Extremes of Emotion
There are a whole slew of interesting theories about investing that simply don’t work. Technical analysis doesn’t work. Fundamental analysis doesn’t work. Elliott Wave doesn’t work except in hindsight. Robert Prechter spent half of the last decade waiting for $200 gold and he’s made millions of dollars selling books teaching people how to use the Elliott Wave.
Now that I’ve got your attention and have you madder than a wet hen because you know TA works or fundamental analysis works or Elliott Wave works, let me clarify what I mean.
They don’t work consistently. They are aids to investing, not magic wands that you wave over your computer and it spits out $100 bills. I don’t know a single investor who got rich using any or all of them. Most investors confuse brains with a bull market. We are in a bull market. If you buy right, you might profit. It’s not much more complex than that.
But there is one theory of investing that does work absolutely consistently and that is Extremes of Emotion. The really smart guys I know, the filthy rich investors I know and I know a few only, all have read one book and understand it. The book was written around 1860 and has stood the test of time. It’s called “Extraordinary Popular Delusions and The Madness of Crowds” by Charles MacKay.
If you read it and follow what it suggests you might get rich as a result. If you don’t, you won’t get rich unless you go sell a bunch of books on Elliott Wave to unsuspecting investors.
Basically the book shows that people are dumber than bricks and are constantly following guys selling scams. As long as the latest “Guru” tells people what they want to hear, he’ll be popular and they will lose all their money. But the book also implies that if you do the opposite of the mob you will make money. And you will, consistently. All you have to do is find Extremes of Emotion and do the opposite of the crowd. You won’t make yourself popular but you will make yourself rich.
Does it work? Sure. How would you have liked to predict the top in gold in November of 2004? Or the top in silver and gold to the day in March of 2008? I was speaking a few days later at a mining conference in Chicago on a panel that had an arrogant young man who claimed to be the world’s leading expert on silver. He proudly told the cheering crowd that silver was going to the moon and he was buying with both hands. I said we were in for a crash. When silver crashed that fall, the young man lost some of his arrogance and all of his silver. March 17 was the top.
Or the plunge in silver in April of last year, would you have liked to make money on it? Actually half a dozen guys got it right and said it was going to tumble and were mocked by the cheerleaders. It was possible to call the top to the day and some did.
There are a couple of ways to measure Extremes of Emotion. Bullish Consensus is excellent but the services that offer it need to get with the program and start overlaying the BC with the price of the commodity.
In April of this year, the BC on silver was the highest it has been in history, higher than it was in January of 1980 at the last top in silver. When I said that record high BC marked tops in any commodity, I had dozens of parrots telling me why it didn’t matter, silver was going to $5000.
You can also use common sense. Markets go up and markets go down and everyone in investing understands that except GATA. They are convinced themselves and have convinced hundreds of people that silver and gold have to go up every single day and if they don’t, it’s proof of a conspiracy to manipulate the price down.
Gold’s gone from $252 in August of 1999 to $1900 and change in September of 2011. Silver went from $4 in November of 2001 to just about $50 last April. If there is some wicked conspiracy holding down the price of gold and silver, those running the conspiracy are doing such a rotten job of keeping the price down that you can safely ignore all nonsense of manipulation.
You can even count and think about the ramifications. If you understand how markets work, you know markets go up one day and down the next. That’s true of every market. So if something goes up two days in a row, it's more likely to go down the third day than go up. If it goes up ten days in a row, it's really likely to go down the next. And if a market goes up 19 days in row as the Naz did in March of 2000, you better head for the exits, there is going to be a giant crash.
Any Extreme of Emotion marks a turning point and you can ignore TA, you can ignore fundamentals, you can ignore Elliott Wave and you can ignore manipulation. All markets are manipulated. Live with it.
I found one last week, an Extreme of Emotion.
From 1999 until August of 2008, the ratio of the XAU over gold provided both highly accurate buy signals and sell signals for gold and gold shares. Here’s how it works.
The XAU is made up of senior gold shares, everything from Goldcorp to Newmont to Silver Standard and Yamana. Gold is obviously gold. So the ratio shows which is more popular, gold shares via the XAU or gold.
When investors love gold, they buy the XAU. When they hate gold, they sell the XAU. You literally could draw lines on the chart and when either one or the other was violated it gave a clear signal to buy gold and gold shares or to sell. That worked right up until August of 2008 at the beginning of what came to be called the GFC or Global Financial Crisis. During August, September and October of 2008, investors around the world were unloading every share they could sell just to raise cash to make margin calls.
As a result, there were hundreds of gold stocks selling for less than the cash they had on hand. The last time that happened was in 2001 at the bottom for gold shares. So with gold at $695 in late October of 2008, gold shares as measured by the XAU were actually cheaper than they were relative to gold at $255 gold in mid-2001. That’s nuts. Gold shares got hammered in November and December of 2008 with tax loss selling and investors dumping every loser they owned but between October of 2008 and six months later gold and gold shares rocketed higher.
If you want to invest and make money, you have to be a contrarian. If it makes you feel better to whine about how the nasty guys at the Fed and Treasury and every bank in the world are making gold go down every time gold drops a nickel, it may make you feel better but it won’t make you feel richer.
If you want to invest to make money, buy when everyone wants to sell and sell when everyone wants to buy. Right now, at $1662.80 gold, investors are more negative on gold shares than they have ever been in history and that marks bottoms. For both shares and gold.