slams gold sharply lower. Wednesday’s gold plunge was the latest in many after FOMC hawkish surprises.

This week each 100-ounce gold-futures contract controlling $264,410 worth of gold on FOMC Eve only required traders maintain $11,500 cash margins in their accounts. That made for extreme maximum leverage of 23.0x! At those levels, a mere 4.3% gold move against specs’ bets would wipe out 100% of their capital risked. At 23x leverage, every dollar traded in gold futures also has 23x the price impact on gold.

So the USDX’s blistering rally after this latest FOMC decision unleashed big gold-futures selling, which slammed gold 1.9% lower on close to $2,593. Bearish psychology really flared, as seen in gold’s effective sentiment gauges of silver and the GDX gold-stock ETF. They plummeted 3.3% and 4.6% that day, the latter to a new post-election low! I thought gold’s 1.9% drop on that hawkish FOMC surprise was resilient.

The day after the elections, gold plummeted 3.0% as the USDX rocketed up 1.6%! Then the subsequent Monday, gold plunged another 2.3%. A couple weeks later, gold suffered a second huge 3.0% down day. So 1.9% isn’t even really big in recent context! And while that apparent hawkish Fed surprise tested gold’s monster upleg, it is nowhere near being in jeopardy as readily evident in any longer-term chart.

As humans, we traders are inherently-emotional. Our greed and fear runs wild on outsized daily moves, which we psychologically weight much more highly than they ought to be. The best antidote for fighting those dangerous emotions which lead to buying high then selling low is perspective. A 1.9% gold drop sure feels bad in real-time, but it’s barely noticeable when properly framed within its broader context.

This chart looks at gold superimposed over speculators’ gold-futures positioning over the last several years. Gold is rendered in blue on the right axis, while total spec longs and shorts are shown in green and red on the left. Gold has proven remarkably resilient since the elections, consolidating high keeping its monster upleg alive and well! So far gold has passed this latest hawkish-Fed test with flying colors.

Despite gold plunging 1.9% to $2,593 Wednesday, it remained well above that pullback low of $2,562 in mid-November. And again that total selloff clocked in at 8.0%, yet uplegs don’t end until selloffs exceed 10% entering formal correction territory. So even if gold-futures momentum selling in the Fed’s wake manages to force gold to a fresh pullback low, gold’s monster upleg remains intact anywhere north of $2,507.

That’s another 3.3% under mid-week post-FOMC levels, quite a ways lower considering fewer Fed rate cuts next year have already spent several months being priced in. As long as gold is merely pulling back and consolidating high, traders need to stay bullish on it. Gold’s 1.9% plunge this week actually makes its near-term outlook considerably more bullish. The main reason is big gold-futures selling had to fuel it.

Back in late September total spec longs surged to 441.0k contracts, a 4.6-year high and their fifth-highest levels ever witnessed! I warned about that at the time, in a contrarian essay on gold’s high selloff risk that drew a lot of flak. But there have been big gold-futures long liquidations since, driving gold’s pullback. By late November total spec longs had plunged to 350.0k, just 52% up into their monster-gold-upleg trading range!

Gold-futures positioning data is only released weekly, current to Tuesday closes. And that isn’t reported until late Friday afternoons. So the latest-available numbers when this essay was published are as of December 10th. Then total spec longs were 370.8k contracts, or 63% up into that same trading range. With the likely-frenzied gold-futures selling necessary to slam gold mid-week, they are likely much lower now.

Typically massive gold down days on the order of 2% to 3% require 20k+ contracts of spec long dumping. So total spec longs could easily have made a new post-election low following Wednesday’s hawkish Fed surprise. The lower they go, the more bullish the near-term outlook for gold since specs have more room and capital firepower to buy back in. Recent months’ excessive spec longs have already really moderated.

Gold also soared to extremely-overbought levels in late October before this necessary and healthy pullback got underway, which was a week before the elections. Back then gold was stretched way up to 1.183x its 200-day moving average, dangerous rarefied levels I warned about in that gold-selloff-risk-high essay. Wednesday’s post-Fed plunge bashed that same metric back down to just 1.054x, not overvalued at all.

Quarter-to-date including that latest 1.9% gold drop, the yellow metal is still averaging a dazzling record $2,667! That trounces the previous record of $2,477 in Q3’24, and is tracking for an enormous 35% year-over-year jump from Q4’23. Hawkish Fed surprise or not, gold is consolidating high way up in amazing record territory. A year ago this week, gold was trading at $2,020 and had never even exceeded $2,071.

So despite the wailing and gnashing of teeth in gold-world after the FOMC, gold is still faring great if not fantastic! Gold has been briefly whacked immediately after many FOMC decisions in recent decades that sparked a stronger dollar. This latest powerful USDX bear rally was already way-overextended and really-overbought before the Fed, and is even worse now. It is overdue to roll over unleashing gold-futures buying.

Gold’s outlook and fundamentals remain really bullish, as I analyzed a couple weeks ago in that monster-upleg-alive-and-well essay. And the fundamentally-superior smaller-gold-miner stocks are big bargains today as explained in last week’s essay. Over the past six reported quarters, the GDXJ-top-25 mid-tiers and juniors have seen their sector unit profits utterly skyrocket 34%, 106%, 126%, 63%, 66%, and 71% YoY!

And they are almost certain to double again from Q3’24 levels in this current almost-over Q4! So let not your heart be troubled if you own gold stocks or want to add allocations before they inevitably mean revert far higher to reflect these awesome prevailing gold prices. The battered gold stocks need to outperform their metal massively for a long time to reflect reasonable multiples of their underlying colossal record profits.

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The bottom line is gold is passing this latest hawkish-Fed-surprise test with flying colors. Inexplicably the US dollar soared despite the FOMC meeting all key expectations, including total 2025 cuts being slashed in half. That unleashed big gold-futures selling, slamming gold. Yet that down day wasn’t huge by recent standards, gold remained well above mid-November’s pullback low, and its monster upleg is alive and well.

Uplegs don’t give up their ghosts without correction-grade selloffs, and gold has been nowhere near suffering one. Yet this healthy pullback has made great progress, normalizing speculators’ gold-futures positioning and eradicating extreme overboughtness. That leaves gold nicely set up to resume powering higher as the overextended US dollar inevitably rolls over. Gold stocks have massive catch-up rallying to do.

Adam Hamilton, CPA

December 20, 2024

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