Opa

Opa

It’s been over a month since I published something on this blog, making it the longest period of quiet I have endured since I fully dove into the world of finance back in December of 2015. At the time, I was on track to play professional Smite, a Multi-Online Battle Arena game or MOBA. At the time I had received a few offers from professional teams to join them in the upcoming season. Fate had other plans.

I woke up on the morning of December 12th to discover my dog of 3 years Dragon had died that night. I found him at the foot of my bed lying motionless on the floor. His sudden death, forced me to take stock of my life. I was depressed, overweight, and stressed beyond reason. I may have climbed to the pinnacle of my “sport” but without my best friend it was a hollow achievement. Later that week, I decided to rededicate myself to the craft of finance, focusing specifically on global macro economics, figuring that if I could climb to the top of one game I could do it again.

I bring this up, because once again I find myself wracked with the sudden departure of another dearly beloved family member, this time, my Opa, Leonard E. Baum. Many in the financial community will know him as a legend, the man who helped build the foundation of mathematics which supports our modern society, but to me and my family he was always just Opa.

He never bragged to us about his accomplishments. In fact, he rarely talked about them. He kept that part of his life a secret, only leaking small details here and there when we probed him enough, like the time he admitted to cracking a certain Russian leader’s personal code.

And despite his penchant for silence, I was able to learn of some of his most inspiring trades.

He bought Amazon so long ago, that his brokerage firm did not have electronic records of the date. During the depths of the GFC when everyone thought the world was going to end, he was buying Citi Bank, temporarily holding the market at $1. Although it briefly broke $1, he never sold and like Amazon still held those shares till his death. Despite these incredible trades, when I asked him just a week before his death, what his best trade was, he without hesitation responded “Julia”, my late grandmother.

It’s no wonder why I’ve always held him in such high regard. But to me, despite those incredible accomplishments he’ll always be the one who taught me how to multiply large numbers when I was three. In fact he gave me so much mathematical instruction that by the time I entered the first grade I was already doing fifth grade math. My elementary school teachers hated accommodating their lesson plans around me.

What is not widely known though were his story telling capabilities. Most children got simple bed time stories, but Opa would give us his rendition of the Iliad and the Odyssey so often that “sulking in his tent like Achilles” became a common phrase around our household.

Little did I know how inspirational these stories would be to me later in life. I wrote my first ever screenplay loosely based on Opa’s serial tellings of the knight Kay who would travel around the world killing witches and freeing princesses and the like. Like his stories, mine too starred a knight, although not in shining armor, his name was still Kay. And even though Opa was legally blind, and even though it was a beyond awful piece of writing he still found a way to read it. He was even kind enough to tell me how much he liked it, noticing the mathematical patterns embedded within.

Fortunately for readers of this blog, I won’t make you read it. Instead, let me leave you with a piece of Opa’s own writing. A critique of what he saw to be his strengths and weaknesses as a trader. I hope you will find it has insightful as I have.

 

 

Baum As A Trader

OPEC: Stronger Than It Looks

OPEC: Stronger Than It Looks

The author ducks.

Peering up from the keyboard with a flame retardant helmet and goggles to protect his most delicate of features he writes…

OPEC is stronger than it looks, much stronger. I’m reminded of the lava planet battle between Anakin Shalewalker and OPEC Wan Kenobi in Star Wars Episode 3.

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You see, OPEC Wan Kenobi has the high ground and is better positioned to withstand an attack. He repeatedly warns young master Shalewalker any attack is folly.

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But Shalewalker is young, arrogant, and brash. He ignores master OPEC’s warnings and attacks anyway, ramping up production like no one ever thought was possible. But it’s still not enough to overcome OPEC Wan Kenobi’s superior positioning and the young jedi ends up a cripple for the rest of his life.

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Incredible puns and film references aside, I think US shale (and the cheap dumb money that flowed into it) will end up doing a great service to OPEC. Thanks to US shale the price of oil has been suppressed for over 2 years now. With the oil price persistently low, companies are loathe to invest in future production.

Even though we’ve seen a dramatic reduction in capex, the major oil companies saw their debt almost double from 2012 levels. From Reuters:

“Five of the largest publicly traded oil companies – BP, Chevron, Exxon Mobil, Royal Dutch Shell, and Total – are trying to work down debts that totaled $297 billion at the end of December. That nearly doubled the companies’ 2012 debt levels.

But even with oil prices about 70 percent higher than a year ago, most companies have yet to reach the point where their cash flow covers annual shareholder payouts and expansion projects vital to the industry’s long-term survival.”

The major oil companies decided instead of producing more oil in the future, they’d rather give money they don’t own to their shareholders…

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And what did OPEC do during this time? They added 2m bbl per day of production.

Instead of taking on debt, OPEC members dipped into their pile of savings while at the same time investing in future production.

While reducing crude demand locally through renewable energy investments and tax incentives.

