Archive for February, 2009

The Golden X

Flexibility and patience are virtues, if timing is unclear. Market’s understanding of patterns has evolved, but we as a society are still poor in timing. This is why we rely more on patterns viz. crisis patterns, excitement patterns, fear patterns, euphoria patterns, seasonal patterns, fundamental patterns, information patterns, sales patterns, earning patterns, immigration patterns, trade patterns, price patterns etc.

The last time we talked about extremes (extensions), now we talk about false excitement and confusions. The corrective X is a price formation that suggests confusion. What we are doing here is explaining mass psychology behavior through price patterns. X waves are one among the 12 labels given to a price movement (1-2-3-4-5-A-B-C-W-Y-Z-X). If it is as easy as classifying investor behavior in a price pattern form, it should be worth a try. After all we get to know whether prices are headed higher or lower, they have bottomed or topped, they are still stagnating or are they ready to move.

Unlike true clear extensions we talked about last time, X waves are dishonest and unclear. This is why they are labeled with B waves as phony waves. This means that unlike extensions which head higher, a push up in X wave is a trap, which gets stronger, the more the prices push higher. X waves are also known to bring out and intensify confusion in society and among analysts. If analysts are also confused and divided regarding market direction, it could be an X wave. These waves are part of correctives (corrections and counter trends), which cannot be properly labeled until they are completed. This is why unlike many other price formations, X waves are tougher to nail down. Forecasting accuracy can be poor, and chances of making a mistake higher in these waves. Above all this, the false nature of the X wave, keeps on building the false illusion of hope. A positive X wave can keep traders and investors excited.

Gold retested 1000 and our belief is that this move up from near 700 levels is an X wave and not the start of a real trend. This means that prices are topping and not moving in a clear true uptrend, but false, phony upmove. This also means that Gold should come down possibly back to 700 and maybe lower. As a society this means a lot to us. Drop in gold prices suggest market still believes in paper assets and stocks and not just Gold, the asset of last resorts. We have illustrated two scenarios here, how we feel Gold should move till 2015. It’s the ongoing X wave that differentiates the two scenarios. Preferred scenario says we should have atleast one year long reprieve in (stock prices) the ongoing crisis. The alternate scenario says “No Reprieve”.

Apart from the mathematical probability, pattern recognition and time forecasting work that we do at Orpheus, we are still optimistic believers, maybe foolishly. We will have to see if the FOOL’s GOLD fooled us too or we are still on track with the last leg down on GOLD and the wave up happening now is indeed an X wave, which will top GOLD end of FEB 2009.


In the last WAVES.GLOBAL, we talked about seasonal weakness and the end of Feb or early Mar cycle should see lower prices. As anticipated prices are heading lower and DOW is nearing 1997 levels. Markets are always full of surprises, so the surprise for us now is not that whether DOW will reach 1997 levels but whether it will break them.

After moving sideways since NOV, broad equity markets are not full of tired shorts. These are fresh shorts, which are emerging out of TRIANGLES, which only assist in stronger hands replacing weaker hands. The reason they are called continuation patterns (INDIA). The final leg down is here. Don’t stand in front of it till you are sure of the bounce back risk you want to trade up. This is a weekly report and will be back next week, which will be MAR.

Time oscillators continue to suggest that end of Feb, early Mar is a key period where any bounce can be expected, not now. Most of the global indices pushed lower meanwhile SSEC, BVSP and SENSEX move from UP and TOPPING to DOWN. We have carried anticipated and happened cases on DOW, BVSP, NIKKEI, S&P, SENSEX and DAX.

The illustrated chart carries the TIME OSCILLATORS, which point to second week of MAR as any respite zone. Even the minor TIME OSCILLATORS are clearly showing no reactivity in price on the upside. A clear negative signal. Trade safe and see how conventionalism starts to decay in TIME.

Enjoy our latest WAVES.GLOBAL


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History makes observations regarding consistent economic and cultural growth by being self reliant. Revisiting those lessons might suggest a way out of the ongoing crisis.

