Inflation

Contrarianism

Commodities and Equities Cycles

Commodities and Equities Cycles

What is a cycle?

As defined by the Oxford American dictionary, a cycle is “a series of events that are regularly repeated in the same order”

In the world of investing, all asset classes, (i.e. real estate, commodities, equities and bonds) move in cycles. Asset class cycles can be in a “bull market” or “bear market”

What does a bull market mean?

A bull market simply means that the price of said asset is rising, which spurs purchases. Moreover, a secular bull market is a long-term bull market as defined by higher highs and higher lows. We will explain this graphically below.

A bear market, on the contrary, simply means that the price of said asset is decreasing, which encourages selling. Moreover, a secular bear market is a long-term bear market, as defined by lower highs and lower lows.

Before we go on and discuss the stages of a trend, we would like to define a couple of terms:

Technical analysis: is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends.

Investor Sentiment

Generally speaking, investor sentiment plays an important role in cycles. Just think about it, real estate was the “thing” to do in 2001 until 2007. If you weren’t investing in real estate in 2006-2007, you weren’t considered “savvy” by your peers.

Stages of a trend

Major market trends (secular or long term) have 3 phases:

-          Phase 1: Accumulation: in this phase, mostly astute investors (the so-called smart money), invest in asset classes that are unfavored by most investors. These assets are usually coming out of a prolonged market downturn. There is no set timetable, but they usually last 15-20 years. These are asset classes, which the astute investors feel that market has assimilated or overreacted to bad news.

-          Phase 2: public participation phase: in this phase, investors with strong technical analysis skills jump into a market. More optimistic or upbeat news start showing on the business media and prices start advancing rapidly.

-          Phase 3: Distribution phase (a.k.a. the Euphoric or Mania phase): this phase appears when the mainstream financial media begins publishing very optimistic news about the asset class causing the price and volume higher than ever. A good indication of this phase is that the said asset class will be the subject of cocktail party conversations, headline news and will contribute to the overall blind optimism. Prices would tend to be based on future expectations. A good example of this was in the real estate bubble in 2007 when housing “was different” and “could only go higher”

Historically, bull and bear markets for different asset classes tend to run opposite of each other. For example, from 1982 until 2000 we had a bull market in equities, while from 1998 and currently we have been in a secular bull market in commodities.

Conversely, we are in a secular bear market in equities, as shown on this equities chart valuation (inverse of ounce of gold)

Understanding the nature and the timing of these cycles is key to preserving your wealth while outperforming mainstream investment houses.

What makes Contrarian Research Group different from other investment groups?

The vast majority of investment advisors base their analysis on a Keynesian or a Monetarist economic framework and invest their clients’ money accordingly.

Why is this important? Gross Domestic Product (GDP), the most common measure of how an economy is doing, is based on final consumption and excludes intermediate goods which are major components of final consumer goods. Mainstream economists see consumer spending as the engine of economic growth, rather than being a consequence of higher production. Most financial analysts view higher consumer spending as the “driving” force behind economic growth and prosperity. Think about it. When someone drives an expensive car, is it because of his higher income or is it because of his car that he is wealthy? It is because of his income that he is able to afford that car. Many mistake the effects of higher income with wealth. Individuals today are not richer than someone who lived two-hundred years ago because of hyper-spending. They are wealthy because of their ability to save, their level of savings, and the amount of capital available to them.

Why is capital important?

Let’s say somebody needs to dig a hole. One man is digging a hole with his bare hands. What can make his job easier, more productive, and more enjoyable? Capital. In this example capital might take the form of, say, a shovel or a complex excavating machine. It creates an extraordinary boost.

On the other hand, Keynesians and Monetarists, see capital as a self-sustaining unlimited fund that does not need to be replenished, preserved or well invested. This view is a major flaw, among the many, of these schools of thought. More savings today translates into more capital tomorrow and, therefore, increased future production and wealth.

 

Mainstream economists think that education and technology are the biggest contributors to long-term economic growth. Although important, capital bridges the gap between an abstract idea and a tangible product or item. People all over the world every day dream of new technology advances and it is capital that makes these blackboard ideas reality.

Our organization views savings and production as the engine of economic growth, as opposed to the deeply flawed idea that consumption and debt spur sustainable growth. Capital is what makes rich countries richer and the lack thereof is what makes poor countries poorer. Therefore, we recommend investments according to our view.

Our view

Our long-term investment prospects are deeply rooted in the Austrian School of Economics. Countries that save and invest grow wealthier while countries that squander and de-capitalize become poorer.

In a free economy, that is, an economy without a central bank, people can preserve wealth and save through money or bonds. In an economy with a central bank, where constant depreciation of the currency is a fact of life, money loses its function as a store of wealth. In this kind of environment, investment becomes a necessity. People often have to choose to invest in stocks or real estate, for example.

Lastly, in an economy with rapid increases in the money supply, people have to move into an asset class that produces no cash flow, just capital appreciation, and that asset class is commodities.

Moreover, commodities and equities tend to run in cycles counter to each other. The current commodities bull market started in 1998-2000 while the last bull market in US equities started in 1982 and ended in 2000. The Dow Jones Index closed at an all time high in inflation adjusted dollars at 12,000 in March 2000.

Understanding the business cycle will make you a better investor. Not only will you be able to spot long-term trends, but you will also be able to avoid bad investments.

Stay tuned for next week’s post where we’ll discuss commodities and equities cycles.

Alfonso 

Jared

Welcome to Contrarian Research Group

Welcome to Contrarian Research Group!

As founders of this group we are committed to comprehensive and thorough research concerning the global economy from an Austrian School of economics and contrarian perspective.

All the best to you and we look forward to provide you with quality investment research.

Alfonso Colombano, Co-Founder
Jared Lopez, Co-Founder