THE BULLISH ELLIOTTICIAN
In the annals of the discourses of men, we occasionally come across statements that seem almost prophetic in their nature and accuracy. Most men may disdain them whilst a minority accept them. But like the imprisoned John the Baptist, the prophesier himself may also doubt his previous utterances.
Consider then this statement from Bob Prechter in his book "At the Crest of the Tidal Wave" (3rd edition 1995 p.351). Here he is discussing the relevance of fibonacci numbers in timing the end of the gold bear market:
"One attractive termination date for wave Y would be New Year's Day of 2001 (+/- a month). That way, it will have lasted a fat 5 years from 1995, a lean 21 years from the 1980 peak, and 34 years from the 1967 bottom."
Six years on from that quote and a fibonaccian 21 years since the end of the last golden bull, gold prices fell and then fell a bit more past January 1st 2001 and hit a bottom of $256 the following month on February 20th. Thereafter, the gold market embarked on a 34% surge from $256 to $389 before falling back. Such is the power of the Fibonacci number sequence, but Bob Prechter does not believe his past prediction and continues to favour further falls to below $200.
But as he says himself, price movement is more important than time movement. To shed some light on the matter, here is the bearish Elliott Wave analysis advocated by the likes of Prechter, though no doubt there are variations on the same theme.
The scenario proposed before us is a massive W-X-Y double zigzag which is now in its final but severe descent into what is believed to be the price range of the fourth wave of the previous bull market (as shown by the parallel lines). That range is about $100-$200 dollars and that prospect undoubtedly makes the eyes of every gold bull glaze over.
However, the wave that has run for the last two years is bullishly impulsive. In the diagram above, this should be the 'B' wave of this final 'Y' wave. Now, B waves are never impulsive, so where does that leave the bearish advocates? The answer is suggested in the rather complex medium term diagram below.
The huge spike generated on the declaration of the Washington Accord is taken to be the start of this B wave with this recently completed impulse wave being its sub wave C. It is interesting to note that on presenting this analysis in November 2002, Elliot Wave International had placed the rightmost B wave above as ending on June 4th 2002 and gave a maximum potential for this final impulsive wave as $360 (i.e. a fibonacci 61.8% retracement of the drop from 1996 to 2001). As it turned out, the bull wave surged on another $29 and the entire bull from February 2001 retraced a full 80% of the previous down wave! Elliott wave prediction can be a dicey game at times.
So, is it all cut and dried? Can we all go home and forget about gold for the next three years or so until it hits $100? No, not until we have addressed several matters that remain unanswered in this arena.
Deflationary Collapse
Whatever may be said about the isolated nature of technical analysis in general, it is never divorced from the fundamentals. For example, when those planes hit the World Trade Centre, there was only one possible outcome on the NYSE and that was down and down. The fact that the major indices were in a downward Elliott wave at that time was no coincidence as Elliott Wave theory predicts and tracks social and economic moods in ever expanding time frames. But, on September 11th, any bullish Elliott interpretation had to be jettisoned when contrary fundamentals came painfully to light.
And such is the case with gold. If gold is allegedly at the start of a serious down wave (as $389 down to $200-$100 would obviously be) then that would imply a serious fundamental problem in the world of precious metals. In harmonising the technical-fundamental symbiosis, Elliott gold bears have looked to a deflationary collapse in the Western economies as the parallel fundamental that drives gold down to its final lows.
The problem is obvious to all. The alleged and final C wave is now in progress according to the bears but where is the deflationary collapse that drives it? That doesn't mean I deny such a thing may happen. My argument is that no such deflation was on the economic horizon as gold dropped from $389 to $322 recently. That $67 fall constitutes at least 20% of a crash down to $100 yet no whiff of a deflation in sight! The fundamentals and technicals are not singing from the same hymn sheet here.
A deflationary collapse may come, but such an event is only possible via a cascading series of bank failures and an impotent Federal Reserve watching on in tears. This has not happened yet and is therefore not the driving force behind gold's recent drop. So where is the major fundamental that is to drive gold down to more than half its current value? It is not there and we must firstly doubt the bearish interpretation on that basis.
(In the fairness of open debate, there is only one other bearish fundamental I can think of that could drive gold so low and that is massive selling/leasing of gold by the central banks. However, since the 1999 Washington Accord restricts such large selling, this fundamental has to be discounted as well (indeed, one wonders whether such selling could drive gold down to $100).)
Internal Elliott Structure
The second question concerns the structure of the W-X-Y double zigzag in the 1980-2002 chart above. Some doubts arise over its form as certain statistical features from Richard Swannell's work at Elliott Wave Research indicate.
Firstly, the double zigzag formation itself is rare as a corrective wave. How rare depends on whether the corrective wave is a Supercycle wave 2 or 4. If it is a wave 2, then statistics suggest this only occurs in about 10% of data samples. If it is a wave 4, it is even more rare with a statistical frequency of 3%!
Secondly, their work showed that for long-term commodity bear markets, an X wave was only found to be a contracting triangle in only 6% of their data samples.
Thirdly, analysis showed that the W, X and Y waves have certain common proportions in terms of time duration between each other. In the first chart above, the X wave is 5.4 times bigger than wave W and 1.9 times longer than wave Y (at most since Y is still allegedly unfolding). The X to Y wave ratio is within "normal" parameters, but the X to W ratio is way off the scale and therefore suspect.
