Elliott Wave Principle : Chapter 6

Chapter 6

Stocks and Commodities

6.1 Stocks and Commodities

Individual Stocks

The art of managing investments is the art of acquiring and disposing of stocks and other securities so as to maximize gains. When to make a move in the investment field is more important than what issue to choose. Stock selection is not unimportant, but it is of secondary importance compared to timing. To be a winner in the stock market, either as a trader or as an investor, one must know the direction of the primary trend and proceed to invest with it, not against it. Fundamentals alone are seldom a proper justification for investing in stocks. U.S. Steel in 1929 was selling at $260 a share and was considered a sound investment for widows and orphans. The dividend was $8.00 a share. The Wall Street crash reduced the price to $22 a share, and the company did not pay a dividend for four years. The stock market is usually a bull or a bear, seldom a cow.

As a mass psychological phenomenon, the market averages unfold in Elliott wave patterns regardless of the price movements of individual stocks. As we shall illustrate, while the Wave Principle has some application to individual stocks, the count for many issues is often too fuzzy to be of great practical value. In other words, Elliott will tell you if the track is fast but not which horse is going to win. With regard to individual stocks, other types of analysis are probably more rewarding than trying to force the stock’s price action into an Elliott count that may or may not exist.

There is reason to this. The Wave Principle broadly allows for individual attitudes and circumstances to affect price patterns of any single issue and, to a lesser degree, a narrow group of stocks, simply because what the Elliott Wave Principle reflects is only that part of each man’s decision process which is shared by the mass of investors. In the larger reflection of wave form, then, the unique circumstances of individual investors and individual companies cancel each other out, leaving as residue a mirror of the mass mind alone. In other words, the form of the Wave Principle reflects the progress not necessarily of each man or company but certainly of mankind as a whole and his enterprise. Companies come and go. Trends, fads, cultures, needs and desires ebb and flow with the human condition. Therefore, the progress of general business activity is well reflected by the Wave Principle, while each individual area of activity has its own essence, its own life expectancy, and a set of forces that may relate to it alone. Thus, each company, like each man, appears on the scene as part of the whole, plays its part, and eventually returns to the dust from which it came.

If, through a microscope, we were to observe a tiny droplet of water, its individuality might be quite evident in terms of size, color, shape, density, salinity, bacteria count, etc., but when that droplet is part of a wave in the ocean, it becomes swept along with the force of the waves and the tides, despite its individuality. With over twenty million "droplets" owning stocks listed on the New York Stock Exchange, is it any wonder that the market averages are one of the greatest manifestations of mass psychology in the world?

Despite this important distinction, many stocks tend to move more or less in harmony with the general market. It has been shown that on average, seventy-five percent of all stocks move up with the market, and ninety percent of all stocks move down with the market, although price movements of individual stocks are usually more erratic than those of the averages. Closed-end stocks of investment companies and stocks of large cyclical corporations, for obvious reasons, tend to conform to the patterns of the averages more closely than most other stocks. Emerging growth stocks, however, tend to create the clearest individual Elliott wave patterns because of the strong investor emotion that accompanies their progress. The best approach seems to be to avoid trying to analyze each issue on an Elliott basis unless a clear, unmistakable wave pattern unfolds before your eyes and commands attention. Decisive action is best taken only then, but it should be taken, regardless of the wave count for the market as a whole. Ignoring such a pattern is always more dangerous than paying the insurance premium.

                                             Figure 6-1                                                                                                                                                      Figure 6-2

                                             Figure 6-3                                                                                                                                                          Figure 6-4

                                                               Figure 6-5             

Despite the above detailed caveat, there are numerous examples of times when individual stocks reflect the Wave Principle. The seven individual stocks shown in Figures 6-1 through 6-7 show Elliott wave patterns representing three types of situations. The bull markets for U.S. Steel, Dow Chemical and Medusa show five-wave advances from their major bear market lows. Eastman Kodak and Tandy show A-B-C bear markets into 1978. The charts of Kmart (formerly Kresge) and Houston Oil and Minerals illustrate long term "growth" type advances that trace out Elliott patterns and break their long term supporting channel lines only after completing satisfactory wave counts.

6.2 Commodities

Commodities have as much individual character as stocks. One difference between the behavior of commodities and stock market averages is that in commodities, primary bull and bear markets at times overlap each other. Sometimes, for instance, a complete five-wave bull market will fail to take a commodity to a new all-time high, as the chart of soybean futures illustrates in Figure 6-9. Therefore, while beautiful charts of Super cycle degree waves do exist for a number of commodities, it seems that the peak observable degree in some cases—especially in non-inflationary environments—is Primary or Cycle degree.

