|Candide: "But for what purpose
was the earth formed?"
"To drive us mad."
- Candide, Voltaire
The world is
unpredictable, maddeningly so. The future of the economy and financial
markets are notoriously difficult to foresee.
Anyone bold or foolish enough to claim to make economic and market predictions
needs to occasionally look back to assess those predictions. If
correct more than 50% of the time, it's time to get out of the
prediction business. Unless you're in show business like James
Cramer. In that case accuracy
doesn't matter. What matters is how well you are
performing while you are misinforming your audience.
If you are in the prediction business and make the cut above 50%
accuracy, the most common question you're going to get from readers is,
"What should I do?" Not only is it inappropriate for me to tell
anyone what to do -- I'm not a certified financial advisor -- but
giving financial advice to anyone without knowing anything about them
doesn't work. The only thing worse is giving advice to people you
know really well, your friends. Worse than selling them your old
car. That's why professional financial planners exist.
Unfortunately, most professional financial planners are
doctrinaire. In the new world of Bubble Cycles that means many,
but not all, give advice that worked well in the era of Graham, Dodd
and Cottle, authors of the famous bible of finance Security Analysis, or Burton Malkiel, author of the bible of beginner's investing, Random Walk Down Wall Street.
But it's a brave new world, where at least for a while the rules of
chance do not apply, where the rule of men in matters of money is
greater than the rule of law. Now that's a conundrum. But maybe there's a solution, and I'll get to that at the conclusion of this commentary.
I'm going to rip through six years of iTulip.com, hitting on the
highlights, to give you the background you need before we dig into the
detail of a theory that's at the heart of a framework for iTulip.com's
predictions, what I call Ka-Poom Theory. Here goes.
As Managing Director of Osborn Capital, my partner Jeff
Osborn and I invested in 20 start-ups. More
precisely, when we
formed Osborn Capital, Jeff had already made most of the investments
that turned out well for us, including Arrowpoint (a 200 bagger) and Compatible Systems, both companies acquired by
We had seven positive liquidity events between 1999
and 2003 with acquisitions by Microsoft, Nortel, EMC and two by Cisco,
and two IPOs.
I started iTulip.com in 1998 to warn readers
not to put their retirement savings into Internet stocks. With
a front row seat at the Internet bubble show I could see the market had clearly
morphed into a casino. After doing a lot of reasearch, I
explain how market bubbles form in Causes of the
Internet Bubble. Research included meeting Charles P. Kindleberger who wrote Manias, Panics, and Crashes: A
History of Financial Crises. He happened to live in the same town
I live in, Lexington, MA. Hard of hearing and, in his nineties,
understandably more interested in friends and family than the stock
market, he did confirm that a historically significant market bubble
was underway. He died in 2003. While best known for the book on manias, he was a leading architect of the Marshall Plan. Everyone liked that America.
Soon I was also writing for Ken Kurson's Green Magazine,
later acquired by Bankrate.com. In 1999 I
explained how the Internet bubble was going to end in What will pop the Internet bubble?
Also in 1999, I took a shot at predicting the economic consequences,
calling for a period of deflation followed by period of severe
inflation, what I termed Ka-Poom Theory: How the Asset
In March 2000, I wrote Janszen Crying Wolf? Not so fast
(not my choice of title) for Green Magazine that warned that the end was approaching, the month
before the NASDAQ tanked.
The next month, in April 2000, with A Bear
Market is Born I
warned iTulip.com readers a long bear market had started. Don't wait for the NASDAQ to "come
The market was a bubble. It isn't coming back. It's
Following this advice, my partner Jeff and I sold our stock from
Cisco and other portfolio company deals between March 2000 and June
2000. At the time I was pointing iTulip.com readers to
Direct. I went 50/50 U.S. treasury bonds and cash back when a 10 year
treasury bond was paying 6.10%. That was in anticipation of
deflation cycle spelled out in Ka-Poom Theory.
