The Cyclical Nature of Markets

posted on: August 07, 2008
Bill Cara

Yesterday, I stated that “…the answers are in the data.” One look at the extreme Cara 100 winners and losers shows that the falling commodity prices (oil, metals, fertilizer) was the driver.

With a bullish mindset, good corporate earnings become great ones and cautionary guidance is ignored. Why? It’s because smart traders are covering shorts and it’s stupid to stand on a train track presuming the engineer knows what he or she is doing.

Yes, hot money or speculative money runs two ways. Yesterday, it went against commodities without regard to fundamental, quantitative, economic or long-term technical factors. That was yesterday. Tomorrow, the hot money might flow the other way. When the Bear market is over, well in the future, there will have been a series of lower highs and lower lows between now and then.

Only then, at the cycle bottom, will market conditions be normalized where the hot money has been played out, and the long-term Bulls can once again look forward to (somewhat) rational decision-making.

So, to answer a flood of mail as to whether or not I believe the precious metals market is now in a secular Bear, like the equity market, which turned that way a year or more ago—before the cycle high—I say no, this is still a secular Bull for precious metals as well as other commodities; what’s changed is that slowing of demand and simultaneous squeezing by lending banks (eg, credit not so freely available) and central banks (eg, higher margins required at the commodity exchanges) has combined to take the wind from the sails of the promoter and their prey, the speculator.

In other words, I believe this is merely a cyclical turn down, of a short or intermediate-term duration, ie, from a couple weeks to several months, but certainly not more than a year. A year from now, I believe the commodity markets will be flying higher than their previous highs, which will set the conditions of your future decision-making. Yes, avoid the banks and most other financials as they will be under-performers for many years.

More to the point, after credit loosens up (or even if it’s just the velocity of money growing again) and the economy starts to boom again, the long-term oriented traders ought to look to the junior oil & gas and metal producers & explorers for the growth in your portfolios. Short-term traders, of course, will seek to exploit any price series anomaly, including in the banks that otherwise should be ignored.

The keys to when the goldminer producers and the speculative explorers as well will start to grow in price strength again are more than a single one. First and foremost, a Bear market tends to sink all ships. Failures at hedge funds, withdrawals at mutual funds, margin calls in over-extended retail accounts, stock promoters on vacation, resting up for the next Bull run, bad news across the financial pages, and so forth, will all pull prices down.

If there is one thing I learned by trading juniors, it is the pullback from former highs is a lot more than the promoters or their speculative followers ever expected. I have written here, you might recall, the page after page charts of the junior mines and oils on the Toronto Exchange in 1981. I listed many cases where the pullback was 80% or more, including in companies that had outstanding quantity and quality in-situ resources.

There will always be speculators in junior issues because we all know it’s where capital gains happen fastest. As a rule, speculators want it fast. Unfortunately, when the facts turn against this possibility when it comes to capital gains they panic (like all those newsletter writers did early in July when they saw the writing on the wall), they turn angry (at realists like me), they deny, they cheerlead, and so forth. But the fact is there are more smart people in the market than stupid ones, and ultimately market prices flow on a natural course the way most of us live our lives. That’s true because we are the market.

Every cycle in the market is different because of differing market conditions, eg, one important one is the amount of traders’ debt (and debt service requirements) versus cash-on-hand to exploit opportunities. Every cycle is unique. In this one, the banks are in worse shape than most prudently managed corporations and individual's portfolios.

Nobody knows in advance how much of a fall in prices will occur or how steep the fall will be. That’s why we study the price action and the market dynamics for clues. That’s why I say, the answer is in the data. It’s certainly not going to come from the bitching and moaning from stock promoters, speculators and fund managers who have been burned.

In the next few days, traders will sit back and be impressed that no increase in central bank rates plus the falling commodity prices are sufficient positives for a mini-rally. After that the sellers and short-sellers will return, and prices will sink again. Lower highs, followed by lower lows. This is a Bear market.

Bear markets end, as I have said and repeated many times, when gold speculators are the last ones off the dance floor. When we see that particular capitulation, then a fresh breeze will be sufficient to put wind in your sails for smooth sailing ahead. Just don’t load too many banks in your boat. Hopefully, if you took good advice in the past you have a yacht, and you are set to grow it into a ship. You’ll look down on all those sad faces in their row boats.