Tag Archives: Final stage of a mania

Back to School; Greenspan on Economic Freedom; How Asset Bubbles End


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Irony (note the author): Gold_and_Economic_Freedom_an_Article_by_Alan_Greenspan_1966

Prices and Fundamentals in Secular Bull Markets or (Bubble Detection) from www.acting-man.com (an excellent blog on money and metals)

Finally, we want to make a brief comment on how secular bull markets in financial assets usually end. Note here that this does not amount to a ‘hard and fast rule’ that is grounded in sound theory. Rather, it is an observation on market psychology based on empirical data.

If we look back at major secular bull markets of the past, such as e.g. the Nikkei bull market from 1969 to 1989, the Nasdaq bull market from 1974 to 2000 or the gold bull market from 1968 to 1980, a few things could be observed in all of them as they entered their final stage.

In all these cases, a vast expansion of the money supply and too low administered interest rates (like 2013!) played a major role in the formation of the bubble stage. Also, in all cases the biggest gains were achieved in a final ‘parabolic’ advance, which exhibited annualized rates of change ranging from 80% up to 200% (the latter incidentally happened in the case of gold’s final ascent in 1979/1980). In short, the by far biggest gains were made in all these bull markets in a very compressed time period shortly before they ended – during what one might term the ‘bubble’ or ‘mania’ stage.

However, two other important aspects unite all of these bull markets: first, in all cases, a major correction occurred just before the bubble stage began. In the Nikkei’s case it was the 1987 crash. In the Nasdaq’s case it was the 1998 crash during the Russian/LTCM crisis. In gold’s case it was the 1975-76 cyclical bear market.

The other aspect is that just as the final, and most stunning price increases were recorded, the fundamental backdrop had already clearly begun to deteriorate.

Contrary to widely accepted lore, not one of these markets proved capable of ‘discounting’ deteriorating fundamentals in advance – on the contrary, they produced their biggest gains well past their fundamental sell-by date, i.e., their final advance lagged the fundamentals (the same by the way happened in the stock market mania of the 1920s – by the time the DJIA made its all time high in September of 1929, the US economy was already in recession).

In all these cases the major ‘fundamental’ datum that changed for the worse were nominal and real interest rates. Investors and traders pumping up the Nikkei in 1989 thought they could ignore the fact that the BoJ was belatedly hiking rates and that JGB yields were rising strongly. Gold traders didn’t believe Paul Volcker would succeed in cracking the inflationary psychology of the 1970’s by raising interest rates and stopping the expansion of the money supply. Nasdaq traders believed that the magic of the internet had made technology stocks impervious to a tightening of monetary policy by the Greenspan Fed.

We mention this because it could become an important feature of how the current secular gold bull market ultimately plays out. If it plays out in similar fashion, then it is clear that it cannot have ended in November 2011. On the contrary, this would mean that the by far biggest price gains have yet to happen.

We personally believe that to be the case – but we must of course warn readers that we may well turn out to be wrong about this. There are no guarantees – all we have on our side is history and what amounts to an educated guess. Oh, and Ben Bernanke of course.