That’s all well and good, but US shale is still ready as the swing producer to put a $60 cap on the oil pice right? The magnitude of the drop in capex suggest that’s highly unlikely.

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With the recent ramp up in shale production focused in the most lucrative areas. The easy oil although not gone is quickly being drained. Repeated frac-hits (where a rig drills into another operating well) might be reducing the efficiency of shale wells.

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The high decline rates of shale wells is another major headwind to sustained production growth. Lastly, US shale’s ability to ramp up further production will be limited by rising service costs.

In the end, we may discover that the technological revolution of shale has as much to do with technology as it does with free money.

Unlike its competitors, OPEC has not produced oil at a loss. It has not spent money it doesn’t have. It has increased investment and now stands to profit from the myopic behavior of yield starved investors. With the world potentially on the eve of a new commodity bull market, the author quite likes the position of OPEC as a future supplier of oil demand that is highly unlikely to fall off to this supposed EV revolution (a discussion for another time).


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

A New Bull Case: OBOR Wan Kenobi

A New Bull Case: OBOR Wan Kenobi

“Help me OBOR Wan Kenobi, you’re my only hope.” ~ Insolvent Governments

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Before I get to the topic of conversation, China’s One Belt One Road project (OBOR), I first want to point out something that has gone relatively unnoticed in the macro community: equity markets around the globe are breaking out of long term ranges.

Japanese small caps have charged to post crisis highs.

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Leading me to believe the Nikkei is not too far behind as it heads to a new millennium high.Screen Shot 2017-06-26 at 7.54.40 AM

After the 2015 bubble bursting, Chinese A shares are breaking out to new highs. Screen Shot 2017-06-26 at 9.11.15 AM

Taiwanese equities are surging above a two decade long down trend line!

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Indonesia breaking out to a multi-year high.

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Trump’s wall talk can’t stop Mexico.

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This bullish price action is not limited just to Asian or Emerging markets. Equities in Germany and France are breaking out of multi year even decade long down trends.

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In the weaker southern states, Greece and Spain have begun to show signs of life as well.

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This all begs the question? WTF is going on here? With debt levels around the world at all time highs what economic development could possibly justify such bullish behavior?

You asked for miracles Klendathu, I give you O. B. O. R.

China’s One Belt One Road program is not just the largest infrastructure project in world history, it is a statement. It is a unified statement from the world’s largest and most insolvent governments that they will not suffer a debt deflation. In one voice they are shouting out:

“…we will not go quietly into the night. We will not vanish without a fight. We are going to live on. We are going to survive. Today we celebrate our Independence Day (from debt deflation).”

For as much as the global elite have decried the end of globalization, the governments themselves have never been busier forming closer economic ties.

Trump is secretly shedding his anti-globalist stance in exchange of US infrastructure investments from China…

And Chinese cooperation on North Korea.

Europe has also boarded the OBOR train. Deutsche Bank has agreed to invest $3B in OBOR projects over the next 5 years. We all know how much the EU loves its Paris accord, and recently Prime Minister Li Keqian reaffirmed China’s commitment to the Paris Accord. Spain’s King recently met with Xi Jinping in Kazakhstan of all places. Here’s a lovely photo of the two:

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But perhaps the most telling geopolitical development that hints at some grand bargain is Japan’s recent shift.

Mind you, Abe’s grandfather is considered a war criminal in China. Abe is a hard core nationalist, and yet here he is, making nice with China on future trade deals. With government debt to GDP at 280%, a central bank that owns 40% of that debt, and a declining population Japan is the epitome of an insolvent country that is running out of time. Some time in the next five years the BoJ will be completely out of financial assets to buy.

Without getting too much into the motivations and plausibility of such an ambitious project, it’s important to realize what the world’s largest and most indebted governments are telling us: “We are going to print the money, we will bailout the banks, we will build the infrastructure, we will do everything in our power to prevent a debt deflation.”

For the remainder of this blog post, I am going to consider the broader implications of a global put option backed by the world’s largest fiscal authorities, mainly this idea that reflation trade is not a trade at all, but a multi-year trend that no one, not even the commodity suppliers is properly positioned for.

While the miners may have not gotten the reflation memo…

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It looks like some of the commodity currencies have.

AUDJPY.

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CADJPY.

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As for commodities themselves, my favorite play going forward might just be copper. On top of the bullish macro demand trends and likely future supply deficit, copper is a way to play the electrification of transportation, which includes not just ground based transportation, but now recently we’ve seen ferries and air planes get the electric engine treatment.

Equities of the two largest copper producers Chile and Peru appear to be in the process of bottoming.

CHILE.

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PERU.

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I find it unlikely that we’d see a continued rally in emerging market equities without considerable follow through from the commodity producers. Below is a (log scale) chart of $EEM / $COPX.

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Note RSI momentum divergence at a key point of double resistance.

