Fun with Fibs

The silverogosphere is in an orgy of self-congratulation following the Chairman of the Federal Reserve's commitment on Thursday to provide $40 billion per month in monetary stimulus (a.k.a QE3) to buy mortgage debt.

In some respects, the cheerleaders merit their day in the sun. I was certainly personally surprised that more QE was actually announced prior to the presidential election, and utterly flabbergasted that Mr Benanke went so far as to essentially commit to stimulus without an end date. Although any sane observer [amongst whom I hope to be able to count myself, although years of being force-fed crystal meth by GM's harem of harpies has somewhat weakened an already tentative grasp on reality - Ed.] has appreciated for some time that the fiscal debt can only be solved practically through one of three broad policies (dollar devaluation; default; mass confiscation from citizens), it still came as something as a surprise to me that the Fed would be so explicit about their choice of option 1, and then be so aggressive about their mode of implementation.

The meme of "QE to infinity" seems apposite, although it's certainly not a done deal. Regardless, whether gold and silver are the best ways to profit from the Fed's decision or not is another matter entirely: a debate perhaps better left for another day. But let's just say that, although I was pleased with the rise in the d'Arc's gold investments, I was disappointed not to have invested more than I had in the resource companies of Kazakhmys (LON:KAZ) and Vedanta (LON:VED), which have both moved by 10% since Bernanke's announcement - compared with gold's 3.5% and silver's 6%  (meaning that Monsieur d'Arc will be getting an especially nice Christmas present this year).

Regardless, the exam question for this post concerns whether or not it is a good idea to immediately throw one's life savings into PMs, resource (and other) stocks, etc. Perhaps the 'Bernanke bounce' was overdone, and Monday/Tuesday will see a sharp retracement. Or perhaps we are now at the start of a serious bull market in stocks that will eclipse the dotcom bubble, and it's best to get on board as quickly as possible.

Of course, the simple answer is that we don't know for sure. But, in such times, I do find it useful to look at the Fibonacci analysis for various commodities in order to get some perspective on where we are, from where we've come, and to where we might be going.

In a recent comment on my unpopular 'RSI - Really Stupid Investors?' post, I made the point that the move on Thursday/Friday was hardly earth-shattering in terms of the technicals. For silver/gold, for example, no key levels were broken, and I feel that we're still at a 'pivot point' in terms of where price may go in the short term. I'd like to expand on that a bit here.

Precious Metals

Fibonacci analysis works by one first choosing a 'high' and a 'low'. Retracement lines are then calculated. Fibonacci analysis is therefore only as good as one's confidence that one is dealing with a 'real' high and a 'real' low. For the PMs, few would argue against choosing silver's near-$50 high in April 2011 and gold's all-time high in September 2011. The lows are more controversial, however, as the choice implies a 'real' bottom - a point beyond which another leg down is deemed to be very, very unlikely. I am always reluctant to call a bottom as it is patently obvious to all but the terminally moronic that new bottoms can be put in at any time, given the right set of events. If 2008 hasn't taught us that, then we have learned nothing.

All that said, silver's 'bottom' of around $26 has been tested multiple times, for over a year, and therefore provides as 'certain' a Fibonacci low as one could ever practically assign. We are therefore able to construct the following chart:

I'd like to stress three very important points arising from this chart:

1. The Fib 'channels' (i.e. the 'gaps' between the Fib lines) have worked pretty beautifully since April 2011. There have been some overshoots here and there, but largely this is as textbook a Fib chart as one will find. For those who say that Fib analysis is nonsense, I would like to refer them to this chart.

2. The move on Thursday/Friday was nothing special. Really. With or without Bernanke's announcement, a move to retest the 38.2% retracement level was always on the cards, and I'd pointed this out on JdA's Trading Set Ups on 9th September, because this level (at around $35) was/is a very tempting area for a short, given the fact that silver hasn't broken this line since March.

3. Silver is now essentially on the 38.2% retracement line. Given the strength of the move on Thur/Fri, the pessimist in me would bet on at least some kind of a move back away from this line. Regardless, it would be courageous to buy until confirmation of the next move is given. In other words, if it fails at the 38.2% retracement, then a short may be in order (or at least not going long!) If it breaks through, then a retest at around $35 seems likely, and if it passes this test than going long to at least $38 (the 50% retracement line) could be profitable.

Gold is in a very similar situation, with the only difference being that it is sitting exactly on the 61.8% retracement line (rather than the 38.2% line like silver), waiting for further instructions. This line has proved to be very strong resistance in the past (see chart), and I would again be cautious about establishing a position either way until we know if it is going to fail or succeed at this point. If it breaks through, then wait for a successful retest, then go long until we're back at the all-time high (then sell like the wind). If it fails, then a move back down to at least the 50% retracement line at around $1725 or even the 38.2% line at $1673 seems to be on the cards:

What about the gold miners? Well, guess what? The HUI is also sitting almost on a Fib line (the 50%). To be fair, it seems to have slightly passed through it, but it is a composite index and a quick look at the individual miners that make up the HUI (not shown here for brevity) shows that most of them are sitting perfectly on the 50% line. Even if the HUI breaks north from here, it will face very strong resistance at the 61.8% retracement line, and that could be a smart place for a short. Conversely, if it breaks through the 61.8% line, then a long all the way up to the 100% line (i.e. the September 2011 high) seems like a wise bet:


