Applying Elliott Wave to Precious Metals

 

I have recently written several articles regarding various analysis techniques for precious metals. The purpose of these articles was to give my perspective on where these metals were headed in the short term. In fact, in one article, I called for a top in the gold market through the use of Elliott Wave analysis, which turned out to be within several dollars of the actual top that gold later hit and reversed.

Yet, what I noticed was that I was receiving one comment after another (some even quite personal and scathing) about how technical analysis cannot work within the precious metals market, even after I had just used my analysis of the “fear factor” to call a top in a market where no one saw a top coming!

The following is just a sampling of some of the comments, which, I am sure, is quite representative of many investors’ and commenters’ sentiments. (I am leaving out all the positive responses that I received, as that does not make good fodder for an article):

Technical Analysis Comments

  • “There is no way you can understand what is going on in gold by doing technical analysis.”
  • You are “following an outdated script with very little relevance as to what is happening now.”
  • “Because of fundamentals, gold does not work very well for technical analysis, for charting.”
  • “Technical analysis is nothing but a wind sock. It is not now nor will it ever be a crystal ball.”

Emotion-based Comments

  • “With all due respect Avi, you plainly do NOT understand the gold market. As others have plainly said, gold moves are induced principally by fear and greed.”
  • “The only thing pausing gold OR silver's meteoric rise right now is fear.”
  • “As for silver going lower, this fear mongering has been holding silver back for some time.”

This Time Is Different” Comments

  • “Your TA is useless. You don't understand the fundamentals because you only look to the past. Gold bulls are forward thinking. The times they are a changing...”
  • “In short, most, in fact ALL historical data about the current macro issues worldwide are kind of moot. The world has never been here before.”

Ultimately, it has left me questioning whether the use of technical analysis can assist in resolving issues within the precious metals market for which fundamental analysis may have shortcomings?

Use of Fundamental Analysis

Many a commenter has attempted to bolster their argument that various forms of technical analysis were useless by claiming that the fundamental paradigm regarding precious metals has changed, which has caused other analysis methods to become obsolete and useless.

They claim that since the world is awash in debt, that fiat currencies are worthless, that the banks are truly insolvent, etc., and, therefore, there is no way that gold or silver will ever go down.

While these are clearly excellent fundamental arguments, we have learned from history that circumstances are fluid and can change on a dime. Furthermore, it is also “possible,” but not highly likely right now, that the public perspective on these matter may change.

In fact, there is even a fundamental perspective that if the Fed offers up no more Quantitative Easing, that the U.S. Dollar will start to soar relative to other currencies worldwide, which can potentially have a negative effect upon owning gold or silver in U.S. Dollars. Yet, it is also possible that, under such circumstances, the public’s fear may still escalate due to some other exogenous event, causing a further rise in gold and silver.

I genuinely feel that only utilizing “fundamental” analysis to analyze the precious metals market, without being able to analyze the driving “fear factor,” does not allow an investor to really analyze appropriately, and I will try to explain why.

What Moves Markets?

During his tenure as the Chairman of the Federal Reserve, Mr. Alan Greenspan testified many times before various committees of Congress. In front of the Joint Economic Committee, Mr. Greenspan noted that markets are driven by “human psychology” and “waves of optimism and pessimism.”

Ultimately, as Mr. Greenspan correctly recognized, it is social mood that will move markets. This is why news does not cause more than a blip in the pattern of the market. Have you ever wondered why a market will continue to go up after the announcement of bad news, or down after the announcement of good news?

This is why an investor who is able to rise above news and emotion, and identify the prevailing social moods and trends will have a significant advantage over other investors.

This is exactly why I use Elliott Wave in my analysis of the precious metals markets. In theory, it understands that public sentiment and mass psychology moves in 5 waves within a primary trend, and 3 waves in a counter-trend. Once a 5 wave move in public sentiment is completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of “news.”

This mass form of progress and regression seems to be hard wired deep within the psyche all living creatures, and that is what we have come to know today as the “herding principle,” which is what gives this theory its ultimate power.

