Bubbles & Monster Money

[Common Sense Party]

Written by Jeff Thredgold, CSP, President, Thredgold Economic Associates

http://www.thredgold.com/html/leaf080702.html

The doubling of oil prices during the past year from $70 per 42-gallon barrel to above $140 per barrel has heightened emotion levels about what, or who, might be responsible for such a development…

…there seems to be plenty of blame to go around

Believers in market fundamentals would argue that the doubling of oil prices merely reflects a sharp increase in global demand that has simply not been offset with higher levels of oil production. They suggest that rising demand from China and India has been the single most important contributing factor.

These market fundamentalists note that China and India, which include nearly 40% of the world’s population, have recorded real (inflation adjusted) average economic growth rates exceeding 10% and 7% annually during the past seven years. As a result of the associated rise in standards of living and industrial growth, the demand for oil and other commodities has spiked higher.

Others suggest that market fundamentals have combined with a sharp rise in market speculation as the principal reasons for the doubling of oil prices. Increased speculation does clearly seem to be part of the answer as well.

In my mind, market fundamentals justify oil at around $70 per barrel. Rising nuclear tensions between Israel and Iran, combined with oil field violence in Nigeria, account for perhaps another $15 per barrel, representing the “what if” scenario. Another $15 is a function of weakness in the U.S. dollar of recent years. Roughly $40 of the rise is likely tied to oil speculation.

An Aggressive Pool of $$
In my view, there is an enormous pool of very aggressive investment money around the globe (let’s call it Monster Money) that chases those assets with the greatest chance of a substantial gain. Much of this money is in the management hands of hedge funds, pension funds, Wall Street and global commercial banks and investment firms, insurance companies, and sovereign wealth funds.

When this money is flowing in, asset prices can and do move quickly higher. When the asset class falls out of favor, the plunge in prices can also be gutwrenching.

Exhibit one supporting this idea is the powerful rise in technology and internet stocks primarily within the Nasdaq stock market during the second half of the 1990s and the first quarter of 2000. During that time, more and more Monster Money was chasing these highflying stocks, with a feeling among many that prices would continue to rise sharply. Tens of thousands of U.S. investors tapped into credit cards and home equity loans to also chase after these stocks.

The Nasdaq eventually rose 640% to an intraday high of 5132 on March 10, 2000, the culmination of a rally that commenced during June 1994 (Bloomberg.com). The Nasdaq then began a frightening plunge of nearly 80% during the next couple of years.

Exhibit two is the next parking spot of much of this Monster Money. As the Nasdaq lost favor with these aggressive investors, they soon saw enormous upside potential in…

…real estate…both residential and commercial properties…both in the U.S. and around the world

The sexiest new investment during 2001 through 2006 was in individual properties and bright and shiny new developments in such places as San Diego, Phoenix, Las Vegas, Orlando, and Miami, as well as in London, across France, Spain, Ireland and many more locations.

Later to the game were individual investors, including residents of communities far from the glamour. Many of us know of neighbors or friends who bought one or more condominiums in such places as Miami and San Diego, fully expecting to make a 20% or 30% gain on their investment in just a few months. A small share of these “flippers” did quite well…while thousands of others still hold those properties today, with mortgage debt sharply exceeding the value of the properties.

As noted frequently, four states fell into the glamour category for flipping real estate…Arizona, California, Florida, and Nevada. Each state (as well as others) is now in, or flirting with, its own recession, with both residential and commercial property values down sharply.

Similar stories are found of aggressive commercial real estate developers, with stars in their eyes regarding boatloads of money to be made. Too many out-of-market lenders from around the country were more than willing to aggressively finance projects large and small.

Exhibit three is the surge in commodity prices of the past two years. The cycle repeated itself again as the real estate buzz began to fade. In my mind, much of this Monster Money soon shifted to the next “sure thing” of commodities. Gold, silver, and copper led the way during the past few years, soon followed by aggressive investments into oil, natural gas, and coal.

These investments also benefited from the decline of the U.S. dollar of the past few years, resulting in part from housing crisis fears and imminent recession anxiety. The Federal Reserve’s sharp cuts to its key interest rate of the past 10 months also contributed to the dollar’s weakness.

The surge in oil prices has now exceeded that of the spike in Nasdaq stocks of 8 to 14 years ago (Bloomberg.com). Oil at $140 per barrel is up more than 700% when compared to the price of $17.45 per barrel in November 2001.

“There’s nothing different between this mania, the dot-com mania, the real estate mania, the Dow Jones mania of the 1920s, the South Sea bubble and the Dutch tulip-bulb mania,” notes Stephen Schork, president of Schork Group, Inc., a Pennsylvania-based advisor to OPEC, Wall Street firms, and oil companies on the outlook for energy prices. “History repeats itself over and over and over again.”

Critics of aggressive investors note that speculators now control more than 70% of oil futures contracts on the Nymex exchange, versus 37% in 2000 (USA TODAY). Congressional leaders have threatened greater regulation and punishment for “speculators” who interfere in financial markets purely for lucrative profits. Talks regarding the need for higher margin requirements, greater investor disclosure, and stricter trading limits are routine.

Exhibit Four?
In my mind, oil and other commodity prices could decline sharply during the next year. However, we will likely see oil move even higher before that happens.

I see some of the Monster Money seeking to cash out of what has been a profitable move into commodities, including oil, and seeking the next market of opportunity…stocks.

I see more of these investors reminding themselves that those who stay at the party too long can get punished. Many understand that stock market or commodity “bulls” and “bears” can make money…

…but pigs get slaughtered




"Reprinted with permission
from the "Tea Leaf" by Jeff Thredgold. Copyright, 2008,
Thredgold Economic Associates, LLC. To subscribe to Jeff's
free weekly email update, visit www.thredgold.com."

