Izzy revisited

I think it's getting very close to the time when this C wave should start to accelerate. Many investors and traders are going to lose their positions prematurely as this progresses. In that vein of thought and in an attempt to help everyone avoid this mistake I think it's time we revisit a little Izzy wisdom.


"You can’t make big money, unless you think big money." Others have said it as well – you can’t achieve that which you can’t conceive. In the world of investments, if you can’t imagine something happening, like a stock or a commodity going up many times in value, then it is highly unlikely you would buy and hold such an item if it did, in fact, go up many times.
- Izzy Friedman

Think silver...and miners!

A question of perception

The following is an excerpt from last weekends report. My point is to demonstrate the difference in how a smart money investor thinks as opposed to a dumb money retail investor.

"This weekend I’m going to do something a little different. An exercise in perception so-to-speak. What I want to do is try to relate how a professional investor thinks as opposed to how most retail investors brains work. In order to do this I’m bringing back our fictional characters John I. Que and Moe Ronn. I think you can probably guess who is the smart money and who is the dumb money.

First off let’s take a look at the gold chart for the last 10 months. I’ve made some annotations as to what’s going on in Moe’s brain as gold has bounced out of the low last year.

One of the differences between Moe and John is that Moe is constantly checking his account balance every day. When gold pulls back Moe freaks out and hits the sell button. He simply can’t stand to watch his account go down.

Browse almost any blog and what do you see? All of them are afraid of draw downs. Most will even brag about how they time their entries with tight stops so they never have to suffer any draw downs. The first thing I’ll say about tight stops is they are a recipe for multiple small losses. The pros can see those obvious stop levels just like Moe and they will invariably run them to get the dumb money to cough up their capital.

Moe is a classic dumb money investor - he buys high and sells low. The reason is because Moe is not in control of his emotions. On the contrary, his emotions are in control of him. So in order to buy Moe needs gold to rally enough for him to feel good about buying. He wants confirmation. Sound familiar? That’s when euphoria kicks in and the buy, buy, buy flood gates open up. Then, of course, what happens most of the time is Moe has jumped in just as gold has gotten overbought. Gold needs to take a breather. It pulls back and Moe, who’s constantly watching his balance sees his positions go into the red. Panic hits and the sell, sell, sell button is triggered. This is especially true if some kind of technical level is breached.

For some reason most retail investors place tremendous importance on charts and imaginary support and resistance levels. I suspect $1000 gold is one most amateurs are watching right now. I know exactly what’s going through their brains. Since gold was unable to hold above $1000 it means the rally is dead. Anyway, the end result for Moe is a loss. So the next time gold rallies Moe is slightly gun shy, he needs more confirmation before pulling the trigger this time. End result…round two of the Moe Ronn debacle unfolds. Repeat until Moe runs out of money or gives up.

Now let me show you how John I. Que thinks. For one he doesn’t watch his balance every day. He’s not concerned about a little draw down. Here’s what is important to John. The first thing John does is pull up a long term chart and decide what the secular trend is.

For gold it is obviously up. That revelation means two things to a professional trader. First, he wants to trade in the direction of the larger trend. Second, this is not a market that he wants to short. You will greatly reduce your odds of making money by trying to trade against the secular trend. In bull markets the correct strategy is either long or out. One doesn’t sell tops in a bull market. One buys dips. Any professional violating this very basic rule deserves to be fired and probably will be as soon as his manager spots him making this kind of newbie mistake. If you want to trade like the smart money you just don’t make these kinds of mistakes…ever!

So John has decided gold is in a bull market. Now let’s take a look at the 10 month chart and see how John’s thinking differs from Moe’s.

First off John would probably be buying close to the bottom as the COT was signaling extreme bullish readings. At this point John would recognize value and not worry about a draw down. John’s not trying to pick THE bottom. He’s buying value. Even if he doesn’t time the entry perfect he’s confident that eventually the market will come to its senses and reprice gold where it should be.

John continues to hold as gold tries to break through the 200 DMA. He has a pretty good cushion so he’s willing to wait and see if gold is ready to resume the bull run.

Once the 50 DMA crosses above the 200, and especially when the 200 turns up, John’s brain switches to full bull market mode. That means buying dips. So instead of freaking out every time gold gets oversold John is happily sucking up shares from the Moe Ronn’s of the world. He’s doing this because he’s now convinced the secular trend has resumed and he’s confident that any pullbacks are going to eventually get reversed.

