This week I’ll focus on gold and silver. Here’s gold’s step sum chart going back to November 2010.  For almost a year (November 2010 to August 2011) gold’s step sum saw an amazing ascent; rising from 220 to 275 (55 net advancing days) in a ten month period.  That’s a lot, but then that’s what a buying panic looks like in a step sum plot.  Then came 22 August 2011, with gold closing at $1,888.70, and that was it for the advance.

The way to understand a step sum chart is realize the price plot (Blue Plot) is market reality, the simple fact of whether the market is trending up or down.  The step sum plot (Red Plot) is a market sentiment indicator of the most important people in any market, those who are actually buying and selling day in and day out.  

Usually, market reality and sentiment are in agreement with each other.  But this isn’t always so.  When these plots conflict with each other a step-sum box forms, such as the big bear box seen below from October 2012 to March 2014.  

Sometimes it’s difficult seeing a box form and develop in real time, other times it’s not. And there are no hard rules to follow when a box begins or ends.  Basically, the only rules I follow are if I see the two plots diverge for over eight weeks, a box is forming. When the two trends undeniably synchronize once again with each other, the box is closed, and I can always change my mind should the situation require it, as sometimes it does.

Whether a box is a bull or bear is determined by the trend of the price plot. Seeing the price plot advance as its step sum trends sideways or actually declines is a bull box. Having the price trend down as the step sum plot trends sideways or actually advances is a bear box. When a box has been identified, trust the price plot (market reality), not the step sum (market sentiment), as the best predictor of the future price trend, though that isn’t always true but usually it is.

If the price plot is so important, why even bother with the step sum plot? To answer that question, let’s study gold’s bear box below. The bear box began in October 2012, a year into a vicious four-year decline. The step sum plot also began declining at this time, but nothing like the decline in the price of gold because the bulls refused to capitulate. After a down day, the bulls all too frequently only want to buy more cheap gold the following day, preventing the collapse in the step sum plot.

I placed a black rectangle around the false breakout in the bear box, from December 2013 to April 2014 when gold saw a good advance off an apparent bottom. Note the step sum plot followed the price plot up as the bulls piled into the market.  At the time it would have been reasonable to have closed the box, as it appeared a bottom was made in December. However, up to this point it was a problem not seeing market sentiment (the step sum plot) collapse along with the price of gold. For a multi-year bear box this was unusual, though not unheard of.

Beginning in late April 2014 gold’s price plot once again turned down, but nothing like the decline of 2012-13. However, this decline broke the back of bullish market sentiment, resulting in an 18 month long collapse in the step sum plot (collapse in bullish market sentiment). Where before the bulls were ready to enter the market after a decline to purchase more “cheap gold”, now a decline in the price of gold only made the bulls want to join in the selling to exit their positions.

Note my second black rectangle, pointing where gold’s step sum plot dropped like a rock – illustrating total capitulation by the bulls in the gold market; total exhaustion by the market’s bulls at the December 2015 bottom. That’s what a hard bottom looks like in a step sum chart.  

Looking at the chart below, I don’t believe gold will ever again trade below $1,100. If I didn’t look at gold’s step sum plot along with its price plot below, I wouldn’t feel comfortable saying that. Take another look at the chart and consider the chart action between the price and step sum plots. Waiting for the capitulation of bullish market sentiment in a prolonged market decline is why following a market’s step sum plot is so useful.

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