Bear
markets can be devious creatures. They start off with a lot of emotion,
usually some type of euphoria and excessive optimism at the top. But
underneath it all the market is typically thrashing, making volatile swings
as buyers are piling in at the wrong time and sellers are taking profits.
Once
the sellers take control the bear market starts it's downtrend. At that
point the bear launches into it's second phase of faking out market
participants, i.e., the bear market rally. These periodic false rallies serve
to make it look like the bear has ended. But once each bear market
rally fails, the next leg of the bear market is kicked off.
As a speculator
it's important to learn from bear markets, how they form and how they deceive
on the way down. The more experience a speculator has with bear markets
the more prepared they will be for the next one. Let's take a look at
some key lessons we can take from gold's latest bear market:
The
first lesson from the gold bear market is simply that it was overdue to
happen. Jim Rogers was right, after 12 up years gold needed a cyclical
downturn. All major bull markets have cyclical bear markets, and it was
actually quite unusual gold went up for so long without a bear market.
Cyclical bear markets are actually a critical component of secular bull
markets because they reset sentiment and clear the way for the
next major upleg.
Many
people are convinced the recent gold bear market ended the long term secular
gold bull. So you could say this recent gold bear market did it's job!
It re-created the wall of worry that should drive gold higher over the
next few years as the secular bull market resumes.
Often
when markets top there are warning signs from related markets ahead of time.
For gold in 2011 the following signals helped warn that gold was
topping and entering a bear market:
Weak Gold Stocks
The XAU
Gold Miners Index topped way back in December 2010. Many major gold
stocks acted very weak as gold made new highs in 2011. They drifted
sideways when they should have been trending higher with gold. In some
cases they entered bear markets even before gold had topped.
The
chart below shows how the gold miners ETF GDX started lagging gold after
April 2011. The ratio of GLD to GDX jumped higher after April
signalling gold was outperforming gold stocks, which usually isn't the case
when gold is in a healthy bull market.
Weak Silver, Platinum, and Palladium
Silver
topped in May 2011 and then crashed. Platinum and palladium failed to
move higher with gold in 2011 and instead went sideways. Seeing all
three metals decouple from gold was a warning sign. In a healthy bull
market, all three metals would have went higher with gold.
Sentiment Was Universally Bullish By Major Wall Street Banks
Wall
Street banks were raising their forecasts for the price of gold in the fall
of 2011. Right as gold was about to make a major top. They had
previously always been projecting gold to be lower in price in the future,
year after year as gold actually went higher. It took them forever to
finally come to the conclusion that gold might be in a bull market and they
should adjust their expectations accordingly. But just as they turned
bullish the market fooled them again and sent gold into a cyclical bear
market.
This is
probably the toughest part about bear markets since everyone wants to call
the bottom and catch a new bull market as early as possible. But we
have to keep in mind that bear markets are going to provide at least a few
false rallies on the way down.
The
bear market rally in gold in the summer of 2012 was probably the best fake
rally of the recent gold bear. It looked like a possible end to the
weakness in the gold market. Gold stocks started shooting higher, and
silver, platinum, and palladium all went higher.
The
chart below shows this bear market rally along with the overall bear market
in gold stocks since 2011. Obviously in hindsight it's easy to see that
this rally ended up failing, but in real-time it looked explosive enough to
possibly be the end to the bear market.
The
first step to protecting oneself from getting overconfident on bear market
rallies, is to be aware that bear market rallies will occur. Be
skeptical, especially for bear market rallies that occur early in the
downtrend. Bear market rallies also tend to fail when they don't have a
big increase in volume, which was the case in the 2012 rally for gold stocks.
Another
thing to note is that the false rally in 2012 occurred when gold wasn't even
in a bear market for an entire year. Cyclical bear markets often last 1
to 3 years in duration, so it's not surprising that the rally in 2012 failed.
It also doesn't make the duration of this gold bear market out of the ordinary
either.
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