Gold and silver were thrashed this past summer, relentlessly pounded to deep new lows. That has fueled extreme bearishness, with traders convinced the precious metals’ fundamentals are rotten. But epic all-time-record futures short selling by speculators was the real culprit. These unprecedented shorts must soon be covered with proportional buying, which is super-bullish for gold and silver prices in the coming months.

Traders generally assume fundamentals drive short-term price action, that real imbalances in supply and demand push prices to market-clearing levels.  Unfortunately, these core underlying dynamics are heavily distorted in gold and silver. Futures speculators who never own these precious metals are able to wield wildly-disproportional outsized influence over their prices. The main reason is extreme leverage inherent in futures.

Investors usually buy gold and silver outright, paying cash in full. That’s the equivalent of 1x leverage. Every dollar of investment capital deployed in the precious metals provides one dollar of buying power to bid them higher. For many decades in the stock markets, the legal limit to leverage has been 2x.  Thus using the leading GLD SPDR Gold Shares gold ETF or SLV iShares Silver Trust ETF, investors can hit 2x.

That effectively doubles their buying power, so each dollar invested in GLD or SLV at minimum margin puts two dollars of buying pressure on gold or silver.  But borrowing half the purchase price of anything comes with big risks, also doubling gains and losses on capital invested. So the great majority of gold and silver investors prudently prefer buying outright. Futures speculation is a radically-different world!

Each CMX gold-futures contract controls 100 troy ounces of gold, while each CMX silver-futures contract represents 5000 troy ounces of silver. But futures speculators are barely required to keep any cash in their accounts to actively trade these contracts. As of this week, the minimum margin required for each gold-futures contract was just $3100 and silver-futures contract was only $3600. That enables extreme leverage.

July and August were miserable months for the precious metals, far worse than usual even in the weak summer doldrums. Gold dropped 4.2% in that recent short span, while silver plunged 9.9%. Gold and silver averaged $1217 and $15.29 in these last couple months, which are relatively-low levels. But 100 ounces of gold and 5000 ounces of silver were still worth a hefty $121,700 and $76,450 respectively!

That’s what investors would have to pay to own and control that much gold or silver equivalent to one futures contract. But the futures speculators only needed to have $3100 or $3600 in their accounts to effectively control the same amounts of precious metals. That equates to maximum leverage of 39.3x in gold futures and 21.2x in silver futures! Such extremes allow speculators to dominate short-term pricing.

Speculators running minimum margin greatly amplify their effective buying power in gold and silver. Just one dollar deployed in gold futures can exert up to $39 in pressure on gold prices. Thus capital deployed by fully-leveraged speculators can have 39x the gold-price influence as investment capital! Silver futures aren’t quite as crazy at 21x, but that’s still radically beyond the 2x legal limit in the stock markets since 1974.

This extreme leverage magnifies risks proportionally, forcing futures speculators to have an ultra-short-term focus in order to survive. At 39x leverage, a mere 2.6% gold price move against speculators’ bets would wipe out 100% of their capital risked! At 21x, a 4.8% adverse silver price move would drive a total loss of capital. So unlike investors, futures speculators’ entire worldview is condensed into hours, days, and weeks.

They are short-term trend riders by necessity, all piling on to whatever gold and silver happen to be doing regardless of fundamentals. And since mid-June, they’ve been aggressively crowding in on the short side of the trade in both gold futures and silver futures. On June 14th gold and silver looked way different, up at $1302 and $17.15 on close. It was looking like a decent summer until a sharp rally erupted in the US dollar.

Tacitly acknowledging that gold is money, gold-futures speculators look to the US dollar for trading cues. They sell gold futures when the dollar rises, and vice versa. On that lazy day in June, the US Dollar Index blasted 1.3% higher. The European Central Bank had released a huge decision that morning, to finally end its massive quantitative-easing campaign as expected. But that hawkish blow was mitigated by a last taper.

Instead of terminating its QE money printing at the end of September, the ECB announced it would be cut in half for one more quarter before ceasing at year-end. A final extension was widely discussed in trading circles before that ECB meeting, yet for some reason, currency traders still interpreted it as some kind of dovish surprise. So they sold the euro hard, hammering it 1.8% lower that day which goosed the US dollar.

Overnight gold-futures speculators started aggressively selling on that surging dollar, crushing gold 1.7% lower to $1279 the next day. That unleashed heavy gold-futures short selling which slowly cascaded as summer wore on. And silver-futures speculators look to gold for trading signals. Thus as gold spiraled lower on surging shorting, silver suffered the same thing in sympathy. It would eventually snowball into a bloodbath.