Investing In Bubbles

Via The Speculative Investor blog,

Many assets show signs of being immersed in bubbles right now.

The most obvious example is the cryptocurrency speculation, which includes Bitcoin, the numerous and rapidly-multiplying Bitcoin alternatives and, more recently, the stocks that are involved in cryptocurrency ‘mining’. Other examples are the broad US stock market, the stocks of companies involved in social media and/or e-commerce, the market for junk bonds, and a group of junior mining stocks where just the hint of a possible discovery has led to spectacular price gains and market capitalisations that bear no resemblance to current reality.

The most enthusiastic participants in each bubble believe that although bubbles exist elsewhere, there is a special set of circumstances that justifies the seemingly high valuations in the asset that they happen to like. For example, many of the cryptocurrency enthusiasts believe that the US stock market’s valuation doesn’t make sense but that Bitcoin’s valuation does, and many stock-market bulls believe that the S&P500′s current level is justified whereas Bitcoin’s valuation is ridiculous.

However, the bubbles are all related in that they all stem from the returns on conservative investments having been driven to near zero by the actions of central banks.

Now, just because an asset is immersed in an investment bubble doesn’t mean that it should be avoided. Buying something after it enters bubble territory can be very profitable, because huge gains will often occur AFTER valuation reaches a point where it no longer makes sense to a level-headed investor.

The problem is, if you ‘know’ that a particular asset is immersed in a bubble then you will be constantly on the lookout for evidence that the bubble has ended and that the inevitable implosion has begun. In effect, you will constantly have one foot out the door and will be acutely vulnerable to being shaken out of your position in response to a normal correction.

A related problem is that once something has entered bubble territory the normal corrections tend to be vicious. Each correction will look like the start of the ultimate collapse, so unless you are a true believer (someone who believes so strongly in the story that they are oblivious to the absurdity of the valuation) you will be unable to hold through. For example, during the first half of September the Bitcoin price had a peak-to-trough decline of about 40%. This looked at the time as if it could be the first leg of a total collapse, but it turned out to be just a short-term correction. Only a true believer in the cryptocurrency story could have held through this correction.

Eventually, of course, a vicious price decline turns out to be the start of a bubble implosion. The true believers will naturally hold, thinking that it’s just another bump on the road to a much higher price. They will continue holding while all the gains made during the bubble are given back.

An implication is that you need to be a true believer to do phenomenally well from an investment bubble, but if you are a true believer then you will be wiped out after the bubble collapses.

Alternatively, you may decide to participate in an investment bubble while knowing it’s a bubble. In doing so you may be able to generate some good profits, but in general you will be too quick to sell. Therefore, while the bubble is in progress your profits will pale in comparison to those achieved by the true believers, although you will stand a better chance of retaining your profits over the long haul.

The worst-case scenario is to be a non-believer and non-participant in a bubble, but to eventually get persuaded by the relentless rise in price that special circumstances/fundamentals justify the valuation and that a large commitment is warranted.

That is, to become a true believer late in the game.

This worst-case scenario is what happens to most members of the general public.

Comments

VD Fri, 11/03/2017 - 17:25 Permalink

fundamentals: the transaction volume of bitcoin over last 12 months is, on average, unchanged. while price has gone up 10x

Mr_Potatohead tmosley Fri, 11/03/2017 - 17:44 Permalink

And don't forget to mention that there are no alternatives to bitcoin.  Bitcoin has gotta go up as the inelastic supply goes down and demand from places like the highest echelon of the Turkish government skyrockets.  The S-curve rules.  Gotta respect the S-curve.  It will protect bitcoin and save us all from the evils of fiat currency.

In reply to by tmosley

HRH Feant2 Mr_Potatohead Fri, 11/03/2017 - 18:11 Permalink

WTF are you talking about? There are nearly 1000 alt coins. Alt as in alternative.

There are plenty of places for people to park their money: cash / currency of your choice, PMs, stockmarket, bond market, forex, art, guns, cars, real estate.

I have some money parked in a few of each. My choice. Not yours.

For the record I have spoken strongly against some of the alt coins, especially Veritaseum. Looks like JSNIP was peddling one that blew up in his face. A lot more will do the same.

I have known about BTC from nearly the beginning.

