Financial Bubbles...

There is a financial bubble brewing somewhere at any point in time....
O Ashuji...

Investors since 2008 crises are having fear bubble while central bankers are having confidence bubble....
O Ashuji.....

In one of the presentation recently, Kyle Bass (Hayman Capital) has put it very nicely - "The Brevity of Financial Memory is only about 2 years". This is precisely the reason why irrationality in hindsight rationally occurs all the time. Financial bubbles are irrational product of rational minds and rational minds when mixed with rational crowd becomes irrational. Numerous studies have been done to study bubbles and various characteristics of bubbles have been identified, yet it always occur with tag "This time is different". This time is different always occur for "Funda-Mental" mind. Study of Price Behavior always warns.

I am neither intellectual enough nor will try to define a bubble and hence will quote people who have put it  in easy way to understand the concept of bubble.

“Much has been written about panics and manias, much more than with the most outstretched intellect we are able to follow or conceive,” wrote Walter Bagehot, first editor of the Economist. “But one thing is certain, that  at particular times a great deal of stupid people have a great deal of stupid money…..At intervals, from causes which are not to the present purpose, the money of these people—the blind capital, as we call it, of the country—is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone, and there is ‘speculation’; it is devoured, and there is ‘panic.’”

Every bubble is different, and every bubble market is exactly alike. Momentum begins to build. Investors start to stampede. The stampede creates a mob mentality that seems to sweep everything along in its path until some unknowable top is reached, panic sets in, and everyone start running for the door. 

Markets, Mobs and Mayhem - Robert Menschel

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of  voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

Ludwig von Mises

Few of the noted historical bubbles

(Source - Markets, Mobs and Mayhem - Robert Menschel, http://www.valuewalk.com/2010/06/comparison-bubbles-john-chew/, O Ashuji)

Certain Common Characteristics of Bubbles (only with respect to price and time)

1) Most Financial bubbles have some fundamental foundation. Price move, tend to accelerate towards the end of the move. 

2) Atleast 65-70% of gains are given up post peak before prices stabilizes. 

3) Typically, bear phase is much smaller than bull phase. 

4) 40-50% of the price move of the entire bull run happens during the few months just before the peak. 

5) Prices don't recover even 50% of the peak for years.

6) Price movement tends to get violent during final phase. In other words, there are large moves during final phase. Clustering of absolute % moves (up and down moves are large)

Lets look at Few Bubbles through charts and their clustering of final moves....

1) NASDAQ 

Monthly Nasdaq Chart

 (Absolute Monthly % Move)

2) Nikkei

Monthly Chart - Nikkei

 (Absolute Monthly % Move)

3) DOW JONES INDUSTRIAL AVERAGE (DJIA) (1920-1932)

Monthly Chart - DJIA

(Absolute Monthly % Move)

4) SHANGHAI STOCK EXCHANGE 

Monthly Chart - Shanghai Stock Exchange (SSE)

(Absolute Monthly % Move)

One can go on and on and nature of rise and fall will be similar because greed creeps slowly while fear comes at speed of light....

I might not be putting anything new in the entire above explanation of financial bubbles and its nature but there is reason of doing so...2 asset class have termed as Financial bubble and in fact one of them has been totally dismissed as one that has seen its rise and end while other one is being seen as having begun its long drawn bear road....Those 2 assets are Gold and Oil....

First, I will take Crude...it has been dismissed as asset which has experienced bubble rise and subsequent fall....BUT

1) Oil 

Monthly Chart - Brent Europe ($/Barrel)

 (Absolute Monthly % Move)

If Crude was indeed bubble and it has ended...then it will differ to previous bubble in following ways....

a) Though Crude like all other bubble rose almost 7 times (2001-2008) and then collapsed 77% within matter of 6 months (July-Dec 2008) BUT it recovered most of the losses within 3 years and is only 20% away from peak.

b) Financial bubbles typically take many years to recover even levels which is 50% away from peak....

2) GOLD

Gold Monthly Chart priced in USD

 (Absolute Monthly % Move)

A) Gold move hardly seems parabolic during the final phase though since the bull market started returns have been 590% (2001-2011). 

B) Clustering of move was seen twice - during financial crises and European crises.

C) Gold is peaked in Sep 2011 in dollar terms and current price is 15% from peak over period of 18 months. Hardly a collapse. 

It gets even more interesting if we look at gold price in terms of various currencies.

GOLD IN VARIOUS CURRENCIES

1) Turkish Lira, Egyptian Pound, Vietnamese dong, Indian Rupee and South African Rand are top 5 major currencies which have lost most against gold since bull market began in 2001.

2) Based on Feb 28, 2013 close, Gold is not even 20% down from peak against any currency in the table. In fact, against Egyptian Pound, South African Rand and JPY, gold is almost at all time highs in those currencies. 

3) Peak dates are vastly different for most currencies and has been spread from  Sep 2011-Feb 2013...

Gold is a bet on government trying to inflate its way out of debt mess. Financial Repression (Cyprus being just start of it) will result in greater rush towards Gold. Price of Gold will be key in determining Government's success at inflating its way out of debt mess. Gold's strength will ensure that STOCK MARKETS WILL CONTINUE TO SURPRISE MOST. Martin Armstrong has put it very nicely....its a battle of Public vs Private Asset.....Bond's Bull Market was rush towards public assets....we might be about to start rush towards private assets....