Also in contrast to the stock market, commodities most commonly develop extensions in fifth waves within Primary or Cycle degree bull markets. This tendency is entirely consistent with the Wave Principle, which reflects the reality of human emotions. Fifth wave advances in the stock market are propelled by hope, while fifth wave advances in commodities are propelled by a comparatively dramatic emotion, fear: fear of inflation, fear of drought, fear of war. Hope and fear look different on a chart, which is one of the reasons that commodity market tops often look like stock market bottoms. Commodity bull market extensions, moreover, often appear following a triangle in the fourth wave position. Thus, while post-triangle thrusts in the stock market are often "swift and short," triangles in commodity bull markets of large degree often precede extended blow offs. One example is shown in the chart of silver in Figure 1-44.

Figure 6-8

The best Elliott patterns are born from important long term breakouts from extended sideways base patterns, as occurred in coffee, soybeans, sugar, gold and silver at different times in the 1970s. Unfortunately, semi logarithmic chart scale, which may have indicated applicability of Elliott trend channels, was not available for this study.

Figure 6-8 shows the two-year price explosion in coffee from mid-1975 to mid-1977. The pattern is unmistakably "Elliott," even down to Minor degree. The ratio analyses employed beautifully project the peak price level. In these computations, the length of the rise to the peak of wave (3) and to the peak of wave 3 each divide the bull market into the Golden Section at equivalent distances. As you can see by the equally acceptable counts listed at the bottom of the chart, each of those peaks can also be labeled as the top of wave ③, fulfilling typical ratio analysis guidelines. After the pattern reached the peak of the fifth wave, a devastating bear market struck apparently from out of the blue.

Figure 6-9 displays five and a half years of price history for soybeans. The explosive rise in 1972-73 emerged from a long base, as did the explosion in coffee prices. The target area was met here as well, in that the length of the rise to the peak of wave 3, multiplied by 1.618, gives almost exactly the distance from the end of wave 3 to the peak of wave 5. In the ensuing AB- C bear market, a perfect Elliott zigzag unfolded, bottoming in January 1976. Wave B of this correction is just shy of .618 times the length of wave A. A new bull market took place in 1976-77, although of subnormal extent since the peak of wave 5 falls just short of the minimum target of $10.90. In this case, the gain to the peak of wave 3 ($3.20) times 1.618 gives $5.20, which when added to the low within wave 4 at $5.70 gives the $10.90 target. In each of these bull markets, the initial measuring unit is the same, the length of the advance from its beginning to the peak of wave three. That distance is then .618 times the length of wave 5 measured from the peak of wave 3, the low of wave 4, or in between. In other words, in each case, some point within wave 4 divides the entire rise into the Golden Section, as described in Chapter 4.

Figure 6-10 is a weekly high-low chart of Chicago wheat futures. During the four years after the peak at $6.45, prices traced out an Elliott A-B-C bear market with excellent internal interrelationships. Wave B is a contracting triangle exactly like those discussed in Chapters 2 and 3. The five touch points conform perfectly to the boundaries of the trend lines. Though in an unusual manner, the triangle’s sub waves develop as a reflection of the Golden Spiral, with each leg related to another by the Fibonacci ratio (c = .618b; d = .618a; e = .618d). A typical "false breakout" occurs near the end of the progression, although this time it is accomplished not by wave e, but by wave 2 of C. In addition, the wave A decline is approximately 1.618 times the length of wave a of B, and of wave C.

Figure 6-9

Figure 6-10

Thus, we can demonstrate that commodities have properties that reflect the universal order that Elliott discovered. It seems reasonable to expect, though, that the more individual the personality of a commodity, which is to say, the less it is a necessary part of human existence, the less it will reliably reflect an Elliott pattern. One commodity that is unalterably tied to the psyche of mass humanity is gold.

6.3 Gold

Gold in the recent past has often moved "contra-cyclically" to the stock market. A reversal in the price of gold to the upside after a downtrend often occurs concurrently with a turn for the worse in stocks, and vice versa. Therefore, an Elliott reading of the gold price has upon occasion provided confirming evidence for an expected turn in the Dow.

In April 1972, the U.S. government raised its long-standing fixed price for gold from $35 an ounce to $38 an ounce, and in February 1973 increased it again to $42.22. This "official" price used by central banks for currency convertibility purposes and the rising trend in the unofficial price in the early seventies led to what was called the "two-tier" system. In November 1973, the official price and the two-tier system were abolished by the inevitable workings of supply and demand in the free market.