I have the privilege of working very close to the city centre and since the city is surrounded by hills, as you move away from the centre, the altitude keeps rising. This gives me a chance to see a big 600 year old church surrounded by long pine trees and celebrated by a huge metal statue of an armed king riding a horse, ready for battle. The view though a few 100 meters away, keeps looking at me from the office window. Matei Corvin the Hungarian king defended the country in 1458-1490 from the Ottoman Empire (1299-1923). The Ottoman Empire is viewed as an offshoot of the Mongol Empire.

During the Renaissance era, the venetians raised great walls around cities threatened by the Mongol empire. The great wall (Qin 221-260 BC) has played a significant role in the Chinese history and defended the country from the same Ottoman Empire. No other culture seems to have adopted walls as enthusiastically as the Chinese, maybe the reason Chinese could retain four thousand years of continuous economic and cultural history.

Starting 1900’s, the republic of China (1912), republic of Turkey (1929), republic of India (1947), the walls are still there but the strategy of war, expansion and protection continue to take different forms. Now we have trade policies, currencies and stock markets. We have a need to grow, to raise payment surplus, to keep inflation lower, and to have a double digit GDP growth.

August 2005, it was all positive stories about China’s extraordinary ability to mobilize workers and capital, tripling of per capita income in a generation, easing 300 million out of poverty and projection of decades of new growth. It was more of competition, India’s inability against China’s ability. India’s lack of subways and a dearth of expressways compared to China’s high tech Beijing.

This was followed by cooptetion with comments like “What makes the two giants especially powerful is that they complement each other’s strengths. China will stay dominant in mass manufacturing, building multibillion-dollar electronics and industrial plants. India is a rising power in software, design, services, and precision industry. What if the two nations merge into one giant “Chindia?” America was expected to make room for China and India. What happened? A majority of us did not see the ongoing struggle for survival over competition and cooptetion stories.

If Thomas Malthus could project the 1929 crisis in 1800’s, it was owing to the population curve he devised. Population curve was popularized and fine tuned by Pierre Verhulst, as the fractal S curve. Barring time, everything has a limit of growth. This suggests that there is a limitation to which even population can work as a growth driver. Conventional thought has population as a constant input in forecasting models. If population will grow, consumption will and if consumption will increase economic growth will follow. The same population curves can explain long pauses in growth despite a booming population and if indeed we have hit a population ceiling, the respective parameter will cease to cause absolute growth or relative growth. Rather it could become a liability. This means that trend forecasts that by mid-century, China should overtake U.S. owing to global output and large internal consumption might be a myth.

Collapse of US economy would see most emerging markets as relative outperformers. This also means that half a million engineers and scientists a year from China and India, vs. 60,000 in the U.S are just numbers. The brains don’t work in depressions and recessions, the stomach does. Population cannot just be a source of instability, but cause instability, if the government can’t provide education and opportunity, which invariably happens.

Consumerism will become a chapter in Econohistory. The old kings did not comprehend this phenomenon, as life was more self sustaining and not about going to the mall. Actually consumerism is nothing but indulgence, like speculation over investment. The current economic times that we live in warrants both consumerism and speculation for profits. This creates larger chaos and larger risks, pushing us again to the self sustaining past. This is why markets can never be efficient, as it is consumerism and speculation that drive it.

In the process of driving the ‘made in China’ consumerism, the country has seen dropping efficiency and increasing wastefulness. More than half of China’s GDP is plowed into commodity, autos and construction. Its factories are known to pollute and are highly inefficient compared to global and Indian manufacturers. More than half of China’s listed companies are known to earn below their actual cost of capital. This is not the case in India. There are numerous studies comparing the better averaging Indian company’s return on capital than their Chinese counterparts.

Conventionalism is a philosophy for an up cycle; it fails miserably when the cycle turns as chaos takes over. Time makes majority look smart at one time and foolish at the other. Dr. Anil K Gupta, author and professor of strategy, University of Maryland said this at a conference in Chicago in May 2007 that “Emergence of China and India is like the emergence of the Internet, here to stay and the only real option for us is to get on board”. The timing to get on board was perfect. The avalanche started after six months.

