Bubbling up? Or bubbling over?

7th September 2011

But before listing more indicators suggesting markets becoming overheated and overblown, here's a true story.

In the late 1970s, I covered a trade fair in Leipzig, then in East Germany. I'd heard stories of denim jeans fetching a fortune in the Soviet Union so I asked what to take.

"Tins of sardines" came the answer. "They can't get them so they'll pay big cash for them."

"So how do they eat them? On toast? In a salad?"

"They don't open the tins, stupid," came the response. "They'll be sold on and on, each time at a profit. These are dealing sardines, very much not-for-eating sardines."

He was right. At the official (rigged) exchange rate for the East German ostmark, my sardines went on to achieve many times their original Sainsbury's price.

They had become too valuable to eat. And for all I know, the same tins were still circulating ten years later at the fall of the Berlin Wall when they reverted overnight to pfennigs. The last owner, lost out. The bubble had burst.

I am reminded of sardines whenever I'm cold called by someone selling wine as a investment or see the price of gold or that of some high tech stocks.

"The Chinese," I'm told, "are buying fine wine. The price has already multiplied many times so it can't fail to multiply again. You can't lose."

Well, yes I can. Bubbles depend on someone being a greater fool and buying from you. But when the bubble bursts, you're left with the loss and an unsellable asset. And at £400 a bottle, I don't think I would enjoy having to drink it. And that probably applies to the Chinese as well – these are dealing and a not-for-drinking wines.

The "not-for-consumption" label is a sure sign of a bubble. And here are some other signs.

Easy money – low interest rates (and they don't get much lower than now) encourage speculation. There is no point in saving since the rewards are so low. Instead, put money into property or gold and make capital gains. The UK housing market was fuelled by the availability of mortgage loans.

Prices out of kilter.

We expect a certain relationship between prices – the fish costs five times as much as the chips, for instance. An ounce of gold is usually around eight times the price of a tonne of oil. Today it is around twice that. Is gold over-valued or oil cheap? Is it easier to make a sustainable case for $2,000 gold or $200 oil?

The "new paradigm".

This was a phrase commonly used in the 1999-2000 dotcom boom and bust. A variation might well have been around in the railways boom and bust in the 1840s. It suggests we are entering a completely new world and that investors should tear up previous rule books. Yes, both the railways and internet changed the world. But this has been in ways that stock promoters could not foresee. Technological change does not mean throwing common sense out of the window. After all, tech companies valued in billions with no profits and barely the turnover of a corner shop demand an almost infinite degree of hope.

Ultra high trading volumes.

When transactions suddenly shoot upwards, it can be a sign of an irrational market. Buyer fuelled markets normally have much higher turnover than ones dominated by sellers.

It's a safe haven.

It's the current excuse for piling into gold and the Swiss franc. But the Swiss authorities have decided to run the printing presses to depress the value of their currency. There is no one way bet. Investors have to ask themselves how safe a haven might be when your only protection could be bubble thin.

Wild predictions and wishful thinking.

The Aden sisters in Costa Rica said in 1983 that gold would hit $3,000. It was $680 at the time and entered a 20 year bear market. And what about suggestions that the Dow Jones would top 30,000 by 2010? These are statements designed to keep a bit of air in the bubble.

It will be different this time. This is the ultimate bubble phrase, used to contradict and discredit anyone who suggests assets are so overvalued that a bust must come. It isn't different this time – and it never will be.

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