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Beware The Signs Of Recession/Deflation

Commentaries & Views

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As I now provide analysis to over 5000 subscribers between my services on Elliottwavetrader, The Market Pinball Wizard, and FATrader, I am the beneficiary of much feedback from various segments of the financial markets. In fact, since we have over 500 money manager clients, I see a lot of what the predominant thinking is on “the street.”

Of late, I have been pointing to the potential for the dollar to rise to the region of 99-100DXY and TLT to take us up towards the 131-136 region. And, it seems many on “the street” are on the wrong side of the boat on this one. In fact, when I wrote a recent article on the TLT potentially rallying quite strongly in the coming months, I experienced quite a bit of pushback in the comment section to that article.

But, that is what normally happens at inflection points, and I suppose this one will be no different.

Moreover, I still see strong potential for the market to drop down to the 2100-2200SPX region in the coming months. And, many will associate the “bad times” of deflationary periods with a rising dollar, a dropping yield, and dropping asset prices. And, that is exactly what my charts suggest we can see over the next several months.

Now, I know that many believe that dropping yields suggest a flight to safety and bearish market conditions. This is how the media and pundits “spin” a rising bond market. But, I do have to ask if these people even bothered looking at rates over the last 30+ years, as they dropped alongside the stock market rallying? But, I digress.

So, should a dropping yield, rising dollar and dropping asset prices over the coming months concern you?

Well, in my humble opinion, I don’t believe it should concern you in the bigger picture. While I do think we have potential for the stock market to drop back down to the 2500-2600SPX region, and even drop as deep as the 2100-2200SPX region in the coming months, I do not think this will end the bull market which began in 2009.

For those that want to understand a bit more about my primary analysis methodology, I view market sentiment as the strongest driver of the larger financial markets. You see, markets do not top when people sell. Rather, a stock market finds a top when buyers run out of money. When there are no more buyers, as everyone has reached a maximum state of bullishness, there is only one direction left for the market to go, and that is down. That is when the selling begins. In other words, when bullish sentiment reaches an extreme, and bearish sentiment reaches the opposite extreme, we often see a top to the stock market.

Moreover, I believe that market sentiment follows a specific pattern, unaffected by exogenous factors, and many recent studies have proven this to be the case.

Back in the 1930s, an accountant named Ralph Nelson Elliott identified behavioral patterns within the stock market which represented the larger collective behavioral patterns of society en masse. And, in 1940, Elliott publicly tied the movements of human behavior to the natural law represented through Fibonacci mathematics.

Elliott understood that financial markets provide us with a representation of the overall mood or psychology of the masses. And, he also understood that markets are fractal in nature. That means they are variably self-similar at different degrees of trend.

Most specifically, Elliott theorized that public sentiment and mass psychology move in 5 waves within a primary trend, and 3 waves within a counter-trend. Once a 5 wave move in public sentiment has completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply the natural cycle within the human psyche, and not the operative effect of some form of “news.”

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

And, over the last 30 years, many social experiments have been conducted throughout the world which have provided scientific support to Elliott’s theories presented almost a century ago.

As one example, 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.

As Elliott stated:

The causes of these cyclical changes seem clearly to have their origin in the immutable natural law that governs all things, including the various moods of human behavior. Causes, therefore, tend to become relatively unimportant in the long term progress of the cycle. This fundamental law cannot be subverted or set aside by statutes or restrictions. Current news and political developments are of only incidental importance, soon forgotten; their presumed influence on market trends is not as weighty as is commonly believed.

- R.N. Elliott on causes of the waves, October 1, 1940

In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili and Zhang, in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially affecting the trading pattern. Their specific goal was to observe financial market psychology “in the absence of external factors.”

One of the noted findings was that the trading behavior of the participants were “very similar to that observed in the real economy,“ wherein the price distributions were based on Phi.

In a different study conducted at the School of Social Sciences at the University of California, they came to the conclusion that “We may suppose that in a human being, there is a special algorithm for working with codes independent of particular objects.” Specifically, when subjects were asked to sort indistinguishable objects into two piles, their decision making within that process divided the objects into a 62/38 ratio. In other words, these individuals exhibited a Fibonacci tendency in their personal decision making.

Therefore, the more research that is being done into this issue, the more evidence we are uncovering that behavior and decision making within a herd and on an individual basis displays mathematically driven distributions based on Phi, which do not seem to be affected by exogenous events.

This basically means that mass decision making will move forward and move backward based upon mathematical relationships within their movements, and not based upon outside stimuli. This is the same mathematical basis with which nature is governed, as Elliott suggested back in 1940’s.

At the end of the day, ALL investors should arm themselves with not just an understanding of the fundamental drivers of the markets, but also an understanding of market psychology. As Bernard Baruch once said:

All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking ... our theories of economics leave much to be desired. ... It has always seemed to me that the periodic madness which afflicts mankind must reflect some deeply rooted trait in human nature — a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea ... It is a force wholly impalpable ... yet, knowledge of it is necessary to right judgments on passing events.

So, I see the market as being within a 5-wave structure rally off the 2009 lows. And, within that structure, I see us as still being within the 4th wave within that 5-wave structure. Moreover, my ideal target for this 4th wave is in the 2100-2200 region. While it is possible that the market already completed this 4th wave in December when it came within 100 points of my target region, the manner in which we drop down to the 2600 region in the coming weeks will give us more indications regarding whether we are still going to target the 2100-2200 region, or whether we will only see a pullback to the 2500-2600SPX before we head to new stock market highs in the coming years.

As far as my longer-term target, well, for years we have had a minimum target of 3200SPX before this long-term rally off the 2009 lows completes. However, I am beginning to see signs that it can extend as high as the 4000-4100SPX region by 2022/23. Much will depend upon how the market takes shape over the rest of 2019, which should then provide us a more accurate perspective as to how high this final 5th wave can take us. Stay tuned.

As an aside, I want to let you know that we have opened a new site – FATrader.com -- dedicated to fundamental analysis.  To this end, we have brought together some of the best minds in their areas of expertise in economics, commodities, biotech, and energy/sustainable investing, and will be soon bringing on analysts for gold mining stocks, real estate, technology, shipping, and dividend/high yield to provide analysis for our members.

In our first week we sold out all our 750 discounted charter memberships.  Those who sign up by March 15 can still get a 15% discount after the free trial.  As one member just posted:  "As a new FATrader member I am finding ... the best array of articles and views anywhere."

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.