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The Three Phases of a Bull Market

Originally posted at https://goldtadise.com/ on April 19, 2016.


The 5 year bear market in the precious metals appears to be over. We wont know for certain until the current rally ends and we undergo a secondary reaction followed by a renewed uptrend. This future uptrend must exceed our current rally high before we can declare the bear market as officially over. So with the presumption that this will occur it is now time to turn our sites towards the bull market which lies before us. We need to understand the structure in which a bull market unfolds and develops. This approach served us well in the previous precious metals (PM) bear, as it enabled us to recognize the bear well before the average investor, thereby allowing us to avoid chasing false bottoms all the way down to its final lows. Some of us even made positive returns being short at critical times. But, even more valuable than skimming profits, this knowledge allowed us to preserve our intellectual capital, thus allowing us to be mentally ready to play the upside once the bottom was in. By chasing false bottoms all the way down the average investor became damaged goods with blown out psyche no longer willing to cast his lot onto the markets once the bottom was in. He arrived at the start of a new bull unable to recognize it and adapt the correct strategy to profit from it. The required strategy of buy and hold and ignore the skeptics had been beaten out of him over the past 5 years. That's the mental capital he had lost. So in review let's look at what has transpired over the past 5 years represented in the price action of the HUI.

HUI Monthly Chart
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The end of the great 10 year bull market from 2001-2011 took the form of a classic H&S top which spread itself out over 2 years. This H&S top encompassed the Phase I bear period in which stocks sell minus the frothy "hopes and expectations" of the final boom of the previous bull market. Once this H&S top violated its neck line we entered Phase II of the bear market. This phase is the longest phase where stocks discount a long period of progressively worsening business conditions. It is in this phase where severe panics occur as support levels are swept away. Once the initial panic crashes are over in phase II the market consolidates these levels in a series of bear market rallies (BMR's) serving to exhaust longs who are chasing false bottoms. Once this process is complete and the longs no longer retain the strength to hold up the market it enters its final Phase III or as I label the annihilation phase.

There are many ways to chart the bear of 2011-2016 and what you see above is my preferred method. The bear encompassed 4 crashes, 2 in phase II and 2 in phase III. I chose to display a diamond formation for the phase II post crash consolidation as once the diamond was violated to the downside we entered Phase III. Using the break out to break out method we had a perfect measured move predicting its final bottom within 3 points and in the middle of its forecast period. Having made this forecast a full 2 years before the ultimate bottom my only regret was in not sticking to it.


Once the initial 102 low was made I waffled and readjusted my forecast for a possible 67 low in the HUI. Things seemed so bearish at the time. Yes, phase III was truly an annihilation an 85% decline from top to bottom in the SENIOR shares.

Now its time to use our method to tackle the upcoming bull market in precious metals. Learning and understanding how bull markets develop and unfold provides us with the tools to operate in them. Bull markets, once begun, travel through 3 distinct phases just as bear markets do. By identifying these phases we can adapt our strategy to ride the bull. Big bull markets can last from 10 to 20 years. This is a long time to be lost wandering in the wilderness without an overarching plan. Our methodology combines classic Dow Theory with Chartology to give us the plan. I have observed the great wall street analysts of old were far superior to anyone providing analysis today. So we use the method of the great analysts, Charles Dow, William P. Hamilton, Robert Rhea and Richard Russell to guide us. When we combine their method with what we term "Chartology" (The modern adaption of the classical TA of Edwards and Magee , as taught by Rambus ) it gives us a means to operate in the market. The Key to making a family fortune every market participant dreams of.

The vast majority of retail traders in a market lose money. So how is one to make the fabled family fortune in a bull market? The answer is simple, buy and hold . Sounds easy right? Well its far from easy. To make a family fortune one must property identify the beginning of the bull market, or phase I and buy when everyone tells you you are a fool. You must then hold all the way until phase III nears its top and sell when that same group tells you to buy. We only encounter a few secular bull markets in our lifetime, three at best, so more than likely you only have the maturity to take advantage of one or two. Consider this, how many people were able to identify the beginning of the great bull market starting in August 1982, then take a major position amid great skepticism, hold that position until the internet bubble peaked, then sell everything? Think of what this would have required. Stay long through the crash of 1987, the bear market of 1990 with its gulf war uncertainty, the Orange county bond crisis of 1994, the Mexican crisis of 1995, LTCM in 1998 and then finally recognize the internet bubble as a final phase III blowoff and sell. How many? I would say it could be numbered in the hundreds of investors...that's all, but you know what? I believe for a dedicated, disciplined student of the market its achievable to do just that. Hold from bottom to top and then sell, that's what we are going to do and our method is going to be the tool we use to do it.

