Boom or bubble: two stages of investment market trends

DVD (Photo credit: Wikipedia)

Date: 9/14/2013​

Investment trends go through stages. Booms and bubbles are just two of those stages. Let’s start with booms, since bubbles are often just a later stage that follows the stage of the initial boom.

 

Economic Booms

A boom is about a shift in practical utility, as in functional superiority. For instance, when consumer demand shifted toward DVD videos and away from video tapes, that was because DVDs were useful in a way that was “more competitive” than VHS or Betamax tapes. The value of Video Cassette Recorders (VCRs) plunged as DVDs “took over.”

So, a boom is a stage in which demand increases for something due to a new trend of evaluating that something as more practically valuable than something else. As cars got more popular as transportation, demand for horses plunged (as well as demand for horse-drawn vehicles). Or, as guns got more popular as weapon​s​, demand for swords plunged.

Booms are temporary. ​Will DVDs always be the most popular format of video recordings? That is highly unlikely (especially because of the word “always”)​.

The nature of technological booms is that booms that start as “explosive” will eventually slow down, plus they may even be interrupted by a new innovation (or by something like war). Just like Betamax tapes are now obsolete, DVDs may eventually be obsolete.

Again, a boom is just one stage of economic change. When DVDs were first getting popular, that was a boom. More recently, the demand for DVDs is not rising as quickly as earlier in the primary stages of the boom. Booms can either suddenly “go bust” or they may taper off and continue to boom, but with a much smaller rate of expansion.

DVD-Video (Photo credit: Wikipedia)

 

​Financial Bubbles

Bubbles are a stage of rapid change that is not based on a new tangible economic advantage. Bubbles are just about the perceived opportunity for unearned gains, like with “flipping” real estate using borrowed money. That is a very high-risk situation, though rapid change can also be very lucrative.

Bubbles tend to form out of booms. When there is no longer any new economic advantage emerging (a new advantage in practical applications), but just an interest in re-sale prices, that is a speculative bubble.

For instance, when people buy gold not to use it in some industrial application, but just as a store of value for later exchange, they are speculating on the future purchasing power of gold. They are not buying gold because they want to use it in wires for electrical conductivity. They just want to eventually resell it. They are just speculating.

English: Series of air conditioners at UNC-CH. (Photo credit: Wikipedia)

Boom or Bubble?

When air conditioning was developed, that redistributed demand for real estate away from colder places toward warmer places (which were suddenly much more appealing as long as there was a reliable supply of electricity plus a stable air conditioning industry). That was an economic boom. People chose warmer places over cooler places because the warmer places had previously been less valuable (priced lower than places with more moderate climates). That is just a shift of economic priority. People want moderate temperatures inside their homes. Air conditioning allowed for that to happen in warmer places, so demand for real estate shifted away from colder places toward warmer places that had

AC easily available.

A city like Phoenix Arizona expanded very rapidly. The basics of electricity and municipal water were already in place. Once air conditioning came along, the city was ripe for a boom.

Other desert areas like Yuma, Arizona did not have the infrastructure in place to benefit from the boom related to the development of air conditioning. Or, just to the east of Phoenix, a town like Scottsdale could have been the primary center of the boom, but the most profound rise of prices for real estate in Scottsdale came much later.

A Fedders air conditioning unit. (Photo credit: Wikipedia)

Scottsdale was a great place to “flip” real estate. That means to buy it for a down payment of a tiny percentage of the total purchase price and then quickly resell it for a huge profit.

That kind of high-risk speculation is not based on an interest in actually using the real estate. The investor is just looking to profit from the investment. They are just speculating.

Because real estate markets involve so much speculating on borrowed money, the speculation of borrowers is much higher-risk than speculating in something like gold, for speculating in mortgages can result not just in a loss of the entire initial investment (the down payment or deposit), but a lingering debt from the mortgage which leads to foreclosure and bankruptcy. Of course, even if someone is investing in real estate without financing the purchase, demand for real estate market is still supported largely by the mortgages, so if the mortgage trend collapses, then real estate prices crash for everyone, whether or not they are in debt and go bankrupt because of the end of the bubble (the sudden deflating of the prior decades of inflation).

East part of Phoenix (on the left) and Scottsdale, Arizona (on the right) by SPOT Satellite. (Photo credit: Wikipedia)

 

Booms, Bubbles, and Busts

 

Another example of a bubble would be when there is a government intervention to favor a particular market. Real estate investors may get a tax-break or a government-guarantee behind their mortgage. That draws them away from other choices towards the choice that the government is encouraging.

When government intervention programs are new, they result typically in a sudden surge of demand (a “boom”). However, those booms can quickly become bubbles. Plus, when the government interventions are no longer new, people may forget that the government has been in effect subsidizing demand for a particular market.

