Why Prechterian Theory is Wrong
on Gold
Nelson Hultberg
February 5, 2003
Under the rules of Elliott Wave analysis, a bullish trend is determined
by the fact that the price being charted forms 5 waves in an upward
direction. The price movement is comprised of three "impulse" waves
and two "correction" waves, alternating in a sequence of Wave 1 up,
Wave 2 down, Wave 3 up, Wave 4 down, and Wave 5 up. Once completed,
these five waves are then termed a major impulse wave.
This sequence is imperative in order to establish a bullish trend.
If the pattern does not unfold in three waves up alternating with
two waves down, then it is not an impulsive wave pattern, and a bullish
trend has not been established.
For example, if the wave sequence unfolds in a 3-wave pattern up,
it is defined as a "corrective" wave, which means that the primary
trend down previously in progress is merely correcting, and soon
to be resumed. Corrective waves can assume numerous different patterns,
and are often quite messy and difficult to identify. Their defining
characteristic, however, is that their major legs always form three
waves rather than five. I realize this is a very rough explanation
of Elliott Wave price movement theory, but all Elliott Wavers will
know what I'm talking about.
The important point for gold in all this is whether Elliott Wave
theory shows the 20 year bear market from 1980 to 2000 to be ended,
or is gold's bear market merely correcting, and doomed to be resumed
eventually finishing at a lower price down the road? If the last
two years of price action has formed a solid impulsive wave
up, then the bear market is over. If, however, the price action is
forming a corrective wave up, then the bear market is to be
resumed.
The foremost practitioner of Elliott Wave theory, Robert Prechter,
has stated for the past two years now that gold is merely correcting.
The wave pattern up throughout 2001 and 2002, he maintains, is not
impulsive. It is a corrective wave only, and the 20 year bear market
will continue on in the deflationary Kondratieff winter, with gold
eventually selling for under $200.
I am not a card carrying expert in Elliott Wave theory, but I do
understand its basics, having read most of Prechter's books and having
charted countless wave patterns of the Dow, the S&P, the Dollar,
Gold, and Silver, etc. in the markets for the past seven years. I
have the utmost respect for Robert Prechter. His work over the past
25 years in formulating a cogent exposition of Elliott's theory of
price movement is a masterpiece of clarity and understanding. He
has integrated it all into the Kondratieff Cycle theory, and has
added a vast array of prescient insights to further the body of knowledge
that Elliott began. This has enlightened us all in many ways.
But that being said, the primary question is whether gold's bear
market is over. The question is whether the wave pattern for 2001
and 2002 is impulsive or corrective. Is Mr. Prechter
right, or has he perhaps succumbed to a flawed analysis of what is
taking place today? I believe it is the latter, that he has made
a wrong call on gold, and that the price action of the past two years
is indeed impulsive.
To get a better grip on this, we need to view the chart pattern
of gold on a monthly basis. Below is a clear depiction of it that
appeared in John Murphy's January 27th article here on Gold-Eagle
entitled, "Gold Bull Market is Based on More than Iraq." It shows
prices forming a double bottom in August of 1999 and April 2001,
and then an upward 5-wave pattern that is bullish, i.e., impulsive
beginning from there.
Price waves, of course, can be interpreted in numerous ways depending
upon who is doing the interpreting. But I think we can find an impulsive
technical pattern here that, when combined with the fundamental picture
for gold, becomes pretty much irrefutable.
If we consider the above price pattern as a double bottom, then
impulse Wave (1) up begins in April of 2001 at $255 and takes us
to about $290 during the month of May 2001. Correction Wave (2) then
commences and takes prices down to $265 by July of 2001. From there,
a subdivided impulse Wave (3) begins and takes prices to $330 in
June of 2002. From there, correction Wave (4) commences and takes
prices back to $298 in August of 2002. From there, impulse Wave (5)
begins and takes prices to the $360-$370 range that we are now in.
This is as clear a 5-wave pattern as any chart technician could
ever ask for. It is a perfect 5-minor waves up, which will form major
Wave 1. The entirety of major Wave 1 is either ending now (and due
for a correction), or it is still unfolding with its fifth segment
perhaps due for some more upside movement, maybe even as high as
the $400-$410 area before correcting down, and then heading up again
for major waves 3, 4 and 5. This is James Sinclair's reading on it,
and it makes for a powerfully bullish case in a technical sense.
