Trust the fundamentals to signal that the bull market is over

“Once you see headlines about the discovery of new oil reserves or wind farms popping up outside major cities, when you see mines coming on line, when you discover that stockpiles of all kinds of commodities are rising, those are fundamental shifts – then its time to get your money out of commodities. The bull market will be over.” – Jim Rogers

A fundamental shift tends to define the end of a bull market. In the late 1970’s it was the discovery of new oil deposits in the North Sea and Alaska. As those fields came online oil production exceeded demand for the first time in years.

The last leg of a bull run always ends in hysteria. Every investor tells themselves that they will continue to ride the bull market and be able to get out before its too late. They are smart, there will always be a greater fool to offload their position onto.

But when the market is showing signs of hysteria, fundamentals are often ignored or dismissed as unimportant – something to worry about for another day. In the late 1970’s few noticed the fundamental shift occurring in the oil market. Fundamentals never matter, until they do.

Even the most prepared, most rational of investors can be knocked off course by events. In his book, A Gift to my Children, Jim Roger’s describes one of the earliest experiences of how psychology affected his approach in a bull market hysteria, undoing his careful planning:

“After the oil shock of 1978 to 1980, when oil prices doubled, I watched the price of oil continue to rise. My research told me that, with supply exceeding demand, the price of oil would soon fall, and so I ended up selling short.”

But then, war broke out between Iran and Iraq, two of the world’s largest oil producers. Roger’s scrambled to reverse his position, kicking himself for not spotting that the two foes were going to come to blows. He made a novice mistake, not only did he buy back his position at a higher price – and so making a loss – the oil price eventually fell, as he predicted:

“In hindsight, I should not have panicked. I should have realised that the fundamentals underpinning the oil price weren’t sound. I had not quite grasped the effect of the mob mentality at the time, and as a result, I made a costly mistake. Losing your perspective in the midst of a market panic is equivalent to losing your money in that market.”

Rather than just cash in his long position that the oil bull market was over, Roger’s also made the mistake of shorting the market. Although we don’t know how big his short position was it was clearly too big to maintain in the event of the war driven oil price spike. Bull market hysteria can always stretch to even more extreme levels.

Related article: What I learned from “Mastering the Market Cycle: Getting the Odds on Your Side”, by Howard Marks

Finally, it’s always to have in the back of your mind that nothing is really new, and you should be very critical of talk of new paradigms. Be extremely doubtful when people proclaim, “It’s different this time.” Being able to check the facts – the fundamentals – is vital to avoid being swept along with the crowd.

“Act without checking the facts, and chances are that you will be swept away along with the mob. Whenever you see people acting in the same way, it is time to investigate supply and demand objectively.”

This is post number 6 in a series of 7 articles.

Article number 1 – The Catalyst. Article number 2 – Pay attention to what others neglect. Article number 3 – Attention to detail separates success from failure. Article number 4 – The art of masterly inactive investing: Knowing when to do nothing. Article number 5 – Being prepared for market setbacks starts with sound expectations

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