At this point John is focused like a laser on building his positions in the ongoing bull market. Pullbacks are meaningless to him. In the meantime Moe is jumping back and forth trying desperately to stay on the hot trend of the moment. Normally with the results we’ve seen above. Buy high sell low. So while John is steadily growing his investments by concentrating on one thing, Moe is steadily shrinking his by trying to avoid draw downs and playing catch up with every hot trend.

One has to decide if they want to think like John I. Que and make money or do you remain in the ranks of the Moe Ronn’s of the world and continue to let your emotions run you around and around till you finally lose all your capital?"

Buy & hold

Occasionally I get into a "discussion" on the buy and hold approach vs. a trading approach. I can assure you that the most profitable approach to a secular bull market, especially one that's getting as deep into the bull as gold is to simply take a position and hold on.

That's how investors get rich during a secular bull. It's how Buffett got rich during the secular bull market in stocks from 1974 to 2000.

However the fear of drawdowns will keep most people out of the investing approach. These people will choose to trade because they can't handle drawdowns.

I will be the first to admit that if you can't stomach drawdowns on your account then you are probably going to have to move into the traders camp.

However avoiding drawdowns isn't the way to get rich. Unfortunately the strategies that produce the biggest gains almost invariably also have the largest drawdowns.

Take a look at the chart of the HUI. Since Apr. (when I started building my mining positions) the Hui is up roughly 35-40% give or take depending on where in Apr. one entered.

A simple buy and hold approach has produced a nonleveraged return of 40%. How many traders can claim a return on their portfolio that large since April? I dare say very very few. (and if they can then they are probably using leverage or very loose risk control. Both of which will eventually turn any account to dust).

By the time this bull is finished a buy and hold strategy will have so vastly outperformed a trading strategy that traders won't even be able to see the investors with a telescope.

Tomorrow I'm going to do a post on the different mind set between smart money professional traders and dumb money retail traders.

Third phase of the bear market

I'm actually talking about the dollar bear market not stocks. Although at some point in the future I do expect stocks to enter the third stage of the secular bear market. As you can see from the second chart it appears we are now in the counter trend rally separating phase two from phase three of the secular bear market that began in March of 2000.

More importantly, at least to most commodity investors, it appears that the rally separating phase two of the secular bear market in the dollar has now run it's course and we appear to be entering the third and potentially the worst stage of the bear market. The 40 week moving average has again rolled over after a strong counter trend move for the last year and a half.

That' s not to say we won't see a 4th, 5th or even 6th stage of the bear market in the dollar and stocks for that matter. Usually humans can learn their lesson after losing three times in a row, but as we saw from Japan since 1990 it is entirely possible for governments to continually make the same mistake over and over. Japan has been in a secular bear market for 19 years.

The Fed is certainly on the same path as the one taken by Japan and so far with the same results. They have shown no ability to learn from their mistakes at all (I doubt Bernanke ever will learn). I suspect until we figure out that Bernanke is simply amplifying the flawed monetary policies started by Greenspan (and get him the hell out of office) we are doomed to ever larger financial catastrophes.

Albert Einstein noted that the definition of insanity is repeating the same action over and over expecting a different result. Until we oust these government officials that continually make the same mistakes over and over, we are going to be in for a lot more and probably much greater pain down the road.

Stealth bull

This C wave advance is doing everything in it's power to shake off as many riders as possible. Lets face it $1000 is a big psychological number. It's probably going to be the toughest hurdle gold will have to surmount during the entire bull market. Once it does though it's going to create a ton of bullishness.

Bull markets thrive on doubters, not on everyone believing. Well at least until we get to the end game when the public comes in.

But let's take a look at what's really going on in gold instead of getting caught up in the day to day gyrations as so many retail investors tend to do.

In the first chart we see that the current A wave advance was the strongest A wave of the entire bull market so far.

In the next chart we see that the B wave decline to correct that A wave was the weakest B wave decline of the entire bull market.

After that gold needed to do something to shake off riders. Let's face it, the A wave and B wave were mega bullish. So what did gold do? It traded sideways for months in a huge triangle consolidation/continuation pattern. The wear you out stage. Impatient traders finally just gave up on gold.

Then when everyone was expecting gold to break down out of the triangle gold did the exact opposite, it broke higher on huge volume and rocketed above $1000 (hey this is a bull market after all and bull markets go up).

That breakout was extremely bullish for gold, it again needed to shake off riders. What better way than to sink back below $1000. I suspect there were a ton of investors waiting to buy gold on a close back above $1000. Those people are now in the process of getting thrown from the bull.