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This theme applies across the commodity complex. I believe on a cyclical basis that commodities have bottomed or are in the process of bottoming. Maybe oil retests the 2016 lows, but overtime it should head higher, US shale be damned. Perhaps this is a reason why the future king of Saudi Arabia MBS declared a “turning point” in US Saudi relations. With Trump and the US on the OBOR train, reflation in the price of oil is only a matter of time.

Of course, higher commodity prices lead to higher inflation as well. Over the next few years we should expect upward pressure on developed market bond yields in particular. One interesting theme might see European and Japanese banks benefit greatly from a steeper yield curve and negative real rates.

And yet as nice as this all sounds, the path towards reflation will be anything but smooth. When such powerful forces (the largest debt bubble in history versus the largest fiscal stimulus in history) battle it out for the soul of Gotham it seems insane to expect our low volatility environment to persist.

In the short term, I am actually looking for the deflationary forces to gain the upper hand. The fiscal forces have not fully aligned and at the same time investor expectations have run ahead of themselves. More specifically, investors have piled into Emerging Markets while ignoring some rather sizable macro risks.

Compounding the deflationary risks, the Fed has been on a rate hike warpath of late ignoring any and all consequences of its hawkish policy. Back in April I argued that rampant vol selling has lulled the Fed into a false sense of security:

“This is rampant selling of vol will lead to a whirlwind of unintended consequences, because it creates a false sense of security at the Federal Reserve. Historically the only thing that has stopped the Fed from hiking is a falling stock market. The Fed never responds to economic data, or dollar liquidity issues or anything of that sort. It only responds to falling stock prices. And if stock prices are being artificially propped up due to this “rampant selling of vol” then the Fed will keep on hiking or said differently vol sellers have numbed the Fed to its own hawkish policy!”

As US equities have pushed to new all time highs, the Fed has been led to believe that the US economy and financial conditions are better than they actually are. When we look at bank lending data, we see a deterioration in demand as rates rise and the uncertainty surrounding the current administration warrant caution out of highly levered US corporates.

Further complicating the situation, is China who through the currency peg is forced to import the Fed’s myopic monetary policy. Despite the superficial stability we’ve seen all is not well in the world’s 2nd largest economy. The yield curve has been inverted. In any other major economy a yield curve inversion would signal caution, but in China it is assumed the authorities have complete control. When in fact liquidity in the interbank market has dried up and some of the largest issuers of Wealth Management Products who have been buying up illiquid assets around the globe have had their funding cut.

In the end, I think it’s quite easy to make a case that the Fed has already tightened too much. Risk assets, especially those most vulnerable to tighter dollar liquidity appear to be overextended, which leads me to believe that the next move in global economy is likely to be a deflationary one that will lead to a stauncher commitment from the fiscal authorities to their reflationary policies. I’ll be looking for commodities to be the first to recover in any sell off.


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

Greece: The Gateway To Mispricetopia

Greece: The Gateway To Mispricetopia

“Location, location, location.” ~ William Safire

As the sea based terminus of China’s One Belt One Road (OBOR) program, Greece’s role as a gateway to Europe is greatly undervalued. There are good reasons for that undervaluation, or at least there were, whether it was the depressed European economy, the debt crisis, crippling austerity, global trade slowdown, or the business unfriendly Greek government. While the Greek government may not change anytime soon, everything else either has or is on its way to turning from a negative into a positive.

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Most importantly, a gateway is only as good as the two locations it connects. With the global economy undergoing a major slow down these past 3 years, and Europe stuck in a series of rolling crises for the better part of a decade, the value of Greece as a gateway was quite small. But that appears to be changing. Global growth is on the rebound (at least temporarily) and more importantly the EU appears to be growing for the first time since 2011.

You can make case for that growth has peaked and sentiment towards Europe is extreme, but if you had any doubt that there might be a recovery going on in Europe, look at the defeat of the populist and Euro-skeptic parties.

These political parties which feed off anger, disappointment, and despair have been pushed into the background. If there ever was a sign of improvement in the region, it would be exactly this.

And with the Euroskeptics out of the way, the EU can push towards closer unity.

The French led by Macron are pushing for Greece to be brought back into the fold. Macron has and continues to be a staunch supporter of Greece. From The Telegraph (my emphasis in bold):

“The confrontation at the height of the 2015 Greek debt crisis is revealed in “Adults in the Room”, the new memoir of Yanis Varoufakis, the controversial former Greek finance minister who tried – but failed – to win debt relief for Greece…

On June 28 2015, with Greece’s bank on the cusp of closure, Mr Varoufakis writes that he received a text from Mr Macron offering to broker a last-minute deal to win debt-relief for Greece in return for structural reforms.

“I do not want my generation to be the one responsible for Greece exiting Europe,” Mr Macron wrote, offering to broker a meeting between the Greek prime minister Alexis Tsipras and President Francois Hollande.