Emotions Within the Market: Fear & Greed

Back in 1968, the bestselling book “The Money Game” by Adam Smith stated the proposition that “the strongest emotions in the marketplace are greed and fear.” In 1971, in a Harper’s Magazine article, an unnamed broker was quoted as saying “Downtown, there are two emotions: fear and greed. The rest is BS.” In 1978, New York broker William M. LeFevre was quoted in Time Magazine saying “There are only two emotions in Wall Street: fear and greed.”

Fear, in most markets, causes selling and drives prices down, whereas greed causes buying and drives prices up. However, in the precious metals market, it seems that fear is what causes the meteoric rise in prices.

“Fear Factor” in the Precious Metals Market

Many of the comments that have been addressed to me have been based upon the theory that fear is what is making the market do one thing or another. In fact, several individuals took the position that “fear” is what is holding silver back, while many others took the position that “fear” of governments, debt, and/or fiat money was making gold and silver rise and will continually make them rise.

But, opposite perspectives based upon the same emotion of “fear” can’t be right, can they?

Based upon Elliott Wave theory, Frost & Prechter recognized that 5th waves in commodities are often extended waves since they are propelled by the “dramatic emotion of fear; fear of inflation, fear of draught, fear of war.” Furthermore, they stated that “one commodity that is unalterably tied to the psyche of mass humanity is gold.” The fact that “fear” is so pervasive right now within social mood is the reason that precious metals have experienced such a parabolic rise.

Therefore, I would hope that we can all agree that it is the prevailing social mood of fear that is driving precious metals at this time.

But, does that mean that fear will continue indefinitely and unimpeded? In human history, has any emotion continued indefinitely into the future? When contemplating the answer to this question, remember that the 5th wave, which is driven by fear in the commodities market, is also the final wave in a five wave move.

Clearly, I think we can all come to the same conclusion that fear cannot continue unimpeded. The “bull” market in precious metals will not go on for centuries as many people claim. This is simply not a human possibility. We are not in some new paradigm of human emotion, as others claim, in which fear will simply continue on and on, which will cause metals to rise well beyond the foreseeable future.

At some point there will simply be fear fatigue.

Can We Predict The Ebb and Flow of the “Fear Factor” in the PM Market?

Since Elliott Wave theory is based upon the ability to track mass social mood and human psychology, as reflected in the price pattern in the market, these price movements should clearly adhere to patterns identified within the Elliott Wave theory, and unfold pursuant to the principles governed by Phi (The Golden Ratio, or as others know it, Fibonacci Ratios).

This is the basis behind the Elliott Wave, and this theory has been proven time and time again throughout history. These concepts have been understood by Plato, Pythagoras, Bernoulli, Da Vinci and Newton. Historic structures have been built by architects of famous Greek structures, such as the Parthenon, based upon the concept of Phi, and even as far back as the architects of the Great Pyramid of Giza in Egypt, who recorded their knowledge of Phi as the building block for all man nearly 5,000 years ago. Therefore, are we going to say that we need a new paradigm to analyze the precious metals market since the “fundamentals” have so significantly changed, or do we say that we should analyze a market driven by a human emotion in the manner in which that human emotion can be tracked through proven methodologies?

Ultimately, we need to ask ourselves if it is the exogenous fundamentals of the market we are analyzing, or are we analyzing the driving force of the market itself – the emotion of fear, or, in other words, the “fear factor?” Based upon the foregoing discussion, I propose that even though, arguably, exogenous fundamentals within a given market may change, we must still look to and analyze the ultimate cause of the price movements within that market – we must analyze the effect of fear within the market.

Conclusion

I believe we can all agree that the human emotion of fear is the cause and driving force of the pricing movements within the precious metals market today. Therefore, it follows that a methodology that is used to track ebbs and flows within social mood and emotions, en masse, CAN provide us with an appropriate analysis technique to track such a market.

Since Elliott Wave Theory is based upon the ability to track mass social mood and human psychology (such as the emotion of fear), as reflected in the price pattern in the market, which unfolds pursuant to the principles governed by Phi, we should then have a methodology that can provide us with high probability forecasting within the precious metals market.