If you insist on watching the day to day action in gold instead of focusing on the big picture then the gold bull is probably going to shake you off his back and leave you standing in the dust as it charges onward and upward.

Markets generally do what they are supposed to do just never in the time frame that investors want them to do it in.

Another coil pattern?

We may have the potential for another coil pattern unfolding on the S&P. Roughly 70% of the time when we see a volatility coil form the initial break from the coil proves to be a false move only to be followed by a more powerful and durable move in the other direction.

We saw a perfect example of this last month. The only caveat is that the current coil got a bit sloppy towards the end of the pattern so I'm not sure if we are really dealing with a true coil or not.

The heavy selling into strength we saw at the top suggested the market would break lower, which it has. Yesterday we saw the opposite and saw very large buying into weakness by institutional traders. So it appears the big money is looking for the pattern to repeat again.

Combine that with the runaway move stats and this correction shouldn't drop more than 35-50 points before reversing again. (If it does then we are probably dealing with a true intermediate correction and not just another fakeout)

I've also noted that if the S&P can close below 1040 we will likely have a Bollinger Band crash trade signal.

Final phase for gold?

I've been asked many times if I think this C wave will be the last run for gold. The final parabolic blow off top. The leg to take us to the Dow:gold ratio of 1.

Nothing of course is written in stone but I tend to think we will see at least one more C wave advance. For one the public still isn't in gold in any meaningful way yet. If this C wave is as big as I think it will be we should see the public start to come in close to the top.

Since the public almost never gets the timing right I expect at least one more severe D wave decline to wipe out all the late comers and any of the public unlucky enough to jump on near the top.

I would compare this to the crash of 98. Tech stocks recovered quickly soothing the pain of Joe Sixpack who was just starting to believe only to suffer the minor market crash as LTCM blew up.

We will probably see the same thing again with gold. Just as the public starts to get on board we'll see one more D wave.

Smart money will be gobbling up shares at the bottom of the next D wave, so much so we may not even have an A wave advance followed by a mild B wave decline. If gold recovers quickly the public may just become convinced they've spotted another "sure thing" and completely abort the B wave. We could go straight from a D wave decline into a final parabolic C wave advance.

Since the next major bottom for the dollar isn't due till 2012 and this will be the third major leg down for the buck I would look for a top in gold to coincide with that bottom in the dollar.

Most major bear markets unfold in three waves although they can surely last longer. The Nikkei has gone through multiple bear legs down in it's ongoing bear market.

So as of right now I think the most likely timing band for a final top in gold would be in early to mid 2012 that is unless Ben still hasn't learned his lesson and continues to run the printing presses. If that's the case we could easily see another 4 years of declining dollar and rising gold.

Commodity bull phase II

Commodity bull markets tend to last anywhere from 15-25 years. It takes a long time to find and bring into production a giant oil field, copper mine, gold mine, etc.

First price has to rise long enough and far enough for resource companies to be willing to expand. Understandably, after a 20 year bear market, companies are going to be reluctant to spend a lot of their precious profits on exploration and expansion. They've struggled to remain profitable for two decades. If the past 20 years is any indication those profits can evaporate quickly.

During the first phase of the commodity bull energy and base metals led the charge, driven by emerging market demand for oil and a world wide economic expansion. Nothing sucks up copper faster than a global expansion.

But sure enough the very thing that resource companies feared came to pass. The credit bubble burst and spiking energy prices poisoned the global economy. Almost overnight demand for everything dried up.

Now I'm not saying energy and base metals won't rise during the second phase of the commodity bull. They surely will. They may even make new highs. But they aren't going to be the leaders during this phase. The fundamentals don't support these sectors anymore. I suspect the world is going to cycle in and out of recession/depression for at least another decade, maybe two.

In their futile attempt to combat the ongoing economic malaise governments are going to turn to the printing press. Unfortunately this is just going to feed the cancer growing in the world.

In the attempt to avoid the 30's style deflationary collapse the world is going to buy into a hyperinflationary collapse. Neither scenario is the cure for a credit bubble collapse and maybe in 80 years when we go thru this again we will have learned our lesson and realize that the only real cure is to let the free market run it's course. That won't stop the pain but it will drastically shorten the recovery period.

