One of the oldest sayings of Wall Street, that happens to be true, is that "there is always a bull market somewhere." In other words no matter how bad one segment of the market may be performing, there is almost always some unrelated asset that is doing well at the same time. Taking that to its logical extreme, if there is always a bull market somewhere, there are almost always a few potential bubbles emerging. This week's posting will unveil some could-be bubbles waiting to burst; which markets look like they have heated up to the melting point?
If there is a bubble in rare earth metals, China is likely to blame. Not only does China have the blessing of favourable and ample resources, but the country actively supported its rare earth mining operations at a time when Western miners were closing up shop. Now, though these elements are critical components of many electronics, China overwhelmingly controls the supply, and the government is cutting on exports and driving up prices. That, in turn, has created a boom time for would-be rare earth miners like Lynas Corp. Ltd. and Avalon Rare Metals Inc.(AVL-T4.620.368.45%).
Ironically, rare earth elements are actually not all that rare for the most part - they are just difficult to find in concentrated quantities on their own, and are typically the byproduct of other types of mining. At prevailing prices, miners are searching throughout Australia, the United States and Canada to bring old mines back into production and begin mining new resources. Simultaneously, those companies that depend upon rare earth elements are doing what companies always do when a key component gets expensive and/or scarce - they are engineering around the problem.
Although rare earth prices could stay high for a while (mines do not open overnight), new digging and new alternatives are likely to put an expiration date on this bull market.
Cotton
Amidst all hype generated about the performance of grains, base metals, precious metals and even cocoa, the record prices in cotton have gone almost relatively unnoticed. Nevertheless, cotton recently broke an all-time price record and prices have jumped about two-thirds from mid-summer.
Unfortunately for investors, the odds are that this cotton bull market has short legs. There is little that can be done to boost supply in the short-term, but high prices for cotton will do what they always do - stimulate more planting in cotton-growing regions. Although it is always possible that growing conditions (poor weather, etc.) could damage the next crop, I think that journalists will be talking about a bumper crop and low prices this time next year.
U.S. Bonds
There are a lot of dynamics at work in the bond market. For starters, banks can make a solid "carry trade" on government bonds - banks take their ultra-low cost deposits and invest them in higher-yielding government securities.
Second, many pension funds were badly wounded in the mortgage-backed bond crunch of 2008 and 2009. Not only have many funds rewritten their mandates to take on less risk, but the supply of bonds has changed. In many cases, pension funds are buying government bonds because they need fixed income instruments and the near-collapse of the mortgage-backed securities market has eliminated that supply.
In other words, this is not so much a bubble (at least not a bubble fueled by unreasonable expectations of gain) as a supply squeeze. That is not to suggest that it could not still end badly.
Gold
The ultimate "is it or is it not" bubble argument has to be over gold. September and October have been full of reports talking about record high prices for this precious metal, and the overall trend has been up for roughly eight years now. Despite this momentum, plenty of gold-bugs will step up to remind the market that gold has yet to reach an inflation-adjusted record of about $2,200 (U.S.) per ounce.
Although gold is often hailed as an inflation hedge, the data supporting that is less than fully compelling. What gold really seems to hedge is uncertainty; when people get nervous, they like to hold gold.
There is, however, an inconvenient truth - hardly anybody outside of coin dealers has ever made lasting wealth out of trading in gold. As gold skeptics love to point out, gold produces no income, is inconvenient to use as is, and could very well be seized by governments during the very conditions that gold-bugs point to as an argument in the metal's favour. While fear in the market seems to justify a lot of the enthusiasm for gold, it is hard to see how prices are not overheated - to say nothing of the fact that if economies fail and governments collapse, people will have more to worry about than their retirement savings.
The bottom line ...
In my opinion the term " bubble "
has become overused in the last few years, as many investors and commentators now slap that label on any market segment that has enjoyed strong appreciation and high valuations. True bubbles are supposed to involve a certain element of self-delusion and mania. For an overheated market to really be a "bubble", there needs to be a collective notion that "it's different this time" and that the only prudent move for savvy investors is to put nearly all of their money in that asset.
Call whatever you want to call it, there is no question that there are some overheated segments of the market today. While momentum investors may be tempted to play their luck and see if they can squeeze more profits from, more conservative investors may want to give them a pass altogether.
What would YOU do?
Regards,
Yacine Dessouki
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