Thursday, November 6, 2008

Smells Like An Economic Bubble

By: Sherry Rashad


Probably you have a whiff of it before because it is known by it’s other names. Such as the speculative bubble, the price bubble, and the market bubble just to name a few. Leading financial academics usually point the blame at trading certain items in high volumes at prices that are considerably at odds from the item’s intrinsic value. Some economists still clung to the belief that financial bubbles never occur. But for those who experienced it first hand rather painfully, the cause of economic bubbles still in most part remains a mystery. Especially those who are convinced that the prices of assets – from time to time – deviate strongly from their intrinsic values. Like what the crude oil trading prices did during the first half of 2008.

To me at least, I do tend to gravitate towards the belief that economic bubbles are primarily caused by uncontrolled speculation. Proven by my first-hand experience in speculative trading and by what has historically gone before. I’ve been relying too often to my psychic-like luck for far too long in avoiding getting burnt on the speculative market. But in this business, history tends to have a very ugly habit of repeating itself.

A case in point is the thoroughly documented Hunt brother’s attempt at cornering the silver market for much of the 1970’s. This resulted in the price of silver briefly rising to 50 US dollars an ounce between September 1979 and January 1980. The Hunt brothers audacious attempt at speculation by hoarding billions of dollars worth of silver to artificially increase it’s trading price became known as the Hunt Silver Debacle. The Commodity Futures Trading Commission – though criticized for being slow to act in the months before Silver Thursday - began putting together new rules aimed at preventing a repeat performance.

Back in the middle of 1997, the lessons learned from the Hunt Silver Debacle wasn’t lost on me. I did develop an uncanny knack of sniffing it out. The shenanigans on the London Metal Exchange and Sumitomo’s attempt at cornering the copper marked could have sent me to the poorhouse – both figuratively and literally – if I haven’t stuck to what I’ve learned before. My financial adviser and then still new mutual fund manager also manage to evade from the poorhouse from heeding my somewhat “speculative” advice.

So does the “Dot Com Bubble” of 2000. Given that economic models that formed the basis of our current sponsored links and on-line advertising were virtually nonexistent back then. The Internet commerce in those days were in effect virtually relying on assigned values of non-existent constructs which would make adherents of trading in concrete assets balk.

The question now is; how does one avert the tragedy of experiencing first hand the damage financial bubbles can inflict on your investment portfolio? What works most of all, in my opinion, is avoiding investment and trading instruments that you don’t understand. Like credit derivatives and mortgaged backed securities whose values are pegged on non-material constructs, which to me at least resemble a legalized pyramid scheme. Mortgaged backed securities for all intents and purposes is speculative money and speculative money is notoriously known for their lack of concrete equivalent in goods and services.

Although investing only in concrete assets is by no means infallible. Even real estate, which is for all intents and purposes a concrete asset, are not immune from the effects of speculative bubbles or from becoming economic bubbles unto itself. Like the US Housing Bubble, which began in the wake of investors trying to recoup their Dot Com Bubble losses that turned a few years later into a financial disaster of gigantic proportions.

It should be also worth noting though that our global economy is primarily a greed driven system were the primary goal of the participants is to enrich themselves and enrich their client base if the exigencies of the markets allow. Government-based regulators are there to make sure that the “players” only enrich themselves by fair means even though regulations – as a stabilizing force in the economy – can’t often be counted on. Because prices in an economic bubble can fluctuate chaotically thus making it impossible to predict from the laws of supply and demand alone.

3 comments:

Ringo said...

So you have a knack of riding the crest then getting-off before the prices fall, seems like you have "Ferengi Genes" - i.e. those ultra-capitalist alien race on Star Trek. Being a "clairvoyant" can be a big help in the ever-risky securities trading marke. But I won't rely on it too often, The time comes when you might get burned.
P.S. please check out this NYU-based blog that's been following me: http://sternfinance.blogspot.com the contributors - NYU-based faculty I think - have a "ringside" view of our current still-deepening financial crisis. I think NYU might be a comfortable walking distance away from Wall Street.

Kirk said...

I remembered the Sumitomo "trading shenanigan" on the London Metal Exchange in 1997 after attending a Hi-Fi convention in London during that same time. After visiting Marantz exhibition on their latest CD 63 SE KI Signature, one of Ken Ishiwata's colleagues mentioned this particular attempt by Sumitomo to corner the copper futures market as the reason why the Marantz CD 63 SE KI Signature has a somewhat relatively expensive retail price. Probably due to the extensive use of copper shielding - a Peter W. Belt design influence. In my opinion, the CD player's retail price could have been cheaper if Sumitomo restrained their "greed" during that time.

Rosemary said...

I think it is probably already "general knowledge" to those insiders in the securities market that for six years in the 1990's, a Sumitomo trader manipulated the worldwide price of copper via the futures market coupled with hiding inventory in off exchange warehouses. And yet not one academic savvy regulator was able to tell. Sadder still, many in the securities business cited this 1997 incident as the root-cause of the global food price rise at the start of 2008.