The Power of Uncertainty & Fear

By: Dr. Richard Appel, Financial Insights
Gold, silver, gold and silver equities as well as numerous commodities suffered severe losses during the past several days. Gold and silver after posting highs a few short weeks ago of $432 and nearly $8.50 respectively, struck their recent lows of $390 and $5.99. Both the major gold and silver producers and their junior exploration counterparts followed the metals lead, and quickly sought lower prices. Similarly, additional commodities including platinum, palladium and copper gave back what felt like much of their recent spectacular gains. It is amazing how the substantial paper profits, which were created by the tortuous movements these markets traversed to their recent highs, could so quickly turn into significant losses for latecomers. Yet, even for those early entrants who still possessed massive profits, the precipitous falls sent shudders through their startled, trembling bodies and left them with a feeling of despair. How could this be, muttered a legion of suffering investors and traders, if these commodities and stocks are truly in Bull Markets?

You had better get used to it! As difficult as the past several days have been for those who are bullish on these markets corrections must be anticipated, for they go hand in hand with all great Bull Markets. If you remember, as recently as during the February through early April, 2003 period, and after having earlier surged to $388, gold collapsed and touched $319. This 18% loss took two months to unfold, and suffer we did. You may have already forgotten that painful time because it was shortly followed by significant profits generated by a subsequent $100 + rise in the yellow metal’s price and simultaneous, soaring share prices.
Earlier, during the great gold and commodities Bull Markets of the 1970’s, there were numerous brief and a few extended price collapses that tested the mettle of those participants who were aligned with the gold bull. The most chilling set-back began from the peak at $200 on January 1, 1975, the day that gold again became legal for Americans to own. It terminated a year and a half later in the summer of 1976, when gold bottomed at $103. It was a grueling, nerve-wrenching period, but it was followed by gold’s march to its ultimate $875 peak in February, 1980. Each time that the bears temporarily gained the upper hand, and prices sharply fell, it similarly sent chills and tremors through the hearts of the “gold bug” investors of that era. However, in the end, massive profits accrued to those who stayed the course and rode the Bull Markets to or near their conclusions.
Why are we suffering these massive price declines across the precious and base metals spectrum? There are a number of underlying reasons for these price breaks. Most are common threads present in all of these markets, and others are more specific to individual ones.
As the title of this missive indicates, uncertainty generated by the lack of a wholehearted belief in the existence of these Bull Markets, and the fear engendered by this condition, has enormous power and influence. Uncertainty and fear, by those who profess undying confidence in the Bull Markets, have allowed this bear raid to produce cascading price declines across the precious and base metal markets.
Many investors and traders, including hedge funds and similar entities of all sizes, jumped onto the rising precious metal and commodity bandwagons in their quest for short-term profits. They observed the rising momentum that these markets generated and wanted to join the party. They couldn’t care less if they were buying pork bellies, corn or cotton! For this reason they were not committed to the markets and exited at the first sign of adversity. Further, many then added short positions which magnified the price markdowns.
To the detriment of all long position holders, the preponderance of those who purport to be believers in the precious metals Bull Market truly still do not yet believe. They repeatedly heard and read in the popular media that the economy is improving, that the Federal Reserve and our politicians have everything under control, and that gold would never again act as a monetary metal. These omnipresent statements caused them to question themselves, their reasoning and their belief. Further, many of these individuals and groups had leveraged their positions. They were either on margin or held futures or options contracts. This placed them in an enormously stressful position and forced them to be precise in both their judgment and their timing. Also, the sharp declines generated wide-spread margin calls which forced sales by weak and strong holders alike. A combination of these situations in turn created a snow-ball effect which further depressed these markets as the earlier longs ran for cover.
Precious and base metals were the hardest hit because they had risen the most and their prices had become greatly overextended. Silver for example traded at a virtually unprecedented 50% above its 200 day moving average. For many base metals such as copper, nickel and aluminum, their major advances were caused by our nascent recovery and by enormous Chinese demand. These conditions had placed great stress upon the available supply of these and other commodities and metals. The demand was so intense that it generated staggering base metal price rises of as much as 100% in less than a year.
