Friday, April 22, 2011

Alert! Alert! Alert! Bubble Warning

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

One of the recurring themes of the past year has been about investment bubbles, how difficult they are to confirm and even tougher to profit from. We've talked about cotton and sugar and coffee and gold.  And maybe next week, we'll do a review and see where they all stand.

Today, I want to share some very brief thoughts and pictures of silver and you some questions. Looking at the chart, from $26 to $43 an ounce in three months, what do you think? Bubble?

How about the chart below with a longer term view?  From $18 to $43 in 8 months.  Bubble?

And now, from the 2008 bottom.  $9 to $43. What do you think?

Bubbles don't appear overnight. They require a confluence of fuel factors, a perfect storm if you will.  First, they usually have a foundation from which they are built. That’s followed by a long-term bull market.  Once there is widespread acceptance, we typically hear that “this time is different” when it comes to overvaluation.

The experts rationalize why conventional thinking no longer applies now and how we have some sort of new paradigm in the making. Just think back to the spring of 2008 with peak oil and how we should expect crude to remain forever high, right before it went from $147 to $35. Remember how they argued that since no one is creating any more land, housing prices would never really decline? And oh those dotcom stocks!  I vividly recall being told it was no longer about earnings; it’s all about EYEBALLS!

When looking at commodities, as I have mentioned before, they behave the opposite of stocks.  Commodities tend to make long, multi-year bottoms or foundations that scrape along, while their peaks are very violent, emotional affairs. Take a look at the monthly chart of crude oil below. That is about as classic and textbook a case of building a foundation, the bubble and the collapse.

Let’s turn back to silver.  How does the chart below look for a long-term foundation?  1990 to 2002!  That was followed by a “nice” bull market to the 2008 peak and subsequent collapse. Now, it’s truly become a bubble with a possible collapse looming.

Just because an instrument is exhibiting bubble type behavior doesn’t mean it must end right away or in total disaster, but the odds certainly are heavily in the disaster direction.  Every now and then, we will see a security go vertical up the right hand side of the page and then enter a trading range where it generally goes sideways, but bounces from one price to another.  That kind of digestion usually does not end in implosion. 

The most difficult thing about bubbles is that they are incredibly challenging to pick the top.  Investors often get burned several times being early. But once they roll over, there usually isn’t time to get onboard.  Remember what John Maynard Keynes said? “The market can stay irrational longer than you can stay solvent.”

I’ll continue to keep an eye on silver and other instruments that exhibit bubble behavior. Just be careful if you trade or invest there!
FYI, I will be on CNBC’s The Call on Thurs., April 28 at 11:05 p.m.
Feel free to email me with any questions or comments at
Until next time…

Paul Schatz
Heritage Capital LLC

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