When a sizeable part of your population is manufacturing oriented, you are in a high risk sector, only if you understand the volatile nature of consumerism and speculation. China hence has a bigger problem at hand than the Indian policy makers. India’s poor got used to living on $1 a day. Above this the cumbersome democracy still has internal ways and means to balance itself compared to China, which attempted selective capitalism. While Chinese leaders might be worrying about how to cope with the ongoing joblessness and protests, India is busy in the election. The time has pushed relative performance in the favor of India, as the challenge of China moving from manufacturing to services faster than India resolves its infrastructure bottlenecks ceases to exist. Building basic infrastructure is a stronger economic activity in tougher times compared to creating a vibrant service sector.

We explained the broken BRIC model first time in Dec 2007 and then we revisited it in May 2008. In a recent paper to the Kyoto University written by Ionut Nistor and me. We used timing models comparing BRIC countries performance against Nikkei. We were forecasting relative performance for 2009-2010 and 2012-2015. Our findings reinforced our initial hypothesis that BRIC is more polarized than the Goldman Sachs’ model assumed. Within BRIC also Russia should outperform Brazil and India should outperform China over the next decade. Like we said earlier, barring time everything has a limit. Chinese outperformance against India can never be linear. The next decade should just prove this, especially now that the ‘Great Wall of China’ is not for the invading Genghis Khan but for happy tourists.

The Gold Dollar

The gold dollar was a United States dollar coin produced from 1849 to 1889. Composed of 90% pure gold, it was the smallest denomination of gold currency ever produced by the United States federal government. When the US system of coinage was originally designed there had been no plans for a gold dollar coin, but in the late 1840s, two gold rushes later, Congress was looking to expand the use of gold in the country’s currency. The gold dollar was authorized by the Act of March 3, 1849, and the Liberty head type began circulating soon afterward. Because of the high value of gold, the gold dollar is the smallest coin in the history of US coinage.

The gold dollar link is divine and stands till date. There has been only one prior instance since 2004 (2) when Dollar and Gold strengthened together. The current situation (6) is also witnessing a move up on DOLLAR index and Gold simultaneously. Conventional thought may find it perplexing how this could happen. But just like everything, correlation is cyclical. There is high correlation, low correlation and negative correlation between two assets. This is what is happening between DOLLAR and GOLD. The negative correlation of past years is moving to a positive correlation. But then paper and hard assets can not move in sync for long. This is why one of the assets has to give in. Either Dollar should stop strengthening or Gold should come down.

One would say why this positive correlation can not last for some more time. Yes it can, but now that both dollar index and Gold are heading towards historical highs, we are reaching inflexion points where we could see this positive correlation break down. A gapping USD only confirms that inflexion point might be near.

Our Gold topping view hence is under pressure. It was under pressure since Gold broke above 900. We were singly negative on Gold and positive on all the rest of the metals. We illustrated many reasons to validate our view, but Gold continued to break all our projected resistance levels starting 900, 940 and now is pushing higher to psychological 1000 levels. A breakdown in the DOLLAR-GOLD parity is what will give us further confirmation. A turn down on dollar here would suggest that Gold is indeed heading higher and any dip from current levels will not take us to new intermediate lows. While a break on dollar to new highs would keep us on our preferred negative view on gold.

On the negative side, time oscillators continue to suggest a topping Gold than otherwise. Any dip from current levels could see prices pushing lower till end of Feb, early Mar.

We have carried anticipated and happened cases on PLATINUM, SILVER and SILVER INDIA spot. We were positive on PLATINUM since 800 levels and now it has broken psychological 1000 and headed higher. ZINC and COPPER are at key supports. Our ‘screaming buy’ view on ALCOA stands challenged now that it is retesting previous lows. Though the prices held above anticipated supports, they failed to push higher. A break at previous lows would be negative. We will review after prices push back above respective levels. Overall, the metals case seems a bit overstretched now and if Gold had a tough time turning down, exhausting trends on rest of the metals should see some supply pressure coming in across the board. But till that happens Gold 1,000 could be some news to watch. At this stage we remain ‘Up and Topping’ on the metals complex.

