A Look at Market Psychology of the Recent Past and Present

Click on Chart to Enlarge

I have been thinking a good bit about the action in gold the last couple months and trying to look at it from different angles. The chart above shows the CRB commodity index at bottom with wheat, oil, and gold prices above as well as some notes of what I believe the general crowd psychology was at some points in the past.

I can clearly recall news stories about third world starvation and global warming in relation to the soaring grain prices last year near the commodity peak. There was some backlash against use of food based fuels like ethanol from corn and sugar, etc. While all these things may be sensible or even true, it only helped to explain price behavior in the past. What most people do is to assume that the same trends will continue into the future. As a contrarian trader or investor, it is important to learn to recognize consensus opinion and behaviors and willingly act against them. For anybody who pays attention to this type of thing at all, I'm sure you can think back on what the buzz was near the high points of certain commodities over the last year.

Well despite the commodity index now being well off the peak, there is a resurgence of inflation fears with primary concern over monetary inflation and the death of the dollar. This has focused the commodity world's attention on gold. My take is that this could very well be just another successive inflationary peak in a longer process of fundamental deflation.

It is not clear cut to me though because when commodities break out to all time highs, they enter a very strong technical position with no overhead resistance to speak of. So maybe this is the early stages of a long and large move up in gold. But from a crowd psychology standpoint and look at measures of real money sentiment, I tend to think that it is more likely just another domino in the line.

Stocks and commodities tend to advance together over the long term in general. However, there is a key difference in psychology at extreme points between the two. When stocks advance to bubble levels the crowd is euphoric and happy about the high valuations. However, as commodity price reach bubble levels, fear takes hold. Fear of famine, shortage, etc manifest at commodity peaks while it is utter complacency at stock peaks. So the difference in psychology may be why we see stocks top out before commodities often. They are both advancing, but then as commodity prices get so high, the general climate shifts towards fear. Then stocks come down on the fear while commodities blow off to higher highs on the fear.

For those familiar with Elliott wave theory, you know it is a result of crowd psychology. So while prices may exhibit identifiable patterns, larger degree patterns will have identifiable psychological/social trends that happen with them. A correction of a larger trend in its simplest form is said to be a 3 phase move (i.e. down up down, ABC). In looking at the crowd psychology of the recent bear market and the advance since, I would say there have been 2 distinct phases thus far: a progressive fear of and recognition of deflation, and now a directed social effort to combat that and re-emerging fears of inflation. I personally expect there to be at least another reversal of the psychology back toward the deflationary side before any great buying opportunity comes in stocks. Maybe that will take the stock market to new lows, maybe not, but I expect it to take stocks down quite a bit lower than they are now.