So, the Prechterian view consists of a rare W-X-Y wave with an X-wave that has yet another rare sub-structure and rare time duration. These observations imply that we should be looking for an interpretation more in line with past statistical probabilities.
Probabilities and Interpretations
Note that I am not saying that someone as skilled in Elliott Wave analysis as Robert Prechter is technically wrong. Indeed, for a man of his expertise, one expects him to be erudite in such an art.
But the world of Elliott Wave analysis is one of probabilities and interpretations (as indeed the world of fundamental analysis can be to a certain extent). One can present a graph that obeys all the rules of wave formations and stands on its own in that respect. However, it is an interpretation that almost certainly will be competing with at least one alternate view. By alternate views, I do not mean views that are diametrically opposed (this is a 21-year gold bear market analysis versus a probable 26-year one) but rather sufficiently diverse to alter investment decisions.
In the context of differing Elliott exegesis, one has to resort to "exogenous" data sets to decide which pattern is the most probable. In this article, such data sets are fundamental and statistical data and I hope I have presented them in a way that invites us to look at other Elliott analyses of the price of gold over the last 23 years.
Alternate Patterns
Robert Prechter admits to alternate gold analyses and presented some in his book, "At the Crest of the Tidal Wave". Having pointed to the rarity of his double zigzag interpretation, statistics show that the overwhelming majority of corrective waves take the form of an A-B-C flat or zigzag (in fact, about 80%). Here is my preferred wave form based on those statistical frequencies:
I feel this is a more defensible interpretation that fits the statistically proven proportions better in terms of price and time movements. The only problematic wave may be wave 1 of C that looks more like a corrective wave but the form does not violate any rules. I would say though that every interpretation I have looked at tests the boundaries in at least one point.
The Current Situation
With these competing interpretations in mind, where do we stand in the gold market? The graphs below displays the recent price move down as well as the overall picture since 2001.
Note that I take the beginning of the bull market to be February or April 2001 and not the previous drop to the $255 area in 1999. I deduce this for two reasons:
- A bull market beginning in 1999 would imply the surge from $255 to $330 was nearly fully retraced back down to 2001. Such near 100% retracements are almost non-existent in long-term commodity bull markets and must be therefore suspect.
- A look at the HUI and XAU gold equity indices shows that they began their potential bull markets around late 2000. Since there is a high correlation between gold and its equities, it is more probable that there was only four or five months between their bull market births rather than nearly 15 months.
From a bullish or bearish point of view, the recent drop from $389 is within "operational parameters". My view that this is a current Cycle Wave 2 correction would allow for a retracement of the preceding wave 1 impulse of anything up to 80% of its entire move from $255 to $389 (i.e. 0.8 * (389 - 255) = $108 drop to $281) but with the most probable corrections being 35% or 50% ($342 and $322 respectively). At the time of writing, the spot price of gold had hit a short term low of nearly $322 which is bang on the 50% fibonacci retracement. Since I expect the time duration of this Cycle wave 2 to be on average about 20% of the entire time of the Cycle 1 wave (which was about 2 years) then we could foresee this correction bouncing around for about four to five months which would point to a resumption of the bull market around June this year.
In that case, I would expect an intermediate B wave of our overall correction to begin soon. The timing of that depends on whether this current A wave is impulsive or corrective. If corrective it has probably finished, otherwise it has one more down leg to go. If it has one more down leg to go, then we must think about a 62% retracement to $306. Since wave 1 in the short term chart above is bigger than wave 3 ($389-$342 versus $357-$324) then wave 5 will be no bigger than wave 3 and hence will hit a maximum target of $33 down from the presumed wave 4 top of $339. This coincidentally brings us to the 62% retracement of $306. The B wave could then retrace up to 38% or 50% of the entire A move before the final C wave down which would probably go back down to $322 or $306.
Thereafter, the gold bull would embark on Cycle wave 3 that is usually the longest wave in terms of price movement. A move of up to 100% to 250% of wave 1 can be reasonably expected which would take us to as high as $641 by 2004 or 2005. My gut feeling however is that the biggest move will be on the final Cycle wave 5 towards the end of this decade (as it was with the last gold bull market in 1979).
Conclusion
So much for analysis, but the question remains as to when one would be sure that the bullish or bearish Elliott analysis has finally prevailed over the other? At one level, the answer is clear, the bull model is invalidated if we drop below $255 and the bear model is invalidated if we move about $389. Closer to home, a move beyond $342 would invalidate the Prechterian view (because our wave 4 above would have breached the price territory of a wave 2). However, such a move would have to happen pretty quickly. Beyond that, a move up and beyond $360 in the new month or two may well confirm the bullish scenario, but a move beyond $390 remains the clincher in Elliott terms.
Advocates of a bullish or bearish Elliott wave scenario will both still be confident of their respective interpretations. How that will be resolved will be decided in the next few months. The current fundamentals and past wave statistics do not favour the bears but the bulls will no doubt feel nervous as gold continues to correct its recent highs.
All I can say at this point is, may the best interpretation win!
"Ichthys"
tiny@cogitate.freeserve.co.uk
7 April 2003
First three charts courtesy of Sharelynx website.
Last two charts courtesy of StockCharts.com.
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