Gold got crushed this week in what can only be described as a capitulation.Cascading selling took on a life of its own
as the yellow metal knifed through multiple key support lines.Newsflow
exacerbated golds free fall, as extreme fear tainted everything with
a heavy pall of bearishness.Gold bears were
euphoric, coming out in droves to pronounce doom on the metal.But
capitulations are actually very bullish events.
Capitulation is one of the ugliest words in the markets, it means surrender.Most of us are taught from a very young
age to never give up, never stop striving.So
traders are loath to admit they succumbed to a capitulation.Rather
than acknowledging they gave into their own fears to sell low at the
worst possible time, they try and rationalize their failing.They
have to believe the capitulation marks the start of selling.
But thats not the way capitulations work.These
sharp selloffs sparked by extreme unsustainable fear always emerge at the
very ends of long demoralizing selloffs.They
actually signal the climax of fear, the moment of peak psychological pain.These cascading plunges shake out all the weak
hands, the traders who havent mastered their own emotions.Only hardcore fundamentally-oriented contrarian
traders resist the fear.
Resisting capitulations is an acquired ability.Newer
traders, or at least traders new to a capitulating sector, are the most
likely to yield to the emotional pressure to panic.The
longer you trade, the easier it becomes to identify capitulations in
real-time and know from experience that they will soon pass.The
very hours where things look and feel the worst, utterly miserable, signal
the end of the capitulation.
Provocatively, this weeks gold capitulation was actually
pretty mild in capitulation terms.By Wednesday,
this metal had been pummeled 4.3% lower over 3 trading days.During
golds entire secular bull that was born a dozen years
ago in April 2001, there have actually been 12 single trading days
where gold lost more than 4%!6 of these occurred
during late 2008s epic stock panic, leaving 6 in normal
conditions.
So on average over this secular gold bull, weve had to weather a capitulation at
least once every couple years.And some have made
this weeks look trivial.Back in late
September 2011 for example, gold plummeted 9.0% over 3 trading days when the
Fed failed to launch QE3 as traders were hoping.Yet
like all capitulations, that extreme fear was actually very bullish.Just 6 weeks later gold was 10.7% higher.
Capitulations are purely emotional events, fundamentals never
have anything to do with them.A series of news
items galvanize a bright fear flare-up late in a long vexing selloff.The resulting fear surges out of control and
feeds on itself, spawning a short-lived panic-like rush for the exits.As battle-hardened gold traders know, some Fed news
is usually the catalyst that sparks the final capitulation selling climax.
That was the case this week too of course.The
markets were nervously awaiting the Federal Reserves
Federal Open Market Committee minutes from its latest meeting at the end of January.Gold traders in particular were concerned about
whether the Fed would signal that its QE3 debt-monetization campaign might
conclude sooner rather than later.Those minutes
indeed proved to be the capitulation spark.
But a spark alone is not enough to ignite a capitulation.It
needs to land in a tinderbox-dry sentiment wasteland where anxiety already
runs high.Similar FOMC minutes were released back
in early January from its previous meeting.They
were also interpreted as indicating the QE3 inflation wouldnt
last as long as gold traders expected.Yet golds
single-day and 3-day selloffs then were only half what we saw this week.
The fuel for golds latest capitulation came from
its poor performance in recent weeks and months.While
each individual weak day for gold was driven by its own unique factors, there
was one overlying dominant thread.The surging US
stock markets.As the flagship S&P 500 stock
index (SPX) powered higher, traders had little interest in alternative
investments like gold.The thriving conventional
ones stole all the limelight.
While gold is the ultimate alternative investment, the general stock
markets are the ultimate conventional one.This
chart looks at gold versus the SPX over the past year or so.Before
November 2012, gold and the SPX were actually enjoying a moderate positive
correlation.Both gold and stocks benefitted from
capital inflows at the same times, often rising in unison.And
they tended to sell off simultaneously as well.
This was the old risk-on risk-off
dynamic that has dominated the global markets in the years since 2008s
once-in-a-lifetime stock panic.When traders were
feeling better about things, they bought everything.When
they were feeling worse, they sold everything.Thus
gold and the SPX each surged dramatically in September when both the ECB and
Fed announced major new monetization campaigns.
But in November this correlation started to reverse, initially driven
by the US elections.When Obama won, the stock
markets sold off sharply while gold surged.His
victory heralded four more years of extreme record overspending,
deficits, and debt growth, which the Fed would have to monetize so interest
rates dont mean-revert to much-higher normal levels.But this truth was soon overshadowed.
After falling to oversold levels by mid-November, the SPX bounced as expected.But after its initial momentum soon bled off, it
kept on climbing with usually-small daily gains.While
the up days were minor, there were few down days.So
complacency quickly overpowered early Novembers fear.Despite the coming record tax hikes the fiscal cliff
threatened, the stock markets kept on inexorably melting up.
