Are You Investing or Are You Chasing Fads?

We looked at GNP, GDP, CPI, inflation, deflation, and stagflation. I think we are ready to use this information to understand how the many markets around the world, labor, and business work.

Fortune Magazine had an article recently called "5 investing bubbles." Real Estate had a long run from the 1940s to the beginning of this century. The Tech Stock fad ran "off and on" from the 1960s to just a few years ago. We had the Japanese stock fad that ran from the late 1970s to 1990. These bubbles usually end in crashes. With the growth of IRAs and 401K programs, people allowed themselves to get into the greatest bubble since the 1920s. The last people to get into these bubbles are the people who lose the most.

This is why I do not like bond funds. I see that newspapers and brokers recently are talking about them. Big name “broker dealers” are making their way around the "talk shows," promoting Bond Funds since the big run in bonds are at its peak. Remember, bond funds do not mature. Bonds have a maturity date. When that comes, my principal is returned to me. Bonds mature so I do not have to deal with a bubble. That is why I am in bonds not funds. Funds do not mature which means that they go up and down with the businesses in the fund portfolio, inflation, deflation, and interest rates. Any investment falls in and out of favor with speculators and investors. People who deal in Funds will see a bubble when the bond fad is over.

Investors have lived through catastrophic crashed in the past. You'd think we would have learned to avoid the sort of group enthusiasm that causes an investing category or group to see its value inflate beyond all logic. But being human, we have not. Professor Didier Sornette, of the Swiss Federal Institute of Technology studies bubbles. Sornette says low-interest-rate, low-return environments, where everyone is looking for safe havens, are perfect for new investment fads. Didier told Fortune Magazine that, "This is a fantastic time for bubbles. Right now there is not one bubble, but many, in our analysis." Fortune Magazine has identified 5 bubbles to look out for.

Bubble Number 1, the Chinese Bubble.
A decade-long boom has lifted many of China's 1.3 billion citizens out of poverty and now the Chinese people are great consumers and builders. As a result, China's stock market has risen nearly 300% over the past 15 years. Doesn't this sound like the Japanese stock market of the 1980s? Much of the Chinese building and spending has been funded by debt, according to Fortune. Last year Chinese banks made twice as many loans as they did in 2008, boosting lending by the equivalent of 29% of GDP. Housing prices continue to rise despite reports that 65 million dwellings in China are vacant, Fortune says. Doesn't this sound like the United States in 2006?

Fortune's analysis -- Cracks appear to be slowly forming. China's stock market is down this year, and in July its manufacturing expanded at the slowest pace in 17 months. China's central bank has tightened its policies in an effort to rein in risky lending. Some savvy investors, including short-seller Jim Chanos, have turned bearish. Chanos said in April that China "is on a treadmill to hell." Looks a lot like the US Stock Market in 2007.

Bubble Number 2, the Interest Rate Bubble.
At a time of economic uncertainty, investors want safety. U.S. Treasuries still inspire more confidence than, say, Greek or Spanish government bonds. Senior Portfolio Manager, Doug Noland of Federated Prudent Bear Fund said, "Bubbles happen because there is no restraint on borrowing, and that's exactly the situation we have now for the federal government."

U.S. bonds have risen 14% in 2010, even as the government has issued $3.3 trillion in debt over the past two years. The supply of US bonds should have brought down bond prices but it has not! The national debt is still a manageable 40% of GDP. Economists warn that growth will slow when it reaches 90% of GDP. The Congressional Budget Office projects it will take nine years to get to that level, and that's if Washington, which is debating the deficit, does nothing. This is why Doug says that this is "the big one!"

Bubble Number 3, Shale Stock Bubble.
Fortune Magazine says, shale massive rock formations deep below ground, may hold enough natural gas to satisfy U.S. needs for the next 45 years. Pure-play shale companies such as Range Resources and Southwestern Energy have seen their stocks rise 72% and 160%, respectively, over the past five years. With gas prices already low -- $4.30 per million BTU -- these discoveries will add supply and further depress prices. The problem is that the political climate may not be right. Environmental fears are fueling opposition to shale drilling. New York, where the massive Marcellus shale is partially located, is considering a temporary ban.

Yet Range (a large Marcellus leaseholder) has a price/earnings ratio of 65 based on 2010 earnings, a huge premium to such diversified gas companies as Chesapeake and Devon, which have P/Es of 7 and 11, respectively. "Everyone is betting gas prices will go up," says Oppenheimer analyst Fadel Gheit. "But I don't see it.", as published by Fortune.

Bubble Number 4, the Cotton Bubble.
I like my cotton underwear but now is the time to sell everything I have made of cotton. At this moment they are worth something. According to Fortune, cotton prices have nearly doubled in the past year to 80¢ a pound. The world has been using more but producing less. Last year's U.S. cotton production dropped to 12.2 million bales, the smallest crop in 20 years. And rising populations are causing nations like China and India to devote more land to foodstuffs and less to cotton.

The two-year run has given farmers plenty of time to ramp up production, which means more cotton will soon be on the market and lower prices will follow. The USDA estimates that U.S. production will hit 18.6 million bales this year, up 50% from a year ago. Analyst Sharon Johnson of First Capital Group says cotton has traded around 50¢ a pound for much of the past decade. When cotton has spiked above 80¢, it hasn't stayed there for long. She claims, at that point, "Prices are overvalued."

Bubble Number 5, Gold Price Bubble.
I would be a seller of gold today. Not a buyer of gold. Fortune says, gold was rising even before the recession. But panic over world markets and the health of European and U.S. economies propelled it into the stratosphere. Prices have risen 150% in the past five years, repeatedly setting new records.

Meanwhile, small investors have stormed in. Some fear that stimulus spending could lead to massive inflation; they believe a tangible material like gold will hold its value better than other assets. I agree with Fortune that inflation isn't rising. It's falling and likely to be restrained for some time by a very weak economy. Gold has already started slipping. It declined 6% in July to a recent $1,160 an ounce. Some economists are warning that continued weakness could lead to deflation. If that happens, expect gold prices to collapse.

So like Fortune Magazine says, watch out for market bubbles. They can be hazardous to your financial health!