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.