(Kitco Commentary) - If I had told you that Israel and Iran went to war and escalated that war throughout this past week, I am sure you would have expected gold to have rallied quite strongly. Well, the truth is that gold ended the week lower than where it sat before the start of this war.
So, if I had told you what the news would be before this past week began, I am quite sure that each and every person who erroneously believes in the mechanical paradigm of our financial markets would assume that gold should have had one of its best weeks in 2025. But, clearly, that was not at all what the market experienced, as we saw the exact opposite action of general expectations. In fact, the market seemed to be quite oblivious to this major war action, and you would never even be able to spot this indication by simply looking at the gold chart. Truthfully, you probably would not even know a major Middle East war was being fought, much less the biggest war in decades is being fought in that region.
I would like to take this opportunity to remind you of several studies which fly in the face of the commonly accepted mechanical paradigm of the market, which will hopefully help you understand the market action this past week.
In a 1988 study conducted by Cutler, Poterba, and Summers entitled “What Moves Stock Prices,” they reviewed stock market price action after major economic or other type of news (including major political events) in order to develop a model through which one would be able to predict market moves RETROSPECTIVELY. Yes, you heard me right. They were not even at the stage yet of developing a prospective prediction model.
However, the study concluded that “[m]acroeconomic news . . . explains only about one fifth of the movements in stock market prices.” In fact, they even noted that “many of the largest market movements in recent years have occurred on days when there were no major news events.” They also concluded that “[t]here is surprisingly small effect [from] big news [of] political developments . . . and international events.” They also suggest that:
“The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases casts doubt on the view that stock price movements are fully explicable by news. . . “
In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years’ worth of “surprise” news events and the stock market’s corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.
In 2008, another study was conducted, in which they reviewed more than 90,000 news items relevant to hundreds of stocks over a two-year period. They concluded that large movements in the stocks were NOT linked to any news items:
“Most such jumps weren’t directly associated with any news at all, and most news items didn’t cause any jumps.”
Even though most would try to view the lack of upside market action this past week in gold as an anomaly, these studies make it quite clear that it was much more in line with standard market action than being an anomaly. And, it again leads me to highlight the wise words spoken from one of the best investment books I have ever read – The Socionomic Theory of Finance:
“Observers’ job, as they see it, is simply to identify which external events caused whatever price changes occur. When news seems to coincide sensibly with market movement, they presume a causal relationship. When news doesn’t fit, they attempt to devise a cause-and-effect structure to make it fit. When they cannot even devise a plausible way to twist the news into justifying market action, they chalk up the market moves to “psychology,” which means that, despite a plethora of news and numerous inventive ways to interpret it, their imaginations aren’t prodigious enough to concoct a credible causal story.
Most of the time it is easy for observers to believe in news causality. Financial markets fluctuate constantly, and news comes out constantly, and sometimes the two elements coincide well enough to reinforce commentators’ mental bias towards mechanical cause and effect. When news and the market fail to coincide, they shrug and disregard the inconsistency. Those operating under the mechanics paradigm in finance never seem to see or care that these glaring anomalies exist.”
Allow me to quote further points from this most insightful book.
“None other than the chairman of the Federal Reserve weighed in on this very topic in testimony before Congress. The morning after a one-day 3.3% swoon in the DJIA in 2007, the nations’ top banker said he could not identify ‘a single trigger’ that caused Tuesdays dramatic drop.” This is a remarkable admission for a macroeconomic mechanist who advocates “financial engineering.” More recently, August 20, 2015 sported the biggest down day in 18 months for stock prices, yet reporters admitted there was a ‘lack of major U.S. economic news’ to explain it.”
To date, we still debate the cause of the Great Depression, or the October 1987 market crash, the 2010 Flash Crash, the Asian financial crisis, and many other “anomalies” in the market. In 1997, a Nobel-prize-winning economist noted “The truth is that nobody really imagined that something like the Asian financial crisis was possible, and even after the fact there is no consensus about why and how it happened.”
As Mr. Prechter further appropriately noted in his book: “Can you imagine physicists endlessly debating the cause of avalanches? . . . Economists are mystified over the causes of market declines and economic contractions because they are using a mechanical model in the realm of finance where it doesn’t apply.”
And, yet, no matter how many times investors see the market react opposite of their general expectations, they still maintain the false beliefs upon which they base those expectations. So, why do we continue to fool ourselves into believing in this clearly erroneous mechanical paradigm as applied by the masses? Well, I believe that Daniel Kahneman, in his book Thinking Fast and Slow, tries to provide an explanation. While there is much depth to his analysis, I am going to try to simplify his perspective in the following quotes and summations:
We have a puzzling limitation within our minds: “[O]ur excessive confidence in what we believe we know, and our apparent inability to acknowledge the full extent of our ignorance and uncertainty of the world we live in. We are prone to overestimate how much we understand about the world . . overconfidence is fed by the illusory certainty of hindsight.”
“Contrary to the rules of philosophers of science, who advise testing hypotheses by trying to refute them, people seek data that are likely to be compatible with the beliefs they currently hold. The confirmatory bias [of our minds] favors uncritical acceptance of suggestions and exaggerations of the likelihood of extreme and improbable events . . . [our minds are] not prone to doubt. It suppresses ambiguity and spontaneously constructs stories that are as coherent as possible.”
