Decline Ahead? TGR Interviews Steven Hochberg, Elliott Wave Intl.
Source: The Gold Report (1/25/07)
Steven Hochberg, a close associate of Robert Prechter and Chief Market Analyst for Elliott Wave International in Gainesville, Georgia, is also co-editor of the financial newsletter The Elliott Wave Financial Forecast and Short Term Update. Here The Gold Report gets his latest insights on the outlook for gold according to the Elliott Wave Theory.
TGR: Gold is now climbing back toward $640 (Jan. 19). In December’s Elliott Wave Financial Forecastt, you noted that there were several possible interpretations of gold’s next larger degree pattern and stated that a decline to correct the recent rally, at the very least, is now due. With gold’s recent uptick, do you still foresee a decline in the price of gold? As you mentioned in the December Forecast, you noted that a decline below $580 would signal, in essence, a decline in the range of $450. Do you feel such a steep drop is likely?
SH: Yes, the most probable path for gold is a further decline from the May peak. Gold’s rally from August 1999 to May 2006 ($728) traced out a clear Elliott wave, which is a five-wave form comprising three up moves punctuated by two intervening down moves. So the entire sequence is up-down-up-down-up. Gold's first up move from the August 1999 bottom ended in October 1999. The first down move bottomed in April 2001. The second up move of the sequence topped in December 2004, while the second down move ended in July 2005. Finally, the last up move carried gold to a peak of $728 in May 2006 (basis the daily continuation contract).
Under the Wave Principle’s tenets, once five waves are complete, the market in study will undergo at least a three-wave correction. The highest probable target area for this correction is the area of the previous fourth wave (within the five-wave form), which in gold’s case is $410-$456 (basis the daily continuation contract). This is the area that was formed by gold’s sideways move from November 2004 to July 2005. In percentage terms, this area also encompasses a 50% retracement from the 1999 low, as well as marking the point of the previous technical “breakout,” which was formed by gold’s highs in 1990 and 1996. So there are sound technical reasons to expect a decline toward the range around $450, as we’ve stated in our analysis.
Equally important, sentiment remains relatively benign toward the potential for a $150-$200 price decline: virtually no one expects it, which ironically is one of the psychological preconditions that make a sell-off possible. It won’t be a straight shot toward this target, and initially prices must contend with a support shelf that has formed around the June and October 2006 lows surrounding $565. But once this support shelf breaks, prices should accelerate lower. There is greater bearish potential than even a decline to around $450, but we won’t know for certain until we see the technical make-up of the sell-off toward this level.
TGR: What are the cultural and economic conditions that would indicate an imminent rise or fall in the price of gold?
SH: Economic conditions have nothing to do with when and how gold moves. For example, most people view gold as the ultimate inflation hedge. Yet suppose you knew for certain that inflation would triple the money supply over a period of 20+ years. What would you expect gold prices to do? Most gold investors would expect the price to soar. Well, from 1980-2003 M1 more than tripled, and gold prices lost over 50% of their value.
The single most important factor in determining major gold moves (or any market move, for that matter) is an extreme in investor optimism or pessimism, one that is widely shared. When nearly everyone is looking one way, they have already acted, so the market has a limited potential to continue the trend and a large potential to reverse it. The day of gold’s May 2006 peak, 95% of gold traders were bullish based on the Daily Sentiment Index survey of traders. When only 5% of gold traders think prices can possibly go down you have as strong a one-way opinion as one will ever find. From the May top, prices dropped over 20% in just four weeks. When there is an equally deep pessimism with respect to gold’s prospects, it will signal that a solid bottom is near. The market is not yet at this point.
TGR: What is the single-most important differentiator that sets the Elliott Wave Theory apart from other predictors of economic behavior?
SH: One of the Wave Principle’s greatest strengths as a forecasting tool is that it looks forward, as opposed to the economic statistics that you see on financial television and read about in the paper that look backward at what happened in the past. Trying to gauge future economic behavior by analyzing past data is akin to driving down the highway while looking only in the rearview mirror. This type of forecasting would work well if the market was a machine that adhered to the rules of physical systems: input A plus B gives you output C. Markets, however, do no operate in this manner. They are social systems that reflect the behavior of people who rarely adhere to linear trends.
The Wave Principle, on the other hand, looks ahead to assess future probabilities. It identifies the market structure, which implies something about the future. By knowing the wave patterns, you’ll know what the market is likely to do next and (sometimes most importantly) what it will not do next.
TGR: In what respects (if any) do the predictors regarding the behavior of the stock market differ from those for the market for precious metals?
SH: There is no difference. The behavior of the crowd is the single most important factor in predicting the direction of any freely traded market. Crowd behavior is crowd behavior. People, en masse, become more optimistic in a patterned way when the trend rises, and they become more pessimistic in a patterned manner when the trend declines. This was one of R.N. Elliott’s most important discoveries as he formulated the Wave Principle.
He saw the same pattern in silver as he did in stocks and in bonds and commodities. Elliott said, "You know what? I’m not looking at a market that reacts to the events of the day, because I'm seeing the same patterns evolve in stocks as in bonds and other markets that disparate news might affect differently." What he discovered is that there is a natural element to the human development of social psychology that is consistent across markets and that creates the same patterns.
Elliott discovered the “model” of financial markets, which takes the form of a patterned fractal (an overall pattern that is made up of similar versions of the same pattern, like a branch of a tree that has the same shape as the tree itself). So as Elliotticians, we look at similar factors, namely, the patterns that crowds display, whether we are trying to predict gold, stocks, oil or the Euro Bund. Our only precondition is that the market in question must be freely traded.
TGR: How far in advance of a definitive market shift or price movements do the social and cultural trends manifest themselves?
SH: That’s a great question that is not easily answered. Crowd psychology, which we also call social mood, and the price behavior of stock indexes are manifestations of the same social forces. There is a constant ebb and flow of these forces and their expression through social action and through stock price behavior. The Wave Principle, which is the form that social mood takes from extreme optimism to extreme pessimism and back, is not time-sensitive. A change of trend occurs when a pattern is complete and not a minute before nor a minute after.
TGR: Are conditions right for a bear market in the near term? Is the Elliott Wave Principle best suited to predicting bull or bear markets?
SH: Not only are conditions right, but there already is a bear market in the major stock indexes when viewed in terms of real money. From 1980 to 1999, stocks rose in terms of paper dollars, gold and commodities. Since 1999, a historic shift out of stocks and into hard cash or “things” has been underway. Relative to gold, the Dow is down 55% and the NASDAQ is off 77%, with new lows made in 2006. Similar stock market behavior occurred from 1966-1980, a time period that included a decline of 50% in the S&P 500 index.
The Dow is at a new high in nominal terms due to credit inflation, which has allowed the index to stay up because the measuring unit (the dollar) is falling. Historically, whenever a discrepancy between the performance of the Dow in real terms and the Dow in nominal terms develops, the Dow in nominal terms always plays catch-up to the Dow in real terms. Thus, before the bear market in stocks ends, stock prices should be down in nominal terms, too.
Since the Elliott Wave Principle is a direct manifestation of crowd behavior, it is eminently suitable for predicting market moves – both bullish and bearish.
Steven Hochberg began his professional career with Merrill Lynch & Co. and joined Elliott Wave International in 1994. He quickly established a stellar reputation providing real time intraday market forecasts to institutional traders and hedge funds covering dozens of world markets for Elliott Wave’s Institutional Outlook services. He became co-editor of The Elliott Wave Financial Forecast for its inaugural issue in July 1999.