So, those government-created “booms” are not produced by “natural” advantages, but only by an “artificial” advantage. That is more of a bubble than a boom really.

Another example is when governments made special tax incentives to lure people in to investing in the stock market, such as tax incentive programs like the 401K and IRA regulations. Excited investors flooded in to those favored programs.

However, there still needs to be a boom first before a government-induced bubble can develop. If stock markets are not already booming, then new laws giving a slight advantage to stock market investment will not produce a surge in consumer demand.

How to invest during a “Bust”

When bubbles collapse, that may actually be the most favorable investment situation of all.

Because the vast majority of people do not recognize the bubble or how to profit from it, that means that a very small group of perceptive conservatives tend to be the only beneficiaries of an immense and sudden redistribution of wealth. Many millions of investors are essentially dumping their assets on what may be as few as hundreds of recipients- or even just dozens.

We could even think of governments as systems that systematically promote some specific bubbles instead of other possible bubbles. The issue is which bubbles will be created and how much of an incentive will be established. Governments can promote a bubble in solar energy or in college tuition (through federal-funding of loans) or health care, but each bubble competes with all of the others.

So, to invest for profiting from a bust, certainly all speculative bubbles must be avoided- and the industries that benefit from such temporary financial bubbles. For instance, while gold prices have remained high in recent years, the prices of silver and copper have not, plus the mining industry itself has been much weaker in recent years. In contrast, in the early stages of the current bubble in gold markets, the stock prices of many mining companies soared several times as fast as the actual prices of the metals that they mined.

The mining companies, as the ones with the biggest concentrations of gold, were the primary beneficiaries of the bubble in gold. Of course, other groups also benefited immensely. Think of the huge profits collected buy the brokers and traders who accurately perceived the early stages of the bubble.

But who benefits from a bust? Brokers do not benefit from a collapse in volume. Their commissions plunge. Only the astute traders benefit.

How exactly do astute traders benefit from a plunge? In the current situation of several overlapping financial bubbles, the safest way to benefit from a deflationary crash of asset prices is through the trading of something called options contracts (such as a auto lease with an option to buy at the end of the lease).

What is the best option?

The trading of option contracts offers all of the benefits of flipping real estate without any of the risk. Basically, options contracts are insurance policies. For a small premium, one can purchase the legal right to a huge future revenue, but with no additional risk besides the cost of buying the insurance policy.

That is kind of like what most people may THINK they are doing when flipping real estate. They may THINK that they are only risking their down payment in exchange for the opportunity for a quick gain of large amounts of money IF real estate rices rise. However, they are gambling much more than the amount of the down payment. Most of them are gambling with bankruptcy. With the trading of option contracts, it is really just the actual cost of the contract that is at risk.

The astute trader can selectively purchase option contracts that can surge in value hundreds of percent with a few months- or even a few minutes! This is like paying a hundred dollars per month and then instantly having the right to receive insurance coverage (financial benefits) of many thousands of dollars.

However, when trading option contracts, you can profit from the investment without having to be in auto collision or having a medical crisis.  You just research the unfolding of the collapse of a speculative bubble. As prices whip down and up and back down, you can profit from the rocketing volatility. You can profit from both rising prices and falling prices.

English: Commercial Building with an air conditioning system VRF (Photo credit: Wikipedia)

Who bears the risk?

However, the party who writes the option contract is taking an immense risk, just like someone who is borrowing hundreds of thousands of dollars to buy real estate in the late stages of a bubble. Many of those folks will go bankrupt.

Similarly, insurance companies typically enter debts far in excess of their capacity to pay, which means they rely on new premium revenues to cover their prior liabilities. This is generally known as a ponzi scheme and it is illegal without a government license. So you may want to be extremely cautious about the high-risk practices of insurance companies, real estate flippers, and anyone who creates certain kinds of high-risk option contracts (which include many desperate institutions like banks, brokerages, and insurance companies).

Creating high-risk option contracts as a last-ditch effort to generate revenues to maintain a ponzi scheme is only a temporary “solution.” Likewise, governments cannot really bail out all the taxpayers at the expense of all of the taxpayers. Governments can only use coercion to redistribute wealth from one group to another, like when rescuing banks at the expense of other taxpayers, or rescue real estate speculators at the expense of other taxpayers.

How to avoid the risk and invest in the best options

Most people do not recognize the simplicity of how markets work. Many people even argue (sometimes passionately) that markets are inherently confusing or unpredictable.

In contrast to the raging jealousy and guilt of the antagonistic mainstream (who may be shocked and ashamed by the results of their actions), some people are humble. A rather small group of people are humble enough to admit that there may be an orderly process in how investment markets develop, but they do not claim to comprehend that order. They are open to partnership and making the experts in to their allies.

For more information on how you can benefit and how much, contact the person who shared this with you. Also, you are welcome to share this article with others.