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Summary

  • Can we use "logic" to invest?
  • What really moves markets?
  • Upcoming week's expectations.

Early on Monday morning, I saw the following news report about Crimea on MarketWatch:

Russian troops took control of a Ukrainian naval base in Feodosia, Crimea, on Monday, according to media reports. The attack was reportedly the third on a Ukrainian base in 48 hours, and leaves Russia with control of most of the country's military bases in Crimea.

And, what was the reaction of gold and silver? DOWN! Yes, that is right, they went down. And, they have been going down right from our target region provided a few weeks ago. Yet, so many would have you track the events in Crimea to know when to buy or sell gold. And, guess what . . . you would have been whipsawed again if you did so.

Now, I must say that it is quite reasonable to try and make sense of our investments through the lens of the world around us. I mean, if you see turmoil around the world, the "reasonable" and "logical" thing to believe would be that the metals would react with a price rise during such times. But, ask yourself this: Do the metals react to logic or reason? Are you reading my analysis, or that of a logician? And, ask yourself, honestly, how accurate have the "news-hounds" been in determining the direction of the metals for the last 3 years?

As human beings, our egos make us believe we are in control of the world around us. We like to believe that we can use reason to make wise and correct investment decisions. We like to make sense of everything we do. But, unfortunately, that is not the case when it comes to trading and investing in markets, especially precious metals.

I know it is hard to believe, but human decision making is often emotional and has a distinct general pattern, and is not as "reasonable" or as "logical" as many of you believe. And turns within these patterns are seen at various Fibonacci ratios. In fact, studies have been performed throughout the last 20 years which substantiate this perspective. One study was performed wherein the participants were not provided any news at all, and asked to trade amongst themselves. The results shocked many:

In spite of the simplicity of our model and of the strategies of the single participants, and the outright exclusion of economic external factors, we find a market which behaves surprisingly realistically. These results suggest that a stock market can be considered as a self-organized critical system: The system reaches dynamically an equilibrium state characterized by fluctuations of any size, without the need of any parameter fine tuning or external driving.

Marsili, one of the doctors conducting the study, was quoted as saying that "the understanding that we got is that the statistics of price histories in financial markets can be understood as the result of internal interaction and not the fundamental interaction with the external world."

In a paper entitled "Large Financial Crashes," published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation for the overall herding phenomena within financial markets:

Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an "emergent" behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.

In fact, one commenter to one of my articles on Seeking Alpha made the following astute point regarding how news affects these subconscious herding trends:

Compare the market to a stream of ants marching by in, generally, a single direction. Run a stick across their path and there will be some momentary confusion and reaction to the direct stimuli but very soon afterwards the original parade of ants continues and the stimulus is forgotten.

So, if news is not needed to cause trading movements in the same manner that we see in our own financial markets, does that not tell us that something else may be controlling investor decision making other than news? Yes, I know this is contrary to what has been ingrained in all your perspectives about markets to date. But, as R.N Elliott once said, "in the dark ages, the world was supposed to be flat. We persist in perpetuating similar delusions."

The problem shared by most investors and traders is that our human egos will not allow us to believe that there is a greater power that is engrained within the human brain that controls market movements, en masse. Humans are hard wired for herding in their basal ganglia and limbic system within their brain, which is a biological response they share with all animals. In fact, in a study performed by Dr. Joseph Ledoux, a psychologist at the Center for Neural Science at NYU, he noted that emotion and the reaction caused by such emotion occur independent and prior to, the ability of the brain to reason. And, yes, other studies have shown that this innate decision making revolves around Fibonacci ratios, which is also the basis for all of nature's laws. But, again, I am sure many of you will dismiss this because it is not based upon your ability to control the markets or to identify the controlling piece of news. You still cling to the notion that "reason" dictates market movements, but cannot explain it when the markets move in the opposite manner in which such reason would dictate. You simply state that "the market is not trading upon fundamentals at this time."