"Poom" inflationary part of the cycle assumed two stages,
inflation then severe inflation. Inflation was expected to
inevitable post-bubble reflation policies: rate cuts, tax cuts and
currency depreciation. In 2000, I had lunch with Dudley
then the managing editor of The
Economist magazine. After teasing him about the
magazine's March 1999 prediction of $5 oil,
I told him I was thinking of buying gold, silver and platinum when gold
hit bottom at the end of the deflation cycle. He thought it
pretty good idea.
In 2001, before I expected the deflationary part of the cycle to end, I
took a lot of the cash and bought precious metals and some gold
stocks. In Questioning
Fashionable Financial Advice
made the case to iTulip.com readers in the one and only piece I
ever wrote about gold, by coincidence near the 20 year bottom of the
market. Gold was trading at $270, 13% of its inflation
I didn't write much after that for either Green or
was busy running VC backed start-up Bluesocket starting in April 2001
until January 2004. During the worst depression in the
IT. For that I cannot claim to have a very good sense of
timing. Aside from writing one article on gold, the only
gave on the stuff was to give members of my management team gold coins
as Christmas presents in 2001. These were intended not only
express appreciation for hard work, but also had a dual role as
advice. As CEO of a company you can't go around telling your
management team or anyone else in your company what to invest in, but I
hoped they'd get the message in the unconventional
gift. (Guys, if
you're reading this, I also hope you didn't
In August 2002, in Yes.
It's a housing bubble.
I made one update to iTulip.com to point out that the housing market
was turning into a bunch of regional bubbles. Coincidentally,
that was the start of the speculative phase of the real estate market.
That piece left it up to the reader to decide whether to play the
speculative housing market or not. As in the case of the
Bubble, there was no reason not to speculate in housing as long as you
know that's what you're doing and you're not buying into the latest
"prices only go up" bullshit and are not over-leveraged.
the problem with speculating in real estate is that when a real estate
market turns it becomes illiquid. Over-confident speculators
stuck and can go bankrupt. It's like buying tons of stocks on
margin. In fact, you can think of what's going on in many
markets around the world today as a giant global margin call on real
After Bluesocket while working for venture capital firm Trident
Capital, in a piece Housing
Bubbles Are Not Like Stock Bubbles originally
published by Always-On Network in January 2004, I explained how housing
bubbles end, with a collapse in transactions followed by a slow decline
in prices versus a sudden collapse in prices as in the case of stock market bubbles.
I wrote a piece Housing
Bubble Correction, Fifteeen Years to Revert to the Mean
in January 2005 outlining a 15 year downturn in real estate.
A year later, Yale Professor Robert Shiller published a second edition
of Irrational Exuberance
that predicts more or less the same 15 year timeframe for a downturn in
real estate. The first edition came out in March 2000 and
predicted the end of the stock market bubble.
Bill Gross at PIMCO has been down on the U.S. economy for a
while and likes to say that what's bad for the economy is good for
bonds. But his latest
As GM Goes, So Goes the Nation sounds
distinctly iTulip.com circa 1999: "Higher inflation, higher
personal and corporate taxes, and a lower dollar point U.S. and global
investors away from U.S. assets and toward more competitive economies
less burdened by health and pension liabilities – those
personified by higher savings rates and investment as a percentage of
GDP. Need I say more than to sell U.S. assets and buy Asian
denominated in their local currencies; or if necessary to hire a global
asset manager with sufficient flexibility and proper foresight to
thrive in an increasing difficult investment environment?"
This leads us to the present and
full circle back to Ka-Poom Theory. Let's compare the
prediction to how events have evolved so far. Below is the
original chart and description from 1999.
Original 1999 Ka-Poom Theory
currencies are primarily valued by the relative economic strength of
trading partners with floating currencies, except for the
major component of dollar strength is the
unique demand for dollars due to the dollar's reserve currency status.
demand and thus price is supported by
all nations trading with the U.S. and among each other as all need
dollars for international exchange,
especially for oil.
dollar reserve currency status declines, either gradually via euro
diversification or suddenly due to an event that causes a loss in
confidence in the future purchasing power of the dollar, dollar demand
and value declines in kind.
interest rates are low mostly due to
demand for U.S. debt from foreign central
banks of nations, especially
Asian, that seek to keep U.S. consumers borrowing at low interest rates
to purchase their exports using strong dollars, e.g., Asian "vendor
- Ka: A
exogenous event (e.g., a stock
market crash predicted in 1999 for year 2000 and recession predicted
for 2001) intensifies disinflation
created by Asian vendor financing, causing
the Fed to
shift from bubble fighting to anti-deflation polices.
responds with an excessive cheap money policy,
targeting Fed funds rate below the inflation rate.
