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The Bubble Has Burst
by Professor von Braun
November 24th, 2000
There should be no doubt in the minds of astute investors that the Nasdaq bubble has burst. Any market that falls 45% from its previous peak is in trouble and this one is no exception. Clean out time has arrived, the music has stopped playing, the punch bowl is empty and losses are beginning to take their toll. The "new" economy is being seen for what it is, hype, more hype, and lofty projections that had no chance of being met. The fact that the unheard of stock valuations reached the heights they did is itself quite amazing.
In the years to come much will be written by the usual collection of authors who seem to specialize in dissecting dead beetles, animal corpses and mysterious diseases that break out in odd places. Questions will be asked, blame will be apportioned, new regulations will be introduced and the culprit may be found. Lawsuits will abound, angry investors will seek redress and new sources of income will, with obvious difficulty, have to be found.
The return to reality will be for many a painful experience as they learn what their grandparents warned them about. Stock markets go up and they go down, valuations do matter, earnings need to be real, there is no free lunch and every new fangled "fad" tends to disappear quicker that it arrives.
The culprit in this "boom of booms" may well turn out to be derivatives, the seemingly never-ending creation of paper contracts upon paper contracts upon even more paper contracts. All of which have, to begin with, derived their existence from the existence of something else, which may need to be delivered one day.
It is quite amazing that early warning signs reflecting the dangers of derivatives that appeared in the mid 1980's were ignored, as were further signs that appeared in the early 90's. The LTCM debacle did not slow down their use either, on the contrary the opposite seems to have occurred.
The "average investor" that CNBC delights in referring to really does not have a clue when it comes to understanding how the use of these computer generated complexities has disguised the real situation regarding corporate profits. Nor are they aware of what happens when things go bad, but they are about to find out.
The use of futures contracts to control the direction a market "needs" to go, a need decided upon by some controlling body, does not stop a correction from taking place, it merely defers it. Deferring a natural correction interferes with the concept of free markets and compounds the eventual correction. The damage is considerably greater as the complexities are forcibly unwound. Reality has a habit of reappearing of its own accord and the lies that have been widely disseminated and believed as the new reality are seen for what they are.
The believers of the "new" reality suddenly find that it, along with their newfound instant wealth, has suddenly "instantly" disappeared. This may come as a shock to many of them, but it will be nothing compared to what they finally learn when they find out that the regulatory authorities, the ones that are supposed to have been watching out for their interests, were asleep at the wheel.
The true legacy of the 8-year Clinton/Gore administration will finally surface. Putting the fox in charge of the chickens is not a good practice, nor is turning a blind eye to the fact that history is repeating itself from an economic perspective. The ingredients of a mania don't change and for several years those well documented ingredients have been present, including the most famous one of all, the "this time it's different" routine. The "new" economy -- every President's dream -- becomes, as the "old" economy returns, the next President's nightmare.
All of a sudden the word value is heard again, along with real cash flow, productivity, supply and demand, personal savings and so on.
The use of derivatives contracts has reached a saturation point; something we are now beginning to learn. Reported losses from these contracts are increasing and are showing up in the most unexpected places. Mining companies selling currency puts, hardware companies playing the lumber markets, computer companies selling puts on their own shares, the Australian government getting caught on the wrong side of currency trades, a large short position in the gold market involving a variety of players, the list goes on.
As the Nasdaq falls more losses will occur, simply as a result of what was responsible for pushing that market up becomes responsible for bringing it down. Every contract has two sides, something Al Greenspan knows, and as these markets retreat the buyers of Microsoft puts may want to collect. Fancy that.
The one market that could create the biggest problem when it comes to collecting the goods may well be the gold market. While the turnover on the LBMA is considerably less now than what it was 12 months ago, the paper gold market is vast and the physical supply is dwindling. We believe that a significant percentage of what is regarded by some analysts as mine supply is well and truly spoken for and the eventual scramble to cover will be an interesting event to watch as it unfolds. How the US treasury and banking officials find a window that dispenses liquid gold, as opposed to dollars will also be interesting to watch.
It will be very difficult for companies that have specialized in illusory profits to report illusory losses, especially when they turn out to be real.
The Prof can be contacted by email at email@example.com
Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.
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