Bull Market Phases

Phase I

Prior to a bull market the previous bear market knocks down prices to below "known values". This occurs in the devastating annihilation phase which we forecast in the early portion of the last PM bear market. This forecast was met with universal derision at the time because everybody's head was still in the previous bull market. These skeptics are no longer ridiculing this call, however they do remain skeptics. The psychological damage that they incurred by their obstinate bullishness in a bear market prevents them from embracing the current uptrend. They see this rally as simply another bear market rally (BMR) within the previous bear market.

It is with this atmosphere of skepticism that Phase I of the new bull market begins. Phase I is the Accumulation Phase, where farsighted investors sensing that prospects although now depressed, are due to turn up. They are willing to pick up all the shares offered by discouraged investors and distressed sellers. They are willing to raise their bids gradually as selling diminishes in volume. The public is disgusted with the market and has now exited. Activity has trailed off and becomes dull. Price action normally undergoes a prolonged sideways movement and becomes immune to bad news. Most remaining investors have a general disposition to expect worse things ahead, but it is now too late to sell.

It is now that stocks have sunk to below "Known Values" and under these conditions informed, serious investors begin their accumulation, therefore this phase is named the Accumulation Phase. It actually starts before the previous bear market is officially over. Competition is at a minimum as the public is disinterested, careful and controlled purchases take place as a long base is established. The uninformed public is incapable of recognizing the bargains as they don't look for value. It is under these conditions that stocks return to Known Values. This all happens in phase I where no rule exists as to how long this process occurs. It may resemble the dynamic of a beach ball under water released or it may be a long grinding process. Either way the objective of the market is to return price to Known Values.

Phase II

Phase II may be called the Mark-Up Phase. It occurs as the improved tone of business and rising price action begin to attract public and institutional attention. This second phase is the longest phase and most deceptive of the three phases. It is characterized by a steady advance building on increasing activity reflected in growing volume. It will be punctuated by secondary reactions when investors become convinced lower prices are out of the question. When the bull chorus is the loudest a secondary reaction often strikes to the downside which is unusually violent compared to the other phases.

The advancement in prices during phase II is in response to the known improvement in earnings. Stocks are marked-up because belatedly the public becomes aware that pessimism or necessity had forced prices too low. They therefore begin to buy the floating supply of stock in the market. The second phase is the only phase a skilled technical trader should actively reposition oneself by trading stocks. If one can avoid being caught in a secondary reaction then reposition oneself back in after a drop and base is formed, he can improve his position handsomely.

Phase III

Phase III is termed the Blow Off Phase or Mania Phase. It is labeled this as the market undergoes a character change. No longer are stocks bought in due consideration of intrinsic value or earnings power, but instead the crowd buys on prospects only with no regard for values. Certain stocks take on a religious component as their future seems certain and the masses flock to them. The market boils with activity, financial news is all good, price advances are spectacular, IPOs dominate the financial headlines and grab everyones attention. It's in phase III where your obnoxious brother in law reminds you how he scored huge by flipping the latest fad stock, oblivious of course to the fact that it had been going up for years and has zero earnings. In phase III the market has been going up for so long it seems to actually take leave of its senses. General confidence has allowed price to discount not only present values, but future dream like possibilities. For those of you in the markets from 1999-2000 you know what this feels like, it's true manic insanity, but there is no stopping it. At the market top in 2000, the bull had been roaring for 18 years and virtually all investors had never witnessed a top and were unaware of what they were seeing. Meanwhile, informed value conscious investors are engaged in quiet distribution while the public is actively accumulating. The mirror image of what occurred during the bull's genesis. Why distribution? Because wise investors sense danger and they protect themselves by converting stocks into cash. The top is now in and the market now enters the first phase of a bear market.

The most important thing to know about phase III is that in an extended bull market a bear market signal is ONLY valid in phase III. This is why it is critically important to know how to discern what bull market phase we are in.

