What REALLY Controls The Metals Movement? (Part 1)Caught Looking the Wrong WaOver the last three years, many have presented quite strong fundamental arguments that various factors would certainly cause the metals to immediately skyrocket to new heights.They have pointed to increasing demand for metals in countries such as Russia, China and India. They have pointed to quantitative easing as being a clear factor to cause the metals to head to new highs.Some have even pointed to the confict in the Ukraine and Middle East as a strong reason metals should head to new highs.What do they all have in common?Yes, all these reasons have failed to have the efect upon gold that everyone was so confdent they would.In fact, a few months ago, I saw the following comment to an article that was touting the bullish side of the market based upon these same old factors:You know something? Your article is so well written, so "clean", and so logical constructed, that it can only be WRONG. Each time I've trusted in this kind of speech, I've lost money.Yes, those that have touted all these reason as to why the metals MUST rally have done a disservice to market participants that followed their advice.What most people dont understand is that markets are not driven by logic or reason.Markets are driven by sentiment and emotion.And, for those of you who have tried to reason with someone being very emotional, how far did it get you?It is akin to the experience of those that have expected reasons to move this market for the last 3 years.And, it has been especially painful to silver investors, who have lost 70% of their value from the 2011 high.Allow me to provide you with a real life example of how sentiment will win out over reason time and again. Right after QE-Infnity was announced, I suggested to all those who read my analysis to ignore this announcement, and to focus on sentiment, as the sentiment analysis suggested that the market was about to crash in the face of this new round of QE.I cannot explain to you the abuse I took for making such a ridiculous suggestion.If you think back to when QE-Infnity was announced, everyone not only thought, but was 1000% sure, that the metals were about to go parabolic. But, even before the Fed announced QE-Infnity, I made the bold call that, irrespective of what the Fed did, silver will turn back down from the $34.40 level in the futures contract. And, yes, this was basedupon my analysis of market sentiment through patterns and Fibonacci mathematics. Well, silver went to $34.49 (nine cents over my target), and then turned down and has not looked back since.I believe we have seen silver drop $20 since that market call.For those counting, that means silver lost 60% of its value since that topping call in the face of QE.So, how does one explain this incredible diference in public expectations as to what the metals were going to do after this QE announcement and how the metals actually reacted?To answer this question, please allow me to quote R.N. Elliott:The causes of these cyclical changes seem clearly to have their origin in the immutable natural law that governs all things, including the various moods of human behavior. Causes, therefore, tend to become relatively unimportant in the long term progress of the cycle.This fundamental law cannot be subverted or set aside by statutes or restrictions.Current news and political developments are of only incidental important, soon forgotten; their presumed infuence on market trends is not as weighty as is commonly believed.Next week we will continue with this series and delve into why fundamentals have failed to guide investors in the metals world over the last three years.2Wh !ave "un#amentals "aile#?In my humble opinion, I believe that, as more and more study is conducted into the social aspect of economics, we will ultimately abandon the use of fundamental analysis as amain research tool in identifying market direction.In fact, many noteworthy scholars and economists have begun to recognize that using fundamental analysis to determine market turning points is akin to driving a car blindfolded, while facing the rear window. As an example, in a paper written by Professor Hernan Cortes Douglas, former Luksic Scholar at Harvard University, former Deputy Research Administrator at the World Bank, and former Senior Economist at the IMF, he noted the following regarding those engaged in fundamental analysis for predictive purposes:The historical data say that they cannot succeed; fnancial markets never collapse when things look bad. In fact, quite the contrary is true. Before contractions begin, macroeconomic fows always look fne. That is why the vast majority of economists always proclaim the economy to be in excellent health just before it swoons. Despite these failures, indeed despite repeating almost precisely those failures, economists have continued to pore over the same macroeconomic fundamentals for clues to the future. If the conventional macroeconomic approach is useless even in retrospect, if it cannot explain or understand an outcome when we know what it is, has it a prayer of doing so when the goal is assessing the future?Fundamental analysis is generally defned as a method of evaluation that attempts to measure value by examining related current economic, fnancial and other qualitative and quantitative factors. Fundamental analysts will utilize current macroeconomic factors (like the overall economy and industry conditions) and company-specifc factors (like fnancial condition and management).Therefore, market fundamentals are the existing conditions of a market based upon historical data. In order to utilize this information for predictive purposes, economists will employ a form of trend extrapolation. This efectively presumes that the current market conditions will continue indefnitely into the future, until they do not. This is possibly the crudest form of linear extrapolation. But, can it really foresee turning points in a non-linear environment? If we wait for the underlying fundamentals