Biotech Year One: A Year of Trials Tribulations and Discovery

Biotech Year One: A Year of Trials Tribulations and Discovery

This was our first year investing in the biotech sector. We had no idea how companies would respond to news, positive or negative. We had no idea what the market understood and how it interpreted data. We had no idea.

The market is its own beast, derived of the aggregate opinions and knowledge of the mainstream thought. And despite incredible advancements, the mainstream’s understanding of biology, physics, and biotechnology remains rooted in early 20th century ideology that has long been disproved.

We understand it is a bold statement to say the vast majority of PhDs, MDs and investors that make up this industry are wrong due to a fundamental flaw in their analysis, but after a year of investing in this space, we have been convinced of this simple yet powerful truth.

Even in the 21st century, with the amount of computing power and algorithms and modern tools available to companies, researchers and analysts, pharmaceutical development remains a trial and error based process. This is because they do not understand biology and physics’ role in biology. Anyone who has done a bit of research into quantum computing will also realize how poor our understanding of physics truly is but that’s a story for another time.

The point is that this trial and error approach and the mental models that support it have far reaching consequences to how biotechnology developments are interpreted by the market.

The market has incredible difficulty trusting new data that does not fit into these preconceived mental models. And because those models are so poor and so fuzzy even reasonably well understood trial results have to be proven again and again over larger patient populations.

The mainstream believes life is dumb and random, that cells are a liquid soup of biochemicals and seawater governed by nothing more than chance encounters driven by Brownian motion.  This is no more evident in the hubristic subsector of gene therapy. These trial and error gurus believe it is life that has made the mistake that only they can correct. When in fact life (and in this case our bodies) are responding to environmental conditions. We hold the exact opposite view of the mainstream; we believe that life is intelligent and coherent down to the cellular level or as we like to say:

“Life does not play dice.”

Life uses natural genetic engineering, a complicated and remarkably intelligent system that far surpasses our artificial means of doing, in order to adapt to changing conditions of existence. Natural genetic engineering is specifically activated, targeted, and precisely executed. Living systems are quantum coherent and therefore “know” more information about themselves than we are capable of knowing through outside measurement.  Artificial genetic modification invariably interferes with natural genetic modification. In fact, it depends on disrupting and overriding the cell’s own precisely regulated natural genetic modification, which explains its total lack of precision, with many uncontrollable and unpredictable effects.

We believe our edge in understanding biological processes and how it translates into biotechnology developments is peerless. But as it turned out, our sharpest sword was double edged. We could accurately predict trial results in our chosen companies but we could not predict how the market would respond. As if some sort of sick irony, our best results were the least rewarded and often penalized while our worst results (although still positive) were rewarded beyond our wildest expectations.

“To fight the bug, we must understand the bug.”
~Sky Marshal Tahat Meru

This has required us to go back to the drawing board in how we approach investing in this space. It is not enough to identify mispricings in the market. It is not enough to understand with near 100% conviction which drugs are breakthroughs, and which aren’t. The market might be stupid, but it is also right and must be respected. We cannot disagree with price and we must adapt to the market if we are to increase our returns over the long run.

At the start of the year we based position sizing primarily around 2 major factors:

  1.  The price of the drug relative to its long-term value
  2.  The timing of the next news release.

We naively believed that once the results were in, it would be “obvious” to the market that certain drugs offered breakthrough potential. Boy, were we wrong.

“Any sufficiently advanced technology is indistinguishable from magic.
~Arthur C. Clarke

Breakthroughs by their very nature are without precedent. And without a precedent the analysts, the company executives, and the market in totality are unable and incapable of accurately pricing in such information.

In our view, the market has a binary, linear, and overall simplistic approach to trial results ignoring the context in which each trial is conducted. Either the drug works, or it doesn’t. If the drug was believed to have “failed” once, it’s more likely to be seen as a failure going forward. If the drug does not show promise at the interim results, the final results are more likely to be discarded despite any promise.

What this means is that in lieu of just sitting in our favorite drug companies and waiting some five to ten years for them to pay off, we have to incorporate the limitations of the market into our process.

“And so, without further gilding the lily and no more ado…”
~Jeffery Chaucer, A Knight’s Tale

Biotech Overview:

Back in October,  we auspiciously called the the top in biotech back in October with the blog post titled “Biotech is not a Bubble“.

Oops.

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But we also identified a few long term structural trends that suggested the bull market in biotech was just beginning.

  1. China, the largest growing market for pharmaceuticals has begun and continued to open up itself to foreign pharmaceutical companies.
  2. The world in particular the emerging world is getting richer and will be able to afford more pharmaceutical drugs.
  3. Populations due to pollution and poor lifestyles are getting sicker.
  4. Innovation drives renewed sentiment – Drug development over the last 50 years has largely been stagnant, that too is changing and will drastically improve sentiment.