As we enter the second phase of the commodity bull our job as investors is to determine where the fundamentals are strongest. The second phase of a commodity bull is almost never led by the same sectors that outperformed during the first phase. With an ongoing global recession the fundamentals just don't support energy or base metals anymore. Certainly they will rise, but it will not be from a supply and demand imbalance. These sectors will rally but it will be driven purely by monetary expansion. That is not the fundamental basis for a large sustained move higher.

During this phase of the commodity bull we need to look at the sectors that stand to benefit from the new fundamentals. Expansionary monetary policy = precious metals.

During the first phase precious metal prices rose but not nearly as much as energy and base metals. As a matter of fact spiking energy prices were a huge drain on miners profit margins. That coupled with the fact that bullion prices in percentage terms didn't rally all that much meant that exploration and infrastructure expansion in the mining sector never expanded much during the first phase of the commodity bull.

Now as the fundamentals turn in favor of precious metals we not only have monetary policy supporting higher prices but we have a supply problem developing at the same time demand starts to surge.

Now throw in the fact that in inflation adjusted terms gold is just about the cheapest commodity there is and we have the makings of a huge move higher as the second phase of the commodity bull gets underway.

Runaway moves

The stock market is and has been in a runaway move since March with one brief pause in June and early July.

The last time we saw this kind of action was as the market came out of the 06 bottom. At the time there was great fear that the economy was slipping into recession. The Fed's response was to destroy the dollar by creating billions and billions of them at will.

That frantic printing spree spawned the runaway move in stocks from the summer of 06 till the China led crash in Feb. of 07. After that the inflationary effects of this monetary policy strictly limited further upside for the market, with the S&P only tacking on 100 more points before finally rolling over into the bear market.

You can see the Fed is at it again. Look at the last chart of the dollar since March. Ben is on a determined path to destroy the currency. So far his efforts have produced another runaway move in stocks. The only question is how long can it last before inflation cripples us again. I suspect not too much longer as we've already seen oil spike over 100%. (Always a economic killer).

Generally speaking when one of these runaway moves gets started one wants to take note of the average size of the corrections. Once any correction exceeds that average size by roughly 20% then the odds swing heavily in favor of that correction being something different, possibly the start of an intermediate trend change.

The reason I mentioned this isn't as a timing mechanism for trading stocks but because I think there's a good chance we could see one of these runaway moves in gold once the $1000 mark is taken out for good.

If we see a powerful surge higher in gold during the next few weeks one might want to consider the possibility of another runaway move and not sell too early. You definitely don't want to sell based on overbought levels or divergences. Notice how the large momentum divergences in 06 and recently have been worthless tools for timing this move.

Fighting the trend

I think it must be human nature to fight the market. By that I mean play the low percentage bet or buck the odds (in this case I'm talking about trying to pick a top).

Now if you are in a casino you will get rewarded if the long shot hits with a sizable return on your original bet (not sizable enough for you to make money over the long haul though. Hey they don't build those casinos by letting gamblers win.) Not so in the stock market. The only reward for fighting the odds is usually to contribute money to smarter more seasoned traders.

Lets take a look at what's involved when you choose to fight the odds investing. Investors trying to pick the top are fighting not only the short term and intermediate term trend but possibly now the cyclical trend. Every time frame is against you. That means the odds are heavily skewed against you correctly spotting a top. Insistence on this strategy is most likely going to result in multiple loses. Sadly that's not a very good way to make money in the stock market. If one is taking big positions these multiple losses can do severe damage to ones account.

The safer course of action would be to either get aligned long with the trend of the market or just get out. Unfortunately traders seem to have this almost uncontrollable need to pick a top. Perhaps it's for boasting rights if they ever do get lucky enough to spot one. I really have no idea what the fascination is with spotting tops.

It seems like almost everyone is trying to pick a top right now whether it be in the stock market or the gold market.

For gold the secular bull market is not in question. It has been rising for 9 years. That means the odds favor that long is the correct position.

The stock market is a little more questionable. It is definitely in a secular bear market and has been since 2000, but the cyclical trend may have turned up. For stocks the short and intermediate trend is still unquestionably up, the only question is whether or not the cyclical trend has also turned. Since the 200 DMA is now sloping up and the 50 DMA has crossed above the 200 I'm going to assume that it has. That means there are only two correct positions, either long or out.

However since there is no question about the secular trend in gold I would think that would be a safer bet than trying to guess at the stock market.

Ask a five year old!

I had a spirited discussion with a trader today who assured me that gold would soon crash along with the stock market any time now.

