The Cyclical Blues

When it comes to investing, the phrase “It’s different this time” usually proves to be wrong because cyclical forces invariably win out. Yet surprisingly few investors know that economic and market cycles exist, or how they work.

In the June edition of BCBusiness, Allen Garr’s article on blueberries (“Kind of Blue”) describes the vicious cycle B.C. farmers are experiencing. Besides the fact that I love blueberries (as a kid I picked them with my mother) and everything they’re in (pies, muffins, pancakes, smoothies, cereal) the article grabbed my attention because it’s a classic example of a cycle.

Borrowing facts from the article, here is how what I’ll dub “The Great Blueberry Cycle” plays out:

• • Farmers are paid around $0.70 a pound for their blueberries.
• • Blueberries are declared one of the world’s 10 wonder foods, and the “health halo” causes demand to take off.
• • Rising demand plus short-term supply limitations equal higher prices: in 2006 farmers are paid $1.60 a pound.
• • Blueberry farmers around the world increase production and less-profitable crops are plowed under. Between 2005 and 2009, North American farmland  dedicated to blueberries increases 30 per cent.
• • Anticipating further growth, speculators get into the act by buying and planting land in the Fraser Valley; prices for farmland go up.
• • While the impact of recent planting is just starting to be felt, production is expected to keep rising for several more years, since it takes three years for plants to produce a blueberry and 10 to reach full production. Meanwhile, storage facilities for fresh and frozen blueberries are bursting at the seams.
• • Prices pull back to $1.00 in 2008 and are expected to be $0.70 in 2009.
• • Farmers are struggling to make a living. Production costs have risen while prices are back to where they were a few years ago.

The blueberry cycle is like all others: oil, metals, chemicals, steel, houses, microprocessors and flat-screen TVs. A surge in demand leads to higher prices. New players rush in, speculators get involved and costs rise. Inevitably, more product becomes available, prices drop and producers get squeezed, especially those who expanded aggressively.

Investors need to remember three key points about market cycles.

First, they are inevitable. Investors tend to have short memories and start to believe that a trend will go on forever, but they have to realize that people and organizations are adaptable and respond to changes in price and availability. There are two sides to this economic equation – supply and demand – and both are subject to change.

Second, cycles are unpredictable. It’s impossible to anticipate when one will start or end, or how high or low it will go. In 2005 there was plenty of evidence to suggest that the U.S. housing cycle was getting overheated, but it was 2007 before it began to unwind.

And finally, the length and magnitude of the up-cycle will define the character of the down-cycle. The higher and longer it goes, the deeper and more extended the resulting retrenchment period will be. It takes time to chew through excessive inventory and rationalize unneeded production capacity. To repeat, this isn’t an exact science and every cycle is different, but it’s irrefutable that extreme ups set the stage for extreme downs.

Having an appreciation and respect for market cycles, even though they’re tough to call, allows investors to make better investment decisions and stick to their long-term strategy. They’re less likely to say, “It’s different this time,” when it isn’t.