Moving on more quickly, as the pattern is rapidly becoming clear and you're probably getting the general idea by now, oil has (like gold) stopped bang on the 61.8% line:

The Continuous Commodity Index (a 'basket' of commodities) has stopped at the 50% line:

The stock markets

These are tricky for Fib analysis, because on Friday the S&P 500, the NASDAQ and the Dow Jones all hit  post-2008 highs. In other words, they have all blasted through their 100% Fib lines, and are on their way to uncharted territory (which means that they could go on to the moon, or top out at some unpredictable level and then fall back down into a new set of Fib lines). However, the UK's FTSE 100, which has not hit a post-2008 high (yet) is worthy of examination:

You may notice that this is a particularly obedient chart. The Fib lines have been very well respected as lines of support and resistance since 2011's highs. You'll also notice that we're currently in Fib 'no man's land', somewhere between the 61.8 and 100% levels. I'd like to think that, given the Bernanke bounce, and in the absence of some horrific Euro news, that this index will overcome previously strong resistance at around 6000 and carry on up to 6100. I for one will be getting ready to short if it gets that far.


Fibs are fun. They're also often freakishly accurate (albeit often in retrospect...) What is striking about the moves on Thursday and Friday, however, is how they took the commodities and stocks right up to important Fib lines, and closed bang on them. This leaves us in a trading quandary.

The silverogosphere will tell you that, given Bernanke's announcement, the only way is up from here. The silverogosphere might actually be right about that - it certainly makes sense given previous experience from announcements of QE. But bad news can quickly change short term exuberance. Don't believe me? Here are a few things that could spoil the party:

- Further tensions in the Middle East/Iran leads to a further release of strategic oil stocks, crushing the price of oil. This is precisely what happened on the day of the intervention in Iraq. Take a look at a chart if you don't believe me.

- Mitt Romney (a) comes out strong against QE, pledging to put a stop to it if elected, and (b) starts going up in the polls.

- The Euro nightmare returns (which it will, periodically, for years).

- A million other things.

In such a wild, wild world, traders big and small need numbers. Numbers that allow one to decide when to go long or short, and to take a reasonable guess at when the selling madness will stop or the buying euphoria will stall. In unchartered territory, one has the option of either pulling a number out of one's arse, or using something more systematically understood. In that sense, there's nothing special about Fib sequences in the stock market: they're just numbers, commonly understood by gentleman's agreement, if you like, to provide a vague sense of order to an otherwise entirely chaotic system.

The flip side is that when such use of the Fibonacci system leads to highly 'entrenched' charts, such as that for silver, above, in which the Fib lines have repeatedly acted as support and resistance, the Fib prophesy becomes self-fulfilled. At that point, they need to be treated with respect. This is the explanation for why everyone halted the buying at these lines on Friday. And this is the reason why small, retail investors, need to be wary about stumping up their hard-earned before some confirmation is given regarding the next direction of travel. Bernanke or no Bernanke.



Byzantium said...

Thank you JdA for a very informative post. This was a clear and concise intro to the topic, with immediate practical benefits.

Regardless the scientific merits or not of Fibs, if this is what the larger trading entities are working to, then it would be foolish for us minnows to ignore them.

On your RSI article, I referred to $40 silver and $1800 gold as points just before which, I would ramp up my selling / profit taking, and you suggested that this might be on the optimistic side. Essentially, the Fib analysis that you provide, shows these as being the highest Fib lines, and you would simply adhere to the lower ones in the short term. The levels I am adopting were earlier also suggested by Dan Norcini as the higher resistance levels, and I went for those without necessarily knowing how they were set, but now it is clearer.

Anyway, looks like good TA karma to me; there is the world of difference being bullish until $39.50, than to $41.50, no?

Looking good for the HUI too, if it can clear the 38% FIb.

Thanks again :-)

Funky Tape said...

Thanks JdA.

Maybe it's just me, but anyone with half a trading sense knew and will always know the the PM's don't "NEED" this QE nonsense. Time and time again, those that *think* and try to come up with a story get broke or miss out while those that *accept* what the tape gives them and trade accordingly bank coin.

While everyone in the BRAG-o-sphere was saying "silver $21" and "$1440 gold, watch out?" I encouraged them to get super short so I could sit with my popcorn and all watch them try to run to the exit doors as fast as possible as they got massively squeezed. But "technical analysis doesn't work in a rigged market!" Yeah, story, bro.

Which makes me wonder why you would even talk about "things that could spoil the party" when it should be zero of a concern from a technical side. In fact, you could be sitting on some great profits by trading those charts alone not knowing if they were silver, gold, blow up sex doll futures. Fundamentals also irrelevant.

Also, was it your intent just from a KISS perspective to use only one Fib set of data on the daily to describe the landscape? I'd think by adding some some extensions, confluence areas, multiple time frames in to one trading soup might provide more clarity?

Oh, and silver to $4700 by QE100! :winky:

S Roche said...

Credit where credit is due, good call.