How to recognize you are in a bubble

The following chapter is an excerpt from Hedge Fund Grannies. Pierre Beauty Products’ discovery has attracted speculators who have overtaken the market and driven prices sky high. Below is the chapter where Pierre executives discuss how to combat the speculative fever in the market for their key ingredient.

Excerpted from Hedge Fund Grannies Copyright © 2014 by Gerard Herlihy

This is a work of fiction. The names, characters, businesses, places, events and incidents are either the products of the author’s imagination or used fictitiously. Any resemblance to actual persons, living or dead, or actual events is purely coincidental. All rights reserved, including the right of reproduction in whole or in part or in any form

ISBN: 0692241744 ISBN 978-0692241745


Eva had circulated a folio to her executive committee before the Labor Day weekend. The top document was a memo for discussion at the Tuesday morning meeting.

To: Eva Marteen, CEO and Olivier Gaillard, Chairman

From: Commodity Analysis Taskforce

Subject: Is the Crabgrass Market Entering a Bubble Phase?

Asset bubbles have certain elements in common:

  • Large available capital willing to invest.
  • Leverage in the form of cheap debt or margin loans.
  • Unknown asset values during early stages.
  • The perceived ability to corner the market.
  • Multiple potential causes of volatility (e.g., limited supply, dislocation, weather, or political instability).
  • Government action to support minimum prices (including tolling, loans, grants).
  • Government policies creating excessive liquidity and cheap interest rates (current U. S. policy on monetary easing).
  • At the market peak, a large presence of speculators.

One of the paradoxes of this type of analysis is investors rarely know they are in a bubble while it is taking place. If an investor truly believed it was in a bubble, he would sell. The alternative is known as the “greater fool theory”. This occurs where investors know an asset value is inflated, but believe there is always another party willing to buy it (the greater fool) when they want to sell.

We have concluded that the latest crabgrass price escalation has all the trappings of many of the most well-known historical booms and crashes – the stock market in 1929, gold now and in the 80s, dot-com, technology stocks in 2000, and subprime mortgages, housing, oil, and various metal commodities from 2007-2009. In addition, economists are now theorizing the cost of a college education and the U. S. Treasury debt are both in a bubble.

Each of these asset hyperinflation phases has similarities as follows:

Large available capital. There is unlimited capital available to invest in CRAB. The Den-Ken funds are sitting on $140 million of invested capital and $300 million of profits. The hedge funds, pension funds, charitable foundations and other institutions that are known investors in CRAB have nearly a half trillion dollars in available assets. The Chinese Investment Corporation, or CIC, has over $500 billion to invest. Its purpose is to invest the foreign currency reserves of China, which now exceed $3 trillion. By comparison, the value of the next three years of crop is a mere $3 billion.

Access to leverage/debt. The margin for CRAB is only 25%. The leverage is a hundred times greater for CRAB options.

Unknown asset values. There is no prior reference value for this asset other than what Pierre initially established and the Chicago commodity community subsequently challenged. The untested constraint for price increases is the price consumers are willing to pay for products using the raw material, or in our case, shampoo. However, other as yet unknown applications may yield a higher and better usage of the material.

The small market size invites attempts to corner the market. Our market size is very small. Wall Street can “buy” the market with a few billion dollars, a small amount of capital by their standards. We would be particularly wary of Buckstown Financial, who has purchased a large commodity position and has begun buying the common stock of NBCI. Buckstown is already under subpoena by the CFTC for its role in a very similar situation – intentionally delaying deliveries from their molybdenum warehouses for the purpose of inflating the price of the precious metal. Despite antitrust laws prohibiting such behavior, the trading houses apparently either feel the laws don’t apply, or feel immune to prosecution.

Interests aligned for price increases. Other than Oxford Collar and possibly one or two competitors in the shampoo market, no current participant in the trading market has any interest in price stability.

No market is too large or too small for speculation. Not all booms are in small markets. Oil is a $3 trillion annual market, yet speculators entered the market and drove oil prices to $147 a barrel in 2008. Wall Street banks, hedge funds and a large number of institutions all joined in. OPEC, big oil companies, and North Sea oil producers allowed them to drive prices higher through benign noninterference. They all benefitted from the increasing oil prices and did nothing to stop the speculation. Car drivers had little say in the matter.

Entrance of speculators in the trading marketplace. Speculators buy assets simply because they believe prices are rising. They neither need nor want the end product. In fact, they would be unhappy if they had to take delivery. We believe institutions already had made a significant move to buy CRAB (see February NYTimes article). Beginning in August, a large number of small-time speculators also entered the market. The open interest in the October 2013 contract is now four times the size of the crop. A single contract costs $20,000, or $5,000 using margin loans. It’s still affordable for small traders. That explains why the number of trades is high but the size of the trade is low.


As can be seen in the accompanying charts, the rise in CRAB prices closely correlates to the percentage gains of commodity prices in 2008. Those commodity prices all collapsed in 2009 precipitated by a worldwide financial crisis, massive sell-off of assets, and financial institution deleveraging.

We are convinced that prices will continue to rise substantially during the next year. The bubble will not break unless a market participant takes action to force the price down. There is virtually nothing impeding another 50% further increase in prices unless we take action now.


Read more in Hedge Fund Grannies. Available on at



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