The higher they climbed, the more enamored investors became with them
and the more alternative investments fell out of favor.This
dynamic was compounded by fund selling.As
high-income investors feared the massive tax hikes targeting them, they
started to realize gains to lock in 2012s tax rates.They
put in redemption requests to funds, and the funds had to sell something in
order to raise this cash.
Some chose gold, their most liquid asset.So
this metal took a sizable hit in late November and mid-December.That
selloff, which I explained in far greater detail in our newsletters, started
molding golds sentiment environment into this weeks
capitulation-ready one.After that gold quickly
stabilized, actually advancing on balance between late December and early February.Its young upleg
remained intact.
But late last week, gold started to break down again as the SPX
continued to claw to a seemingly endless series of new cyclical-bull highs.Trading volume was light as most Asians were on
week-long market holidays for Lunar New Year celebrations.So
American shorts took the opportunity to launch a bear raid, to sell gold
aggressively at a time when the world wasnt
paying attention.So gold started sinking lower.
Once again there was a bearish rationalization for every individual
down day, which I will detail in our newsletters.But
the net result was gold started breaking key technical levels.First
its young uplegs support
failed, along with its critical 200-day moving average.With
each additional technical breakdown, fear and anxiety grew.So
by this Wednesdays FOMC minutes
release, sentiment was ripe for a spark.
As gold plunged below $1600 that morning on traders
anxiety about what the minutes would reveal, that was the last straw for many
remaining bulls.They had reached the limits of what
they could bear, so they sold aggressively.And
naturally selling begets selling.The more sellers pile in, the lower prices go
which scares in a whole new round of sellers.And
this self-feeding cycle cascades into a capitulation.
The climaxing day of any capitulation marks peak bearishness, when
everyone is utterly convinced the falling price will keep selling off indefinitely.And indeed on Wednesday, we saw a rash of
hyper-bearish predictions for gold.Many analysts
claimed its secular bull was ending.I had to
chuckle at that, as its latest interim high was 18 months earlier in
August 2011.Highs are when to be bearish,
not new lows!
This weeks capitulation was the end result of a multi-month
decay process that began with alternative investments falling out of favor in
November.Remember that gold and the SPX had a 0.55
positive correlation between January and October 2012.From November to this
week, that reversed totally to a much stronger 0.74 negative correlation!The levitating stock
markets melt-up rally really weighed on gold sentiment.
That alone is a very bullish omen.The
general stock markets are topping, due to roll over into a new cyclical bear.The SPXs cyclical bull
that began in March 2009 is long in the tooth.As of
this week it had powered 126.3% higher over 47 months, far bigger and longer
than the mid-secular-bear cyclical-bull average of a doubling over 35 months.And complacency is
off the charts, the primary topping indicator.
So the probabilities overwhelmingly favor a major selloff in the stock
markets, likely a new cyclical bear that will cut the SPX in half over a
couple years.Just as alternative investments fall
out of favor when stock bulls top, they regain favor in a big way as stock
bears deepen.This dynamic is certainly very bullish
for gold today, which has been a proven performer in
this secular stock bears past cyclical bears.
But even without the prospects for a new stock bear, golds technicals still look very bullish despite this weeks capitulation.In the chart above note that gold has been consolidating high,
trading in a range between roughly $1550 and $1775.Despite all the technical
carnage this week, gold still remains above its longstanding consolidation support!From these same levels
last summer, a major rally was born.
Ive been studying and trading the
markets for decades, and I would love to be able to predict capitulations.Seeing them coming would make trading a lot
easier.Normally you want to buy low late in a
correction, and the majority of corrections dont end in capitulations.But for the exceptions that do, the
absolute best time to buy is that very capitulation day.As
fear peaks, prices are at their cheapest.
But unfortunately capitulations are inherently unpredictable.Much of the time a long
demoralizing selloff necessary to fuel a capitulation doesnt
experience a proper spark before the next upleg begins.So if you waited for a capitulation that never
came before buying, youd miss the low prices.Each
capitulation requires a complex intertwined mix of events, technicals, and sentiment that are unique to that time.
So the only rational strategy for bulls is to buy cheap late in corrections
without waiting for capitulations that usually dont come.But when they do, simply steel yourself and weather
the brief plunge.They are a great test of your
contrarian mettle, separating those who can really walk the walk from those
who merely talk the talk.If gold looks like a
bargain before a capitulation, it is far more attractive after one.
Last week before all this unfolded, I wrote an essay on golds young upleg.In it
I made the bullish case with the technicals at
the time that gold was due to surge.I still
believe this is true, as the capitulation since was an extreme emotional
anomaly that has already passed.While it did damage
technicals, it doesnt
change the bullish thesis on gold one bit.Heres an
update of last weeks chart, post-selloff.
