This article was written by Plunger
Over 2 years ago I presented my first analysis of this precious metals bear market. After extensive study of the characteristics of past bear markets I forecast a brutal bear market that would undergo three psychological stages. The third stage would be a wrenching decline that would ultimately reach levels so shocking that it would cause the destruction of the gold investment class.
My analysis, which was dubbed Plunger’s Flush, was met not just with skepticism but outright derision. I believe I know how Galileo felt.
Two years hence, this analysis has proven itself. We have now entered into phase III of a bear market, wherein the bears, held at bay for four years, will now have their way with the Precious Metals. They will now perform their function of clearing out the accumulated mal-investment, built up in the preceding 10 year bull market.
At the time of my first writing, when I presented my initial analysis, it was not polite to use the word “Bear Market” since consensus belief still regarded the gold bull to be active. The market was considered to be in 'a pullback of an ongoing bull market.' Therefore, my forecast of a crushing decline was met with universal skepticism and ridicule. Investor sentiment was not prepared to accept the reality that the sun had set on the precious metal bull market and a full course bear market lay ahead. My forecast was derived from my study of the process of development of bull and bear markets. I see little understanding of this area among the analysts who populate the gold market sector. Instead, fervent believers of the gold narrative seem to dominate the landscape.
As a review, I recommend reading my academic study (here) on major bear markets since these principles apply to our current bear market in the precious metals. Also, if you have not read my earlier pieces defining the phases of a bear market I recommend viewing them here and here.
Recent market developments provide full vindication of the bearish forecasts made over the past 2 years. I will now provide an update on the progress of this precious metals bear market and describe the model I use. Below is a big picture view of the past four years and how I have interpreted it.
The above ARCA Gold BUGS (HUI) chart depicts the major events which define this bear market. It has been classified into three psychological phases which are defined by the price action.
After the phase I distribution top was completed in December 2011, the market entered into a prolonged phase II decline lasting another 2.5 years. Phase II developed in classic form; Once it completed the back test of the neck line of the phase I H&S it entered into a long slide. This slide ended with a sharp bear market rally (BMR) in the summer of 2012. This rally served to reinvigorate the bullish crowd and keep them believing that the bull market was still on and it had all been a corrective move.
After the BMR exhausted itself, the market entered into a prolonged phase II decline into the spring of 2013. I recall investor psychology at this time as being stressed, yet still optimistic that the bull would resume. In fact, the prevailing term used to describe it was “ its a correction”. This all ended with the Goldman raid on the gold market in April 2013. The 19 month slide had eroded investor sentiment to the point where they were now primed for a collective change of perception. With the crash, bullish hopes were abandoned and it was recognized as a bear market.
The classic point of recognition (POR) had arrived. The bear market process places the POR squarely in phase II….Always.
What occurs after the POR is a period of prolonged consolidation. A deceptive tug of war between bulls and bears ensues, made up of several BMRs which serve to ultimately exhaust the bulls. Once this process runs its course, the market is now cleared to exit phase II and stocks can now fall of their own weight. This process of bull exhaustion took 18 months when it finally completed its post POR diamond consolidation in October 2014 and entered phase III.
The 18 month diamond formation lasted such a long time, likely because stubborn gold bulls refused to give up the dream of a bull market, instead expending their energy chasing apparent bear market bottoms. It is interesting to note that the ursa bear of 1932 and the Nikkei bear of 1991 both ended their post POR consolidations with a diamond formation.
After the diamond formation breakdown of October 2014, the market was now in phase III. By definition, when a market breaks down out of its post POR consolidation it then enters phase III. Normally, a downward impulse drives the price to its ultimate bottom and the bear is then over. This bear however, was peculiar because instead of an immediate downward impulse, the index chose to go into nesting mode for the next 7 months. During this interval it build out a deceptive H&S pattern just beneath the phase II diamond consolidation pattern.
I suspect this was again caused by die-hard gold bulls still clinging to the hope that a bottom was being formed. Their error was in not understanding that all phases of a bear market had not yet completed. In fact, phase III was just getting started and now the end-game process is just kicking off.
With the June break of the nesting H&S neckline, the phase III downward impulse has finally begun. We are now in the dreaded annihilation phase which I have described in previous essays. The annihilation comes from the market's “no one gets out alive” liquidation.
Over the past four years, the bear has been restrained by stubborn bulls. Those bulls are now exhausted and the bear will now have his way with this market. The blind capital of the great unwashed will now be devoured. The bear will end when the worst that can happen has been discounted by the price structure.
The junior and mid-tiers have long been destroyed. Now the bear will focus on the big cap stocks, where liquidity remains. Bulls will sell their good stocks, held for a rainy day, because now it’s raining. It has been rather tragic watching the majority of PM analysts lead their followers to slaughter, because it has been unnecessary. What the majority of investors have not grasped is that a bear market is a process. A process that must progress through various stages of price action and investor psychology. This is what I have attempted to describe over the past two years.
There are several principles at play here. Once a declining market encounters a POR, you know a bear market is active and it’s not just a correction. All calls for a bottom are now invalid until the market enters into an identifiable phase III. Bull signals are now only valid in a phase III. Once in phase III, the market will undergo a cathartic selling event and volume will then begin to recede on subsequent declines.
Prior to this, any attempt at a bottom will fail and prove to be false until this process completes. So now we wait and observe the bear do his destructive work. We will watch the language of the market to identify its ultimate bottom. Serious money is made identifying the probability of a bear market low, not by buying apparent bear market bottoms.
The bear has not yet finished his work. The ultimate bottom will prove to be so shocking that it will devastate a generation of old school gold bulls. But, it will allow the foundation for the next bull market in the precious metals.
This will be my final essay devoted to the great precious metals bear market. We have fought the good fight, we have survived four years of decline, we have properly identified the trends and market phases. We have been wise enough to know when to step aside. We have arrived near the bottom with both emotional and physical capital intact. We will be there to deploy at the bottom.
It is time for us to focus on the upcoming epic bull market that will soon unfold in the usual deceptive manner . Join me and other like minded PM Traders at Rambus Chartology for the ride.