The events of the past month have created something of a paradigm shift in financial markets. This article will look at (a) what caused the surge in prices of GameStop, silver, etc.; (b) why lack of exit strategy caused the surges to fizz out; (c) what might be the positive effects or lessons learned from this phenomenon?

(a) What caused the surge in prices of GameStop, silver, etc?

Let me describe events leading up to the surge, (which I acknowledge is oversimplified).

One might start by ascribing responsibility to the “loose money” policies of central banks and helicopter money from Governments. Excess liquidity provided a fertile environment.

The trigger was provided by social media activities of a subgroup of the Reddit internet platform; the later silver surge was driven mostly via Twitter. The coordination of a large number of retail investors via social media to move markets to this extent was unprecedented and revolutionary.

Retail investors had cleverly discovered a highly unstable situation in GameStop ownership: short sellers had sold 140% of the shares, many of them naked shorts (e.g. where they sold shares they did not own). This made short sellers extremely vulnerable—as they tried to buy shares to eventually cover their positions; this served to further drive up prices. In theory, prices could have moved to infinity. GameStop shares, which a month prior had been trading in single digits, reached $347 on January 27, 2021, at least a tenfold multiple of what the shares were really worth.

(b) Why did the surge fizzed out?—lack of exit strategy

Share prices collapsed shortly thereafter, reaching $54.50 on February 4th.

Ever since my 2011 book, Business Exit Planning¹, I admit to a bias of looking at investments from a perspective of exit strategy.

In the case of GameStock, there is not a shred of evidence that the retail investors had any exit strategy. Emotion—greed, anger at the financial establishment—is not a strategy. Some large investors who jumped on the bandwagon may have also been guilty of “pump and dump” techniques, further charging the emotional atmosphere.²

Any student of exit strategies would predict that the way to make money in these kinds of situations would be “First In First Out” (FIFO). The earlier you invest, and the earlier you exit (presumably just before or after peak price was reached), the more money you made. It was fully predictable that once prices started to decline, a total collapse was inevitable. There was no leader, no coordination on the way down, everyone would simultaneously run for the exits. The surge on GameStop lost its focus when retail investors started targeting other shares like AMC, and even the silver market (vastly larger than the capitalization of GameStop, with much less shorting) Henc,e driving silver to $100, a much talked about objective on Twitter, was a pipe dream).

When is the best time to engage in exit planning? Before you buy the asset you are considering.

Ironically, if a large hedge fund had decided to squeeze GameStop shorts, chances of success would have been higher. A single buyer could have maintained prices, forcing naked shorts to accept their terms.

(c) What might be the lessons learned or positive effects in future?

First and foremost, laws on short-selling should be enforced. One of the reasons the Securities and Exchange Commission was created back in the 1930’s was precisely to stop naked short selling, that had been rampant in the 20’s. These laws are on the books—US regulatory authorities should be held accountable for not enforcing them, helping to prevent bubbles in future.

Second, hedge funds may be less inclined to do naked short selling, or any type of short-selling in future, as the whole equation of risk pertaining to short selling has changed, given the new found power of retail investors. We should not expect a cessation of short-selling, perhaps a moderation.

Third, events serve as a warning to retail investors to invest less out of emotion (greed, anger, etc.) and be more rational, with attention to strategy and underlying value. As Warren Buffet’s said: you shouldn’t own a stock for ten minutes if you aren’t prepared to own it for ten years.

Fourth, events of the past month have created a new awareness of how manipulated markets are—not just short sellers manipulating prices of individual company shares down , but that in the case of silver and bullion markets there seems to be a pervasive manipulation of markets.³

Buyers of physical silver did not get nearly as hurt as buyers of GameStock. Whereas most GameStock investors invested way above intrinsic value, arguably silver was below intrinsic value, even at the highest recent values. I plan to own silver for ten years.

As the saying goes, it’s a shame to waste a good crisis. Investors and regulators can each learn lessons and draw conclusions that should improve the investing experience make markets better in future.