Friday, April 29, 2011

Gold Market Psychology

Every trade has a buyer and a seller.  The buyer is making a decision to trade currency for a security believing it is under-priced.  The seller is presumably of the opinion that the buyer is a fool and takes cash for his securities.  For a rise in price to occur there must be more buyers than sellers.  What factors determine the number of buyers for any given security?

The mass of investors making up a market creates it's own psychological toxic soup and must be understood if profits are desired.  While we have written at length on the 5 Phases Of A Bull Market there are 3 phases involved in a major macro-economic change.  We are currently in phase 2 as people slowly realize that fiat currency is worthless and governments are bankrupt.  

In phase 1 rogue investors shunned by the finance community begin to ask questions about the sector and investment vehicles that are tied to it.  Things don't make sense to them and they become curious. These types of individuals have consistently been in trouble for disrupting the normal flow.  Your editor nearly lost his seat in chain smoking Dorothy "Dottie" Alfred's 3rd grade class for asking the following question.  "If, as you say, U always follows Q in every circumstance, why not place it after Q in the alphabet?"  When the other market participants formed a herd rallying for this change she became enraged.  No alphabet change was achieved but maybe we all were better off for asking?

While phase 1 is the longest in duration phase 2 will come if macro-economic factors pushing the market continue without significant interruption.  Phase 2 is characterized by increasingly more participants climbing the wall of worry and painfully driving prices higher.  There is immense pressure on them as they push.  At every turn the herd that will be buying in phase 3 are ridiculing them and scoffing at their persistent stance.  Their broker is reminding them, "The bottom will fall out eventually."  Everyone is now an "expert" and offers phase 2 bulls unsolicited advice on this trade.  While they face difficulty in terms of popularity this phase does reward them with large gains.  Gold entered phase 2 when it crossed $1,000/oz for the second time.  Price charts show that patient bulls have been rewarded with a more than 50% appreciation since that time.

Phase 3 is the most exhilarating for participants and the most disturbing for early bulls.  Finally the herd can buy as they have convinced themselves that it is safe and people will not dislike them for purchasing.  This is where things get complex.  Several types of buyers enter the fold.  The analytical types can now draw a chart back 5 years and see a consistent price rise so they feel safe.  As a side note, this line of thinking is like staring at the rear view mirror while driving.  Next comes the brilliance of bank trust management teams recommending sector blue-chips for dividends to safely fund the lifestyles of their beneficiaries.  Also, here comes the guy who got burned flipping condos.  Watch out, he is dangerous and his presence tells you that things are getting frothy.  US News & World Report will likely administer the coup de grace by running a cover story on gold.  This phase is driven by a dangerous fear of missing out on the next move which causes the discount to fair value that attracted phase 1 and 2 bulls to turn into a premium.

As you consider your position on precious metals, look to the following statements as mile markers on the bull run:

  • "Gold pays no dividend"
  • "It is in a bubble....soon it will pop"
  • "You can't do anything with that useless asset"
  • "It cost money to mine it, process it and store it"
  • "It has gone up too will come down hard soon"
  • "Over the longterm the S&P has performed much better"
When you here these statements ask yourself how something can that is this hated and misunderstood by the masses be in a bubble?  In many settings you will still be the only person that owns any precious metals.  That does not seem like a bubble to me.  In 2007 you would not have been the only speculative real estate investor in the room.

With respect to the last statement, this chart compares the S&P to gold over the past 5 years.  We still have a long way to go.  Please remember, we are predicting that gold will begin rising in the 3rd quarter, cross $2,000/oz in late October or early November and close the year just under $1,800/oz.  
Chart forSPDR S&P 500 (SPY)

1 comment:

Mr. M said...

Props. Definitely my style. Come check out what we're doin at blog, maybe a collab?