Fed keeps interest rates too low for too
long, creating a new asset bubble. But in what? We
know in 1999. The answer: real estate and other credit
A random or not
so random exogenous
event that has not yet happened (the stock market crash we predicted
for 2000 did not have the impact we expected but a collapsing housing
bubble may do it) exposes the true level of
risk to lenders that is inherent in
this unbalanced system, causing lenders to loose confidence in the
future purchasing power of the dollar and seek alternative reserve
rates and inflation rise rapidly as
dollar demand and value falls, import prices rise, and the Fed moves to
raise rates to stem the tide or dollar repatriation.
- The first
central banks to move will be those with the least exposure to losses
in national income from sales of exports to the U.S. or depreciation in
the value of the dollars they are holding as reserve assets (e.g.,
Here's the grade on Ka-Poom 1999 based on what happened since then with
a revised Ka-Poom prediction below.
On predicting the timing, length and extent of the deflationary or "Ka"
part of the cycle, I'll give myself an "A." It started from the
middle of 2000 and ended in the middle of 2002, as predicted.
Inflation during 2001 averaged 1.6% for the year as shown in the
updated 2006 graph below and it hit bottom at -3.3% in October 2001 as shown
in the 1999 original above.
Here's where reality and the prediction diverged. Reflation
policies had the intended result of preventing a collapse of the
economy into a deep recession, as expected. We had the first
inflation that sent gold up from $270 in 2001 to around $450 in 2005.
Still earning a good grade on the prediction. But we did
not see the loss in confidence in the dollar that would have sent
foreign creditors running for the exits, dollars coming home, and
interest rates and inflation spiking in 2006 as shown in the original
original graph. Is that a "C" or an "I" for "Incomplete"?
That may be starting to happen now, driving gold from
$450 in 2005 to over $700 today. These prices are leading indicators
of rising interest rates and inflation. If that's the case, I'd simply
phase shift the original Ka-Poom prediction out by six months to a year.
But there's more to it than that.
The primary reason for the delay in the predicted semi hyper-inflationary "Poom" cycle is cooperative
devaluation of currencies over the last year. This has delayed the "Poom" but there's a
fine line between cooperative
devaluation and competitive devaluation.
Revised 2006 Ka-Poom Thoery
This is the essential paradox of current
global imbalances that Ka-Poom Theory attempts to model and
The Fed does not need to go on a printing binge to
produce the kind of inflation that the theory predicts. All
the dollars that are needed to produce the inflationary "Poom" have
already been printed and reside outside the U.S. as dollar denominated
assets owned by individuals, institutions and central banks.
In fact, if the Fed were to completely stop issuing new money -- stop
the printing presses tomorrow -- the U.S. economy would fall into crushing
recession, foreign investors would flee and the dollar money supply and
inflation in the U.S. would rapidly rise. Why? Because every
time a foreign holder of dollar denominated assets sells, they have to
sell dollars and buy their own currency. If the Chinese,
Japanese and Brits were to panic and all do so at once, suddenly demand
for yuan, yen and pounds increases and demand for dollars falls; the
price of the former rises and the price of the latter
declines. If this happens in an uncontrolled fashion, you get
cycle of a declining dollar, rising interest rates, a slowing U.S.
economy, a declining dollar, and so on, until a free market valuation
of U.S. interest rates and the dollar valuation is restored.
though the process appears to have started, if
you are heavily hedged against dollar depreciation, such as with
precious metals, you
need to be prepared for a last stand that supports the dollar and
forestalls the "Poom" event. For this reason you see a
second deflationary and inflationary period added in the updated
version of the Ka-Poom model. Doesn't mean it's going to happen,
we may have entered into the Poom cycle that will in fits and starts
run through to completion. The added dis-inflation cycle is
a bit of optimistm that assumes it's possible for central banks to
cooperate to stall the "Poom." It's useful to keep in mind that
there is very likely to be a period during when the dollar is rising
again and the crisis will appear to have passed.
