Sunday, July 5, 2009

Secular bull markets

Let me explain how secular bull markets work. They start from a fundamental supply and demand imbalance. As they start to rise only the true believers, really smart money or the lucky get on board. The rallies are slow and grinding. The corrections are swift and scary (I think that accurately describes what gold bugs are experiencing now).

Usually this first phase lasts up to five years long. At some point a secular bull market will undergo a massive correction that will serve to wipeout all the optimism that was built up during the first phase.

I think that correction occurred in 06. Notice how long it took to move to new highs after gold crashed from the 725 highs. Over a year and a half.

In the second phase institutional money will start to come in to the market. However in the second phase the corrections are much larger than the first phase, making it harder for riders to stay on board the bull. Most investors will still doubt the bull all the way through the second phase. Many will try to short him.

In the third phase the public will come in and the asset will become entirely detached from any fundamental underpinnings. Overbought levels will be meaningless. Excessive sentiment will be meaningless. The bull will ultimately move to levels that virtually no one will foresee and as such very few will be able to ride the bull to completion.

Now let me tell you exactly what's going to happen in the coming months and years. First off gold is going to do whatever it takes to wipeout as much bullish sentiment as possible so that when it does finally move above $1000 almost nobody will trust the move. Many will try to short the move because gold will most certainly be overbought at that point.

I've pointed out before that gold and especially silver are thin markets. That means they are volatile. So here's what invariably happens to shorts. Maybe they get lucky and catch a short term decline and they make a little money. The problem is that volatility. At any moment the buyers can come in and when they do the metals can move big and quick as shorts panic. The shorts profits can evaporate in the blink of an eye. Often they evaporate before the market even opens. One never even gets a chance to book their profits.

I can guarantee once gold goes above $1000 it won't be long before the shorts are trying to pick a top and nervous longs sell way to soon and then sit on the sidelines as the bull goes up and up and up. This is going to happen all the way up. The vast majority of investors are going to turn the opportunity of a lifetime into no profit. Those gullible enough to short gold will lose massive amounts of money as this bull progresses.

Shorting a secular bull market is like walking through a dynamite factory with an open flame. Sure you may get lucky once or twice but you still have a very short life expectancy.

Now look at that first chart. Gold never dropped below the 200 week moving average even during one of the worst market crashes in history. The 75 week moving average never even turned down. There is no other asset that one can make that same statement for. What earthly reason could one have for trying to sell short that kind of strength?

Now look at the other chart. The Dow:gold ratio has been moving steadily down since 01. Is there any logical reason to expect that this time the Dow gold ratio bottomed at a level almost 7 times higher than it has at any other time in history? I don't know of one, although I can think of several trillion reasons why it may bottom lower than any other time in history.