People use what works. BTC works.

In reply to by Mr_Potatohead

Raffie Mr_Potatohead Fri, 11/03/2017 - 18:03 Permalink

The more u haters cry, the higher cryptos grow. CRY ON JUNIOR!! Making me rich is a great idea.In reality, if cryptos was truly gonna crash, most of you would say nothing at all because you would figure why bother.But that is not the case, you choose to lie and wicker the facts of cryptos because the truth is painful to you all. Think cryptos are going away? Get back with me in 5 years and you will see they are part of our everyday life. Your kind blah blah blahs about any corrupt central bankers that get involved with cryptos, YET you will keep gold/silver when that has been held by the same people for many decades. Makes no sense at all.  

In reply to by Mr_Potatohead

Mr_Potatohead Raffie Fri, 11/03/2017 - 18:39 Permalink

All kidding aside, Raffie.  You've got a lot to learn.  If you learn it without getting wiped out, you'll be okay.  Every successful investor has paid his/her tuition to learn how to control their emotions and how to do smart things that go against emotions that deceive you.  Learning new info, admitting that you've been wrong, and getting out in time to invest another day is a critical skill.  You clearly don't have it yet, but cheer up.  If you can stay in the game long enough, you'll learn alot and probably do well.If you're heavily invested in bitcoin at prices typical for the last month or two, you're going to learn a great many things - especially about yourself.  Whether you believe it or not, you're caught up in a bubble and incapable of thinking objectively.  You'll understand this after the bubble pops. It's okay to take on risks associated with investments that you truly believe in.  I admire this greatly.  But think carefully about this: if you recently bought a cryptocurrency, do you know at which price you are going to sell for either a fiat profit or a loss?  Do you truly understand the assumptions you're making about the ability of your investment to appreciate in price or maintain its value?  Are you strong enough to recognize that you might be wrong about your assumptions?  (After all, somebody took the opposite side of your trade because thay thought differently than you do.)  And do you know now how you're going to handle things if/when you discover that you're assumptions are wrong and your emotions are running wild?I can guarantee you that I won't remember you in 5 years, but if I'm right about what's going to happen, you're going to remember me forever.  Enjoy the weekend.

In reply to by Raffie

Justin Case Mr_Potatohead Fri, 11/03/2017 - 18:55 Permalink

Every successful investor has paid his/her tuition to learn how to control their emotions and how to do smart things that go against emotions that deceive you.After trading for 35 yrs. it is difficult to be rational and trade on pure fundamentals without getting emotional. As you say, the tuition is expensive and it's part of the learning curve. The DOT Com bubble reminds me of the bitcoin investors here. I told a co-worker to sell his holdings in Nortel when it hit $126.00/share in March of 2000. When it dropped to $89.00 he bought moar instead. He was laughing at me b/c I was in precious metal stocks in Nov.1999 from tech stocks. Nortel went to 79 cents last I looked at it back then. I didn't say anything to him after that, as I know he lost his shirt and was out of markets forever on.People get greedy and eventually lose it, by not taking a profit or atleast their capital and a reasonable profit. They like to let it all ride. Just greed.As you said, he'll remember you for a very long time. Words of wisdom ring forever when you screw up. But it's too late by then. 

