Going the Way of the DodoGoing the Way of the Dodo
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
—Charles Mackay, 1841, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds
The dodo, a flightless bird, has been extinct since the 17th century.
According to Wikipedia, the verb phrase to “go the way of the dodo” means to become obsolete, to fall out of common usage, or to become a thing of the past. The dodo is considered the poster child for an extinct species because its demise was directly attributable to human activity. (They were good to eat and easy to catch.)
Have you ever wondered whether the last dodo bird was aware of being the very last one?
On the first trading day of 2008, the price of crude oil easily exceeded $99 per barrel, due to a Nigerian rebel attack on oil-producing facilities. The rumor circulating trading desks globally was that this would be the day—the first day in history that oil prices would trade at that psychological stratospheric barrier of $100 per barrel.
I was watching the oil market that day and saw it approach $100, but it never quite reached it. The market traded at a new all-time high of approximately $99.80 but then ran out of steam and rolled over. Oil prices continued trading lower just as I received a “Breaking News” e-mail from Marketwatch that read: “Oil trades at $100 for the first time ever.” I turned to my assistant and asked her what she showed as the high crude oil price. “It’s $99.81,” Nancy told me. “Last print, $99.50.” So I looked at the other delivery months, but they were all trading at a discount—not even close to $100. I thought to myself, they just got it wrong this time.
That night, I was watching the evening news on NBC and the anchor reported: “Oil in New York traded today, for the first time ever, at $100 per barrel.” “How could they all get this so wrong?” I thought. Then it dawned on me. Like most traders, I was watching the electronic oil market where more than 99% of all trades take place. I didn’t think to check the pit market that hardly anyone traded on or looked at anymore. Sure enough, “the pit” had recorded a different high than “the screen”—exactly $100 per barrel. The wire services had picked up on this feat and reported it as headline news around the world. Of course, this raised the question, why would anyone pay more than the market when they could have easily bought at the screen price? The pit trade is fast disappearing because it’s slower than electronic trading. Was this merely an aberration?
The next day, the full story came out. On January 2, 2008, 747,748 one-thousand-barrel contracts changed hands, with 99% of them trading on the screen and just one of those contracts trading at the price of $100. This lone contract changed hands (as we had already discovered) in the pit. I really wouldn’t call this a “legitimate” trade, even though an exchange spokesman called it just that in a press release the following day. The man behind this record-high price was an anonymous professional pit trader. Did he make a mistake?
No, he knew exactly what he was doing. This guy was willing to lose $300 for bragging rights. The BBC subsequently termed this a “vanity trade.” He absolutely overpaid for the right to tell his grandkids, “I was the first person in history to buy $100 oil.”
This “achievement” will no doubt turn out to be one of the last hurrahs of the pit trader. Electronic trading is faster, cheaper, more efficient, and, in certain ways, more honest than having market makers take the other side of a trade. These are the reasons why the pit trader is fast “going the way of the dodo,” and as with that tasty flightless bird, the pit trader’s demise is directly attributable to human activity.
It’s Different This Time?
As you read The New Commodity Trading Guide, be aware that “New” will always be in the title whenever you read this. So at what point does this book become similar to the pit trader—obsolete and no longer “new”?
The book presents commodity trading in a new light because I believe the commodity markets perform differently today than any time before. During most of my career, which spans more than 30 years, futures trading was viewed as a casino. Now many financial planners treat commodities as an asset class, and they allocate a portion of their portfolios to commodities alongside traditional stocks and bonds. Then consider the electronic factor that has dramatically changed the way the markets behave. Add in increased demand from the emerging economies, the hedge funds and the index funds, and you’ve planted the seeds for change. Because the commodity markets act differently now, new techniques are required for trading success. Still, it’s important to remember that these four words—“it’s different this time”—have collectively resulted in more lost money for more traders than any others.
A few years after the 1929 stock market crash, the great trader and philanthropist Bernard Baruch wrote a foreword to a reprint of Charles Mackay’s classic Extraordinary Popular Delusions and the Madness of Crowds. Originally published in 1841, Mackay’s book chronicled various investment manias from the 1500s through the 1800s. From the tulip craze to the Mississippi and South Sea Bubbles, the basic underlying premise was that manias (economic and otherwise) are a condition of the human species. They will come and go over time but never disappear. My reprinted edition of Popular Delusions was published in October 1932, right in the thick of the Great Depression. In this quote from the foreword, Baruch refers to that most recent mania he termed the “1929 market madness in America”: “I have often thought that if, in the lamentable era of the ‘New Economics,’ culminating in 1929, even in the presence of dizzily spiraling prices, we had all continuously repeated, ‘two and two still make four,’ much of the evil might have been averted.” Those very words could be used today; just substitute the dates.
The 1929 panic and eventual recovery from the Great Depression that followed were not firsts for America. Crashes and market panics occurred in 1837, 1857, 1861, 1873, 1893, 1901, and one could make a case for 2008 as well. The 1857 panic was preceded by the California gold rush. The 1873 panic was preceded by a speculatively induced bubble in railroad stocks. The panic of 2008 was preceded by a speculative boom in housing prices that created the subprime debacle. Still, more has been written about the 1929 crash than any other crash in history because more people in the newly minted middle and upper classes were affected, and also because few people saw it coming. People held a widespread belief at that time in the “new economics”: A period of permanent prosperity had arrived. Certainly, the 1920s was an unprecedented period of prosperity, with new wealth created from the automobile industry and the accompanying boom in road building and travel. A plethora of new technologies and new household electronic appliances, such as the radio, were born. To top it all off, the 1920s saw the creation and widespread use of installment credit products. Perhaps this was one of the main unsung underlying causes of the crash. Looking at modern history, we can point to the dotcom mania of the late 1990s. In recent years, examples include the condo mania in Florida and Las Vegas and the subprime housing crisis in California and many other places. Obscure manias also pop up nearly every year but fail to reach the mainstream media because they affect only a few of those directly involved. (I chronicle one of these, with the accompanying valuable lessons, in Chapter 2, “Capturing a 5,000% Return,” a recent commodity bubble that ended with the inevitable burst.)
One shared trait of all manias is that the majority of players never see the collapse coming. If you read the financial press from 1929 to 1931, all during the period the market was falling, respected analysts continually considered it a correction that would soon be over. When stocks finally did hit bottom in 1933, more than 80% of all value had been lost. Will this be how the current commodity boom ends? Will today’s commodity bubble burst? The answer to this question is, yes, it certainly will end badly because the history of mankind is that all economic bubbles eventually burst. The only question is, when? It will take place after any bull market move in a particular commodity market morphs into a mania. This will be the time when the general public is totally immersed in the story of the day. It’s never “different this time”: It always ends the same way—badly for the general public. However, as this is being written, I question the premise that, in a macro sense, this commodity bull run is anything close to a mania or a bubble. It’s more similar to a balloon, inflating and deflating but overall somewhere at the half inflation point. Before the 1929 stock market crash, shares in shell companies were being manufactur...