The attempt, however, was blocked by Germany whose ultra-hawkish finance minister Wolfgang Schaueble was suggesting that Greece take a ‘holiday’ from membership of the euro.””

Although Schaueble shot down the deal in 2015, a lot has changed since then.

On top of Schaeuble’s shift towards a more unified EU, Greece posted a 2016 budget surplus of 0.7% versus the 0.8% of Germany. This is in stark contrast to the 15% budget deficit Greece ran in 2009. And more importantly if Germany continues to push a hardline, it and the EU could cede even more of their influence over Greece to China.

From the article:

“Cooperation in infrastructure, energy and telecommunications should be “deep and solid”, Xi added, without giving details.

Tsipras is in Beijing to attend a summit to promote Xi’s vision of expanding links between Asia, Africa and Europe underpinned by billions of dollars in infrastructure investment called the Belt and Road initiative.

Greek infrastructure development group Copelouzos has signed a deal with China’s Shenhua Group to cooperate in green energy projects and the upgrade of power plants in Greece and other countries, the Greek company said on Friday.”

China also is a major stake holder in Greek ports. From Al Jazeera:

“Chinese shipping company COSCO is the majority stakeholder in Piraeus port, Greece’s largest, and Chinese officials harbour hopes it will become a major international trading hub.”

From Jing Daily:

“Chinese nationals have taken almost half of the investment licenses the country has granted to foreign investors over the past four years through its “Golden Visa Program.”

But it’s not just investment, China is going to start sending vast amounts of tourists to Greece after it launches the first direct flight between the two countries in September of this year. Over the next two years that Chinese tourists to Greece is expected to climb from 150,000 per annum to over 1,000,000 according to Chinese estimates.

Given that Greece’s tourism industry contributes 20% to GDP, this infusion of cash rich Chinese tourists should be a shot of adrenaline into Greece’s capital starved economy, which will go a long way to easing negotiations between Greece and its creditors. But it’s worth noting that China isn’t the only non-EU country investing in Greece. Russia has taken the 2nd most real estate investment licenses in the last year. From Jing Daily:

“By the end of January 2017, the Greek government issued a total of 1,573 real estate investment licenses to foreigners, out of which Chinese buyers took 664 seats, followed by 348 from Russia, 77 from Egypt, 73 from Lebanon and 67 from Ukraine, according to the data published by the Ministry of Economy. (The data is based on the number of real estate permits they have released.)”

Once again, this poses a huge problem for the EU who is beholden to Russia’s natural gas and oil exports. From MacroPolis (my emphasis in bold):

“To this end, the EC considers a route via the Mediterranean – the Southern Gas Corridor – a crucial investment, stating that “the Mediterranean area can act as a key source and route for supplying gas to the EU.”

This is where Greece comes in. The first major achievement was the signing of the Trans Adriatic Pipeline (TAP). This project sees some 550 km of the pipeline passing through Greece which will link to with the Trans-Anatolian Natural Gas Pipeline and the existing South Caucasus Pipeline (SCP) connecting Turkey to the Azerbaijani gas fields in the Caspian Sea via Georgia.

Together, the three pipelines will form the Southern Gas Corridor, seen as essential for Europe and to diversify away from its current dependency on Russia for gas.

In essence, Greece finds itself at the center of a tug of war between the east and the west. But this is not a zero sum game for Greece. Both sides need Greece to do well for their respective side to thrive. China needs Greece for the success of its OBOR program. The EU needs Greece to form a stronger Union, for it’s role as a buffer from migrants, and as a alternative energy route to end Russia’s gas monopoly among many other things.

It’s a win win situation for Greece, a country who has suffered for five years under harsh austerity without access to the capital markets. The economy is a coiled spring waiting to explode. With China and the EU vying for the country’s undervalued assets its a matter of time before the energy in that spring is released.

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Disclosure: The author is long GREK.


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

The Price Of Stability In China

The Price Of Stability In China

Heading into the year of 2017, the word on everyone’s lips when it came to China was stability. With Xi looking to consolidate power in the upcoming government reshuffle in November, he would need the country as stable as a rock for another 11 months, and for the last 4 months, China appeared to be pulling it off. The PBOC’s pile of FX reserves had not only held steady, but began to rise. The country posted a higher than expected GDP growth of 6.9% in Q1 (that is if you think the market cares about the GDP number). SOE industrial profits were soaring… But above all, the Yuan held steady. From the WSJ (my emphasis in bold):

“BEIJING—President Xi Jinping gathered with his economic mandarins in December for their annual strategy meeting at a heavily guarded government hotel. In closed-door sessions, say people familiar with the confab, he made clear what their mandate was for 2017: He would tolerate no wobbliness in the economy.

The communiqué coming out of the session singled out one policy objective in particular—keep the yuan stable.

What followed has been the marked acceleration of a shift in priorities at the People’s Bank of China, the central bank, toward preventing the currency from cratering above all else.