This past week we saw a perfect example. As I noted above, many wrongly believed that the events surrounding Crimea were the cause of the metal's rally. In fact, I warned you several weeks ago to ignore the events surrounding Crimea, and to only focus on price. I noted that the market will likely top in the GLD133.50 region (it topped at 133.76) no matter what happens in Crimea. And it has become much less likely that we will exceed that level any time soon. So, yes, the metals still dropped despite the negative news that came out at the beginning of the week regarding Crimea, which most would have assumed would cause the metals to rise.

That being said, I am now going to assume that some news event will likely hit the wires to which many will point as the reason for the metals heading higher. I know this because my expectation is that the metals are going to "bounce" very soon. But, please let me explain to you that I am not speaking in circles when I say to "expect" some news to hit the wires. Rather, I am saying that I am looking at the market from a completely different perspective than most. I am saying that I see the metals about to get a "bounce," so I am assuming that some news event will be cited as the "cause" of such expected movement. And, truthfully, I will expect such movement even if we do not get any news to which most can point as the reason for the rise. In other words, I am expecting a rally, and I am sure that many will find some news event to point towards as the cause, but the "cause" is not needed, as sentiment is suggestive of an upcoming move higher. My only caveat is that GLD must maintain over 123 for us to be able to see such a rise.

But, I must admit that I did not expect GLD have dropped by 9 points in this initial move off the highs. It may be signaling that GLD is weaker than I initially expected. In fact, silver is in such a potential bearish posture that it can target levels as deep as the $11-14 region in this posture.

Now, when the silver market was at 45-47, I noted that my downside target was around the 26 region, and was summarily "laughed out of the room," since everyone "knew" that it was going higher at the time. Little did I expect that it would be hit as fast as it did. But, once we bounced off that region and invalidated a bullish potential set up I saw in 2012, my next target became the 22 region, which was easily hit. Since that time, my next lower target region has been the 16-17 region, but due to the manner in which silver is set up currently, unless something drastically changes over the next few weeks, the current set up will likely take silver below that region. It would surprise me to see silver strength maintain that region as support in the current set up. Therefore, there are a cluster of Fibonacci targets between the 11-15 region, and I will need to see how strong the next decline phase is to better identify the higher probability target within that region.

In GLD, as long as we maintain the current set up, my expected downside target had remained the 90-100 region for quite some time. But, before we embark upon a trip down to those nether-regions, I am expecting a bounce towards the 127.50-131 region.

Finally, as I have done my weekly perusal of metals articles, it seems many are suggesting to buy metals on this "pullback." While I do not disagree with that trade, as long as we hold over 123 in GLD, I do disagree with the "why." Some are still clinging to the "Crimea" perspective for a metals rally to new heights, while others are still looking towards Chinese demand.

But, again, has the Crimea news even prevented the strong drop we saw this past week, much the less cause a rally?

And, has the Chinese demand done anything to stop gold's major slide from its all-time market highs in 2011 - and that was coupled with QE infusions? So, why would one now assume Chinese demand, along with the Fed tapering, is going to cause a rally? Well, it seems they are effectively saying "history-be-damned, this time is different."

If the metals have gone down on these events in the past, what must be different this time to cause them to go up? Let's add a little intellectual honesty to this perspective, because these inconsistencies in perspective do not float the boat. And, what is truly different this time is the sentiment set up. As I have said over and over, unless sentiment is aligned with your perspective, seemingly similar news events can "cause" different directional reactions in the market.

The question I pose to all those following only "news" or "fundamentals" is when and how will you know you are wrong? From my perspective, I will question if I am wrong if GLD is able to move over 131.50 before heading back down towards its prior lows, and I will then go back to my initial target up to the 140 region before the downside begins. In silver, the relevant level is 21.85, which, if exceeded, will have me re-targeting the initial 24-25 target region. But, those that cling to only fundamentals are still claiming they are right, even though silver has now lost over 60% of its value from its 2011 highs. It must be nice to live in a world where you lose more than half your assets, still be able to claim you are right, and have the masses agree. As for me, I would much rather grow my and my client's account values, and have my perspective be viewed as "wrong" by the world at large.

Disclosure: I am long SLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have an intermediate term put position on GLD.

Source: Silver Should Rally, But Can Then Drop As Low As $14