In the end, it was a combination of the earlier panic to acquire needed, immediate supply, as well as the influence of hedge funds and others who wanted to profit from these price rises, that drove their prices to unsustainable lofty levels, and set the stage for the declines that we have been forced to endure.
One facet common to all markets is that they act as vehicles for and become controlled by the expression of human emotions. During a Bull Market or any important upward price movement, the rising prices generate much excitement in the psyche of its followers. As the prices continue to trend higher most investors and speculators gradually lose control of their rational judgment. They begin to project far higher price targets than they had originally anticipated, and their greed begins to take over. Simultaneously, they observe other players aggressively competing with one another. This reinforces their bullish beliefs and instills excessive and unwarranted confidence that the market is heading still higher. Unfortunately, at some point the market is bid to overvalued levels which cannot be supported. When this occurs the last buyer is satisfied, and prices fall. Typically, the more overvalued and overextended a market becomes, the greater will be its ultimate decline. This is the reason why Bull Markets rise to levels which often overshoot all reasonable, value-related, upside projections.
All significant market corrections act to dispel the euphoria that accompanied the earlier rising prices. In an instant, investor greed becomes transformed into abject fear. Fear that even still lower prices are in the offing. This leaves them questioning the validity of their beliefs in the Bull Market’s existence. These are but a few of the issues that market players in the precious and base metal arenas have been forced to once again struggle with, due to the recent wide-spread price collapses.
Gold and silver were trending far above their 200 day moving averages when the current correction set in. Gold had traded about 15% above this average and silver about 50%. Last week, gold once again returned to its 200 day moving average and silver to within 4% of its 200 day average. Throughout the 30+ year period that I have followed the yellow metal, the 200 day moving average has always offered great support during declines in a Bull Market, and exceptional resistance to advances during Bear Markets. Silver on the other hand, rocketed to an area of excess that beckoned the short sellers! It had risen so sharply and so far above its moving average that the stage was set for a bear raid. And attack they did!
The major gold and silver producers broke below important areas of support. The XAU violated 93 and the HUI 208. This attracted technical short selling. The market technicians then entered the fray believing that lower prices were at hand. This helped further depress the XAU and HUI to their recent lows of 87 and 192 respectively.
Prior to this event, the junior exploration companies had absorbed a considerable amount of newly free-trading stock without a significant negative impact to most of their share prices. The shares were issued during the latter part of 2003, in conjunction with the unprecedented amount of company financings that had occurred. The sale of these shares were allowed by the expiration of the mandatory four month hold periods. However, with the price collapses of gold and silver the downward pressure on junior companies, combined with the evaporation of across the board bids, caused the majority of the juniors to experience further weakness and losses.
Much of the damage to the precious and base metal markets, as well as to the stock prices of companies that either produce or explore for them, did not have to occur! It is true that all of these markets had gotten price-wise far ahead of themselves. It is also true that this exposed their markets to bear raids. This, by both the professional pit traders who make much of their income from targeting vulnerable short-selling entry points and, in the case of gold, by those powers that desire to restrain its advance. However, much of the damage was produced by those who lacked conviction in their belief of gold’s Bull Market, and the fear that the steeply falling prices generated.
Nevertheless, I for one am steadfast in my belief that we remain in secular Bull Markets in gold, silver, gold and silver shares, as well as in commodities in general. Despite the difficult few weeks that we have been forced to endure, and the possible small declines that may temporarily lie ahead, I am confident that by years end we will look back upon the recent events, and wish that we had bought more and sold less. It will likely be a similar experience that we struggled through when gold plummeted from $388 to $319 during early 2003, only to explode to above $430 an ounce a year later. When this correction has run its course, the gold stocks will likely rapidly rise from their bases. This will leave many investors who waited too long for still lower prices in the lurch, and without the positions that they had hoped to acquire.
Source: May 2004 issue of Financial Insights © April 25, 2004.