Much has been said about the relative success the Chinese government has achieved in the first quarter of this year but there has been little said about the costs of their actions. There’s no such thing as a free lunch, and you can bet the Yuan’s recent stability did not come cheap. Since late February, financial assets in China have been selling off. The industrial commodities were the first to fall.

The equity market was next.

But more importantly the bond market has witnessed a dramatic sell off across the board.

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The sell off in Chinese Corporate credit has been even more dramatic.

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Even more serious signs of stress have begun to show up in the system.

Sharply rising interest rates threaten China’s massive shadow banking system which is “estimated” to be at $9.4T or 87% of China’s GDP. From WSJ:

“Shadow banking in China has nearly tripled in size to around 65 trillion yuan ($9.4 trillion) by the end of 2016 from five years earlier, equal to around 87% of gross domestic product, according to Moody’s Investors Service.”

I say estimated because no one, not even the Communist Party knows where all the risk is hidden. From Bloomberg (my emphasis in bold):

“Rising defaults in China are unearthing hidden debt at companies across the country.

Small firms that can’t get loans by themselves have been winning banks over by getting other companies to guarantee their borrowings. The companies making those pledges exclude them from their balance sheets, leaving creditors in the dark. Borrowers often extend the guarantees for each other, raising the risk that failures could ricochet, at a time when increasing borrowing costs have already added to strains.

China’s banking regulator has ordered checks of such cross-guaranteed loans, Caixin reported Friday.

Essentially, the regulators have marched straight into a mine field before checking where the mines were. Only after a few blow ups did they decide to ask the mines to reveal themselves. Talk about an omnipotent top down management style you’d want to bring home to your country. In stark contrast to these warning signs, investors have continued to throw money at Emerging Markets.

Investor flows/sentiment aside, if we take a closer look at where these cross guaranteed loans are located, we find the story only gets worse as much of the shady dealing has occurred between the weaker firms in the weaker sectors of the economy.

“This debt minefield could be big. The amount of loan guarantees at privately held firms in China is equivalent to 11 percent of their equity, and at LGFVs is 18 percent, according to Citic Securities Co. The load is even heavier at weaker borrowers. About 44 percent of issuers rated lower than AA- have a ratio of more than 30 percent, according to Everbright Securities Co.

Mal-investment is often the price paid for keeping zombie companies on life support for decades. The least healthy companies are given just enough to survive and nothing more. And there’s good reason why you shouldn’t give zombie companies more than they need… because they do really stupid things with that money.

From Caixin:

“In the 12 months ending Wednesday, 9,641 publicly traded companies listed on China’s A-share market moved 887.2 billion yuan ($128.5 billion) of capital into such financial products, according to data compiled by Chinese financial information provider Wind. That was a whopping near-46% jump over the same year period ending May 10 of last year.

That’s right, China’s zombie firms took the “free money” the government handed out like candy back in Q1 2016 and invested it in these Ponzi Wealth Management Products. To be fair, $128.5B is just a small amount of the total outstanding WMP market which has ballooned to $4.35T or over 10% of China’s financial system in just a few short years.

Zombie companies investing in WMPs for gains is just the next step in the evolution of WMPs. From investing in the same assets to themselves, WMPs are interconnected in more ways than we can imagine.

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Given WMPs are really just levered bets on other financial assets, and that every financial asset class in China is in some form of a sell off at the moment, it’s not hard to believe that the losses have begun to pile up. These losses are compounded when one WMP is invested in another. If one WMP loses money so too do the WMPs that are invested in it. So the Chinese banks, in order to survive will have to issue an accelerating rate of WMPs to paper over these losses…

Except we are seeing the exact opposite. WMP growth began to slow in March. From Bloomberg:

“Outstanding products issued by banks stood at 29.1 trillion yuan ($4.2 trillion) as of March 31, up 18.6 percent from a year earlier, according to the China Banking Regulatory Commission. The growth rate slumped from 53 percent during the same period last year, CBRC said.”

Only to slow even further in April. From Bloomberg:

“The number of wealth-management products issued by Chinese banks slumped 39 percent in April from the previous month, while trust firms distributed 35 percent fewer products, according to data compilers PY Standard and Use Trust. Sales of negotiable certificates of deposit, a popular instrument of interbank lending known as NCDs, tumbled 38 percent from a record, figures compiled by Bloomberg show.”

With rising losses and not enough additional funding to paper the losses the liquidity in China’s interbank market has dried up and recently like the Chinese government yield curve, inverted.

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Of course it’s not just WMP issuance that has slowed dramatically, the entire shadow banking sector has tightened its lending. From Reuters:

“Trust loans, entrusted loans and undiscounted banker’s acceptances, which are common forms of shadow banking activity in China, totaled 177 billion yuan in April, down from 753.8 billion yuan in March, according to Reuters calculations based on the central bank’s data.”

