Sand Spring Advisors LLC
Retracement Rallies After Bubbles
September 19, 2003
by, Barclay T. Leib
When markets implode from bubble tops, a period of reprieve almost inevitably follows the initial Armageddon.
When gold and silver reversed from $800 and $40 respectively in 1980, they fell to below $300 and below $5 within two years.
But then in such dramatic decline situations, the bulls typically come charging in again. They don't really realize that the world has changed -- that a secular bear market has begun. While few today may remember the 1982-1983 rally in gold and silver, both markets advanced spectacularly for 7 months -- gold to above $510 an ounce (in total a 74% advance from the prior low) and silver to above $14.90 (a 212% advance from the prior low). Of note, they did so when Paul Volcker took his foot off the tightening pedal and became more relaxed about inflation.
This 1982-1983 rally period in the metals reminds us quite a bit of the recent 7-month surge in the U.S. equity indices. Equity bulls are today acting the same way metal bulls did back then: they don't really understand that the world has changed -- that a secular bear market exists. Instead, they are simply reacting to a loosey-goosey Fed policy of 1% interest rates. As one indicator of the Fed-induced froth, equity margin debt has simply exploded to the upside in recent months. At 1% interest rates, we'd even call this relatively rational human behavior.
In the above 1982 monthly chart of gold, one will note that the metal rallied 38.2% of its entire previous decline and 50% of its prior swing-move decline. The equivalent level on today's S&P chart falls between 1042.28(50% of last swing decline) and 1068.20 (38.2% of entire S&P decline). We are already in the 7th month of the equity reaction bounce, and as with the metals in 1982-1983, bull moves often end in increments related to 7.
So while we have found the last 100 points of the S&P advance singularly irritating, from a mechanistic analog point of view, this rally period cannot be deemed abnormal. Instead, it is simply best viewed as a psychologically necessary setup for subsequent disappointment. Current equity valuations being what they are vis a vis any reasonable expectations for corporate profitability growth and consumer spending, the recent rally is (in our humble opinion) unlikely to be sustainable longer term.
Sand Spring Advisors is currently short the S&P and will sell more if the 1042-1068 window is reached. We do not think that such levels are absolutely necessary to achieve, but on an analog basis, they remain possible.
Non-subscribers are invited to access our September 7th article, "Tops 11-Weeks Apart & Regime Shifts or Lack Thereof" together with other past articles, by signing up for a quarterly Sandspring.com subscription below.
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