First warning of bursting of the financial asset bubble

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Rudi Fronk and Jim Anthony, co-founders of Seabridge Gold, explain why they think the financial markets generated the biggest bubble in history.

As we noted earlier, we believe financial markets have generated the biggest bubble in history. There are many facts to support this view, from extreme measures of market sentiment to prolonged record low volatility, unprecedentedly low interest rates, record levels of debt and historic overvaluation.

Bulls will try to tell you that earnings, economic growth and low interest rates justify record stock market performance. But a little thought calls those assumptions into question.

earnings only recently managed to climb above the 2014 high, but the index jumped 40%; the stock run is driven by P/E expansion, not earnings growth.

The economic recovery since 2008 has been the weakest on record, with shockingly poor performance in key metrics such as productivity, wages and capital investment.

Interest rates have hit a 5,000-year low, which has made dividend-paying stocks attractive, but the same factor cannot continue to drive stocks higher, especially as interest rates have now started to increase.

Earlier this week we got the first real warning that the financial asset bubble was starting to burst. . .a drop of 1178 points in one day of the Jones industrial index. Yesterday we had another drop of 1000 points. Some analysts blame the small number of funds that shorted volatility and have since exploded while rising. This may be a short-term factor contributing to the market’s decline, but we believe the real issue is that we are in a bubble that is only supported by speculative momentum.

Bob Hoye of Institutional Advisors, a market historian, has studied bubbles for many years. He writes that there have been five major bubbles since the invention of the stock market. These bubbles peaked in 1720, 1772, 1825, 1873 and 1929. Each was a mania that took years to develop and then collapsed. All great speculation runs to its apogee. Throughout history, climaxes have had a lot in common, as have the resulting contractions. It is the “up” that causes the “down”.

Hoye notes that each mania peaked in the ninth year following the collapse of great commodity inflation. A financial boom followed the commodity boom. The commodity boom that peaked in 1920 was immense, as was its collapse. The South Seas bubble peaked in 1720, nine years after the peak of the commodity boom in 1711. The same is true of the three bubbles in between. We also saw the collapse of a commodity boom that peaked and crashed at the end of 2008, and here we are, some nine years later.

The financial bubbles that burst in 2000 and 2007 were not preceded by a collapse in commodities nine years earlier. They were also not allowed to finish; the Federal Reserve and other central banks prevented the normal collapse by reinflating the bubble with huge monetary stimulus, first in real estate and then in the bond market. Quantitative Easing (QE) and Zero Interest Rate Policy (ZIRP) delayed judgment day, but the commodity bubble has not returned. So are we staying on the nine-year clock? Does the current bubble follow Hoye’s classic Big Five bubble model?

In the historical pattern, the high robbers ( ()?) collapse first. start to climb. Note that the stock market reversal began immediately after long rates hit new highs in late December. The psychology of mania is replaced by risk aversion, credit spreads widen and the bubble bursts. Today spreads suddenly widened significantly. The unwinding process typically takes months to unfold and over a year to bottom out.

In the aftermath of a classic bubble, historically gold and gold miners have been the best performers. Will it happen again this time? We will see. As investors begin to realize that the Fed is now trapped, that it will not be able to respond to rising inflation by tightening aggressively due to a bear market in equities, could we see explode upwards?

We believe there is much to learn from history. As students of markets, we are also wise enough to know that anyone’s thinking can turn out to be wrong, including our own. So we present these ideas to stimulate questions; each of us must find our own answers.

Disclosures:
1) Statements and opinions expressed are the opinions of Rudi Fronk and Jim Anthony and not those of Streetwise Reports or its officers. The authors are fully responsible for the validity of the statements. Streetwise Reports was not involved in any aspect of the content preparation. The authors were not paid by Streetwise Reports LLC for this article. Streetwise Reports was not paid by the authors to publish or syndicate this article.

2) Rudi Fronk and Jim Anthony: We, or members of our household or immediate family, own stock in the following companies mentioned in this article: Seabridge Gold. We are personally, or members of our immediate household or family are, paid by the following companies mentioned in this article: Seabridge Gold.

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