Tulip prices increased throughout the decade as more speculators got into the game. In 1633, a farmhouse was traded for three rare bulbs. By 1636 any tulip could be sold for extraordinary sums. Futures markets started. Trades were made in fields or taverns, between farmers and merchants. Some bulbs were bought and sold 10 times in a day. One father left his seven children an inheritance of 70 tulips. One sold for the all-time record price of 5,200 guilders.
Then, one day in 1637 everyone decided to stop playing. No buyers showed up at the local tulip auction in Haarlem. Within days, panic started, then spread. Tulips that sold for 5,000 guilders soon went for less than 50. (Source: Tulipomania by Mike Dash)
The Roaring '20s earned the name. It was a new era of economic fundamentals with free trade, anti-inflation measures, less stringent anti-trust laws and higher worker productivity. It was the best of times which would never end. The idea of leverage came into being in big way. Consumer credit expanded exponentially as Americans bought cars and radios and stocks, especially stocks. Margin was stretched to the limits. Of course, once prices start to fall, margin accounts get calls. Lots of them. To meet those calls, stocks must be sold, adding more downward pressure to prices, eliciting more margin calls. The vicious cycle continues until everyone is out of leverage and mostly broke. We know what happened after that. The country didn't pull itself out of the Great Depression until WWII.
There were many other bubbles, such as the Japanese Bubble Economy in 1984 to 1989. There was the South Sea Bubble in 1720. The most recent one? The housing bubble, which famously burst in 2007 and is still, according to many, still deflating. History is full of times when people got a little crazy, spent way too much on a commodity or thing, then watched all the "value" go away the day the bigger fool stopped coming to buy or easy credit was gone.
Now let's look at oil and gold and silver and cotton, to name just a few. They have all pushed limits not seen in decades. Some hit new all-time highs. There are good reasons. Turmoil in the Middle East leaves a great unknown for oil flows. The natural response is to buy more oil since it's more valuable with constricted supply. Or gold. It's always a safe haven when times are troubled. Or silver. And cotton is going up because of useful demand.
But here's the thing. The oil is still in the ground. There are plenty of other countries with large reserves willing to sell into higher prices. Supply will ultimately fill demand. Cotton plants can be planted. Farmers are always anxious to plant new crops that pay more. Watch as many farms produce the white puff, taking out tobacco or other crops that are less in demand. As for gold, it's in limited supply no matter how much the Alaska TV troop finds. But it's being driven up by fear, not industrial demand. When the fear subsides so will the price of the yellow metal.
How far these commodities can run is unknown. But anyone thinking about buying into them now has to believe the worst is still ahead, that oil producers won't increase their output to take advantage of higher prices, and that no new supply of whatever commodity is hot won't be coming soon. Prices have reached the bubble stage in many sectors. And when the bubble bursts, it's never pretty.
Ted Allrich is the founder of The Online Investor, chairman of the board of Bank of Internet USA, as well as the author of the book Comfort Zone Investing: Build Wealth and Sleep Well at Night. In this weekly column, he offers advice to investors who are just getting started.