Secular bears end in ‘surrender’ not euphoria

A host of reliable metrics scream that the secular bear that began in equity markets from the 2000 tech bubble is far from over.  I have summarized many of them here of late.

But for those who feel confident that a new secular boom started from fresh nominal highs on the S&P 500 over the past year, the below BNN clip, discussing recent trends in the commodities space, offers a very valuable point of reference.

The latest secular bull for commodities began in 2000 after what had been 20 years of falling asset prices and underinvestment in the space, thanks to massive over-investment and over-valuation in commodities and producers during the secular boom from 1966 to 1980.

When China joined the World Trade Organization in 2000 and the US Fed slashed rates following 9/11,  demand took off, while global commodity production was low and stockpiles limited.  Investment opportunities in the mining and materials space presented some extraordinary value at that point,  precisely because most market participants were disinterested and still fixated on recklessly over-valued ‘hot areas’ in tech, health care and finance.

As the global credit bubble went parabolic into 2007, commodity demand and sales went along for the ride, before crashing down in the 2008 recession.  But then a funny thing happened on the way to the much needed secular mean reversion in financial assets:  stock, debt and commodity prices.  Central banks and governments around the globe decided that they did not want the natural cleansing cycle to run its free market course and have stepped in with round after round of ‘stimulus’ for asset prices ever since.

For the first couple of years into 2011, commodities traded along for the ride.  Investment banks and hedge funds were busily hoarding inventories and manipulating prices.  The finance world went back to selling the public on the ‘insatiable Chinese demand’ narrative and prices of many assets mounted a breath-taking ‘v’ rebound for the history books.

Except that none of it was true or organically sustainable.  Global demand sputtered again in 2010 at half the rate clocked before the credit bubble peak. At the same time, spiking commodity prices erroneously told producers that their products were in high demand.  Scrambling to sell more, their gushing supply flooded weak demand.

Predictably, market dynamics have proved brutal on the unsuspecting, amid the usual elements of excessive leverage, over-investment, greed and misplaced optimism.  Metal prices have continued to plunge and mining and resource companies have suffered to date through 3 years of liquidation in an ongoing consolidation that will purge weak companies and managers from a still bloated market place.

In a different cycle, the March 2009 lows in stock markets might have been the final low of the secular bear that began in 2000.  But everything that has happened since has negated that likelihood.  If it had been the final low of our secular bear, prices would have plunged and then slumbered with only modest gains for several years thereafter, as valuations worked below, and dividend yields well above, long term averages.  Reckless participants would have been wiped out and turned off financial markets for years if not decades.  And a good many culprits from the previous boom would have been prosecuted–some sent to jail.  But none of this has happened. Yet.

It is critical to understand, that brutal as it is, the mean reversion process is necessary to correct for the exuberance and reckless valuations of the prior secular boom.  It is the process by which markets are cleansed of fools and speculators and assets are brought back down to attractive investment levels once more.

Secular bears do not end in euphoria, a confident financial sector and near-unanimous investor optimism such as we find today.  They are a long, drawn out slug-fest that serves to crush perma-bulls into surrender.  The metals and mining industry is working through this process right now.

Listen to this clip on ‘surrender investing’ in the metals industry and compare it with the exuberance presently passing as capitulation in other sectors and markets.

Here is a direct video link.

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