As gold climbed to its December 2010 all-time high of $1,431 an ounce, virtually everyone believed it would only go higher. Sentiment readings in metals were extreme for much of 2010; they grew more extreme near the peak. As the January 2011 Elliott Wave Financial Forecast reported,
"Several weeks ago, [the net position of large speculators] pushed to an all-time record high, as hedge funds [also] became fully committed to gold’s rise."
Market observers commonly offered the following reasons for gold's rally:
- Quantitative easing in the U.S. and Europe made investors fearful that all that "money printing" would devalue currencies
- Investors worried that Europe's sovereign debt crisis may spread
- Fear of inflation was fuel to the fire
Well, here we are, a month-and-a-half later. "Madman Bernanke" is still at it. Europe's debt crisis remains fundamentally unresolved. Inflationists are still waiting for a Zimbabwe-like collapse.
Yet on January 21, gold fell as low as $1,337 an ounce. So the question is:
Why is gold falling when the same fundamental reasons that made everyone buy it last month are no different this month?
Mainstream analysts can reply with a dozen "reasons." Yes, they might say, quantitative easing continues, but it's designed to strengthen the economy -- maybe it's "not all bad." Yes, Europe is still in trouble, but "they are working on it." Yes, inflation is coming, but "it's not here yet."
Do you know the word for this? It's rationalization. In 2010, people who felt bullish about gold rationalized their bullishness by focusing on the supposedly bullish factors. When the same factors seem less bullish today, the same people rationalize why they aren't.
Emotional bias is as old as investing itself. Consider what EWI's president Bob Prechter said in his December 2010 Elliott Wave Theorist:
On Sunday, December 5, I was in Dallas speaking to a group of savvy money managers... Several of them were keenly aware of the role of market psychology in markets. Still, the only investment comment I received, unsolicited, was “There is only one market I know is going up: silver.” It came from a seasoned, successful investor... I asked what his reasons were, and he mentioned that silver mostly comes as a byproduct of other mining (true), that there are new uses for silver invented every year (true), and that much industrial silver is used up and not recovered (true).
I mentioned that I already knew these things because I read about them 30 years ago, around the time silver topped at $50/oz. Jerome Smith’s book, Silver Profits in the 80’s, cited the following “four primary causes” for a renewed silver boom:
"...electronics industry has exploded [and so] has the...use of silver"
"While demands for silver are soaring, market supplies are declining..."
"Silver production has been far less than consumption..."
“[T]he U.S. Treasury…sold [silver] to fill the gap between production and consumption...in the 1960s and the 1970s. Now it is virtually gone.”
Every one of these statements was -- and still is -- correct. If markets followed the rules of mechanics, silver would have risen to the moon for the stated reasons. But silver had already peaked at $50/oz. two years prior to the book’s publication. To this day, it has not matched its peak price of 30 years ago. Yet the bullish fundamentals...have remained in place the whole time.
Which brings us to gold's almost $100 decline (so far) off its December all-time high. Psychology plays an enormous role in market trends. Investor mood -- bullish or bearish -- sweeps nearly everyone off their feet. They will grasp at every fundamental reason to justify their bullish or bearish conviction.
And when the mood changes and the scales fall away, the "reasons" are still there -- but the world suddenly looks very different.
Market charts reflect these psychological extremes in the form of Elliott wave patterns. This makes markets predictable, within a range of probabilities. Read our latest gold and silver Elliott wave analysis risk-free today in The Financial Forecast Service, our most-popular online subscription package.