For a full explanation of this chart and its implications
pre-capitulation, read last weeks essay.Today I
want to focus on the new technical picture golds latest
capitulation created.It hammered the metal down to
a new upleg support line labeled Support 3 above.Yes, golds young upleg
is still intact albeit uglier.It began in
mid-May at $1538.As Wednesdays capitulation climaxed, gold was
still 1.7% higher at $1565.
Whenever a major support line breaks like happened to Support 2 this
past week, some traders freak out.It is never fun
to be long something expecting it to head higher and then see the bottom fall
out technically.But realize technical analysis is a
dynamic process, the best-fit lines are constantly evolving as new price
data flows in.Actually Support 1 was this uplegs initial support, not last weeks Support
2.
As long as gold remains above its mid-May low that birthed this upleg, it remains alive and well regardless of where
support lines are drawn.Typically fast
capitulation-like selloffs quickly reverse, as the extreme fear triggers
short covering which generates a sharp V-bounce higher.So
if we only stay under $1600 for a few days, Support 3 will be redrawn at a
steeper ascent.Temporary breakdowns are
considered extra-trend anomalies.
But what if gold keeps heading lower?What if it breaches its May lows?In
that case, what looked like a mid-upleg pullback
within an ongoing upleg between October and
February will simply be recast as a correction between uplegs.Gold
will still be in its high consolidation that began in mid-2011, poised for a
major new upleg on wildly oversold technicals and bullish fundamentals.Just like it was
last summer.
Support and resistance lines are subjective, drawn manually by
each analyst as best-fit lines between price limits.They
continually evolve and change on a monthly, if not weekly, basis as prices
meander up and down.Technical analysis only works
because so many traders choose to buy and sell based on it.But
since it is subjective and always changing, theres no
sense getting worked up over broken support.
Also realize that bearishness peaks with fear during capitulations.So it is perfectly normal to see nothing
but bearish predictions during and after a capitulation selloff.We
humans have the natural tendency to extrapolate the present into the
indefinite future.So when prices are falling, we
assume they are going to keep falling.So we rationalize
our outlook, selectively look for arguments to support our emotional bias.
Just after a capitulation, almost all commentary is bearish.It varies from the end-of-the-bull arguments to
merely further downside.Even the less-bearish end
of this spectrum is dominated by views looking for the falling price to keep
trending a little lower before it bounces.Analysts
and traders never like to call bottoms because it makes them stick out from
the herd, leaving them with the risk of being proven wrong.
But contrarians dont care, because we are always
fighting the crowd.We strive to buy low, when a
sector is already hated late in a major selloff.If
prices fall lower still after we buy due to a relatively-rare unpredictable
capitulation, so be it.If you liked gold for
fundamental, technical, and sentimental reasons when it was trading near
$1675 earlier this month, its outlook is far more bullish now near
$1565!
Regardless of what the Fed says, it cant stop
monetizing debt anytime soon.Interest rates would
soar which would devour the US government thanks to Obamas debt bomb.And quantitative
easing is just a sideshow to the Feds real monetary inflation,
which continues perpetually.The Fed fears inflation
expectations far more than inflation itself, so it is constantly trying
to jawbone them back down.
And despite inflation garnering all the headlines as far as the
bullish case for gold is concerned, it is but one facet of this metals
bullish fundamentals.There are other major
drivers of gold investment demand globally, inflation is just a tailwind.So no matter what the Fed does with QE3, or
tries to convince the world it is going to do, the great majority of golds
bullish case remains intact.The Feds
role is minor.
At Zeal we are hardcore experienced contrarians who have successfully
weathered every capitulation of this entire secular gold bull.Weve suffered the misery, pain, and
despair, and have been forged into far tougher traders because of it.We refuse to sell low in capitulations, wed
much rather sell high later.This has contributed to
our stellar track record.Since 2001, all 637 stock
trades recommended in our newsletters have averaged annualized realized gains
of +33.9%!
If you want a detailed account of what triggered this latest
capitulation and its implications, subscribe to our acclaimed weekly and monthly newsletters.They follow the gold market in great detail,
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the opportunity to buy low!
The bottom line is golds capitulation this week is very bullish.These sharp selloffs indeed happen within healthy
secular bulls from time to time, if just the right mix of technicals
and news converge.They trigger panic-like selling
driven by extreme fear that quickly burns itself out.While
challenging to weather psychologically, these shakeouts are nearly always
followed by major rallies as sentiment rebalances.
Golds low-volume holiday technical
breakdown that cascaded into this weeks capitulation was purely emotional.Golds bullish fundamentals havent changed much at all since the
summer of 2011 when its last bull high was achieved.After
a long high consolidation since, this metal is overdue to surge to new bull
highs over the coming year.If the capitulation
scared you out, you are going to miss the coming gains.
Adam Hamilton
February 22, 2013
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Thoughts, comments, or flames?Fire away at zelotes@zealllc.com.Due to my
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