The catalyst

A pile of dry timber and twigs in the forest will just sit there, undisturbed, dormant. Unless that is, it is disturbed by some change in the environment; an especially hot day coupled with litter lout picnickers. That catalyst – the change in the environment – increases the risk of a forest fire.

Asset markets can also remain dormant for years. As the years go by, industries begin to lose their luster, commodity markets suffer decade long bear markets as over-capacity grinds away at returns, and markets disappear off the radar of even the most committed of investors.

After a certain point though, things start to look…interesting. A decade long bear market can look very appealing to a contrarian investor, especially if it’s lost 90% or more in value. The potential upside could be enormous. If only there was something to spark a change in perception. For that to happen you also need a catalyst.

Examples of catalysts in commodity markets include the USA abandoning the gold standard in 1971 and the pressure it put on Middle Eastern oil producers, the emergence of China as a dominant consumer of raw materials in the late 1990’s, and more recently the snarling of global shipping routes in 2020/21 creating commodity supply bottlenecks.

match ignition
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Without the existence of a catalyst your cash can remain parked in a non-performing commodity market for years, while other investment opportunities in which a catalyst ignites go amiss. According to Jim Rogers, “If something is forever cheap, then it has no recognised value, and its stock may very well remain a worthless piece of paper. For a bargain to soar in price, there has to be a catalyst, and from an investment perspective, that catalyst is change.”

Key is distinguishing between the perception of change and actual change. Actual change tends to lead perception, but it doesn’t have to work that way. The former can lead the latter especially if an increase in positive sentiment leads to a rebound in real activity. As Roger’s outlines, if the change is real, other investors will notice soon enough:

“Whatever the change may be, it must have a significant impact within a country or an industry, and it must also be recognised as significant externally within a few years. If the change is real, others will notice the improvement, and prices will rise to reflect the new circumstances. New investors will catch on and prices will rise considerably for years.”

But how can you spot the catalyst? Well, one of the best ways to think about it is to look into the past and try and identify the bullish signs in the past that may have led to a boom. History doesn’t repeat itself, but it often rhymes. History tends show you which forces are driving the markets.

Research major bullish and bearish markets of the past, and then figure out how they could have predicted the rises and falls in advance. What was going on in the world when prices surged or plummeted? What was it about those events that acted as a catalyst, when similar events in another time failed to ignite? Looking back upon history is an invaluable way to learn how to analyse trends, and it can give you clues as to how to anticipate future trends.

There is a danger though in waiting too long for a catalyst to show itself. It might appear without you noticing, or by the time one sparks into life the market has already priced in the likelihood of its existence. The opportunity has gone.

The solution then is to gradually scale into a moribund market. As with the buildup of dry tinder on the forest floor, the day will come when it eventually erupts into fire. The lessons from financial history provide valuable signposts to watch out for. As those signposts appear, gradually scale into the position before the presence of a catalyst becomes common knowledge.

This is post number 1 of a series of 7 articles that will be published in coming weeks.

Article number 2 – Pay attention to what others neglect

Moon Over Forest Fire
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