to change, are we not already within a diferent trend within the market that is now changing underlying fundamentals?Well, lets look at the metals world and see if this has helped us over the last 3 years. During the entire 3+ year decline in the price of metals, I have read so many analysts proudly note that allof the fundamentals that supported the precious metals trade on the long side in 2011 are still there. I am sorry to put it this way, but I almost gag when I read that, and really cannot believe thatpeople have the gall to make such a comment after silver has lost 70% of its value from the highs.So, the fundamentals that support a silver price of $50 are the exact same fundamentals that support a silver price of $14?Does it sound like these fundamentals have been helpful or accurate? Nothing evidences the utter failure of fundamental analysis in the silver market more than this. Anyone following such an analyst should be incredibly angry at the continued utterance of such drivel in light of a 70% loss in value.And, every time the metals move into a short term counter-trend rally, these pundits dust of these same old fundamentals, such that we are heading into the Indian wedding season, demand in China is strong, etc., and sell them to the public. The question is if, you, as an investor, will be foolish enough to continue to believe these supposedly fundamental perspectives in the metals, despite their clear lack of efcacy over the last three years?It is about time that all of you that have been severely burned by fundamentalists in the silver marketget up now, and go to the window, open it, stick your head out and yell Immad as hell, and Im not gonna take this anymore. Or, you can at least post it as a comment to any articles that you see spewing such fawed perspectives.As I noted last week, that is exactly what this commenter did with an article citing these same bullish fundamentals only several months ago:You know something? Your article is so well written, so "clean", and so logical constructed, that it can only be WRONG. Each time I've trusted in this kind of speech, I've lost money.Next week, we will attempt to compare and contrast why sentiment analysis has a clear edge over fundamental analysis to determine market direction on all time frames.3Why Sentiment Analysis Prevails Over Fundamental Analysis The common perception in the market is that the news causes changes in market psychology and fundamentals, which then causes changes in stock prices. But I believe that the correct, more consistently applicable premise is that market psychology and sentiment are the causes of news events and changes in stock prices, whereas fundamentals are purely lagging indicators, and the result of psychology and sentiment changes. Bernard Baruch, an exceptionally successful American fnancier and stock market speculator who lived from 1870 1965, identifed the following long ago: "All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking ... our theories of economics leave much to be desired. ... It has always seemed to me that the periodic madness which aficts mankind must refect some deeply rooted trait in human nature a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea ... It is a force wholly impalpable ... yet, knowledge of it is necessary to right judgments on passing events."During his tenure as chairman of the Federal Reserve, Alan Greenspan testifed many times before various committees of Congress. In front of the Joint Economic Committee, Green- span noted that markets are driven by human psychology and waves of optimism and pessimism. Ultimately, as Greenspan correctly recognized, it is social mood and sentiment that moves markets. I believe this makes much more sense when deriving the causality chain. During a negative sentiment trend, the stock market declines, and the news seems to get worse and worse. Once the negative sentiment has run its course, however, and its time for sentiment to change direction, the general public then becomes subconsciously more positive. When people become positive about their future, they are willing to take risks.What is the most immediate way that the public can act on this return to positive sentiment? The easiest is to buy stocks. For this reason, we see the stock market lead in the opposite direction before the economy and fundamentals have turned. This is why R.N. Elliott, whose work led to Elliott wave theory, believed that the stock market is the best barometer of public sentiment. Lets look at the same change in positive sentiment and what it takes to have an efect on the fundamentals. When the general publics sentiment turns positive, this is the point at which they arewilling to take more risks based on their positive feelings about the future. Whereas investors immediately place money to work in the stock market, having an immediate efect upon stock prices, business owners and entrepreneurs seek loans to build or expand a business, which take time to secure. They then place the newly acquired funds to work in their business by hiring more people or buying additional equipment, and this takes more time. With this new capacity, they are then able to provide more goods and services to the public, and, ultimately, profts and earnings begin to grow after more time has passed. When the news of such improved earnings fnally hits the market, most market participants seem shocked that the stock starts to move up strongly (even though the stock likely bottomed well before the public takes notice when the investors efectuated their positive sentiment by buying stock), and they simply attribute the stocks rise to the announcement of positive earnings.There is a signifcant lag between a positive turn in public sentiment and the resulting change in the fundamentals of a stock or the economy, especially relative to the more immediate stock-buying activity that comes from the sentiment change. This is why fundamentalists can be left holding the bag at the top of a market, when the news and fundamentals