Market bubble or merely market froth?

Investopedia defines a market bubble as a state of euphoria that causes asset prices to skyrocket, it could be said that caution on the part of investors is mostly thrown out the window. On the other hand, market froth, as defined by Investopedia, refers to enthusiasm driven market conditions preceding an actual market bubble, where investors begin to ignore market fundamentals and bid up an asset’s price beyond what the asset is objectively worth.


Market analyst Colin Twiggs concluded his analysis today as follows:

Comparing market cap to corporate profits is a useful indicator of stock market valuation. Go overweight stocks when the ratio is low (below 8.0) and underweight when it is high (above 10.0). The present extreme reading of 14.45 warns of another stock market bubble similar to the Dotcom era.

Long-time readers here know my feelings. When the Goldminers leave the dance floor, the party is over. I have been saying recently that Goldminers are likely to party hardy for maybe another 18 months. But, a bubble in Precious Metals prices could cut the time frame down to maybe 6 to 9 months. What I will be watching for is a Copperminer Bull to kick into gear about 3 to 6 months before the entire equity market bubble bursts.

In the meantime, I am not too hung up on terms like bubble and froth and will not be until I see it in the stocks I own.

About a month ago, I noted extreme market froth in my Goldminer stocks, and so I sold one-third positions. As I noted at the time, there had been a three standard deviation move over two weeks, which is unsustainable. In a normal Bell Curve distribution, three standard deviations puts the probabilities of a reversal at 99.7%. Price motion in the stock market is clearly not a normal process, but you get my point.

Why I did not interpret that time as a bubble versus froth is because I sensed the market was more enthusiastic as opposed to euphoric. At some point, there will be a state of euphoria reached in the Precious Metals market — but just not yet. I suspect that when the price of Gold per ounce hits $2,500, and the usual Gold bugs are writing articles that point to $5,000 and $10,000, there will be a bubble ready to burst. That is when I will be selling 100% of my positions.

Students of the market might want to review standard deviation.

Like every concept in markets, understanding the broad principle is far more important than the formulas.

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