Unsurprisingly none of these trends have diminished over the past 2 months. Price may have changed but the structural trends remain firmly in place. The world is getting wealthier and sicker at the sametime. Or said another way, our ability to afford the drugs we increasingly need is also increasing. China has continued its drive towards reforming its pharmaceutical market. The US remains the bastion of pharmaceutical development making biotech potentially one of the best short USD trades over the next 5-10 years.

And yet sentiment towards the space is incredibly negative. Despite XBI and IBB being up ~40% and 25% respectively inflows turned negative for the year.

Despite the solid returns in 2017, biotech remains historically cheap to the broader market.

The low vol, ever rising broader equity markets might be partly to blame. High vol biotech equities remain a difficult place for investors to allocate capital when every equity market around the globe rises in lockstep to the tune of record low and falling volatility.

Perhaps it is not a coincidence that biotech’s best period relative to the broader market came after the broader market had stagnated (from late 2014 to mid 2015) and appeared to have topped out. SPY (orange line, LHS), IBB/SPY  (black line, RHS).

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We note that the previous 3 times biotech has been this cheap to the broader market marked a buying opportunity.

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XPH, SPDR’s S&P Pharmaceutical ETF has lagged the XBI, and IBB, but may be key to showing renewed sentiment towards the space. These large cap pharma companies have struggled since Q1 2016 but we believe that may finally be changing.
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We attribute a lot of the sideways chop to the growing divide between the winners and losers in this space. The FDA has approved drugs at a record rate this year which has gone a long way to increasing competition in the space.

This increased competition from new drugs has put a burden on the incumbent drug makers who have gotten fat off annual price hikes and patent trolling. TEVA’s generic drug business model has been decimated.

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AGN appears to be having similar problems with its generic drug business.

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While names like JNJ are probing new highs.

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Some medium size names have taken some heavy licks but appear to have bottomed or in the process of bottoming. MYL.

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Biogen, Merck, Incyte, Pfizer and BMY are other possible examples.

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In our view, we’ve seen a good amount of creative destruction in the space. The initial damage has been done to some of the weaker components of the sector. The stronger ones have continued to thrive, and the middle of the pact may have already suffered the worst.  Thus we could see some more consolidation but believe that with the benefit of tax cuts and time the trend should be higher from here. After all, it’s not like our population is getting younger or healthier.

Merry Christmas and Happy New Years to all my readers! 

 


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, this blog post 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: We hold no position in any of the stocks and ETFs discussed here and have no intention to do so in the next 72 hours. 

The Unholy Union: The Marriage of Technology and Geopolitics

The Unholy Union: The Marriage of Technology and Geopolitics

The world economy is undergoing a technological revolution that resembles the dotcom bubble on steroids, gamma rays, and LSD. From AI to biotechnology to quantum computing to renewable energy to energy storage, the number of fields undergoing rapid advancement are beyond counting. We have reached the point when the sheer vastness of these trends creates a sort of network effect – an innovation in one area can lead to rapid advancements in other areas.

Due to the improvement and efficiency in hardware and computing power, launching a startup has never been easier. There are now thousands of startups around the globe working on applying AI and ML to various aspects of our lives.

Innovations in battery technology are powering a second transportation revolution which is separate but further enhanced by the autonomous driving revolution. Within a few years electric powered drones will be capable of flying people across cityscapes reducing the travel time by 90%. Cheaper more durable batteries are enabling grid power that can solely rely on renewable energy.

This accelerative and widespread technological revolution stands in stark contrast to the fears of a global depression just beyond the horizon that sends the world’s nationalist elements into conflict against each other. Instead, the global economy is a non-zero-sum game and for the first time in my life time, from Trump in the US to Xi in China to Abe in Japan to Modi in India to Macron in France to MbS in Saudi Arabia to Macri in Argentina the world’s largest economies are headed by pragmatic deal makers set to make their mark.

Which brings us to our favorite macro theme, The Unholy Union: The Marriage of Geopolitics and Technology.

These big players have just begun their dance, with each one jostling for a bigger share of a growing pie. This competition is incredibly positive for global growth. Already we’ve seen Japan and India form a partnership (The Asia Africa Growth Corridor) to offer an alternative to China’s Belt and Road Initiative (BRI). At the same time, Japan is not shunning China entirely. Abe and Xi have renewed their countries commitment to each other.

‘“At the end of the meeting, President Xi said this is a meeting that marks a fresh start of relations between Japan and China. I totally feel the same way,” Abe told reporters.’