The importance of this is that the price action is IMPULSIVE! It
is comprised of five clear waves rather than three. We have the beginning
of a bull market price pattern that adheres to the rules of Elliott
theory. It confirms technically the clear bullish fundamentals that
have been unfolding for the past several years.
The only technical foothold that Prechterians have to cling to for
their bearish case is if the entire price movement from August 1999
to January 2003 can be construed as an A-B-C correction. This, I
am assuming, is how they read the price action of the past three
years. If one looks at only a chart and its configurations, then
this is one possible interpretation. But why use only a
chart and various technical indicators for one's guidance? Are
there not other tools to incorporate into one's analysis that will
clarify whether gold's price action is corrective or impulsive? When
the waves indicate that either scenario could be unfolding, is there
a way to determine which one has greater probability? Yes, there
most indubitably is. We must examine the fundamentals. What they
are indicating will confirm the wave pattern as either bullish or
bearish, which will give us much more certainty.
Fundamentals Versus the Technical Charts
This brings us to one of the most important issues in market forecasting
-- the question of whether we should place more importance on the
fundamentals of the market, or whether we should concern ourselves
more with the technical chart patterns. Which methodology is the
better tool with which to get a handle on future price action? And
do we dare rely solely on one or the other? This debate has been
waged over the past century by many colorful and profound intellects,
and it no doubt will continue to be debated well into the future.
Many technical advocates (e.g., hedge funds) actually pride
themselves on being totally unconcerned with "fundamentals." They
churn out prodigious amounts of numbers from their computers, which
guide them in their decisions. They don't care what the fundamentals
are, because they feel the fundamentals are far too convoluted a
mess for any human to interpret effectively and incorporate into
a workable strategy. Mathematics, being clean and simple, is their
chosen tool; and their little computer boxes automatically make
their decisions for them. This eliminates the subjective element
of the human mind and makes for a much more workable forecasting
tool.
Many fundamental advocates think just the opposite, and maintain
that all the fuss over technical charts is either pure subjectivist
hooey if humans have to interpret it, or such information is just
too late in coming to the investor to be of any meaningful use in
fast changing markets. Such advocates prefer to concentrate on getting
a grasp of the major fundamentals of the market in which any particular
investment operates (e.g., supply and demand, corporate earnings,
Fed policy, geopolitical concerns, etc.), and then to buy or sell
according to what the sum of those fundamentals indicate. Only in
this way, they maintain, can one make adequate decisions as to future
price movements.
I myself am basically a traditionalist, and believe that fundamentals
are the more important tool. They must always be taken into account
first, and then if one wishes, he can supplement his strategy with
chart analysis. Technical chart analysis is a marvelous way to get
an overall picture of where one is in any price movement scenario,
and there are numerous chart theories complete with dazzling indicators
to pick from, Elliott Wave being one of the best. But technical wave
analysis ALONE is like trying to sail the oceans with a map indicating
islands and reefs, but without a radar system to be forewarned of
impending storms and icebergs. (We will come back to this map vs.
radar example later, so remember it.)
Both methodologies are necessary if we are to really achieve high
accuracy. But fundamentals always come first. Know the supply and
demand configurations, get a grasp of what the Fed and the monetary
authorities are doing, stay abreast of the relevant geopolitical
events, etc. and one can quite often pull off profitable trades and
investments.
Gold's Bullish Fundamentals
This is why gold has such powerful potential at this juncture in
history. Its fundamentals are incredibly bullish: 1) There is a deficit
every year in production, so the supply and demand ratio is favorable.
2) The Fed has indicated that it will print up paper dollars and
drop them out of airplanes if necessary to avoid deflation. 3) Our
nation is running the largest trade deficit in history. 4) Congress
has embarked upon massive deficit spending. 5) American citizens
are in debt up to their eyebrows. 6) Many major banks are involved
in highly dangerous derivative trades that could come unwound. 7)
Terrorism grows with every year to wreak havoc in the minds of investors
and create a world rife with insecurity. 8) Third-world countries
are honoring their debts like Hollywood stars honor their marriages.
9) We are no longer a producer nation, but a mass of pampered consumers
with a gang of counterfeiters leading us from Washington. 10) The
dollar has entered a bear market that should extend for several years.
