3 Bubbles Investors Should Watch Out For
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investopedia characterizes bubbles as a “rapid expansion followed by a contraction.” The dot com bubble of the 90s where technology stocks with lousy fundamentals soared to the stars due to the enthusiasm surrounding the “new tech paradigm” serves as one of the most famous examples. Then at the turn of the millennium the dot com bubble burst taking the rest of the stock market along with it. Investing during a bubble period can bring great harm to a portfolio. Being mindful of bubbles can tell the investor what to stay away from and whether or not to wait for a better stock price entry point. Right now, three bubbles quietly expand.
Corn prices rose 15% during 2012 (chart below). Drought conditions in the U.S. lowered corn supplies to record lows. According to a Farm Journal article the corn stocks (inventory) to use ratio stands at 5.3% versus the historical average of 12% to 13%.
data by YCharts
The rise in corn prices led to a boon in domestic fertilizer demand for producers such as Mosaic (NYSE: MOS) and Intrepid Potash (NYSE: IPI). Strong domestic fertilizer demand increased Mosaic’s North American potash sales 41%. Intrepid Potash which operates mainly in the United States increased its overall sales 14% last quarter.
A number of people in the farming industry rightly worry that corn prices rest at unsustainable levels. A number of farmers see gold in them there corn stalks and want to raise corn in the next growing season. In addition, the disappearance of the dry conditions will result in increased harvest. The boom in supply could put an end to high corn prices, upsetting the robust domestic demand in fertilizer and leading to a short term correction for Mosaic and Intrepid Potash.
The gun bubble
The political climate surrounding gun control creates fear of decreasing access to guns. This fear of lowered access creates panic buying of guns before the perceived reduction in access goes into effect.
This panic and fear increases the sales and profitability of gun companies leading to a run up in gun stock prices. The stock price of gun companies Sturm, Ruger (NYSE: RGR) and Smith & Wesson (NASDAQ: SWHC) increased 91% and 60% respectively over the past year (see chart below).
data by YCharts
Smith & Wesson sales increased 48% in its most recent quarter driven by sales of pistols designed specifically for concealed carrying, and sporting rifles. Ruger’s sales growth in its most recent quarter included new products such as the semi-automatic Ruger 10/22 Takedown Autoloading Rifle. If people fear in some way that they won’t be able to purchase rifles in the future then they will rush in to buy them.
The gold bubble
Over the past 11 years gold prices increased 511% (see chart below) driven by many factors. First, skepticism brought on by the so called “currency wars” where countries devalue currencies against one another in order to increase the value of their exports. Second, end of the world fears brought on by myths such as the end of the Mayan calendar bringing apocalyptic doom and the collapse of society as a whole.
In the event of an apocalypse, land and food production capability will take priority. Without food, gold will be a moot point. When the world wises up and sees that soft currency will remain then gold prices along with the stock prices related to gold mining will plummet.
Fundamentally, gold miners such as Kinross (NYSE: KGC) continue to benefit. Revenue and net income increased 7% and 9% respectively versus the same time last year. Adjusted operating cash flow increased 5% versus the same time last year.
On the down side, if the price of gold drops below the cost structure of some of the gold mining companies then they will cease to exist. For example, Kinross’s cost to mine gold ranged between $690 and $725 per ounce. If the price of gold suddenly plummets this company could face bankruptcy.
data by YCharts
On the whole, the aforementioned bubbles will burst from different types of pins. Better weather and speculative farmers wanting to capitalize on higher corn prices could bust the corn bubble. The pin that will bust the gun bubble will come when gun buyers realize that gun control laws won’t oppress as much as feared. Good ole’ common sense and acceptance of global currency realities will eventually bust the gold bubble. The need for food and fertilizer used to grow it along with the sense of security brought on by gun ownership will make the stocks of these companies viable for the long term; however, the bursting of bubbles for their products may induce a short term correction and a better opportunity to buy.
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