By working together, Japan and China can fill gaping holes in each other’s economy. Japan wants to weaken its currency, and invest in projects that return more than 0.4% yielding 40 year JGB. China has the projects and the factories to make it happen but needs help with financing. Japan can shift its savings to Chinese bonds, weakening the Yen against the RMB, propping up China’s economy and currency which in turn would boost the rest of the emerging world which so heavily depends on China’s ongoing economic expansion. As a net exporter, Japan would gain an increased benefit from positive global growth. In this scenario, a key barometer of success will be the CNY/JPY exchange rate.

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But this is just one example. There are many new deals forming, under the surface between global powers. Did you notice that MbS announced a major turning point in US Saudi relations months before he purged his political enemies?

Do you think Trump’s bid for Aramco the very moment MbS had purged his government of political enemies was a coincidence?

Or that some of those caught in the purge just so happen to have funded some of Trump’s political enemies as well?

The good thing about these deals, is that they cannot be fully obscured for the players are too big to hide their hand. The bad news is that the financial risks have never been greater. The debt has never been this high. The demographics whether it be our aging populations or the deteriorating health of those populations has never been worse. And the wealth divide has never been this large. The cost of failure is very high and very very real.

On our current trajectory, inflationary pressures that send shockwaves through the OECD bond markets may be less than 2 years away. At the sametime, central banks have embarked on tightening monetary policy in earnest for the first time since the crisis. But with the help of accelerative technological trends and improving geopolitical relations world leaders still possess the tools and resources to prevent or at the very least delay any significantly bad outcomes for years to come. Which means, that for the foreseeable future, the biggest risk to global economic stability is not economic, but geopolitical.

 


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, this blog post 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!

Vanadium: The Next Commodity You’ll Pretend To Know Everything About

Vanadium: The Next Commodity You’ll Pretend To Know Everything About

Ever since China arrived on the global stage at the turn of the 20th century, front running the rising juggernaut has been an incredibly lucrative strategy. In the early 2000’s this meant buying exposure to common elements like copper and iron ore, but more recently emerging technologies have shifted the focus to more niche and illiquid elements like cobalt and graphite (carbon) making the trade harder to put on. The next link in this chain is Vanadium, which is fast becoming a key component to many technologies and industries.

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Vanadium is used to make steel and aluminum stronger while reducing the weight. Lighter and stronger metal alloys are increasingly important in our modern society where we strive for lighter more fuel efficient vehicles. From WSJ:

“By 2025, the amount of lightweight, high-strength steel in a car or light truck in North America is projected to rise to an average 483 pounds, 76% above the 2015 average, according to industry consultancy Ducker Worldwide.”

“Aluminum content in cars and light trucks in North America is expected to reach an average of 520 pounds in 2025, a 31% increase from 2015, according to Ducker Worldwide. More than two-thirds of closure components, such as hoods and trunk lids, on light vehicles are expected to be aluminum by 2020, double from 2016.”

More recently, Vanadium has found its way into the energy storage business. Vanadium redox batteries may not have the same energy density as lithium ion batteries, but they make up for it in terms of reliability, durability and robustness. As renewables create more demand for grid storage we should see yet another source of demand for vanadium. Here’s a link to cool visualization for all the uses of vanadium.

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All else being equal before I even take China into account, there is a very bullish backdrop for vanadium demand. Vanadium’s global annual inventory change is shown in the chart below.

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As for supply, the vast majority of vanadium comes from a byproduct of iron ore mining, which like every other commodity industry in the past 6 years has undergone heavy consolidation. Russell Clark of Horseman Capital wisely notes, capex from the four largest iron ore miners has fallen off a cliff.

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As part of China’s movement to deleverage parts of its economy and reduce environmental damage, potentially 1/3rd of iron ore mining licences in China will be revoked. This policy also extends to some pure vanadium mines that will be forced to shutter as well. But that’s not all, because China recently banned the import of low grade vanadium scrap metal reducing vanadium supplies further.

At the same time, China is moving up the value chain and will need to create high quality products that are worth of the “Made in China” and OBOR brand names. So this summer, China announced a new policy that raised the standard tensile strength of steel rebar from 335MPa to 600MPa, which could boost China’s demand for Vanadium by 30%, bringing it more in line with western levels.

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Note India at the low end of the consumption spectrum is planning a massive infrastructure overhaul of its own country. Obviously roads aren’t made of steel, but the point is clear, India is serious about upgrading its poor infrastructure.

Also worth noting the last time China upped its vanadium demand through similar policy was in 2005.

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To quickly sum up, supply of vanadium is falling or stagnant. Demand is seeing notable increases from a wide range of sources. And the two world’s largest countries by population are set to supercharge these imbalances through new policies. Unless Earth is about to be hit by a bug meteor full of vanadium it seems to me that prices have only one direction to go.


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, this blog post 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!

