There’s a reason why commercial traders are regression to the mean traders. In this business it is the one thing that you can absolutely bank on. It's like death and taxes, it never fails. All markets eventually return to the mean. An appropriate corollary to this rule is that the further an asset gets stretched above or below the mean the more violent the regression is, and the further it will move past the mean during the snapback.
You can see this clearly in the chart below.
that during the bull market from 2002 -2007 the S&P never stretched
extremely far above the 200 day moving average (well until the final euphoria phase in 2007). Consequently each
intermediate correction halted at or slightly below the 200 day moving
This changed when the new cyclical bull
market started in 2009. It changed because the markets were not allowed
to trade naturally. They were warped by massive doses of quantitative
easing. This caused markets to stretch much further above the 200 day
moving average than would have occurred normally. The consequences of
course were that when the corrections hit they unwound violently and
moved much further below the 200 DMA than would have occurred naturally.
market is much more volatile than the previous one because the market is
being driven by currency debasement instead of true economic expansion.
Now we are in a situation where the
stock market has been stretched ridiculously far above the mean by QE 3
& 4. Trust me; Bernanke has not abolished the forces of regression
to the mean. All he has done is guarantee that the regression is going
to be many multiples more violent than it should have been.
When this house of cards topples over, I
think there is a pretty good chance it’s going to be even more severe
than what happened in 2011.
Also notice the red arrows marking
major cyclical bull and bear market turning points. Notice the Fed
warped the last cyclical bull market much higher and longer in duration
than should have occurred naturally (he turned a 4 year cycle into a 6
1/2 year cycle). Consequently the forces of regression responded by
triggering the second worst bear market in history. The current cyclical
bull market, although not stretched as long in time, is extremely
stretched in magnitude so the resulting bear market will almost
certainly be exceptionally violent and protracted.
regression rule: Without fail liquidity eventually finds its way into
undervalued assets. An appropriate corollary to that rule would be that
liquidity will eventually find its way out of overvalued assets.
Bernanke has found a way to break the natural law of regression to the
mean (he hasn't) then at some point we are going to see liquidity flee
the overvalued stock market. When it does it's going to look for
undervalued assets to land on. Nothing is more undervalued in my opinion
than commodities in general and precious metals in particular.
to the mean doesn't just apply to assets stretched to the upside. It
also acts to levitate extremely depressed assets, and the same rules
apply. The further an asset is stretched below the mean the more
violently the regression usually is once the selling exhausts.
Considering that gold is now stretched about as far below the 200 day
moving average as it was in 2008 the rally, when it arrives, should be
every bit as powerful if not more so than we saw in 2009.
opinion we now have the setup to drive either another C-wave as large or
larger than the one out of the 2008 bottom, or this is the set up to
drive the bubble phase of the bull market.