Elliot Wave Theory and Gold

Two otherwise compatible schools at odds

November 7/2002

It could easily be a story of "two against the world", Gold Bugs and Elliot Wave theorists standing shoulder-to-shoulder, shouting into a hostile headwind of mainstream denial. The two are in agreement on so many things: Equities are in a fundamental bear market, both put a premium value on owning physical gold and silver, real estate is bubbling and the USD is circling the drain. Elliot Wavers insist deflation is imminent, GoldBugs feel safer than most. Inflation? Deflation? Either way an ounce still buys a good suit, gold is money, paper is, well, paper.

It looks like a match made in heaven, this week on Gold-Eagle.com appeared the article Gold Trends - Elliott Wave Analysis, which was a written by technical analyst Clive Maund and made the case that we are currently riding out the end of Wave C in an A-B-C corrective wave and about to embark upon another impulsive 5-wave up. Its all well reasoned and accompanied with charts demonstrating a clear 5-wave up from about January 2002, followed by a corrective A-B-C wave which bummed us all out over the summer, bringing us to now, about to finish off wave-C (which may take us back down to support in the $300/oz area) and then its lift-off time for the next leg up, 5-waves.

Which is all fine except it is in total conflict with the current "orthodox" Elliot Wave Theory view on gold, which is that gold is still in a secular bear market, is right now finishing wave 2 in a corrective rally, and is about to embark on a long long wave 3 down. Current Elliot Wave thinking by the priests of the temple at EWI calls for gold to end out a 22 year bear market somewhere around $200/oz:

"Our bearish stance is surely a minority view, as we keep reading progressively higher forecasts for the metals. The wave pattern is unchanged. It calls for an eventual move below $200 prior to end the 22-year bear market. Primary wave C down started at the $333 high of June 4 or will do so from slightly higher resistance (the maximum potential remains the $360 area)."

The Elliot Wave insiders will not deviate from that position. The technical basis for it is that gold should pull back the area of wave 4 of one lesser degree and their current wave count puts that at under $200/oz. In the message forums on EWI there is a post dated Aug. 7/2002 entitled "Could we be looking for a wave 3 rally in the XAU? ", the author is basically positing the same wave count as the aforementioned Gold-Eagle article. The answer from EWI's Tom Denham is short and sure: No. The advance was not impulsive, the overlap between the waves was too large, the rally was corrective. Some hardline converts to Elliot Wave Theory have so completely bought into this view that they have gone so far as to liquidate profitable precious metals positions to await the coming crash in the POG.

Fundamentals & fear: are they chickens or eggs?

While I find Elliot Wave theory both compelling and fascinating, I would not be exiting gold positions unless gold breaks down below $300 or so. While still a fledgling at Wave Theory I can't reconcile myself with their bearish outlook on gold. Is my own wishful thinking intervening? I don't think so. There are too many fundamentals buttressing the price of gold. The USD is another area where Goldbugs and Wavers concur: it's going to hell in a handbasket. Wavers are waiting for a similar long, hard, bearish wave-3 down, down, down, and that will inflate the POG.

Fundamently, and this may be simplistic reasoning, but gold may become the investment class of last resort. Since equities suck and will for a long time, bonds are turning into garbage, and real estate is bubbling towards a blow-off, where else will there be to go? The fundamental economic outlook smells uniformly dismal across nearly all geographic areas and asset classes, and all this has a recipricol effect on precious metals.

Then there's the four-letter f-word: "fear". While Wavers hold that market movements are the result of mass psychology and goldbugs concur that fear moves markets; outside of the CNBC prattleheads talking "New Bull Market", fear is widespread and it moves gold up. A drop to $200 gold would have to mean a worldwide euphoric explosion of optimism and between Iraq, Israel/Palestine, terrorism, random snipers, shoe bombers, Worldcoms, Enrons, anthrax letters and suitcase nukes, there are just too many wildcards keeping everyone in a state of perpetual red alert. For gold to drop to $200 it would mean that everyone is in such a good mood that all of that would have just somehow "gone away".

$330 is the near term key...

Where the two camps are in agreement is on this: the picture changes above $330. Goldbugs consider that level the "line in the sand" drawn by the shadowy sinister Central Banks and gold shorters, when gold decisively takes out that level derivative positions collapse, short squeezes ensue, paper plummets and gold soars. For the Wavers, who believe that the price of gold (and everything else) is governed by mass psychology, and Central Bankers couldn't control it even if they wanted to, gold taking out $330 will at least warrant another look at the ole wave count.

Guess we'll all see...

Further Reading:

The Elliot Wave Principal - The classic text you should read first when delving into Wave Theory.
Conquer the Crash - Elliot Wave Theory and the coming deflationary crash it predicts.
Gold Wars A great overview of the underlying factors behind gold as money (or paper as money) Read my review of it over here.

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By Mark Jeftovic, Nov 7/2002 © 2002 MyGold.ca All Rights Reserved