Turning Points: Tops and Bottoms

Helped along by an unexpected rise in unemployment claims to 8-month highs,  various asset classes are selling off. This is nothing out of the ordinary; we are just removing some froth from markets. Silver especially has been due for a fall. The dollar, quite frankly, has been due for a rally. Remember yesterday when I said that extremes are easy to trade? Well people are “extremely” bearish on the dollar right now. Just a word of caution.

Every single time gold or silver rise, the dollar falls, or Treasuries rise, you will get a host of people who claim the end is near. This is what I like to call emotion-based investing. In the midst of the silver bonanza, I asked how the end of the dollar was imminent, like so many were claiming, if Treasuries were trading near all-time highs and interest payments on our debt were falling. At the time, predicting that the dollar crisis was years away was heresy. While I believe the dollar will eventually be in crisis, the key is not necessarily predicting the fall, but timing it as well.

Turning Points

A lot of people who got caught up in silver are getting shaken out right now, as I warned. From their perspective, every single drop in silver marks the bottom, while every single rally marks the beginning of a new uptrend. These speculators are not viewing the markets through clear eyes because they got burned. Those who applied leverage don’t have the luxury of being patient because they are down over 50% in a matter of days. Unfortunately, patience is exactly what you need in the midst of a correction. As you can see, mistakes tend to compound.

Now let’s think through markets from the exact opposite position. Those who unloaded near the top, a list that I’ve heard includes George Soros, are very relaxed right now. Every single drop in silver is viewed as more retail money capitulating. Every rally is viewed as shorts taking profits. Those who sold into strength have the luxury of being patient. In other words, they will tend to trade this move correctly.

As someone who lightened up near silver’s highs, I can tell you that I am personally starting to consider adding small positions. I am trying to think from the perspective of those who went long right when silver went parabolic. At what level would I capitulate? At would level would I call a bottom and add, only to capitulate 10 minutes later? At what percentage decline from the highs would I start feeling comfortable buying “for the long run” due to the anchoring bias? Thinking things through in a relaxed manner is a privilege one has from not getting caught up in the madness of crowds.

Understand that silver has collapsed in price without much observable strength from the dollar. If I had a leveraged position in silver, I would be very, very fearful right now. In my opinion, there are two very likely scenarios. One scenario is a continued sharp pullback in silver followed by a sharp rise back to $40-$50 dollars. The other scenario is a prolonged period of general weakness and sideways action. In either scenario, buying some silver soon (perhaps under $35 dollars) is not a horrible position to take.

In order for silver to rally again, I believe sentiment needs to get very, very bearish. We are not there yet. We are in what I like to call quasi-bearishness. This is when everyone is “bearish”, yet everyone expects a rally at the same time. Hmm? The bottom is going to look like the top in reverse: People will be lecturing you for buying when it’s “obvious” silver is going to fall at least another 10%. People will be talking about deflation and the end of QE2. You will hear about the popping of the silver bubble. Basically, people will be saying exactly what they should have been saying 2 weeks ago at the top.

Turning Points: Tops and Bottoms is a post from: Expected Returns

HTTP://expectedreturnsblog.com

Read more at Expected Returns