If you are hedging inflation risk with PMs, get ready for a wild ride.
The chart below shows U.S. Global Investors Gold Fund USERX from
1986 to May 2006. Considering USERX in this chart peaked on the
dead cat bounce of the last gold bubble that peaked in 1980, at not
even 1/3 of that peak it appears we are no where near a cycle top.
Also, note that USERX has outperformed gold EFT GLD.
The key value of Ka-Poom theory is that it has given us a framework within which to interpret the Reports from the Front from our readers, Interviews with noted professionals in the investment community such as James Rogers, Guest Columns and the AntiSpin in the Daily News.
A lot of ideas that
appeared in iTulip.com six years ago are starting to become
mainstream. Yesterday the Wall
Street Journal runs an article that claims that gold is due to keep rising due to
pressures on the dollar and U.S. economy. Today, MSNBC reports US dollar takes a pounding over deficit: "The US dollar suffered a severe sell-off on Friday, taking it to its
weakest level against a trade-weighted basket of currencies since
October 1997, as fears about the US current account deficit crossed
world markets. Marc Chandler, economist at Brown Brothers & Harriman in New York,
said: "Precisely what officials feared would happen from the large
global imbalances is now taking place in reaction to their clumsy
attempt to 'fix the problem'. Volatility in the capital markets is
rising. Global equities are tumbling."
Go to google.com and enter "Bubble
Cycle." Up pops a piece I wrote for Always On in January
2005. The thesis is that the only way to make money in the markets is to
play the cycle of bubbles that the Fed has been managing since the U.S.
went off the gold standard.
month, nearly a year and a half after the AO piece introducing the
concept of The Bubble Cycle, the equity research team of Francois
Trahan, Kurt Walters and
Caroline Portny from Bear Stearns issued a report titled Approaching an Inflection Point in the
Bubble Cycle (pdf) where they say, "The end of one bubble
often triggers the beginning of another. A bubble-induced
economic slowdown oftentimes leads the Fed to once again inject
liquidity into the economy. This phenomenon typically acts as
a trigger that paves the way for the beginning of a new asset bubble."
Normally, imitation is the
sincerest form of flattery, but iTulip.com plays at the semi-lunatic
fringe of future possibilities curve while striving for well informed
carefully conceived fringe prognostications. When
investment bank analysts, the guy running the world's largest bond
fund and mainstream financial media outlets like MSNBC start to sound
like iTulip.com did five years ago, you know the economy and financial
markets are in deep yogurt.
I am not a certified financial advisor. I'm not going to tell
you what to do with your money. I will from time to time tell
you what I'm doing with mine and you can decide to do as you wish with
To sum up three decades, my observation is that to optimally play
inflation and interest rate cycles of the Bubble Cycle economy since
the start of the Bubble Cycle system, only four major asset allocation
shifts were needed in 30 years:
If you want certified financial planning
advice, iTulip.com will soon be advertising a few that I feel meet
iTulip.com's standard of intellectual honesty. If you
generally agree with the arguments made here, you're probably going to
agree with the investment philosophy of the financial planning firms advertised.
- Stocks to commodities in the early
- Commodities to stocks in the early
- Stocks to cash and treasuries in
- Cash to commodities 2001
Still, maddeningly, like Voltaire's Candide, you'll
still have to wrestle with the ambiguities of the world and your
own ambivalence to decide among them for yourself.
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|Recent Weekly Commentaries
- Hedge Funds Still in the Dark
3/15/06 - iTulip.com
3/22/06 - Frankenstein
3/29/06 - Housing Bubble Correction Update
- Financial Markets are Poluted with Risk
- China vs U.S.A.
- The Modern Depression
5/4/06 - Energy and Money Part I: Too
Little Oil or Too Much Money?
5/6/06 - James Rogers Interview