May 29, 2009

By Robert Prechter, CMT

The following article is excerpted from a brand-new eBook on gold and silver published by Robert Prechter, founder and CEO of the technical analysis and research firm Elliott Wave International. For the rest of this fascinating 40-page eBook, download it for free here.

Have you ever traveled abroad and taken a look at the local currency and wondered how the citizens of that country could take seriously what looks like “Monopoly money?” I’ve got news for you: You’re using the same stuff. Monopoly money is the money over which some government has a monopoly. It is the currency of the realm only because the state makes it illegal to use any other type.

Promissory notes issued by a state and declared the only legal tender are always doomed to depreciate to worthlessness because of the natural incentives and forces associated with governments. A state cannot resist a method of confiscating assets, particularly one that is hidden from the view of most voters and subjects. By extension, it is unreasonable to advocate a standard for such notes, which is simply a state’s promise that its currency will always be redeemable in a specific amount of something valuable, such as gold. A gold standard of this type is only as good as the political promises behind it, reducing its value to no more than that of paper. It could be argued, in fact, that a state-sponsored gold standard is far more dangerous than none at all, as it imbues citizens with a false sense of security. Their long range plans are thus built upon an unreliable promise that the monetary measuring unit will remain stable. Later, when the government’s “IOU-something specific” becomes, as Colonel E.C. Harwood put it, “IOU nothing in particular,” reliability disappears and the arbitrary reigns. Although the populace tends to retain its confidence in the currency for awhile thereafter, the ultimate result is chaos.

The only sound monetary system is a voluntary one. The free market always chooses the best possible form, or forms, of money. To date, the market’s choice throughout the centuries, wherever a free market for money has existed, has been and remains precious metal and currency redeemable in precious metal. This preference will undoubtedly remain until a better form of money is discovered and chosen. Until then, prices for goods and services should be denominated not in state fictions such as dollars or yen or francs, but in specific weights of today’s preferred monetary metal, i.e., in grams of gold. Anyone might issue promissory notes as currency, but the acceptance of such paper certificates would then be an individual decision, and risks of loss through imprudence or dishonesty would be borne by only a few individuals by their own conscious choice after considering the risks. Critical to the understanding of the wisdom of such a system is the knowledge that private issuers of paper against gold have every long run incentive to provide a sound product, just as do producers of any product. As a result, risks would be minimal, as the market would provide its own policing. Thievery and imprudence will not disappear among men, but at least such tendencies in a free market for money would not have the potential to be institutionalized, as they are when a state controls the currency. From a macroeconomic viewpoint, occasional losses resulting from dishonesty or imprudence would be extremely limited in scope, as opposed to the nationwide disasters that state controlled paper money has facilitated throughout history, which have in turn had global repercussions. As Elliott Wave Principle put it, “That paper is no substitute for gold as a store of value is probably another of nature’s laws.”

That being said, it is also true, and crucial to wise investing, that markets come in both “bull” and “bear” types. Being a “gold bug” at the wrong time can be very costly in currency terms. For nearly three decades, gold and silver’s dollar price trends have confounded the precious metals enthusiasts, who for the entire period have argued that soaring gold and silver prices were “just around the corner” because the Fed’s policies “guarantee runaway inflation.” Yet today, 29 years after the January 1980 peaks in these metals and despite consistent inflation throughout this time, their combined dollar value (weighting each metal equally) is still 40 percent less than it was then.

It is all well and good to despise fiat money, but it is hardly useful to sit in gold and silver as if no other opportunities exist. In contrast to the one-note approach, which has had an immense opportunity cost since 1980, competent market analysis can help you make many timely and profitable financial decisions in all markets, including gold and silver.

For more in-depth, historical analysis and long-term forecasts for precious metals, download Prechter’s FREE 40-page eBook on Gold and Silver.

Robert Prechter, Certified Market Technician, is the founder and CEO of Elliott Wave International author of Wall Street best-sellers Conquer the Crash and Elliott Wave Principle and editor of The Elliott Wave Theorist monthly market letter since 1979.

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In the 1930's Ralph Nelson Elliott observed repeated patterns in stock market movements. He recognized markets move in five waves up, followed by three waves down. He saw this basic pattern linked together to form larger versions of itself, in ever increasing size. He called his discovery the Elliott Wave Principle.

Elliot waves are predictable repeating patterns, in form but not in time. Elliot waves can be observed in any market of reasonable size. Markets are complex systems which undergo punctuated growth; a period of expansion followed by partial retracement. Elliot wave is a principle that uses the idea that people engage in repeated predictable patterns of behavior. Once this principle is understood, it should be clear that it is applicable to any buy or sell position with any market.

If markets such as the djia and forex markets move in predictable patterns, surely this is knowledge you could use to profit from? The sure answer is of course it is! Elliot wave traders make good profits using this principle every day, including the writer of this article.

Elliotwave is at its simplest form five waves up (impulse waves) followed by three waves down (corrective waves). The end point of the corrective waves down is a fibonacci retracement (0.618) of the upwards impulse waves. There are more subtleties, but this is the basic principle. If you realise the implications of being able to predict markets, short and long term, you will want to use the many free educational materials available to begin learning more about this powerful principle.

One of the most powerful pieces of Elliott Wave Analysis is the application of fibonacci ratios to retracements. Once the market has clearly turned, applying fibonacci ratios to the corrective wave provides traders with an eventual target the retracement will reach. Traders can set limits on trades with confidence by applying Fibonacci Retracements.

Most economists think events drive social mood and the markets. The Elliott Wave Principle flips this idea on its head and says it is social mood that drives events and market behavior. The stock market is the most real time up to date indicator of social mood, so studying the stock market gives insight into social mood and events society may engage in.

To learn how to apply elliot waves in your trading, a thorough understanding of elliot wave theory is necessary. Fortunately this is easy and plenty of information is available for traders education.

More and more traders and investors are using elliott wave analysis in their trading. As the public begin to realize mainstream economists did not predict the current economic crisis with any accuracy, indeed they mostly called for continued growth just before the economy dove off a cliff, investors are seeking out those who have systems and understandings that provide more accurate predictions. Elliot Wave is one of those.

Elliott Wave International is the authoritative site on elliott wave theory. They have many services tailor made for all subscribers, and offer many updates and reports on a daily basis.

Can you afford to not learn about the elliott wave principle? There are many free educational resources you can use to begin your education, and yesterday was the time to do so.

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