[no_hypocrisy]

1. It's been my fear that bubbles are here to stay.

Once a certain group of investors gets the thrill of fast, immense wealth versus patient, wise investment, they won't go back to their grandfather's strategy of a well tempered portfolio.

[Common Sense Party]

2. Bubbles have always been around from time to time (tulip bulbs).

But now that capital has no borders, and one can instantaneously place capital halfway around the world with the click of a mouse, I believe bubbles will be more frequent, faster to grow, and perhaps more painful when they burst.

The bubble-chasers have always been around. They don't believe in "diversify and buy and hold," even though it's the most sensible thing to do.

[Warpy]

3. You are right about that for now

and nobody's more addicted to the bubble economy than the hedge fund.

However, bubbles always burst, revealing they had only hot air supporting them and when a critical mass of the pigs gets slaughtered, the rest of them retreat to the woods and take their lessons from the bears living there.

This too shall pass, as anyone who has ever had a kidney stone will tell you. It hurts, but it passes.

[aspergris]

4. Bubbles have ALWAYS existed

Patient wise investment STILL works

I'm gonna repeat this for the studio audience. there has never been any 20 yr period in US stock market history where dollar cost averaging wasn't a good investment. EVEN the great depression

Grandpa's strategy works. I have done it since I turned old enough, and it was the best thing I ever did.

But this idea that bubbles exist shows no understanding of capital markets on your parts. Bubbles have existed as long as markets. Heck, read about the great dutch tulip bulb scandal, the market of the 20's, the Nifty Fifty, etc.

Those who are ignorant of history won't prosper from it :)

This is NOTHING new under the sun. STUDY history

[Common Sense Party]

5. Grandpa was a smart ol' coot.

Not MY Grandpa, of course. My Grandpa never invested in anything except his farm.

But I agree with your whole post.

[aspergris]

7. thx

It's really amazing the way history repeats itself

REcall in 1987 - it was the END OF THE WORLD

(it wasn't)

in 1998 Tech Stocks were a new paradigm

(they weren't)

[A HERETIC I AM]

8. And oil will continue to go up forever..

(it won't)

[aspergris]

9. and

The American Dream (tm) is over

(it isn't)

[Common Sense Party]

10. FReeper! Neo-con!

Don't you know it's not progressive to believe in the American Dream?






:sarcasm:

[A HERETIC I AM]

11. "LOL" is such a fucking cliche'.....

But I really LOL'd!

I was thinking of posting a similar sentiment!

God damned Pollyanna's. If you aren't convinced the world is coming to an end, you MUST be a Republican!

(I love the fact that I was called a Pollyanna on one thread a few months back, merely because I didn't agree the market was going to crash to 7000 or some such nonsense)

Yup. It seems to be a proper DU'r in the eyes of many these days, you have to be struggling paycheck to paycheck, not have any money in the bank and be convinced that it's all a conspiracy against the little guy.

[aspergris]

12. SO true

I got called a Freeper, accused of using "republican talking points" etc. in that thread MERELY for stating the american dream was NOT over . I agreed the economy is in the #$(#$ right now, AND we are in a recession, but that's not enough.

It is NOT a republican talking point to believe in the american dream, or to believe that there is no evidence the end of Life as We Know it (tm) is here.

It's merely being somebody who looks at facts.

[Common Sense Party]

13. Facts?!? We don't need no steenkin' facts!

We have emotion and hubris!

[pansypoo53219]

6. if america doesn't move beyond oil,

we are doomed as #1 anything, but #1 losers.

[TroubleMan]

14. Economy changing asset bubbles happen about every 80 years.

Tulipomania bubble (1637)
South Sea Bubble (1721)
French Monarchy bankruptcy (1789)
Hamburg Crisis of 1857
1929 Wall Street crash

Just long enough after everybody involved in the first one is about dead, everybody forgets the lessons of the past, and the circle starts all over again. There's a tightening of regulation right after the bubble pops, then everybody forgets about it. Deregulation greed rears it's ugly head, then another bubble forms pops up. It will happen about 80 years from now, too. There are smaller bubbles from time to time in between, but the really big ones pop up every 80 years or so.

[Common Sense Party]

15. I think the pace is accelerating now in the global marketplace.

Because of the speed and facility of capital movement. If you think the technology bubble wasn't a huge economy-changer, think again. That caused the worst bear market we've seen in 30 years. Four years later, we were neck deep in a real estate bubble. That burst, and the money is chasing oil and commodities.

[fasttense]

16. Bubbles are cause by unregulated capitalism.

Bubbles occur in any economy that is not regulated. It is the nature of capitalism for a few to stockpile and accumulate all the wealth. In large diversified economies it usually means one commodity or item will bubble over because a handful of people have control of that one commodity.

In large diversified economies that were previously regulated to prevent monopolies and scams, bubbles start to appear as regulations are removed and as groups of people get together to corner the market. Eventually all the wealth will move to the uber wealthy and elite. That is the nature of capitalism.

If you have money when the economy is deregulated, you will have money to invest and play financial games so that money can grow more money. But if you only have your labor when the deregulation begins, you get no where because labor is devalued and allowed to be exploited. A person's labor in an unregulated economy makes barely enough to feed and cloth him. A laborer will be unable to accumulate wealth.

So those who are rich at the start of the deregulation get richer and those who are poor remain poor, unless they get caught up in a scam. The bubble speeds up the transfer of wealth from the poor and middle class to the wealthy. Bubbles do little to improve the laborer's life.