The chain of bullish fundamentals acquires new ominous links with
each passing month. It points to $500-$600 gold near-term, and quite
possibly much higher long-term.
But still, there has always remained in the back of many investors
minds who follow Elliott Wave analysis, a fear of the bearish scenario
that deflation portends. With Prechterian newsletters shouting every
week for the past two years that "Gold is topping," and maintaining
that the upward waves of 2001 and 2002 are "clearly corrective," these
investors have remained pulverized on the sidelines, and some of
them even short in the market.
In my opinion, this is clearly wrong. The chart above (when combined
with all the fundamentals of gold) strongly indicates that
the upward waves of 2001 and 2002 are NOT corrective; they are
impulsive. The bottom for gold is in. We have a bull market. It
will be volatile and messy. It will involve corrections that drive
us to despair. And it will climb an endless wall of worry. But
we have the beginnings of a classic bull market.
Only if we combine the fundamentals and the technical chart
data, however, can we arrive at this much certainty. Since Prechterians
do not believe in the importance of fundamentals, they cannot see
this certainty. Thus, they interpret the price action over the past
three years as corrective with the bear market to be resumed.
This kind of sole reliance upon wave patterns and technical indicators
is like going into a fight with one hand tied behind one's back.
Is there anything that could possibly sabotage the bullish case
for gold? Yes, if the dollar somehow rallies because of severe deflation
in the upcoming years. This is a possibility, of course. But it is
difficult, in face of the Fed's announced intentions recently, to
envision any kind of sustainable rally for the dollar. Unless the
Euro and the Yen somehow start depreciating faster than the greenback,
it looks like 70-75 on the charts for Greenspan's "US Peso." The
rest of the world's nations will probably embark upon a rash of competitive
devaluations in the upcoming years so as to try and achieve an advantage
over their neighbors in the export business to the US. But will they
be able to outpace the dollar in depreciation, thus creating a sustained
dollar rally? Highly doubtful. America's trade deficit will force
the Fed to compete in the depreciation game. This will put all major
currencies into the toilet, and it will push gold upwards to $500-$600,
and then who knows how much higher?
Understanding the Primary Causes
To the Elliott Wave purist, such fundamental events are superfluous
and irrelevant. The waves are all that are important. They indicate
the future and are brought about by the psychological mood of investors.
This latter point is certainly true. Investor mood moves the market
and determines the wave patterns that prices take. But what is
it that causes the psychological mood of the investing public? It
is not a given. It doesn't exist as a primary. Investor mood is caused
by something. In my opinion (and in the opinion of a whole bevy of
highly astute analytical minds going back many decades), investor
mood is brought about by a myriad of fundamentals acting upon the
human minds that comprise the marketplace. It is the summation of
all these various fundamentals in the millions of investor minds
every day (supply and demand, corporate earnings, monetary growth,
Fed policy, wars, tragic events, corruption, debt overload, etc.)
that determines the mood of the investing public. This psychological
mood does indeed form waves, and therefore it can be charted. But it
is not primary! It is derivative. That is to say it is derived
from the fundamentals that comprise everyday life.
According to Prechterian theory, though, it is just the other way
around. As Prechter sees it, fundamentals are brought about by the "psychological
mood" of the public. Thus, Elliott practitioners' insistence on charting
this mood via wave analysis. They maintain that they are tapping
into the primary force of the market with their wave counts,
and that this will lead one to the best possible forecast for future
price movements.
But if this is so, then they still have to answer the question, what
causes this psychological mood? And once that cause is identified,
would it not then be the real "primary" force to tap into? All
phenomena of the universe are caused by something. They do not
exist axiomatically. They are brought about by preceding causes.
This is basic science -- cause and effect. It extends to all phenomena
of the universe. Therefore, Prechterian theory is flawed in that
it appears to consider "psychological mood" as a given and does
not try to explain it's origin.
Traditional fundamental analysis, on the other hand, does explain
the origin of the investing public's psychological mood. It
does not consider it to be a given. Investor mood is brought about
by the vast coalescence of fundamentals in the minds of millions
of investors that make up the marketplace. Investors then bid prices
up or down depending upon the mood that results from their interpretation
of these fundamentals.
Are the fundamentals then primary? No. They are caused by human
action guided by all the various drives of human nature -- ambition,
love, power lust, greed, security, etc. Investor mood moves the market,
but it is fourth in the cause and effect chain. For example:
Human nature [creates] human action [which creates] fundamentals [which
create] investor mood [which creates] price direction.
