Gold has suffered a sharp pullback over the past couple weeks, stoking much bearish sentiment. While a variety of factors fed this selloff, the precipitating catalyst was a gold-futures shorting attack. These are relatively-rare episodes of extreme selling specifically timed and executed to manipulate gold prices lower rapidly. Traders need to understand these events, which are inherently self-limiting and soon bullish.
Gold-futures shorting attacks are very real, with telltale volume and price signatures unlike anything else. I've studied them for many years now, and have written extensively about them in our newsletters as they occur. But it's critical to realize these rare events are only responsible for a tiny fraction of all gold selling. The vast majority of the time gold selloffs are driven by other far-more-normal factors, not shorting attacks.
These isolated anomalous episodes are often cited as proof the gold price is actively manipulated. But whether that's true or not, gold-futures shorting attacks can only explain tiny sporadic swaths of gold-price behavior. When they occur their impacts can definitely be outsized, but these are always short-lived. That's because the huge selling necessary to execute a shorting attack is far too extreme to be sustained.
Gold-futures shorting attacks are naturally a subset of gold-futures trading, which dominates short-term gold prices. Gold-futures speculators enjoy a wildly-disproportional impact on gold levels for a couple of key reasons. The American-gold-futures-derived gold price is the world's reference price. So whatever the futures speculators as a herd are doing greatly affects popular psychology among gold traders globally.
Speculators' gold-futures trading is a sentiment multiplier. When these guys are buying and driving up gold, other traders grow bullish and start committing their own capital. This virtuous circle feeds on itself. But when speculators are selling gold futures and pushing gold lower, the rest of the traders get nervous and bearish. So they tend to join in the selling, exacerbating the downside. Traders key off gold-futures action.
On top of this, gold futures inherently enjoy extreme leverage to gold which greatly amplifies their impact on its price. Each gold-futures contract controls 100 troy ounces of gold. At $1250, that's worth $125,000 in notional terms. But the margin required to trade a gold-futures contract is merely $4200. So a speculator running minimum margin can employ extreme leverage nearing 30x! The legal limit in the stock markets is 2x.
Compared to normal gold investors buying outright at 1x leverage, every dollar of capital bet by futures speculators can have 20x to 30x the gold-price impact! So even though gold investment dwarfs gold-futures trading, on a short-term basis the latter is like the tail that wags the gold-price dog. This extreme leverage inherent in gold futures is the only reason shorting attacks using them are even possible in the first place.
The mechanics of a gold-futures shorting attack are simple. A large speculator or group of them short sells gold-futures contracts at dizzying rates only sustainable for minutes on the outside. That's far too much selling pressure for gold futures to absorb, radically beyond normal trading tempos. The resulting extreme sell-side imbalance forces gold prices to plunge before enough buyers emerge to absorb that selling.
The speculators executing these attacks hope they spawn widespread gold-futures selling. Because of gold futures' extreme leverage, traders can't afford to be wrong for long. At 25x, a mere 4% gold-price move against a position results in a 100% loss of capital risked! So the short sellers hope their selling blitzes will force opposing long-side speculators to capitulate and sell, usually via mechanical stop-loss orders.
This additional selling of gold-futures long contracts drives its price even lower, tripping more stop losses already in place. Then with gold sharply lower, the speculators who launched the shorting attack start to gradually buy gold futures to cover and close their positions. Buying back at lower gold prices than they sold at leads to profits. This whole process is very fast, measured in minutes for shorting and hours for covering.
Gold-futures shorting attacks are easy to identify because the trading volumes are so extreme. Every week, the Commodity Futures Trading Commission details speculators' total long and short gold-futures positions in its famous Commitments of Traders reports. A big swing in total spec longs or shorts in any entire week is 20k+ gold-futures contracts. Gold-futures shorting attacks dump 20k+ contracts in minutes!
