Beware the next bubble

• Buy to cover short positions in Hythiam (HYTM, news, msgs) and China Natural Resources (CHNR, news, msgs).

• Shell short in equal amounts Pier 1 Imports (PIR, news, msgs), Cyberonics (CYBX, news, msgs) and Libbey (LBY, news, msgs).

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"There is a very easy way to return from a casino with a small fortune: Go there with a large one." -- Jack Yelton

All over the media one can read stories about another "sure thing" investment opportunity. This time, it's agriculture and anything related to it.

Sometimes it takes a lot of effort on my part to understand. How could the public -- still recovering from the bursting of the real estate bubble -- be herded into another "sure thing" sector that is quickly becoming the next bubble of gigantic proportions?

That's why being a skeptic is a must-have quality for anyone hoping to be successful long-term investor.

Too often, we forget the stock market is simply a giant supermarket where two nearly identical products can sell at vastly different prices just because one has better advertising, is in short supply or is "hot" at the moment.

Remember the dot-com bubble

If you are a permanent investing optimist who accepts rosy management projections and likes to move in lock step with "popular" opinion, you're likely one day to learn a painful and expensive lesson. Cheerful momentum and growth investors learned it in the late 1990s, when buying AOL was just as fashionable as buying Mosaic (MOS, news, msgs) or Potash of Saskatchewan (POT, news, msgs) is today.

Even value investors, who once claimed that they would never do such a stupid thing like invest based on hype, learned a painful lesson over the past 18 months. It all started with a same notion that one group of stocks or a sector deserved a premium over historical valuations because "this time was different."

The whole notion of cyclicality inherent in the financial industry was quickly forgotten even by so-called "rational" value gurus. We all heard numerous explanations why Lehman Bros. (LEH, news, msgs), Citigroup (C, news, msgs), Bank of America (BAC, news, msgs) and Goldman Sachs (GS, news, msgs) were supposed to grow in double digits forever and thus were "extremely" cheap even at historically sky-high multiples.

"This time is different" stories that we all heard a few months ago were just as prevalent during in last fall's "Shanghai boom" as they where during the tech boom. Now, after the Shanghai Composite's 40% plunge, it's amazing to read some of the explanations people came up when justifying why, for instance, PetroChina (PTR, news, msgs) was worth more than ExxonMobil (XOM, news, msgs).

Wasted money and greed are fueling the bubble

A new bubble has now almost certainly formed in agriculture-related stocks. We are hearing stories about how the world is running out of food and how the same billions of hungry consumers who were just recently predicted to make Asian economies immune to the woes of the mighty U.S. are going to put "never-ending" pressure on food prices for the years to come.

Come on, guys. Give me a break!

No one is going to run out of food. The world's population has barely grown in the past few years. Although many people are shifting their diets toward more protein consumption and are increasing the demand of the ag commodities somewhat, the multifold increases in corn and wheat prices are definitely not the result of the increased consumption.

• Another view: Could we really run out of food?

Rather the price gains are a direct outcome of the incompetent politicians doing what they do best: wasting money. Plus, greed has pulled too much cash into the stocks in the sector. Ethanol and other alternative grain based fuel subsidies are absolutely ridiculous, stupid and irrational.

All the stories about how the farming industry is at the start of the next "sure thing" boom and how supercyclical companies like Potash and Mosaic deserve their ridiculous valuations because they will grow by 20% a year for the next 10 years are simply silly.

Remember: We've heard that about China, real estate, AOL, etc.

Like all other "booms," agriculture is sure to experience a bust that will cost a lot of retail investors' money. Does one reasonably believe that Potash and Mosaic -- with 12,000-plus employees and less than $2 billion in free cash between the two of them -- are worth a $100 billion market cap just because there is a short-term fertilizer shortage?

• Counterpoint: Jubak backs agriculture-related stocks

Once again, let's get real here. How many years do you think the fertilizer prices need to go up by 50% a year to justify a sustainable cash flow sufficient to pay investors dividends worthy of current "sky is the limit" prices? How about the fact that both companies spend 50%-plus of operating cash flow on capital expenditures?

How about the skyrocketing costs on everything from labor and industrial equipment, to energy required to produce the final product? How about the almost certain long-term threat from substitutions that are virtually guaranteed to show up every time there is such a heavy short-term supply-demand imbalance? How about the fact that neither company has provided shareholders with some real returns either through dividends or stock buybacks?

Don't be left holding the bag

Though it is always difficult to predict when a bubble is going to burst, it is easy to avoid suffering from the eventual consequences. In the game of "bubbly" musical chairs, someone always loses. Although one would hope that small retail investors won't be the ones left behind, unfortunately, they will probably end being the ones who are going to pay for the greedy mistakes of the big boys.

Neither Mosaic nor Potash fits my short-selling profile. But I think that risk reward here is definitely not in the long-side investors' favor.

Don't be surprised if the ag rally goes on for a few weeks or may be even months. (Potash closed Friday up 1.9% to $170.89; Mosaic added 10% to $115.07.) But the rally could also abruptly end today. Greed is a powerful momentum driver, but, in the long run, fear always wins, and the outcome is likely to be quite painful for whoever is left holding the bag.

Please visit my Skeptical Capitalist blog for more opinions, and feel free to e-mail me your comments at skepticalcapitalist@gmail.com.