In reply to by Mr_Potatohead

Michigander Mr_Potatohead Fri, 11/03/2017 - 19:33 Permalink

I had an employee that couldn’t think, couldn’t rationalize, and couldn’t connect dots. We called him Mr. Potato Head too. Did you pick that name or did someone give it to you? It appears you struggle with the same issues my employee had.Your thesis is illogical because you use terms like “truly believe” and “heavily invested” to make your arguments against cryptocurrencies when anyone who is heavily invested or truly believes in anything is a Potato Head.I started buying bitcoin as a fiat hedge, in addition to my bullion hedges, about  5 years ago. Bitcoin has done for me, what I thought bullion would do for me.  So is bitcoin in a bubble? Not yet.Like it or not, it is money. Not because I say it is, but because the preponderance of the evidence shows that it is. As people awaken to their devaluing fiat, its not bullion that they are turning to, its BTC. It has definitely been a store of value.  It is a unit of account, a medium of exchange, limited in supply, portable, and fungible. The acceptability progresses daily.  So go ahead with your maximum, minimum, all in this and that arguments. It doesn’t change that acceptance is growing exponentially.Less than 3% of the global population owns it. They say it took  10 years to get to the first 1%, 10 months to get to the second 1%, and 10 weeks to get to the third 1%. Coinbase opened 100,000 accounts in one day last week. In  10 years,  people will look back on 2018 as the year it all began. The moves to now are pocket change.There is around 75 trillion depreciating units of currency in the world against 21 million possible bitcoins. Individuals alone have been hedging their fiat and look at where the price has gone. Wait till institutional money comes in. Wait till it captures a portion of the forex markets. I see the Potato Head arguments coming about forks and splits and how Bitcoin is not limited in supply. Yes, it forks, but the forked coin is not a true Bitcoin. It may find its way on its own path, but Bitcoin Core is battle hardened.Oh, and please don’t use the Potato Head arguments about power and internet.  If they do go down, you have bigger problems than no bitcoin access. You’re/my bullion will be equally worthless as we go into the grub and guns sunset of our lives.I would have loved to see 100,000 accounts a day opening at SD bullion, or goldmoney, or any of the other bullion dealers but it just ain’t happening. So if you’re all in on bullion because it’s the only real store of value, or its been money for thousands of years, then I do feel sorry for you. You are missing out on one of the most important events since the advent of the internet.I can also guarantee I won’t remember you in 5 years. Frankly, I’ll forget you by tomorrow. But, if I’m right about what’s going to happen…that’s where we part company. I don’t know whats going to happen. You don’t either.  That’s why we hedge.

In reply to by Mr_Potatohead

Mr_Potatohead Michigander Fri, 11/03/2017 - 20:13 Permalink

I've traded and invested for about 35 years.  Paid my tuition early.  Learned a lot - especially about myself and about  the motivations and behavior of other people.  Much more successful in so many ways and happier today than in the 1980's.  Wish I knew then what I knew now.  Will never forget the wise old fart who tried to teach me something important about investing when I was in my twenties.  I wouldn't listen because I knew better.  Big mistake!  He definitely knew better because he made the same mistake years earlier.  Ironically, I probably learned the lesson better because I didn't listen and had to pay a higher price.Mr_Potatohead has been my username for many low-security things since about 1989.  Long story how I got it.  Kinda cute, but not worth sharing.  Definitely won't use it for opening an account associated with crypto-anything.Regarding Bitcoin being "money"...  I think we have different definitions of money.  Bitcoin is definitely a currency - i.e., a medium of exchange - for the exact reasons you stated.  But is it really money - i.e., sound money?  Hmmm.....Missing out on bitcoin is okay with me.  I missed out on pets.com, webvan, and a host of other now-defunct companies around 2000.  Also missed out on TSLA and APRN for the same reasons.  Other choices were more attractive. Seems like we may have much in common.  Despite your comments, I suspect that you and I have a pretty good idea about what might happen in the not too distant future.  If we're right, Bitcoin and many other things indeed won't help much.  But with 35 years of acquired knowledge and wisdom, I'm quite sure that Mr Potatohead is going to outlast most bitcoin "investors".  

In reply to by Michigander

HRH Feant2 Michigander Fri, 11/03/2017 - 21:40 Permalink

Great comment! Well said.

I would say that your estimate of 3% of the global population owning BTC is off. I would estimate that maybe .005% of the global population owns BTC or knows about it.

Do you remember the debates about PMs? About 1% of the population owns PMs. If the number of people that wanted to buy PMs doubled to 2% that would make the PM prices skyrocket. 3%? To the moon!

The numbers are minuscule. The great thing about BTC is you can buy $5 worth. I know. That was my first purchase. $5 of BTC.

I look back and ask myself what took so long? Stupid. Just stick the "kick me I'm stupid" sticker to my back.

In reply to by Michigander

Justin Case Raffie Fri, 11/03/2017 - 18:43 Permalink

Just as importantly, I don’t get emotionally attached to gold… or stocks… or Bitcoin. I believe people who get emotionally attached to gold or Bitcoin or any other investment are making a huge mistake. Getting emotional about your investments is sure to cloud your judgement. Save the emotional attachment for your kids. They will love you back. Your investments won’t.

In reply to by Raffie