The free-market price of gold rose from $35 per ounce in January 1970, reaching a closing "London fix" peak of $197 an ounce on December 30, 1974. The price then started to slide, and on August 31, 1976 reached a low of $103.50. The fundamental "reasons" given for this decline were U.S.S.R. gold sales, U.S. Treasury gold sales and I.M.F. auctions. Since then, the price of gold has recovered substantially and is trending upward again.

Despite the efforts of the U.S. Treasury to diminish gold’s monetary role and the highly charged emotional factors affecting gold as a store of value and a medium of exchange, its price has traced out an inescapably clear Elliott pattern. Figure 6-11 is a graph of London gold, and on it we have indicated the correct wave labels. Note that the rise from the free-market liftoff to the peak at $179.50 an ounce on April 3rd, 1974 is a complete five wave sequence. The officially maintained price of $35 an ounce before 1970 prevented wave formation prior to that time and thus helped create the necessary long-term base. The dynamic breakout from that base fits well the criterion for the clearest Elliott count for a commodity, and clear it is.

The rocketing five-wave advance forms a nearly perfect wave, with the fifth terminating well against the upper boundary of the trend channel (not shown). The Fibonacci target projection method typical of commodities is fulfilled in that the $90 rise to the peak of wave ③ provides the basis for measuring the distance to the orthodox top. $90 x .618 = $55.62, which when added to the peak of wave III at $125, gives $180.62. The actual price at wave V’s peak was $179.50, quite close indeed. Also noteworthy is that at $179.50, the price of gold had multiplied by just over five (a Fibonacci number) times its price at $35.

Figure 6-11

Then in December 1974, after the initial wave Ⓐ decline, the price of gold rose to an all-time high of nearly $200 an ounce. This wave was wave Ⓑ of an expanded flat correction, which crawled upward along the lower channel line, as corrective wave advances often do. As befits the personality of a "B" wave, the phoniness of the advance was unmistakable. First, the news background, as everyone knew, appeared to be bullish for gold, because legalization of American ownership was due on January 1, 1975. Wave Ⓑ, in a seemingly perverse but market-logical manner, peaked precisely on the last day of 1974. Second, gold mining stocks, both North American and South African, were noticeably underperforming on the advance, forewarning of trouble by refusing to confirm the assumed bullish picture.

Wave Ⓒ, a devastating collapse, accompanied a severe decline in the valuation of gold stocks, carrying some back to where they had begun their advances in 1970. In terms of the bullion price, the authors computed in early 1976 by the usual relationship that the low should occur at about $98, since the length of wave Ⓐ at $51, times 1.618, equals $82, which when subtracted from the orthodox high at $180, gives a target at $98. The low for the correction was well within the zone of the previous fourth wave of lesser degree and quite near the target, hitting a closing London price of $103.50 on August 25, 1976, the month just between the Dow Theory stock market peak in July and the slightly higher DJIA peak in September.

The ensuing advance so far has traced out four complete Elliott waves and entered a fifth, which should push the gold price to new all-time highs. Figure 6-12 gives a near term picture of the first three waves up from the August 1976 bottom, where each advancing wave divides clearly into a five-wave impulse. Each upward wave also conforms to an Elliott trend channel on semi log chart paper. The slope of the rise is not as steep as the initial bull market advance, which was a one-time explosion following years of price control. The current rise seems mostly to be reflecting the decline in the value of the dollar since in terms of other currencies, gold is not nearly as close to its all- time high.

Figure 6-12

Since the price of gold has held the previous fourth wave level on a normal pullback, the count could be a nearly completed five-wave sequence or a developing third wave extension, suggesting coming hyperinflationary conditions under which both the stock market and commodities climb together, although we offer no definite opinions on the subject. However, the Ⓐ-Ⓑ-Ⓒ expanded flat correction implies great thrust in the next wave into new high ground. It should be remembered, though, that commodities can form contained bull markets, ones that need not develop into waves of higher and higher degree. Therefore, one cannot necessarily assume that gold has entered a giant third wave from the low at $35. If the advance forms a distinct five-wave sequence from the low at $103.50 adhering to all Elliott rules, it should be regarded as at least an interim sell signal. Under all cases, the $98 level still should be the maximum extent of any important decline.

Gold, historically speaking, is one of the anchors of economic life, with a sound record of achievement. It has nothing more to offer the world than discipline. Perhaps that is the reason politicians work tirelessly to ignore it, denounce it, and attempt to demonetize it. Somehow, though, governments always seem to manage to have a supply on hand "just in case." Today, gold stands in the wings of international finance as a relic of the old days, but nevertheless also as a harbinger of the future. The disciplined life is the productive life, and that concept applies to all levels of endeavor, from dirt farming to international finance.