April 29, 2012
Bb: Robert Hallberg, Topics: Credit Bubble
Over the past 20 years we have had two major asset booms infused by easy credit. The lose money policies of the 1990âs under the watch of Mr. Greenspan led to a stock market mania. After the .com crash and the recession following 9/11 the Fed once again came to the ârescueâ and lowered interest rates to multi-decade lows. This led to a second bubble in real estate that burst in 2007/2008.
The combination of easy credit and legislation encouraging home ownership ignited a real estate boom throughout the country. Coastal areas in California and Florida saw prices rise several times over to ridicules levels within a few short years. It seemed like everyone was involved in real estate in one way or another, whether they were buying houses, selling houses, building houses, or worked as loan officers providing loans.
The US went into a severe recession after the housing bubble burst and the fed quickly came to the rescue and lowering interest rates to about zero in addition to throwing trillions of dollars at the problem through programs like TARP, QE I, QE II, etc. This stabilized the system and the economy has been in stagnation or in a slow recovery ever since.
One might ask why the fed did not try to take away the punch bowl before the party got out of hand. The problem with money printing and keeping ultra low interest rates is that the undesirable effects of inflation and asset bubbles occurs with a time lag, making it difficult to know when itâs gone too far. Central banks can only measure the effects after the fact, and by then it may well be too late.
Furthermore, inflation usually does not increase across the board. The Fed can print money but they cannot control where this money goes. When the Fed and ECB print money it typically flows into specific asset classes and cause unintended consequences like the .com bubble and the housing bubble.
We are now in the process of creating a third credit bubble. We donât know for sure which asset class the Fed will inflate this time. But we know that the creation of new money erodes the purchasing power of existing currency in circulation and we have so far seen a rise in stocks and commodities. As the currency continues to depreciate, it is probable that people will try to protect their wealth buy putting it into tangible goods like commodities and gold.
I believe that gold and gold stocks are a bubble in the making and like all other bubbles; it will probably end in a mania phase. Just like all other manias it will make a few people rich, those that got in early, while most people who jump in at the end will lose money.
To get an idea what a mania in gold stocks may look like we only have to look at previous bubbles in gold. The chart below shows the performance of the juniors during the last mania in the gold market that ended around 1980. Many stocks literally went from a few cents to tens of dollars.
The next chart shows the performance of large gold producers. These companies are much larger and subject to less volatility. But even these companies went up in price several times over in just a year.
Just like any other bull market that ends in a mania, the people who get in early will make all the money and those who get in late will suffer all the losses. Getting in early requires some patience, but the rewards are often plentiful.
To learn about trends and spot the next investment opportunity read the Casey Report from Casey Research. It's a monthly investment news letter that breakdown economic trends in a way that is easy to understand. They make recommendations based on economic reality and their track record is several times better than the market or any mutual fund for that matter.
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