The entrusted loan industry is $1.7T. Of which $500B comes from WMPs! Not only are WMPs invested in each other, but they are also loaned out to asset managers who lever up and speculate with those funds. From Bloomberg:

“When banks sell wealth-management products — popular savings vehicles that offer higher yields than deposits — the firms sometimes farm out client money to entrusted managers such as hedge funds and mutual funds. The managers invest the cash in bonds, stocks and other securities, hoping to generate enough income to cover the banks’ promised returns to WMP clients — plus some extra for themselves.

Chinese banks allocated an estimated 3.46 trillion yuan of WMP cash to such managers as of Sept. 30″

With paper wealth losses piling up and magnified by the leverage, China’s banking system is in dire need of liquidity. Unless the PBOC is going to allow a hard landing this year, we will have to see a massive amount of liquidity pumped into China’s banking system. Which brings us right back to where this all started, the Yuan’s stability.

Despite the PBOC’s dramatic tightening of monetary policy, the Yuan barely held its own against the dollar. The pattern in USD/CNY looks eerily similar to past instances prior to a weakening of the Chinese Yuan.

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It’s worth noting that the dollar hasn’t even been particularly strong in 2017. It has fallen quite steadily against a basket of currencies since the year began.

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So if the Yuan, despite dramatic tightening out of the PBOC, cannot maintain its value against a weak currency, what’s going to happen to the Yuan if the PBOC is forced to unleash a new wave of liquidity? Will CCP be able to prevent capital flight again?

I don’t think they’ll be very successful. At the same time, I recognize the futility in trying to time an event that is over a decade in the making.

Instead, imagine you are a Chinese citizen. Due to strict capital controls, you cannot get your money out of the country. Financial assets, and industrial commodities are falling in value. The government has put tighter controls on housing speculation preventing you from buying a second or third or eighth home. You are left with just a few options:

Crypto-currencies…

And precious metals.

 


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

 

Oh Canada: Have The Stars Have Aligned For A Loonie Eclipse?

Oh Canada: Have The Stars Have Aligned For A Loonie Eclipse?

Apologies for the title, but it was worth a shot. Speaking of shots, Canada has taken quite a few recently. If you’ve been on twitter and follow Marc Cohodes you know exactly what I’m talking aboot (sorry I couldn’t resist).

Before I get to the implosion in a few of the subprime Canadian Mortgage lenders, I’m going to be very honest here: Last year, I went to the John Mauldin’s investment conference and told everyone brilliant enough to listen to a man-bunned millennial how much I hated the Canadian banks and how I was short them with low delta puts. The banks proceeded to run up another +25% on me while paying 4% dividends. Needless to say, I nailed that trade…

With that said, John Mauldin’s investment conference is rolling around again, and like clockwork I once again find myself short some of the Canadian Banks which I believe are at the nexus of a number of deflationary trends.

1. Canada’s two biggest subprime lenders, EQB and HCG (DISCLOSURE: both of which I am short) are on the verge of bankruptcy threaten the very fragile Toronto Real Estate bubble.

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EQB went crashing back down the 2007 highs. Likely a matter of time before it heads much lower.

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HCG which plunged 60% in a single day is speculated to be guilty of fraudulent lending and is levered 15 to 1. Against this back drop, investors have been pulling money out of the bank to the tunes of hundreds of millions of dollars per week. With the bank run in full swing, HCG has been forced to borrow at an incredibly high rate of +15%. When you take into account the fact that HCG lends at 5%, it doesn’t take much intellectual prowess to come to the conclusion that the equity is worthless.

2. More importantly, the sudden collapse of Canada’s two largest subprime lenders has sent the sector in a whirlwind. Subprime borrowing rates are set to go higher. With some mortgage brokers saying as much as 20% of their mortgages go to subprime, the impact higher subprime borrowing rates have on further demand  And despite what Canadians and Canadian bank bulls say, their housing market is loaded with hidden risks. Canada’s shadow banking sector per capita is actually 5x larger than China’s! Yes you heard that right.

From the article (my emphasis in bold):

“While BoC researchers caution there are “significant gaps” in data and knowledge, what they could find was massive. They estimated that the industry has liabilities of $1.1 trillion dollars, just a little more than half of the $2.1 trillion in liabilities Canadian banks have.

Given the size of the shadow banking sector in Canada, it is likely that EQB and HCG are likely the tip of the iceberg of a levered financial system that has pushed real estate prices to all time highs.

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In the wake of Vancouver’s 15% foreigner’s tax which redirected all the Chinese capital flight elsewhere, we’ve witnessed Toronto’s housing market “go to plaid”.

3. With the most excellent of timing and in a bid to prevent housing prices from rising any further the government of Ontario instituted a similar 15% foreigner’s tax, which should put further downward pressure on real estate prices.

