Cognitive Dissonance and Uranium Stocks

by JDH on April 11, 2009

Happy Easter. After the unwelcome snowfall here in Ontario earlier in the week, we are basking in much nicer weather this Easter holiday weekend, which gives me time to spend outside with my family (we spent Friday afternoon on a long bike ride), and to spend some time pondering cognitive dissonance.

Huh?

As many of you may know, dissonance is a lack of agreement. In particular, it is an inconsistency between the beliefs one holds or between one’s actions and one’s beliefs. Dissonance is not good, because it means you are out of sync with yourself, and that’s bound to cause problems. If you are out of sync with your ideas or cognitions, you’ve got a real problem.

Thus, cognitive dissonance is that uncomfortable feeling caused by attempting to believe and follow two contradictory ideas or cognitions at the same time. We humans do not like to be out of sync. We have a strong internal drive to reduce dissonance by changing our attitudes, beliefs, and behaviours, or by justifying or rationalizing our attitudes, beliefs, and behaviours. (You can read a nice summary of the original experiments about cognitive dissonance here ).

Let me illustrate with two charts. Here is a chart of the Dow over the last two months:

What do you think? You probably think that the Dow is in an uptrend. It looks good. It looks like a bull market. You probably want to be a buyer. Now, try this chart:

This chart of the Dow over the last three years does not look nearly as good. There appear to be a successive series of down trends in place. We appear to be a bear market, that has had a bounce over the last few weeks. However, the last of the down trend lines will not be broken until the Dow is well above 11,000, so we appear to be a in a bear market.

Here’s the cognitive dissonance part: What I believe will effect what I see. As I have stated many times before, I don’t believe the depression is over. I believe that high unemployment, a decimated manufacturing sector in North America, and massive government spending will take more than a few months to correct. A bear market bounce is not uncommon, but an end to the depression is not here yet. Therefore, when I see the short term chart of the Dow, I see a bounce, not the start of a new bull market. I use the “facts” to rationalize my own beliefs. If you believe we are in a new bull market, your interpretation of the “facts” will be different than mine.

Let me give you another example of cognitive dissonance.

Monkeys and Jelly Beans

A monkey likes three colours of jelly beans: blue, red and green. He likes the three colours equally. He is given two jelly beans to choose from: a blue and a red. He chooses the blue one.

With the red one still in front of him, he is now also given a green one, so now he can choose from a red one and a green one. Remember, we know he likes all three colours equally, so it would appear that there is an equal chance that he will either pick the red one or the green one. So which one does he pick?

Most of the time the monkey will pick the green one. Why?

Because once he rejects the red jelly bean, it becomes less desirable. So, given a choice between the “new” green one and the “old” red one that he already rejected, he will pick the green jelly bean. He’s got a good old case of cognitive dissonance, and he can’t reconcile in his mind picking a jelly bean he already rejected, so he picks the new one, even though both jelly beans would be equally good choices. (If you want to play amateur shrink, tune in to the Psych Files podcast, with which I have no affiliation).

Now most of my readers are not monkeys, and I myself don’t like jelly beans, so why do I raise this example?

Because sometimes we sell a stock, and never want to look at it again. Once we “reject” something by selling it, it’s hard to get over our cognitive dissonance and buy it again. We simply are not wired that way.

Uranium Stocks and Cognitive Dissonance

When I started this blog back in 2006, the first stocks we discussed were uranium stocks. Our big winners in 2006 were uranium stocks. I made a lot of money in uranium stocks, as did many of you. Then came 2007. And 2008. We stopped making money in uranium stocks. In fact, we lost a lot of what we made. So now, we don’t want to own uranium stocks.

In fact, to buy uranium stocks after selling them would mean we are buying something we rejected, which sets up a bad case of cognitive dissonance.

(For those of you who are into technical analysis, what role does cognitive dissonance play in resistance levels? I suspect that “overhead resistance” is another way of saying that when a stock hits it’s peak and then falls, we can’t bring ourselves to own it again until it surpasses it’s previous peak, thereby proving us right to own it, thereby eliminating the dissonance).

Here’s the chart of DML.TO – Denison Mines Corp., a senior uranium company, over the last month:

Denison appears to have bottomed, and is on the road to recovery. Of course the three year chart tells a different story:

A quick review of Merv’s Uranium Index shows that at the moment Merv’s indicators are bullish.

So here we potentially have a classic case of cognitive dissonance. On the one hand, I got burned in uranium (not literally; getting burned with uranium would be fatal; I’m talking about stocks here, people), and so I don’t want to own it again. On the other hand, uranium stocks may have bottomed, Merv’s numbers are bullish, and the need for nuclear power hasn’t gone away. In fact, it is quite likely that the Obama administration will realize that nuclear is the only logical way to wean us off foreign energy, which is the only way to ultimately preserve our national security.

The key for all wise investors is to separate their “feelings” from the “facts”, and act accordingly. My take on uranium is this: there are a lot of investors, like me, who got caught in the uranium bubble and didn’t exit soon enough, so for us, we won’t be quick to rejoin the party. We are the overhead resistance. However, the long term fundamentals are just as good as they were back in 2006, probably better. Therefore uranium stocks should have a place in my portfolio.

But, once this bear market rally burns itself out in May, or June, and the market retreats to retest it’s lows, all stocks will get carried down with it, including uranium stocks. Therefore my plan is to place stink bids and accumulate on days of extreme weakness. For Denison a stink bid of 85 cents makes sense.

Even more importantly I will hold a lot of cash. I could try to play the bounce, but I’m not nimble enough to do that. I don’t want to get caught on a big down day, so I will hold my golds and silvers, and yes I will hold some shares of Denison, but the biggest portion of my portfolio will be cash, because when the market retests it’s lows, cash will be king.

I’m an optimist, and I want to buy, but the facts tell me otherwise, so I have to try extra hard to separate my feelings from the facts. Dissonance ain’t pretty, but dis is da way dat it is.

Thanks, and next week I promise to avoid the psychobabble, if you promise to analyze why you buy what you buy; all intelligent thoughts welcome on the Buy High Sell Higher Forum; see you next week, and Happy Easter.