Separating the Phases

Secondary Reaction or Cyclical Bear

What separates the phases is a change in market psychology. It is therefore often hard to pinpoint precisely the transition from one phase to the next. The transition is often defined by a break in the price action caused by either a secondary reaction or an actual cyclical bear market within the context of a secular bull market. A secondary reaction typically lasts from 3 weeks to 3 months and it corrects 1/3 to 2/3 of the previous advance. It arrives when least expected and serves to dampen the enthusiasm of amateur speculators. It is as necessary to the stock market as a safety valve is to a steam boiler. When too many investors have climbed aboard the valve is released in the form of a intense sell off. This sell off is often mistaken as a true reversal of the primary trend, however it is not. Instead it has simply served its function of controlling the level of exuberance while a new base is constructed to support a further advance. In some cases and entire cyclical bear market lasting from 8-24 months may be required to complete the transition. These mini bears can be particularly deceptive.

Bull Market Case Studies

Secular bull markets tend to span long periods of time. Long stock bulls can last upwards of 20 years, while commodity bull markets seem to reach a limit at around 10 years, presumably since that's about how long it takes to bring about massive new supply which overwhelms existing demand. The oil bull of 1998 to 2008 is a good example of this. Rising prices into the mid 2000's incentivized development of new oil supply which met demand by 2008. Since then we have been in a secular bear market in oil. In the below examples we can see how full secular bull markets can be broken down into three separate phases.

USA 1949-1960

In 1949 the public was uninterested in the stock market. Daily volume averaged less than one million shares. The general consensus was the long expected postwar depression had arrived. It was in this fearful depressing atmosphere that the greatest bull market to date was born. Through three recessions , war scares, through Korea, Suez, Lebanon, Eisenhower's heart attack, Sputnik the market climbed the wall of worry and the averages surged upward. Finally, in early 1956 the market seemed to peak and over the next year put in a triple top. It then underwent a devastating secondary reaction lasting 3 months. This convinced the majority of market opinion that the bull was over. However there was a young independent market observer by the name of Richard Russell who noted that the market had not yet shown characteristics of a phase III. Instead the market had been busy climbing the wall of worry and hadn't had time to become manic yet. He therefore made a market call that one should buy the correction and hold on and wait for the phase III. His career took off from there.

Do Jones Industrial Average 1949-1960
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USA 1921-1929

This epic bull market has clean and obvious separation between the 3 phases. William P. Hamilton called the end of the preceding bear on September 18th 1921, 6 points from the bottom. He stated that the stock market was acting as if there were better things in sight and he declared the beginning of the great bull market of the 1920's. The initial phase I accumulation was met with normal skepticism yet motored higher for one year before putting in a major decline. A 7 month 20 % bear market provided the transition between phase I and II. The market then provided a gift it seldom extends. It offered the fabled "gentleman's entry". You can see in June 1924 it successfully retested its previous low signaling it was alright to get back into the water- unusual indeed.

Scores of wonderful books have been written about this epic bull market, my personal favorite is Rainbow's End by Maury Klein. He gives the reader the feel on just how crazy it got in that final phase III.

Dow Jones Industrial Average 1921-1930
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USA 1982-2000

This is what I regard as the End of Empire Mega Bull as it finished up its insane blow off phase III at the time the USA empire peaked in the year 2000. This is the one I watched intently from beginning to end. I clearly remember the week it launched in August 1982, it was ever so powerful of a launch yet one would believe it. Once the blast off occurred there was absolutely no gentleman entry. It simply never looked back. It never ran out of juice for an entire 17 months. If you didn't just close your eyes and buy you never had a chance to get in. I have recently gone back and reviewed market commentary from this time period and seasoned newsletter writers were scared to death to buy this market and they got stuck on the sidelines. Kinda reminds me of todays gold bugs.

After the impressive broad rally of almost 2 years the market finally entered a mini bear market of -20% lasting 7 months. Very typical and consistent with our other secular bulls that we have reviewed. If you had missed the accumulation phase it was now time to get on as the market climbed the wall of worry. For the next 3 years the market made its ascent with not even a 10% pullback. This is not desirable, as when a market goes that long with out a correction it sets itself up to correct all at once. This was the set-up for the the crash of 87.

Sadam's incursion into Kuwait was the catalyst for the next mini bear market, but the market smelled victory in the first gulf war by October and discounted the victory ahead of time. By 1995 the market had been in a secular bull market for 13 years and it began to take on a character change. Note how once the market passed 4000 its angle of ascent changed permanently. This was the start of the roaring 90's. I find it difficult to definitively classify when phase III actually began on a chart. After 1995 the market progressively gained steam. It began displaying Phase III characteristics in 1996. and by 1997 the uncontrolled tech boom was full on. I recall a workmate of mine getting cleaned out in April 1997 (notice minor blip) because he let his broker put his entire account into new issue tech stocks. These were the "cats and dogs" that start to fly in a phase III. So by 1997 I would consider the market in phase III, however after LTCM in October 1998 when Greenspan "rescued" the market with the LTCM bailout and Y2K juice it entered an accelerated Phase III. This was in my view even a greater mania than the 1929 market. It became more than just a "New Era" it became a religion. If you were not in it, you weren't just stupid you were an infidel.

