Michael Burry Warns “The Mother of All Crashes” Is Close Upon Us. I Would Buy Gold.

June 23, 2021
  • market crashThe legendary investor Michael Burry warned the markets about losses “the size of countries”. He posted this warning on Twitter.
  • This warning also contributed to an even bigger correction last week after the Fed signaled a more hawkish stance towards its monetary policy.

  • There are reasons to worry about market bubbles. Many of them have happened in the past.

  • After bubbles burst, central banks are forced to further easier their monetary policies, thus pushing the prices of precious metals upwards.

Michael Burry, the Scion Asset Management boss, became a famous and a widely followed investor after his winning bet against mortgages just before the 2008-2009 crisis. His highly ambitious bet against the bubble was described in the book and the film "The Big Short." He is now worried about the cryptocurrencies boom and meme stocks mania. I agree with Michael Burry. It is uncertain when this bubble will eventually burst. However, there are hawkish signs from the Fed. Even if the Fed does not make any big moves any time soon, it might make the markets even more overvalued than they are now. In that case, the crash will be even bigger and the Fed would have to ease the monetary conditions even further, thus pushing the demand for gold even further. I will explain why it is the case and will also compare the current situation to other manias and crises.

Burry’s Tweets

According to Burry, people's fear of missing out has made asset prices soar to ridiculously high levels. This won’t end well, in Burry’s view. In other words, "#FOMO Parabolas don't resolve sideways". Michael Burry attracted his followers’ attention to the fact crypto fans borrow recklessly to buy their favorite coins. "The problem with #Crypto, as in most things, is the leverage," he tweeted. "If you don't know how much leverage is in crypto, you don't know anything about crypto."

As paradox as it sounds but Burry helped stimulate the GameStop short squeeze in January, which kicked off the meme-stock mania. He bought a stake in the video-game retailer back in 2019. He later wrote a few letters to the company’s board, encouraging retail investors to bet on the stock. As we all know, in January 2021 GameStop’s stock rallied significantly. Burry sold his stake just before that incredible rally. There were no sound fundamental factors behind that monstrous rally. In fact, GameStop is currently a non-profitable highly overvalued stock that I wrote about earlier on. Michael Burry sold his stake just before this remarkable stock rally. He is now highly bearish on the meme stocks and cryptocurrencies in general. “All hype/speculation is doing is drawing in retail before the mother of all crashes,” Burry wrote on Twitter before his posts were deleted. “When crypto falls from trillions, or meme stocks fall from tens of billions, #MainStreet losses will approach the size of countries. History ain’t changed.”

The remarkable thing is that Burry posted on Twitter last week after deleting his profile in April. He's previously used the social network to warn the public about Tesla. He is short this stock. Burry has also previously issued warnings about GameStop, bitcoin, dogecoin, Robinhood, inflation, and the wider stock market.

The Fed and The Bubble

Many previous crises were due to asset bubbles and the Fed’s tightening. I believe this is the case now.

In my view, we should learn from history how stock market manias end. Some examples are the Dot.com crisis and the Great Depression. During the Dot.com bubble there was plenty of enthusiasm about the internet stocks. The market was overcrowded and the high-tech companies’ fundamentals did not matter to investors. In order to cool the markets, the Fed raised the interest rates. The federal funds rate increased from about 5% to around 7%. This led to a stock market collapse and a recession. After that, the Fed had to ease the monetary conditions, thus making the gold prices rally wildly.

During the so-called “Roaring 1920s”, the U.S. stock market expanded rapidly, reaching its peak in August 1929. There was, quite logically, a period of wild speculation with even “shoe-shine boys” interested in buying stocks of fashionable automobile and radio companies. At the same time, the macroeconomic indicators had deteriorated. Production had already declined, whereas the unemployment rate had risen, leaving stocks highly overvalued. Among other reasons for the stock market crash of 1929 were low salaries, high indebtedness, a struggling agricultural sector and a large number of “bad” bank loans. Additionally, during the economic boom lasting from the fall of 1927 to the fall of 1929, interest rates moved higher. Yields on four- to six-month commercial paper rose from 4.00% to 6.25%, and interest rates on highest grade corporate bonds increased from 4.50% to 4.80%. So, the tightening monetary conditions were the so-called trigger. As we all know, the Great Depression followed. During this time period physical gold became extremely valuable. So, the US government even obliged its citizens to sell their gold holdings at a fixed rate.

These two stock market collapses and crises that followed the Great Depression and the Dot.com bubble were mainly caused by overvaluation, excessive general public’s enthusiasm, high indebtedness and tight monetary conditions.

Similar threats seem to be here right now. The problem here is also the fact the Fed now seems to be more hawkish. At the same time, Jerome Powell gave no concrete guidance about tapering soon. The Federal Reserve’s dot plot now forecasts there will be two rate hikes in 2023. Fed’s James Bullard even forecasts one interest rate hike as early as 2022. But there is still plenty of uncertainty. No-one has issued any guidance as to when the current pace of the asset purchases will be reduced. It is currently at $120 billion per month, which is considerable. Even the dot plot should, according to Jerome Powell, be treated with a “big grain of salt”. So, there is absolutely no certainty here. But if the Fed does not start tightening the monetary conditions any time soon, the crypto bubble and the meme-stock mania may grow even bigger. If that carries on for a while, the crash may be much bigger. The indebtedness level right now is also very high. Michael Burry very correctly noted that many traders and speculators borrow lots of money to buy overvalued assets. And how many zombie companies do we have right now? What is more, the macroeconomic indicators and companies’ accounting fundamentals do not match the stock markets’ current valuations. That is worrying too.

Conclusion

Although many traders that are long meme stocks and cryptocurrencies do not want Michael Burry to be right, the current situation does look very much like an asset bubble. The stock market situation resembles some past crises. However, the problem is that we cannot be absolutely sure when the bubble will burst. So, in my view, it is reasonable to have some gold as an insurance against the next crisis.

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Anna SokolidouAnna Sokolidou, a graduate of the University of Edinburgh, is a research analyst and a freelance writer with a strong interest in commodities. She has several years of investing experience and working as an in-house analyst. She is particularly enthusiastic about researching precious metals and conducting macroeconomic analysis. Her work has appeared on a number of investing websites but she now mostly publishes her work on Seeking Alpha.

24 karat gold is pure elemental gold.

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