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We are often told that too much of a good thing isn’t good at all.
This became all too clear during the period from 1636 to 1637, when a huge part of the world realised that “too” can be dangerous, even when it’s applied to something as innocent and beautiful as the tulip.
This flower takes a long time to multiply, and even though it can be propagated from bulbs or seeds, it takes between six and seven years to produce a flowering tulip bulb.
Although it was already discovered in the 1400s, it was only during the 1630s that the Dutch began to dominate the market, and trading in this “new age commodity” quickly became a status symbol.
Tulip cartels were established, and prices were manipulated. According to the data to our disposal, a single Semper tulip bulb sold for 1 000 guilders in 1623, and for a staggering 3 000 guilders only two years later.
What makes this so fascinating is the fact that the average labourer’s annual income amounted to a mere 300 guilders.
By 1636 the same tulip bulb sold for 5 500 guilders. The dreaded “too” eventually caused a sharp decline in tulip bulb prices, and by the end of 1637 these bulbs were practically worthless.
Countless investors lost all their wealth overnight.
What we can learn from this is the importance of analysing all the facts before we make decisions regarding our investments, interest rates, finances and so on, especially when it comes to objects of which prices can be manipulated.
These tulip price movements weren’t caused by increased production costs, for example, nor were there suddenly new and exciting uses for the flowers to support these movements.
They were caused by irrational behaviour, which obviously somehow was well justified at the time by the many buyers of these tulip bulbs.
To date, I haven’t commented on yet another new age commodity that has emerged over the last few years, called Bitcoin.
Before I continue, however, I want to make sure that you understand that if you’re looking for another strong opinion on the subject, you’ll be disappointed for two reasons.
First, I can’t call myself an expert on a subject/object of which the creator(s), to date, remains a mystery.
Second, I believe in investing my clients’ capital in assets of which the physical value can be assessed, and which can provide more peace of mind over the long term in terms of increasing value and, subsequently, wealth.
Although there may be no direct relation between Bitcoin and tulip bulbs, it does somehow feel a little bit like déjà vu.
This digital payment system/currency was created in 2009 by a programmer (or programmers, no one really knows) under the pseudonym of Satoshi Nakamoto.
Bitcoins can mainly be earned via electronic “mining”, but they can now also be exchanged for other/standard currencies.
I might not be an expert in the field, but I can and will highlight some statistical facts to help you form your own opinion.
Three years ago (September 2014), one Bitcoin would have cost you $387. Today, three years later, one Bitcoin will cost you $4 500.
This is a massive 137% growth per year in US dollar terms. In light of these facts, I can certainly understand why this subject is attracting so much attention, but it’s only when we delve a little deeper into the actual figures that the possible dangers emerge.
If you had Bitcoins in August 2014, you would have seen them losing 44% of their value roughly five months later, before gaining momentum again.
I have referred to the standard deviation of investments in several of my previous articles.
The standard deviation is based on historical data and gives us an indication of what we possibly stand to gain or lose on a particular investment over a period of one year.
Historically, low-risk investments such as the money market are trading at a standard deviation of 1%, cautious investments such as bonds at 8% and higher risk investment such as local shares at around 19%.
Based on this ratio, investors in local shares could have either experienced up to 19% growth in their investments or could have lost up to 19% of their capital over a period of one year.
Take a look at Bitcoin’s price movements over the past three years. It’s currently trading at a standard deviation of 69%, and although the best growth to date was a fantastic 65% in one month in US dollar terms, there was also a month during the past three years in which it lost 32% of its value.
It’s also no longer legal all over, with China’s central bank announcing early in September that trade/exchange of virtual currencies is illegal in the country (although none of these virtual currencies were mentioned by name) and that all such trading activities should be halted with immediate effect.
I’ll leave the discussion of whether there will ultimately emerge more uses for Bitcoins than for tulip bulbs in the 1600s up to you. Only time will tell.
My message is simply that if something looks too good to be true, it usually is. So make sure that you have all the facts before you invest.
Schalk Louw is a portfolio manager at PSG Wealth.
This article originally appeared in the 21 September edition of finweek. Buy and download the magazine here.