4. At the same time, Canada’s economy remains heavily exposed to the Chinese economy, which has likely peaked in Q1 of this year due to base effects.

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From Reuters:

“The National Bureau of Statistics’ official Purchasing Managers’ Index (PMI) fell to a six-month low of 51.2 in April from March’s near five-year high of 51.8.

Analysts polled by Reuters had predicted a reading of 51.6, the ninth straight month above the 50-point mark that separates growth from contraction on a monthly basis.

Demand weakened across the board with the biggest decline in the input price sub-index, which fell to 51.8, its slowest expansion since June last year, from 59.3 in March.”

Despite the headline, this slowdown was entirely predictable given the YoY base effects. China’s economy bottom in Q1 on the back of a the largest government stimulus since the 2008 financial crisis. Ever since last summer, the PBOC has been on mop up duty, attempting to de-lever and drain liquidity from the financial system.

One of Chinese speculator’s key vehicles of shadow banking risk, WMPs have seen their growth slow in the wake of this dramatic tightening. From Bloomberg:

“Outstanding products issued by banks stood at 29.1 trillion yuan ($4.2 trillion) as of March 31, up 18.6 percent from a year earlier, according to the China Banking Regulatory Commission. The growth rate slumped from 53 percent during the same period last year, CBRC said.”

In order for the credit cycle to continue, these Ponzi finance vehicles need to grow at an accelerative rate. This slowdown in credit growth is a warning sign that should be noted as China’s credit cycle approaches its Minsky moment.

 

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Given M1 growth in China, it is a matter of time before the PBOC turns on the liquidity taps again, which would push the US dollar higher.

It’s important to understand the impacts a slowing Chinese economy would have on future oil demand and prices, a key component of the Canadian economy. China has surpassed the US as the number one importer of oil in the world, in large part due to massive vehicle demand and an unsustainable stimulative push. As of Q1 of this year, China’s government also ended a car subsidy, leading to a dramatic slowdown in sales. From MarketWatch:

“Growth in China’s car sales slowed sharply in March, illustrating the effects of a higher sales tax on the world’s biggest car market.

Sales of vehicles, excluding those typically used for commercial purposes, grew 1.7% to 2.1 million units in March from a year earlier, the government-backed China Association of Automobile Manufacturers said Tuesday.

This marked a slowdown from the 6.3% growth in the first two months of the year. By comparison, sales grew nearly 10% in March 2016 from the previous year.”

Inventories have risen sharply as well.

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In the end, despite OPEC’s best attempts to jawbone the price of oil higher, we find the price resting at a key technical level as well as its 200dma. A breakdown in oil, would put even more pressure on Canadian banks who remain highly exposed to the sector.

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Lastly, the charts of some of these banks listed on the NYSE look very weak. (Disclosure: I am short both CM and BNS on the NYSE). CM has broken below the reflation trade trend-line as well as its 200dma.

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BNS chart is similar, with a familiar H&S topping pattern to boot.Screen Shot 2017-04-30 at 7.28.22 AM.png

Also the longer term weekly chart of BNS shows the stock failed to break at a previous resistance line.

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Given these pressures on the Canadian banking system it is very likely we see a significant drop in the Loonie against the dollar. Although we should all be weary of millennial hedge fund managers bearing “obvious” trades. Cheers!


DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!

Additional Disclaimer: The Author is short the NYSE listed CM and BNS as well as TSX listed EQB and HCG.

The Correction: Don’t Forget To Look Ahead

The Correction: Don’t Forget To Look Ahead

TRIGGER WARNING: This post will include political analysis with very trace amounts of opinion thrown in. As investors so often like to say and rarely actually do, “I am just observing”.


“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” ~ Winston Churchill

The first correction in the final leg (according to me) of the post crisis bull market has begun. Given the tremendous tremendous divergence between market expectations and reality there is likely a bit more downside to come. Positioning, and sentiment are polar opposite to the bottom we saw in Q1 2016.

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Especially, if you consider at what the market was pricing in: record business and consumer optimism as well as a smooth and efficient US government that would pass healthcare and tax reform in short order.

Instead we have a bellicose interventionist President Trump who has sparked geopolitical tensions in the Middle East and North Korea. At the same time, the French elections are turning out to be less clear than the market also predicted (notice a pattern).

In the end, shit is about to get somewhat more real, but that doesn’t mean the highs are in (more on this later). For now the Trump/reflation trades, which have looked weak these past few months are beginning to unwind. The key 2.30% technical level on the US 10 year was finally breached this week.

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The technical breakdown in the US 10 year treasury likely signals further downside in US financials (XLF), a key beneficiary of the Trumpflation narrative.

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The Yen a key measure of risk has been strengthening, blowing through stops, and just generally crushing risk appetite. Now below the 200dma and the 0.618 fib re-tracement level off the pre-election lows.