Dow Jones Industrial Average 1982-2000
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Japan 1971-1989

Japan's super bull began by announcing Japan's entry as a world manufacturer and ended in a credit fueled, real estate driven insane blow out. Their post bubble adaptation of Keynesian policies has insured they remain mired in a debt trap to this day 26 years later. The beginning of this bull had all the elements any savvy market operator could wish for. A double bottom followed by a launch into a 7 month surge. This move was rapidly corrected back down to its break out point where it held at support. The market then offered the rare "gentleman's entry"...an obvious no-brainer entry point, granted to latecomers. Once offered, the market then zoomed up a correction free 250% within the next 14 months. It now paused to rest and delivered a pounding 40% bear market over the next 2 years. This bear served to separate phase I with phase II.

While western markets remained mired in stagflation throughout the 1970's Japan powered ahead in its own private phase II advance. Stocks steadily got marked-up over the next 11 years. The word was now out and Japan was recognized as a world juggernaut. Nixon's Watergate comment made in 1972 that he didn't want a "cheap" Sony recorder seemed embarrassedly dated. "Made in Japan" no longer meant inferior it represented quality. As a result, the market entered a credit fueled mega blow off lasting 4 years. This final phase III market spasm could do no wrong and embodied every element of a classic phase III. Buying Rockefeller Center to Pebble Beach was a resultant manifestation of the credit binge of the blow off. Japan Inc. occupied the covers of US business publications, and we pondered how to be as smart as the Japanese. The reality was it became a credit stoked belief system where human frailties exhibited themselves to the world. A 19 year bull market leads to humans becoming full of themselves and letting a crescendo of credit creation distort all reality.

Japan Super Bull Market 1970-1990
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Oil Bull 1998-2008

Commodity bulls are somewhat different animals as they are more focused on a single product as opposed to a broad equity market. In an equity bull market we see rotation from one class of industries to another, lending it staying power. However in a single class commodity it seems to take around 10 years to bring on excess supply which ultimately kills the bull. We all know that commodity prices are often much more volatile than equity markets and we witness this in the oil bull of 1998-2008, however many of the principles remain the same.

Phase I rallied the oil market for 22 months without ever offering a gentleman's entry. This no look back rally powered the price up 350%, a classic case of "got to be in it to win it". Once exhausted, however the market demanded a one year 55% crushing bear market to transition itself into phase II. This ran coincident with the equity bear market, but ended a year ahead of it.

Phase II proved to be the classic mark-up event which was interspersed with normal secondary reactions along the way. We see that volume followed trend as it gradually grew as price rose. We see in the chart that the series of higher lows eventually led to a breakout above the $40 resistance level. This level essentially goes all the way back to 1980 so the channel between $10 and $40 contained the oil price from 1974 to 2004, a period of 30 years. Market price spent 30 years coiling energy which would be released in an upward impulse once it could break through its $40 resistance level. Amazingly the move all the way to $147 over the next 3 years was a forecastable event as it complied precisely with its measured move distance of channel range built out over 30 years.

The division between phase II and III is clearly defined and separated by a short 6 month mini-bear market of 38%. So quick it's tempting to simply call this an extended secondary reaction. We can see how volume exploded as the cult of Peak oil took hold. The top of $147 was matched with a RSI indication not seen since 1980 which was the start of that 20 year secular bear market. True to form this indicator announced the start of the next secular bear market which is still in effect today 8 years later.

Oil Bull Market 1998-2008
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In conclusion, these models are examples of how secular bull markets transition from Phase I to Phase III. Each phase has its own psychological characteristics. By understanding these principles we can effectively navigate through the vagaries of a bull market as it unfolds. These are time tested methods discovered by the greatest of market analysts with no parallel to be seen on the likes of CNBC. Successful investing requires one to be a student of the market and its message combined with a disciplined approach.

Now we shall turn our attention to the budding new precious metals bull. The reader having this background in market history is encouraged to have his own personal plan in place for riding what promises to be a truly life changing investment opportunity.

Trade prudently and prosper.

Plunger, Market Historian.

Editor's Note: To contact Plunger email gmag@live.ca


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