Markets are now a beauty contest on steroids – a wealth of common sense

Markets are constantly evolving.

There are better products, services, research tools and technology. Our knowledge of the past influences the way you invest in the future.

In that sense, market cycles are always different.

But human nature does not change.

People are emotional. You get stressed, anxious, greedy, nervous, scared, excited and all the other feelings that money brings.

In that sense, market cycles are never different.

Human nature is the one constant in all market cycles, but there are ways innovation can heighten our emotions that can impact the markets.

In 1936, John Maynard Keynes compared the stock market to a beauty pageant in his book. The general theory of employment, interest and money:

Professional investments can be compared to newspaper competitions where the participants have to choose the six most beautiful faces from a hundred photos, with the prize being awarded to the participant whose choice most closely corresponds to the average preferences of the participants as a whole; so that each competitor must choose not the faces which he himself likes best, but those which he thinks will be most liked by the other competitors, who all look at the problem from the same point of view. The point is not to choose those that, in your best judgment, are really the most beautiful, nor even those that the average opinion honestly thinks is the most beautiful. We have reached the third degree in which we devote our intelligence to anticipating what the average opinion expects the average opinion to be.

That was already the case in the 1930s and it is still the case.

However, the information age has added an element that never existed before, changing the way markets function, especially in the short term.

For example, the parabolic rise and eventual crash of the silver price over the past few months looks breathtaking on a chart:

How do you explain a 55% return within weeks, followed by a crash that wiped out a third of its value?

There are always many different reasons why markets make big moves up and down, but allow me to explain the crazy moves in silver this year.

Gold initially took off after the seizure of Russian financial assets following the war in Ukraine. This caused central banks around the world to hoard and buy more gold to own more physical assets that couldn’t be taken away at the push of a button.

Silver is considered to have a higher beta for gold trading.

Then we entered a world of de-globalization because of the trade war. That caused a rethink of materials and precious metals in the supply chain. Silver has many industrial use cases.

We also had the boom in AI investment, which will require a lot of physical resources.

Then you are concerned about the reduction due to higher budget deficits and national debts.

It was a perfect storm¹ for the precious metal complex.

But when everyone started to see this bull market taking off, the investment bots swarmed.

Leverage came into trading. The Reddit/Robinhood/memestock crowd jumped on the bandwagon. Hedge funds saw activity increase and decided to jump in the pool too.

The information age has taken upside and downside volatility to new levels.

Just look at the daily price fluctuations compared to silver’s history:

The peak in volume in the early 1980s is when the Hunt brothers tried to corner the silver market to drive up the price. It worked until it didn’t.

Over the past few weeks, spot silver prices have now experienced the two largest single-day declines in history. The previous record was a decline of -18.6% in March 1980. Since the last trading day of January this year, there have now been decline days of -19.6% and -26.4%.

Social media has changed markets forever. There are also more products that allow investors to easily use leverage.

The ProShares Ultra Silver ETF (2x leveraged)² went from $1 billion in assets to almost $6 billion at its peak in January:

Some of this was due to the price increase, but clearly a lot of money has flowed in.

The speed of information accelerates market movements and causes manic movements in both directions.

I first wrote about how technology is accelerating the markets in 2014. Here’s what I said at the time:

Technology now allows irrational exuberance, misinformation and fear to spread across the world at a frightening pace.

Therefore, the abundance of information is both a blessing and a curse. It is very easily accessible, creating a level playing field for people all over the world. And social media provides instant feedback on just about everything. The problem is that people make hasty decisions without waiting or thinking about the consequences. The world is now focused on short-term thinking. Many default to an “act first, think later” mentality. When the implications of our decisions are not accompanied by sufficient time and deep thought, unintended consequences are more likely to occur.

This still feels good, but I definitely underestimated the meme stock nature of the market, where groups of investors swarm specific securities or assets. It’s almost like a Netflix algorithm highlighting the hottest investments for people who like to chase the hot dot.

Keynes’ beauty pageant is alive and well. It’s just happening faster than ever.

And it’s hard to know where opinions will go next.

Further reading:
Would Keynes have been fired as a money manager today?

¹I’m normally anti-perfect storm as a financial term, but it fits here.

²This fund is up 158% on the year through the last week of January. It is now down 63% from its highs. Leverage works both ways.