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Semiconductors, the post Brexit leader, up 50% from the lows, has closed below its 50dma and is testing the super special (sarcasm) 79dma. But seriously. We haven’t seen a close below the 79dma since BREXIT. This will be something to watch going forward.

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There’s a clear H&S pattern on the Russell 2000.

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At the same time, XLE has led oil this year and looks to be headed lower. Given the importance US shale plays in the economy, this could signal further economic weakness.

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Throwing salt on the open wound, retail sales and inflation both disappointed expectations on Friday.

In short: “It’s an ugly planet, a bug planet!” (Video might be broken, but hey! At least you get the reference now).

 

Although the risks, given the lofty valuations, are asymmetric to the downside, it is of vital importance to not get carried away with our bearishness. I made this mistake in 2016. I missed the signs of a bottom. I had been short on the way down, but instead of pulling back, I pushed harder and paid for it. Maybe this is the time to do that, but maybe it’s not (more on this later). It is worth noting that folks are still incredibly scared of a one off event (including myself).

As investors we are in constant conflict with our inner animal which tells us us to sell when we should buy, and buy when we should sell. Not only must we not give in to these primal instinct, we must also be keenly aware of the fact that if we are experiencing these emotions it is quite likely that others are as well.

If this correction continues it does NOT mean equities are about to fall apart. Market tops are long processes that take months if not years rarely ever days. Sure the parallels to a 1987 style event have been shown time and time again. Vol selling is the new portfolio insurance. Passive is only passive on the way up. CTAs have record assets under management. The fuel is certainly there. I get it. I am aware of it, but so is everyone else. Stocks have barely fallen and yet the cost of hedging has already shot up dramatically.

Investors remain keenly aware of any downside risk. Meanwhile the central bank put is still there. The Fed may be hiking now, but with economic data coming out towards the downside, Trump meeting stiff resistance in Congress, and most importantly a falling stock market the Fed can quickly pivot from hawkish to dovish rhetoric. If the sell off does accelerate, I expect talks of balance sheet reduction to give way to QE4.

Perhaps this shift potential shift from hawkish to dovish may already be showing in precious metals.

 

Although I’d likely attribute most of the move in gold to the war premium.

Worth noting, as Luke Gromen likes to remind people smart enough to follow him on twitter: high stock prices are now a matter of national security.  Even with equity markets at at all time highs, pensions remain tremendously underfunded. A fall in financial assets would cripple pension funds. The knock on effects would spiral out beyond the government’s control leading to consumer debt crisis with the Fed forced to monetize an ever widening US Federal Government deficit.

Thus the Fed, and “the powers at be” have a hefty amount of incentive to keep stock prices elevated. At the very least, the Fed, armed with its newly minted ammo, should be able to hold the line for 3-6 months before it has to even think of threatening the nuclear option, QE4. Look for the Fed to buy time while the market narrative adjusts to the reality.

From the WSJ:

“A growing number of forecasters are beginning to reconsider their bullish outlook for the U.S. economy as doubts grow over the extent to which President Donald Trump will be able to implement his agenda.”

Now that price and economic soft data are beginning to reflect the “hard: reality, I find it quite comforting to see economists like rats jump from the sinking ship that is Trumpflation and the hopes of fiscal stimulus that come with it. Ironically, as the mainstream lose faith in any Trump stimulus or healthcare reform, the odds of the passage of said legislation are actually rising, albeit from a very low base.

WARNING: Here be Dragons. You are entering the political analysis section of the blog post.

What the narrative surrounding Donald Trump refused to acknowledge was just how little power US presidents have domestically. This is especially true when Congress is gridlocked to a standstill. Throw in debt and demographics on top of the rigid congress, and the US president’s domestic policy is practically set in stone.

After failing domestically, Trump has turned his focus abroad. He needs to score some quick wins politically and I’d say he’s done just that. He has used missile strikes in the Middle East to threaten North Korea and force Chinese action (at least superficially).

By projecting US military strength abroad, Trump has pulled the war hawk members of Congress on both sides of the aisle closer to his point of view. At the same time, he has allowed more of his policy decisions to be influenced by Jared Kushner a left leaning New Yorker further bridging the wide divide between his administration and the Democrats.

At the same time, as the economic backdrop continues to deteriorate, Trump will be more than happy to lay the blame at the feet of a gridlocked Congress. I can see it now: “Congress can’t pass much needed health care reform while bad Obamacare implodes. Sad!”

The Democrats have the most seats in contention next year, and will need political wins to secure those seats, else they’ll cede total power to the Republicans and Trump. They can’t do that if they sit by idly as the economy implodes. With some of the Dems coming closer to Trump’s camp, it won’t be hard to leverage the necessary votes for health care reform which would then pave the way for tax reform. Throw in talks of QE4 and the stock market could surge for the final leg of the post crisis bull market.

 


DISCLAIMER: This blog is the diary of a twenty something hedge fund manager who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!