Investing now makes no commonsense

And how many of them heeded the warnings in articles on this website that a clear bubble was forming in local stock markets? How many investors still have huge loans to pay back that were used to buy shares that are now worth a fraction of the price paid?

It is a hard lesson in financial, and indeed all asset markets, that prices move in cycles. What goes up must come down! And in particular what has gone up far too high most certainly will come down.

The Arabian stock markets are just a very recent example. Upward momentum and irrational enthusiasm sucked in more and more buyers, many buying with credit, until a near vertical upturn became unsustainable and collapsed under its own weight despite strong economic fundamentals like the oil price.

Bubbles everywhere

You don't need to look very hard around global or local investment markets to see bubbles forming, and some of them very obvious and very large. It is arguable, however, that the next bubbles to burst will be in global asset markets because these now appear to be the ones closest to defying gravity.

In the past few weeks we have seen the largest loss in history by the hedge fund Amaranth Advisors, more than double the 1998 loss by Long Term Capital Management; US house prices fell for the first time in 11 years; US auto makers are losing billions and close to a crisis; and US economic growth has slowed to a degree pointing to a strong probability of recession next year.

Yet capital markets are behaving as if nothing were wrong. Indeed, the Dow Jones Index hit a fresh all-time high on each day of the past three last week. And Venezuelan bonds yield only 2.3 per cent above US Treasuries as investors are ignoring risk.

What is supporting this whole rocky edifice is a massive pool of debt, accumulated during years of low interest rates. But as the meltdown of the Amaranth Advisors hedge fund has showed, leveraged investments can sink as surely as they can deliver exceptional performance for a period.

Where to watch next

So where will the pain be felt next? The US housing market is clearly imploding and must drag Wall Street down with it within a short time. This might give a new breath of life to US Treasury bonds but the Fed has already said it not hesitate to act if inflation ticks upwards which would be bad for bonds.

But if the US economy catches a cold, then how much of the rest of the world will be immune from pneumonia? What will be the knock-on effect in emerging markets, in Europe, the UK and Japan?

Who knows really? But it might not be such a good time to hang around and find out. Surely the wisest move today is to pay down debt and move to a liquid position, perhaps buying some gold and silver while the current euphoria in traditional asset markets persists.

For precious metals will be one of the few safe havens in this coming storm, alongside US dollars - with asset prices bearing the pain of structural readjustment rather than the currency for a change. Indeed, the US dollar will probably rebound as it did this May when markets fell.