Monday, April 26, 2010

Another Bubble Debunker

Chris Weber used a cocktail-party gauge to see if gold is in (the climax of ) a bubble. According to his latest sampling, there isn't the same excitement and advice-giving with gold that there was with, say, Internet stocks in 1999. The article in which he mentions that finding contains an eye-opening depiction of what it was like buying near the bottom:
It was this time, nine years ago – back in 2001 – that I put what was for me a large percentage of my assets in gold and gold stocks.

At the time, I saw that gold was looking very good on the charts: its recent lows were for the first time higher than the previous lows. Then there was just a feeling I was getting that the 20-year bear market was over. At the time, the idea of investing in Gold or gold stocks was regarded as laughable, a relic from another generation.

At the start of 2002, I first talked about gold with my readers, recommending some gold stocks. I had to be careful even then, because writing investment newsletters as I have since 1974, I learned long ago that you can't get too far ahead of your readers. If you suggest something that is totally off of their radar screens, they will not be happy.

"Give people what they want... Tell people what they want to hear": that was the advice I'd always been given by other newsletter writers. And it is true, most people only hear and believe what they want to hear and believe. It has been said before, but if there is ever to be a change in anything, "the minds of men must first be fitted to it."

Also, between the time when I first bought the gold area in April 2001 and the time I first mentioned it in February 2002, I told three people what I had done. First was my brother. He looked at me with an expression of pity and sympathy. Next was my neighbor and good friend. He looked at me like I was crazy. Finally was a friend of mine in the gold-mining industry itself. He told me I was much too early, that he saw no end to the 20 year bear market anytime soon.

I relate this to say that the best investments I've made have been at the time when most everyone else thinks you are deranged for even talking about them.

Needless to say, the reaction to gold today is nothing like it was in '02. I note that the cocktail-party indicator is good for spotting the climax, but not necessarily the end, of a bubble.

And (perhaps unfortunately) acting on the cocktail-party indicator is a reliable means of getting out too early, as many professionals do. It's a strong soul that can stand to watch an investment class keep rocketing up, amateurs getting rich with little or no effort, naifs looking like geniuses, the buying public clamoring to get in (as the cocktail-party indicator implies), month after month, while keeping one's distance from the whole party. Although vindication comes in the end, the wait is a psychologically grueling one.

Of course, many professionals get back in due to customer pressures. "Give the clients what they want" also applies to managing money.

Weber's good enough to say that a large majority of people who buy in early, get out before the bull market finishes. He ascribes it to the nature of bull markets, but there's a psychological explanation that gets to the heart of the matter. People who buy in near the beginning of a bull market are also buying in after the end of a bear market. [Gold's last one was 20 years long, or 20 long years.] Even if the fundamentals show undervaluation, there's no guarantee that the investment will become even more undervalued. Moreover, a large valuation gap may indicate a hidden bearish factor that wrecks the fundamanetal value of the asset in question. The only people who can hold on are those who repeat the fundamentals as if they were a mantra. Others, guided more by market internals, are weeded out early on when the asset jumps to an ostensibly unsustainable level.

The trouble, as the bull market matures, comes from using a contrarian stance to stay in. The person who buys an investment near the bottom, when it's widely disparaged or widely ignored except to disparage, tends to become uncomfortable when the same investment becomes popular. In order to buy and hold gold since 2001, someone would have had to tolerate being thought of as a nut or an oddball. [Believe it or not, the same pressure applies for even orthodox investments; it just takes different forms.] The only kind of person who can do this with equanimity is someone who's destined to become uncomfortable when the crowd discovers the asset and likes what it sees. Let's face it: taking pride in being part of a breed apart tends to make newfound popularity at best bittersweet.

To sum up: when the crowd discovers an asset on the merit of its fundamentals, the early entrants (being conscious or unconscious contrarians, or otherwise not caring a fig about being popular) get uncomfortable and leave. The rest of the bull market continues without them.

It's a situation that can be described as tragic. The kind of popularity hound that thrives on being in the swim will be nowhere near an investment that's truly undervalued, like gold was in 2001. The ones who are in, take pride in being beyond the reach of the conformist crowd. As the former type wades in, the latter type gets antsy and pulls out. By the time the second stage of the bull market is through, and the lengthy third stage is beginning, the breed apart is either gone or besotten by worry. Tragically, the ones who hold on tend to allay their anxiety by becoming hyperbullish - it's the only reinforcer that works. These guys are the ones who are likely to hold on to the bitter end once the bubble pops.

The only way around this dilemma seems to be buying in secret in the early stages and telling no-one until it becomes popular. The discretion this approach requires takes a different kind of psychological toll.

[And to think there are people who believe that speculation isn't real work...]

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