Wise Article About Bubbles

This article comes recommended by Jon Nadler in his Feb. 3rd market commentary, and it carries a fair bit of market wisdom. It's by Andrew Allentuck, and it discusses bubbles. The title's quite a grabber: "Know your enemy."

He discusses bubbles of the past, and sketched out the necessary conditions for one. Most of the examples come from the Internet bubble that ended in 2000. His depiction of the "barn-door effect" is worth taking to heart:

Another telling sign of bubble formation in an asset or asset class is called the "barn-door effect," a rush to get a piece of the game before prices move higher. (The barn-door effect can also be seen when a stock has been promoted in an initial public offering, prompting a rush among investors who fear that if they don't buy, they will lose out on the inevitable profits to come.) But there is always some point at which expectations of ever more wonderful earnings or market share - whatever - are disappointed. Then the descent begins. The last investors to buy in hasten to leave and find that there are no buyers willing to pay anything like what they paid.

The problem begins when the masses see investors who bought in early make money on an emerging asset or investment sector. New investors think there is little risk in joining them. "The truth is that after the easy money has been made, risk - which are the odds of price gains running in reverse - begins to rise faster than price," says Charles Mossman, a professor of finance at the University of Manitoba's Asper School of Business. As public enthusiasm increases and investors scoop up the best assets, say the stock of the best companies in a sector, the also-rans get bought up, Mossman says. Declining stock quality increases investment risk. The bandwagon effect that has supported asset prices collapses when investor expectations are disappointed. The rush to the exits begins.

In the gold market, the "also rans" are exploration stocks with lots of hope but no chance of begetting a producing mine except at bubble-high prices for gold. Brent Cook of Exploration Insights came up with one characteristic of such a company: its flagship property is one that's been passed from exploration company to exploration company to exploration company, repeatedly promoted but never developed. When exploration companies of this stripe are rocketing up, then gold's definitely in a bubble.


I myself treaded the same bubble path 'way back in late November, but I have to say that Allentuck's own take is more down-to-earth.