Enjoy the latest WAVES.GOLD





WAVES.GLOBAL 06 Nov 2008 we said that Nov lows should hold. It is three months since then, DOW is still above respective lows at 7,500. Market does not fall under extreme negativity conditions and it does not rise despite all extreme optimism sometime. This is what extremities are about. A trader selling in NOV could have avoided unwanted short positions that could have brought major losses or maybe no gain. Markets are falling from July 2007 – JAN 2008 globally and though our YALE HIRSCH cycle paused the negativity for some time, markets have not bounced back as we expected. This means that classic seasonality of the NOV – APR period stands challenged. It was building on this market inability to move higher that we mentioned about the potential negation of our positive expectations in a weeks time.

We have reviewed the seasonality and it seems that market negativity could continue till end of February or early March. NIKKEI held above anticipated supports, but successive retesting suggests that the Nikkei might also give in to the FEB end negative seasonality. We have carried TIME OSCILLATORS on DOW, BVSP, NIKKEI, S&P, SENSEX, DAX and FTSE and each one of them suggests cycle lows around early March before any sustained bounce back.

Talking about bounce back after all negative talk might look strange. But looking at the composite of global indices around the world one can see more of a broad equity basing rather than distribution. We have carried the sharp anticipated C wave up move on SHANGHAI. This upmove is a classic emerging market non confirmation against the developed market Indices, which suggest that any legs lower should be final at least on a few emerging market indices. We also have some anticipated and happened cases on BVSP, RTS and DAX.

Enjoy the latest WAVES.GLOBAL.

WAVES.GLOBAL - WAVES.GLB is a perspective product published on Monday. The report highlights top GLOBAL indices and emerging market indices viz. Dow Jones Industrial (.DJI), S&P 500 (.GSPC), German DAX (.GDAXI), Russian IRTS (.IRTS), Shanghai Composite (.SSEC), Nikkei 225 (.N225), Brazil BOVESPA (.BVSP), Indian Sensex (.BSESN). The product covers all the DOW 30 stocks. The product highlights Primary (Multi Month) and Intermediate (Multi Week) price trends. The report illustrates key price levels, price targets, price projections and time turn windows. The product uses Elliott waves, traditional technical analysis tools, sentiment indicators and other alternative research tools like INTERMARKET to spot outperformers and market trends.





When you say ‘FIRST’ or ‘LAST’, you are already attaching 100% probability to an action. Such high probability forecasts are generally prone to error because even if ‘TIME FRACTALS’ and ‘PRICE FRACTALS’ were perfect, the human ability to see patterns and form is not.

Above this market’s have an ability to surprise or markets always have another top and another bottom. This is why calling a last leg is risky. There is one aspect, which keeps us a bit hedged and that is the degree. There are various trend degree’s in market, a minor, an intermediate and primary. The ongoing action in GOLD is nearly 12 month old, making it a primary leg down. The overall formation still seems incomplete and indicates that the move up is indeed a corrective preferred X.

So, if the GOLD 30 year cycle is still ongoing till 2015, and if the relative performance of Gold against global assets is any indication of strength, any fall from here should be the last and of intermediate degree for GOLD till 2015.

The TIME CYCLE illustrated here also suggests that momentum is overstretched and Gold is indeed exhausting at current levels rather than getting ready to move higher. India spot gold also seems topping. The latest WAVES.GOLD carries ANTICIPATED and HAPPENED cases on PLATINUM, SILVER, STEEL, COPPER and ALCOA, which continues to hold up against all negativity.

Enjoy the latest WAVES.GOLD

WAVES.GOLD is a perspective product published on Monday and Wednesday. The report highlights GOLD and other precious and base metals. The product highlights Primary (Multi Month) and Intermediate (Multi Week) price trends. The report illustrates key price levels, price targets, price projections and time turn windows. The product uses Elliott waves, traditional technical analysis tools, sentiment indicators and other alternative research tools like INTERMARKET to spot outperformers.