Even human nature is not primary, though, because it comes from
something. But to go beyond this basic cause and effect chain is
to enter into fields such as sociology, physiology and metaphysics,
which serves no useful purpose for our analysis here. So for investing
theory, we can safely make good old human nature our primary.
To sum all this up then, both fundamentals and technical
chart data are important. But fundamentals are more important
than the charts and technical indicators because they cause the mood
that is reflected in the charts. And that is why we must always be
concerned with as sophisticated a grasp of the fundamentals as our
minds can encompass. This is most difficult to do, but it is the
requisite for any successful venture in investing, and for that matter
in life itself.
The Power of Fundamentals
It should be stated here that Elliott Wave theoreticians do concede
that certain fundamentals (such as tragic events, interest rate changes,
etc.) can at times alter investor mood, but they maintain that such
causation is only of very minor, short-run importance. It is of no
consequence for the long-term unfolding of price movements. And therefore,
they insist that concern with fundamentals is not necessary.
If one accepts this premise, however, it means that when the Fed
signals it is going to become very accomodative with its printing
press, as Bernanke recently did, such a fundamental event (in both
its announcement and in its implementation) will have no long
run effect on the mood of investors for the dollar and precious
metals. In other words, telling all investors around the world that
the Fed will trash the dollar to avoid deflation, and actually implementing
that trashing, are merely "mundane affairs" in the routine of modern
day living that we need not concern ourselves with. These affairs
will not change the mood of the public for more than a few days or
weeks at best.
It should be obvious that this is totally untrue. This fundamental
(Bernanke's signal), and its implementation via monetization, when
combined with other fundamentals such as 12 rate cuts, massive trade
deficits, etc., have in fact set the mood for the currency and precious
metal markets for many months, and probably years, into the future.
These fundamentals are the primary causes of the dramatic mood swing
that has taken place in the minds of the big money investors throughout
the world, and which are causing them to now shift assets into the
gold market. These fundamentals are massive straws that have broken
the back of world confidence in the dollar. These fundamentals are
the salient dominos that will set off scores of other fundamentals
to swell the investing public's bullish mood for gold in the upcoming
years. To claim otherwise is mystifying indeed.
Recall now the above analogy I used about a map and radar at sea.
In 1993 the Prechterian wave map showed its true believers
that the Dow was topping. But because Prechterians eschew fundamentals,
they were at sea without any radar system. This caused them
to miss the raging "fundamental" storm of inflation hidden behind
the Clinton-Rubin dollar policy, which signaled a coming bull market
for equities for the rest of the decade. The Prechterian wave map
with its technical indicators showed them only a partial picture.
If it had been combined, however, with the radar of fundamental analysis,
the two methodologies together would have shown them what was actually
happening. Are Prechterians making the same mistake again in
the gold market? I believe they are.
To further demonstrate the power of fundamentals, we need only to
consider the Kondratieff Cycle. Is it not brought about by a fundamental
policy? Is not its linchpin the practice of fractional reserve
banking and the inflation that such banking policy subjects an economy
to? Without inflation, we would not have a Kondratieff Cycle. Does
this not then make fundamentals of prime importance that are causitive
agents that drive the mood of the market? Yes, I believe it does.
Fundamentals matter! We can change them via human action, and therefore
we can alter the mood that forms the Kondratieff Cycle itself, and
thereby change its alleged "inevitability." (See my previous article, "How
the Kondratieff Cycle Might Play Out.")
Herein lies a lesson that humans have been learning and relearning
for centuries. Truth does not come easily packaged with all the t's
crossed and i's dotted. It is a Herculean task to decipher the markets.
It takes more than charts and technical indicators. There is no one
simple tool or array of tools that will ever absolve us of the necessity
to encompass as many of the fundamentals as we can into our minds,
and then combine the knowledge of such fundamentals with all our
experience and all our intuitive skills to anticipate the path that
prices will take. Fundamentals are paramount. Any analysis devoid
of their guidance will ultimately prove to be flawed.
(This article is for general information purposes and not intended
as specific investment advice. I am not a registered investment advisor.
Investing in equities, precious metals, and futures entails risk.
Do your own due diligence.)
© 2003 Email Nelson
Hultberg .... Author's Bio .... More
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