Now I don't know about the stock market. We surely haven't entered a new secular bull market, so at some point yes we are going to be making a trip back down to new lows. I'm kind of leaning towards this being a cyclical bull market within a much larger secular bear market but it could just be history's biggest and baddest bear market rally (actually a cyclical bull market is just a really big bear market rally).

But I am under no delusions as to whether gold is in a bull market or not.

Just to make this simple, enlarge the chart and then go stand on the other side of the room and decide whether you think gold is going up or down.

If you don't trust your judgement or perhaps your eyesight is bad (don't get me started on that one, damn I hate getting old!) ask any five year old for their opinion.

If the consensus is up then one has no business selling gold and buying dips is the correct strategy.

Dow:gold ratio revisted

I've posted the Dow:gold ratio many times along with my feeling that we will eventually see this ratio drop to or near 1:1 just like it has during almost every commodity bull market.

I think there's a good chance that the Dow:gold ratio has completed the correction from March and is now about to begin the next leg down. So far the trend line has been broken and at the moment is forming a small bear flag.

Now I don't know if stocks are going down or if gold is just going to rise much faster. Either one of those scenarios would send the ratio lower. If I had to guess I would say gold is going higher while stocks stagnate or rise sluggishly.

One of the great investing truths is that liquidity will eventually find its way into undervalued assets. Over the last 6 months the stock market has risen by about 50% while gold traded sideways. I suspect it's now time for liquidity to drain out of the stock market and back into precious metals.

Once the ratio closes back below 8.5 I think we will have confirmation that the secular trend is back in force.

Watching the wrong number

Obviously $1000 is a big psychological number and most investors are concentrating on a breakout of that level as a sign the secular bull market is still intact. However $1000 isn't the important level. The important breakout has already occurred when gold took out the 1980 highs of $850.

W.D. Gann noted that the size of the consolidation often signals how large the ensuing rally will be once an asset breaks out of that consolidation.

The 28 year consolidation in gold is foretelling a bull market rally like no other that any of us have ever seen.

That's not surprising considering the monetary policies now being adopted by every central bank in the world in the attempt to halt the slide into a global depression.

I've posted the Dow:gold ratio many times on this blog along with my feeling that we will again see that ratio hit 1:1.

Actually I don't think we are going to see 1:1 this time. The size of gold's consolidation and the magnitude of central bank stupidity is suggesting that the Dow:gold ratio is probably going below 1. I wouldn't be at all surprised to see .5:1 before this is finished.

The one thing you can count on from a secular bull market, especially a gold bull, is that it is going to go much further than almost anyone expects.

Gold is good but silver is ... too cheap!

I know I've been talking mostly about gold but the real money is going to be made in silver.

The above chart is the ratio of gold to silver. During the crash last fall silver got simply destroyed. Unjustly so I might add. But then silver is a thin market so these kind of swings are to be expected.

Historically silver should trade at about a 20-30 to 1 ratio compared to gold. As of yesterday it still took over 60 oz. of silver to buy 1 oz. of gold. Just like mining stocks silver is stupid cheap.

Ultimately I expect we are going to see another 400-500% gain in gold before this bull market is finished. Silver on the other hand will probably double those gains or more as it works its way back down to a more "typical" valuation compared to its big brother gold.

Now remembering what I said about mining stocks being cheap, what does that say about silver miners?

A rational bull market?

I had a conversation today with an investor who informed me that gold simply couldn't rise in the face of a higher dollar because gold was priced in dollars.

For some reason this investor assumes that bull markets are rational. Rationally speaking a rising dollar should cap the price of gold since it takes fewer dollars to buy an oz.

However let me pose a question. Was it rational that oil continued to rally all the way to $147 a barrel last year despite a dollar that bottomed in March? Oil is priced in dollars after all.

How about the fact that oil continued to rise day after day even though the global economy was already obviously in recession and tankers were sitting in the gulf with no place to unload their oil. Was that rational?

Bull markets aren't rational folks. They are a product of 1. Supply and demand imbalances and 2. Human nature. At some point fundamentals leave off and human greed takes over. Otherwise known as higher prices beget higher prices.

I guarantee you that eventually the course of the dollar is going to become meaningless to gold (it may be already). Those insisting that gold prices be controlled by the dollar are going to get left behind in the dust.

Eventually gold is going to trade on its own supply and demand fundamentals and that will have nothing to do with the dollar. Then at some point further down the line gold is going to trade on nothing more than human greed.

I suggest one ignore the dollar and instead stay focused on gold.