Finding Peter Lynch

Both Jonathan Clements and Hersh Shefrin say it’s tough looking for the next Lynch. Clement said it in 1990 in an article in Wall Street Journal, while Hersh says it loud in his book on behavioral finance. Actually they are both true, finding a 13 year stellar growth record with the underlying fund growing from $ 20 million to $ 13 billion is a text book case study, rare.

Though they both say the same thing Clement is pointing to a high skill, but Shefrin on the other hand says it was also luck and not the simple investing approach which Lynch followed. There is another aspect that they disagree on, past performance. The ex Wall Street Journal columnist does not discredit past performance as an indicator to future performance but the behavior guru says past performance is difficult to evaluate.

The subject of past is widely debated between people who live ”there” and believe in it to drive the future, and people who say past is meaningnless, future is always different. The non believers forget that life is ruled by law and not by accident and action and reaction is part of life’s mystery or misery. If the past is such an important driver for the evolution of a society, how can past lag behind. Future builds on the past and so does performance, positive or negative. The famous quote of Jean Baptiste Alphonse Karr “The more things change, the more things remain the same” summarizes how we cannot break away the two ends of time. So if we keep revisiting the past, how can the future we so different from the past and how can past stellar performance not be delivered again. If randomness was the future, why do option traders keep waiting for the black swan from 1987?

Cyclicality is another thing which behaviorologists miss. Teaching masses how emotionally flawed they are is one thing and telling them how economic cycles change and force us to adapt is another thing. We as a group of humans can learn how error prone we are but we still need to understand how changing asset cycles force us to change our thinking. Emotional maturity is just a step in the right direction.

There is a host of literature written about understanding and identifying a professional. The process becomes tricky when prices are falling and belief levels are less in institutions and professionals who run them. Just like individuals, majority of professionals tend to be overconfident about their skills. The institutionalization of the professionals intensifies the incompetency further. Hersh illustrates the ‘games’ institutions play to mask failure. Merging loss making funds can have multiple aims like showing the winners, masking the risk and failure.

Benchmarking an industry wide practice is more of a performance masking than performance illustrating technique. Michael Jensen (1968) who studied performance over 1945-1964 found that past year winners don’t repeat. He said that a fund could only be expected to return more than the market if it held a portfolio that featured more systematic risk than the market. What Jensen did was to take the raw return to a fund and subtract out a portion that reflected the compensation for taking risk. He called this residual “alpha” and it is called as “Jensen’s alpha”. In effect, Jensen found that all mutual fund alphas were indistinguishable from zero. This is one reason, why the skyline has very few positive return histograms standing if you compare funds locally or globally. Majority of them fall and rise together. Grinblatt, Titman and Rauss Wermers (1995) find that about 77 percent of mutual fund use momentum strategies, meaning that they purchase stocks that have recently gone up. There is a clear herding behavior with respect to stocks that have recently gone up. They move in to buy past winners at the same time but don’t herd when it comes to selling past losers.

Past performance indicator for future success is not the fair coin flip catch up, but fading rationality as overconfidence enters. It’s tough to stand alone with a performance less than the benchmark. It’s tough to resist a big city glitter for a small city bland shine. It’s tough to be conservative when risk taking is the norm. It’s tough to stand against the peer group pressure. We have lived with peer group pressure from the day we were born, competing with siblings, competing at school. It’s is this which makes us herd and not stand alone as a fund manager or investor happy with single digit portfolio returns in a double digit market or be a fund manager more focused on risk control than on return increase. The time ahead will change this, as new genre of individuals emerges, new professionals creating new institutions.