look the most attractive, right before the market begins to dive, as sentiment turns in the opposite direction well before the fundamentals. This lag is a much more plausible reason as to why the stock market is a leading indicator, as opposed to some form of investor omniscience. This also provides a plausible reason as to why earnings lag stock prices, as earnings are the last segment in the chain of positive mood efects on a business growth cycle. It is also why those analysts who attempt to predict stock prices based on earnings fail so miserably. By the time earnings are afected by a change in social mood, the social mood trend has already been negative for some time. And this is why economists fail as well the social mood has shifted well before they see evidence of it in their indicators.Lastly, we really have to begin to question whether exogenous events actually move markets. Dont you ever question why markets go up after seemingly bad news or go down after seemingly good news?Social experiments have actually been conducted which resulted in price patterns that mirror those found in the stock market. In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili and Zhang, in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially afecting the trading pattern. Their specifc goal was to observe fnancial market psychology in the absence of external factors.One of the noted fndings was that the trading behavior of the participants were very similar to that observed in the real economy, wherein the price distributions were based on Phi (.618).Their ultimate conclusion would surprise the most avid trader today:In spite of the simplicity of our model and of the strategies of the single participants, and the outright exclusion of economic external factors, we fnd a market which behaves surprisingly realistically. These results suggest that a stock market can be considered as a self-organized critical system: The system reaches dynamically an equilibrium state characterized by fuctuations of any size, without the need of any parameter fne tuning or external driving.Marsili was quoted as saying that the understanding that we got is that the statistics of price histories in fnancial markets can be understood as the result of internal interaction and not the fundamental interaction with the external world.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 markets corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difcult 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.Robert Prechter Jr., in his book The Wave Principle of Human Social Behavior, in which he cites many of these instances, concludes:once you realize that even if you got [the news] in advance, you could not forecast the stock market. Though these facts are counter-intuitive, it does not take a dedicated market student long toobserve the acausality of news to the stock market.R.N. Elliott, in his 1946 publication of Natures Law, probably puts it best when he said:At best, news is the tardy recognition of forces that have already been at work for some time and is startling only to those unaware of the trend.So, then what actually drives market movement? As we mentioned before, Mr. Greenspan noted that markets are driven by human psychology and waves of optimism and pessimism. Ultimately, as Mr. Greenspan correctly recognized, it is social mood that will move markets. This is why news does not cause a change in the trend of the market, unless that trend is already set to change. In fact, have you ever wondered why a market will continue to go up after the announcement of bad news, or down after the announcement of good news?This is why any investor who is able to rise above news and emotion, and identify the prevailing social moods and trends, will have a signifcant advantage over other investor.Ralph Nelson Elliott postulated that public sentiment and mass psychology moves in 5 waves within a primary trend, and 3 waves in a counter-trend. Once a 5 wave move in public sentiment is completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative efect from some form of news.This mass form of progression and regression seems to be hard wired deep within the psyche all living creatures. This is what we have come to know today as the herding principle, and the herd seems to turn at Fibonacci ratios, as supported by the studies mentioned before. Humans are hard wired for herding within their basal ganglia and limbic system within their brain, which is a biological response they share with all animals. In fact, in a study performed by Dr. Joseph Ledoux, a psychologist at the Center for Neural Science at NYU, he noted that emotion and the reaction caused by such emotion occur independent and prior to, the ability of the brain to reason.In a paper entitled Large Financial Crashes, published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation forthe overall herding phenomena within fnancial markets:Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efcient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an emergent behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.In fact, one commenter to one of my articles on Seeking Alpha made the following astute point regarding how news afects these subconscious herding trends:Compare the market to a stream of ants marching by in, generally, a single direction. Run a stick across their path and there will be some momentary confusion and reaction to the direct stimuli but very soon afterwards the original parade of ants continues and the stimulus is forgotten.So, based upon much research, it does seem that the market may be considered to be on a path that is determined by a mass form of herding that is given direction by social mood. It sure doesexplain the oft asked question of why markets go up when bad news is announced or vice versa. I also explains why metals dropped strongly even though QE-infnity was put into action.And, italso takes out all the guess work in attempting to determine the next news event that may move markets.