Over the years, I have tried to convey this message and direct investors away from mechanical paradigm thinking in order to view markets more objectively, thereby allowing them to increase performance in their investment accounts. But, alas, it has been an uphill battle.
To this end, I will continue to highlight greater minds than mine. Francis Bacon is one such person who comes to mind. For those that may not be familiar with him, he was a 17th century English philosopher and scientist. He is best known for his philosophical advocacy of the scientific method and is considered the creator of empiricism. His works established and popularized inductive methodologies for scientific inquiry often called the Baconian method.
I think he also provides insight as to why I have been facing an uphill battle. So, I will now combine the thinking of Kahneman and Bacon to try to explain the reason for my struggle:
Kahneman: “A reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguishable from truth. . . “[E]vidence is that we are born prepared to make intentional attributions.” In other words, our minds engage in an automatic search for causality. Moreover, we also engage in a deliberate search for confirming evidence of those propositions once we hold them dear. This is known as “positive test strategy.”
And, Francis Bacon concluded something similar centuries before:
Bacon: “The human understanding when it has once adopted an opinion (either being the received opinion or as being agreeable to itself) draws all things else to support and agree with it.”
So, as the media continually reinforces the clearly erroneous mechanics paradigm day after day for decades on end, investors have been trained in this false methodology, and have mindlessly adopted it as the absolute in truth. And, as Bacon noted, once it has been adopted as an absolute truth, investors shut out all contrary evidence to this false truth, and this is the reason they simply shrug off empirical evidence, such as what was experienced by this past weeks’ market action. And, now we have a better understanding of Mr. Prechter’s point when he noted that “[t]hose operating under the mechanics paradigm in finance never seem to see or care that these glaring anomalies exist.”
This now brings me to a quote from Daniel Crosby’s The Behavioral Investor, wherein he noted that “trusting in common myths is what makes you human. But learning not to is what will make you a successful investor.” Which leads me to the more modern work of Benoit Mandelbrot, a French-American mathematician, who outright stated that one cannot reasonably apply an economic mechanic model to the financial markets:
“From the availability of the multifractal alternative, it follows that, today, economics and finance must be sharply distinguished . . .”
Hence, you now have the basis and the reasoning as to why we apply Elliott Wave analysis, a fractal-based market analysis system, as our primary market guide. And, this is why I advise all our clients to turn off their televisions and be quite judicious as to what you read when you are making your investment decisions.
Now, I will tell you that I ignored the news of the day, and simply provided a mathematical analysis to our clients over the past week, which provides a much better guide to understanding and tracking gold than any of the fundamental or news factors which most follow. As you can see from the chart below, I had a resistance box outlined to our clients, which began at 3474 in the gold futures. And, despite the escalation of the Middle East war, I expected gold to turn down at this resistance.
As we now know, gold topped within $2 of hitting my target, and has since turned down as we expected, despite the escalation of the war. Now, I am quite sure many of you will attempt some mental gymnastics to explain why gold is now lower than when the war began, but you would simply be fooling yourselves. This is clearly not what you expected from the gold market when a major war was being fought. And, I would like to provide you with two quotes from Ben Franklin to assist you in opening your mind as to how gold really moves:
“So convenient a thing it is to be a reasonable creature, since it enables one to find or to make a reason for everything one has a mind to do.”
“Geese are but Geese tho’ we may think ‘em Swans; and Truth will be Truth tho’ it sometimes prove mortifying and distasteful.”
To those I will also add an insightful quote from another of our forefathers of The United States – John Adams:
"Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence."
So, this leaves all investors with a choice. Either you can continue to track the gold market in the false manner to which you have become accustomed, or you can open your mind to a different path, which has proven through the years to be much more accurate and insightful as to the machinations of the gold price through its upside and downside cycles.
To that end, I want to reiterate an expectation I maintain. As long as that resistance box that you see on the chart above holds as resistance, I am expecting a larger decline to take shape, which will likely be our next buying opportunity in the gold market. But, I will warn you that this will lead to what I believe is the final rally in the cycle which began at the end of 2015, when gold bottomed in the $1,050 region, which we also called at that time.
In fact, one of my long-term clients posted this in our trading room at Elliottwavetrader.net this past Thursday:
“For those that have been here long enough. Anyone remember this post [by Avi]:
‘If many of you follow us on metals and miners, I think we will likely generate more millionaires on this site than any other over the next 10 years. Yea, I know I am sounding crazy, but this stuff is the best set up I have seen in my life.’
Why I think Avi is the GOAT with metals. He said in 10 years, it’s almost 11 years since his post and nearly 10 years since we bottomed in metals.”
And, for those wondering about the my shorter term outlook, I would like to see the GLD price drop down to at least the 275GLD region for the next buying opportunity. We will adjust as needed based upon the action we see in the coming few weeks. But, for now, that is the set up that I am seeking to develop.
In conclusion, while I certainly provide analysis to our almost 9000 members and 1000 money manager clients at Elliottwavetradet.net, I also encourage investors to think independently and test what you are told through a prism of truth and history. Much of what you read and are told through your media of choice usually presents noise which often has you looking the wrong way in the financial market you track. It is time to take a more mature and accurate approach to financial markets, which will assist every investor’s goal – increasing the value of your investment account.