It is this individuality that is first step to finding Peter Lynch out there or inside us. In a recent sentiment survey that Orpheus conducts with Prognosis, the individuals preferred sector of investment was “None”, while the professionals were looking at “Utilities”. Even if late, the fact that the professionals are looking at taking risk when risk aversion has reached an extreme, places the professionals higher in skill above individuals. We as a society are scared at the wrong time, more after an 80% collapse and less before that. Fool’s Gold continues to hold below historical highs suggesting a global reduction in panic levels rather than an increase. Even if we see a fall in Q2 2009, the current price levels remain a relatively attractive time to invest for the next 15-18 months. It is late to close the exchange, go back to the village and look for a job out of capital markets. The damage is already done. It’s rebuilding time now. A 10% spot allocation on metals, energy, health care and FMCG now, increasing it to 25% by the end of Q1 is how we would allocate. Broad markets may still be failing, but FMCG pushed up. BSE health care has made clear five wave structures down, suggesting we might be hitting a base there too. Recession times and late economic cycle is the Pharma outperformance time, as market takes a toll on a healthy society.

The human mind may be full of biases, but it has an amazing will power and determination to stand alone, sometimes foolishly. Daniel Kahneman’s famous words regarding the great mystery of finance ” Why do people believe they can do the impossible? And why do other people believe them?” is more about how we are constructed to dream the impossible, dreaming to become Peter Lynch and not just finding him.

We don’t think the Lynch record is unassailable, human brightness is limitless, a double edged sword, determination to succeed versus spending time hiding evidence and failure. This reminds me of a Bill Naughton short story I read in school titled ‚seventeen oranges’. Clem Jones’s (the delivery boy at docks) love for oranges puts him in trouble when Pongo the policeman decides to punish him. There was no escape, locked in the hut and with the oranges on the table, Clem had to think of a fast solution before Pongo brought a witness. The inner voice ’Oh, my god! What can i do? Eat the oranges. Eat the evidence. No time to eat, you have to swallow the pips too.’

Trading an Extension

Traders are excited about large and fast moves. One such move, which traders would love to trade, is called an extension. These are also known as Elliott impulse waves with exaggerated subdivisions and an ability to catch the majority of the trading community by a surprise. Identifying a beginning of an extension can be extremely profitable. And just like beginning, knowing where the extension is ending could also offer a good exit avoiding unwarranted losses.

So how should we identify them and where is one likely to find them? Extensions can happen both in rising and falling prices. The third wave is the most commonly extended in the stock markets as they are part of a larger impulse within Elliott’s five wave structure. Extensions can also be witnessed in corrections. When an extension happens in a falling market, it’s generally referred to as collapse or capitulation. Extensions of SUPERCYCLE degree lower caused ‘The Great Depression’ and the 2008 crisis also saw emerging markets erode 90% in value owing to extensions.

Since asset markets are linked and human psychology is similar at all time frames (fractalled), extensions can be seen in every asset class at all degrees. Elliott named it the ‘powerful wave’, because it generates the greatest volume and price movement and creates large gains in the market. An extension of a primary, cycle or higher degree third wave sees unprecedented price growth, creating euphoria.

How does an extension look like? We have illustrated here a typical third wave extension in an Elliott five wave structure. As you can see the counting on the chart, this is what Elliott called an extension within extension. Inside the extended intermediate (3) wave, the minor 3 wave is also extended. Do you see how the prices keep extending? Now since the underlying asset in a currency, rising extension is causing increase in worry and fear in the society. The Romanian central banker and the society is afraid regarding the macro economic situation of the country. But as we said the emotion linked with such an extended natural market pattern is an extreme.

We at Orpheus read extreme sentiment as unsustaining and believe that just like BETFI, which is witnessing a negative extension, EURRON is seeing an up extension, both of which suggest more of exhausting trends rather than an unending crisis. In the case of an extended three wave, we can expect the fifth wave to be simple as both fifth and third extensions together are rare.

EURRON here seems to be in the final wave of the Elliott structure, we expect the final fifth to nout push up above 4.7 where we see the currency turning back (strengthening) for a multi month period. This should be accompanied by a reversal on BETFI. Time windows suggest a key inflexion point early MAR and then in JUN.

In conclusion, identifying an extension is useful because it’s a guide to the expected lengths of the ongoing trend both in value and time. Call it fractals, patterns or time cycles, interpreting markets is a science which has more predictability attached to it than all the external information one can ever process. Even if we had access to all the information, we believe an extension simplifies and expresses the essence.

Trade Well
The Orpheus Team