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Early Stages of Bear Market in Gold?

Chad Karnes

Recently I came across a debate that questioned what was wrong with gold since it only returned 7% in 2012, well below its decade long average.

The counter argument for gold's bullishness boiled down to comparing 2012 with 2004 since that was the last time gold underperformed its average.  The logic used was something like this:   

Gold underperformed in 2004, returning only 5% that year, well below its 12 year average of 17%. 

But, the following years, in 2005, 2006, and 2007 it returned 18%, 23%, and 31% annually.  Therefore, because gold underperformed in 2012, just like it did in 2004, it is poised to outperform in 2013, 2014, and 2015.

Reasoning such as this just goes to show you can find a statistic for anything (even the statisticians, though, would have a field day with the above flawed logic). 

This is just another easy example of the confirmation bias that investors have.

Confirmation Bias

Most people have opinions and biases already and then they seek out a reason to reinforce their own pre-disposed beliefs. 

It is typically much easier to find a supporting reason you are "right" than it is to ultimately change your opinion.  After all, changing your opinion would require you to admit that you were "wrong".

The best example of this is the obvious polarity between cable news channels. On one side is the more liberal channel and on the other side is the more conservative one.  Are there any in between?  Talking points are tailored to reinforce already existing beliefs, not to try to form new ones. 

In the gold (GLD - News) discussion above it is not hard to draw the conclusion that the wannabe statistician is likely a gold (GDX - News) owner and thus seeking reinforcement of his already strong beliefs that gold will rise while searching for meaningless statistics for support. 

This of course is normal human behavior, but unfortunately having a bias heading into an investment is not a good strategy for success.

Removing the Bias One of our goals is to try to see beyond the noise and biased opinions that all too often are based on ulterior motives.

We remove the bias by using data and charts which completely ignore the pundits and those with vested interests.

The sentiment story of gold (IAU - News) and silver (SLV - News) has certainly changed over the past few months. 

Over the summer, precious metals were in negative territory for the year and sentiment was in the gutter.

On 6/27/12 when gold was at $1550 an ounce, CNBC ran an article capturing the sentiment of the moment, "Is Gold on the Edge of a Violent Downturn?"  At the time, it was among the many negative precious metals articles. 

The mainstream media wasn't the only ones bearish as professional investors' opinions of precious metals also hit yearly lows as gold bears in a rare occurrence outnumbered bulls.

How Sentiment Helps Us Keep Focused on the Facts After finding support at an all-important level throughout the summer, gold and silver (AGQ - News) both broke out of a downtrend in August setting up the opportunity and stop location which we identified, "Good risk / reward setups such as these are what we look for".  By early September, Gold and Silver were on a tear.   

Silver rose over 25% to $33 and Gold by means of the Gold Miners Bull 3x (NUGT - News) was up over 60% by late September as sentiment did a 180.  Sentiment on the precious metals by late September had now reached into the 80th percentile bulls, an area that often coincides with precious metal tops.

"Silver: Technicals Suggest Very Bullish Long-Term Outlook", proclaimed a popular financial website on 9/19, which, combined with the technicals, was right on time to warn us sentiment had again reached an extreme, this time a bullish one, and we should look to take profits.

Our long trade was complete as we noted 9/23, "Silver (at $33.48) and Gold (at $1750) are at sentiment extremes.  A sell/short signal on Silver (ZSL - News) is a breakdown of the trend channel (chart and commentary found here) with a stop above this week's high of $34."    

The following week prices began to fall, our short signal was triggered, and sentiment again reversed, eventually hit a low in late October where we took short profits. 

What Now?

Today, sentiment on the precious metals (DBP - News) remains largely mixed while the short-term trend in gold mining stocks (GDX - News) remains down. Our Weekly ETF Pick from 2/14/13 pointed out the large price divergences between physical gold and gold equities and our short trade has already gained around 10%.

At the ETF Profit Strategy Newsletter we combine sentiment, fundamental, and technical data to help us stay on the right side of a trade.  The main focus right now is on gold and silver's sentiment to see if a move to more optimism can propel prices higher.  Updates are provided twice a week in our Technical Forecast.

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