Biotech Is Not A Bubble

Biotech Is Not A Bubble

With the SPDR S&P Biotech ETF XBI [disclosure: We hold no position in XBI] within 5% of its all time highs, we hear a lot of people calling biotech a bubble. Let’s be clear, biotech is not a bubble. There are may be many bubbles out there, but this is not one. And if that is too much of a leap for you to take, then assume biotech is a bubble but that it will get a lot bigger, so big that Trump is going to have to invent a new word to describe it (my vote is for Yugenormous).

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After falling 50% from the peak the SPDR S&P Biotech ETF XBI has almost fully recovered and is within 5% of the all-time highs. Despite this resurgence, some biotech companies irrespective of the quality of their drugs are still down over 90% from their 2015 highs.

These companies to the community at large are practically untouchable. Fund managers are afraid to touch them because they are too illiquid. And even if analysts understood the science (which they don’t), they won’t bother to cover companies of so little consequence, which means retail investors know nothing about them as well.

In short, these are hated companies, and yet these companies were able to tap the market for funding at an extreme overvaluation back in 2015 allowing them to ride out the storm which we have believe is now over.

We’ve begun to see flows come back into some of these “left for dead” companies. Some of which have doubled and tripled without any news whatsoever. To be clear these are hated rallies, simply for the fact that no one owns them. And for some perspective a company that falls 90% then doubles is still down 80% from its highs. The bull market in biotech is still in its infancy and we think the macro backdrop supports this for three main reasons:

 

1. The regulatory backdrop in the US for bringing new drugs to market has never been better. Meanwhile, big pharma companies, with their dwindling legacy pipelines and boatloads of cash, have a decision to make, develop new drugs, buy new drugs at a premium, or fade away. Gilead’s recent $12B acquisition of Kite Therapeutics is likely to be the beginning of a wave of acquisitions.

2. The 2nd largest and fastest growing market for pharmaceuticals, China, is in the early stages of opening itself to big pharma.

Red tape is being cut in China as well.

“Under China’s new rules, data from overseas clinical trials can be used for drug registrations in the country. “

China’s large population combined with its environmental and pollution problems combined with a poor diet/lifestyle have been a perfect storm for creating massive demand for high quality pharmaceuticals. From McKinsey:

“China faces mounting medical needs—for example, it has 114 million diabetic patients and more than 700,000 new cases of lung cancer diagnosed each year.”

But don’t forget, the rest of the emerging world is growing and gaining wealth.

As the emerging world’s middle class grows, so too will its demand for prescription drugs. Not only will this create profits for US drug companies, but it will also reduce their reliance on overcharging US consumers for access to medicine. This in turn will reduce the cost of health care in the US at the same time quality of care improves…

3. It’s 2017 and we are still using chemotherapy and statins to treat deadly diseases. This is simply appalling. The truth is that advancement in pharmaceutical care since the War on Cancer was declared back in the 1970s has been pathetic, especially when you consider the amount of money thrown at the problem.

But that too is finally changing. Real drugs offering real improvements in patient outcomes are coming down the pipeline. Cancer, alzheimer’s, cardiovascular disease, mitochondrial malfunctions, you name it there’s likely a drug coming to change patient outcomes for the better. And as these drug breakthroughs come to light we believe this sector will experience yet another euphoria driven bubble that could make the 2015 peak look like an ant hill. 


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, this blog post 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!

Big Week For The Once Mighty Dollar

Big Week For The Once Mighty Dollar

Be warned, this is a short post.

Janet Yellen and the Fed surprised markets this week by actually doing what they said they would do. Shocking!

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If you could not tell from the tone of my first sentence, I was not in the least bit shocked, and had shorted some EURUSD. What I was not expecting, however, was that despite the Fed’s hawkish surprise, the dollar barely budged.

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The lack of a dollar move is especially concerning when we consider the context of the move. So far this year the DXY has fallen over 11% against the backdrop of consistent Fed tightening.

Meanwhile speculators haven’t been this short the dollar in over 4 years.

The lack of a dollar rally at this juncture given spec positioning and the dollar’s dramatic fall is a bit concerning here for those of us who were trying to catch a bottom in this dollar rout (guilty). Now it’s only been a few days since the Fed indicated its hawkish intentions, but if you were to ask me right now, I’d be leaning towards a continued breakdown in the dollar.

What’s interesting about this continuation of the dollar’s fall is the threat it poses to the low volatility regime we find ourselves in. Large moves in any direction for any major asset class is bound to cause ripples even if the move is initially seen to be as a positive.

The issue here is that the ECB and the BOJ have kept rates so low for so long that the savers in their respective countries have been forced into incredibly dumb trades. For example, being long USDs and long USTs…

Read that number again, and then read it again. European investors bought almost $600B of US debt last year. Perhaps these foreigners are the real speculative position we should worry about. The dollar has fallen 15% against the euro this year alone. At what point does the fall in the dollar become too painful? How many years of income must these foreigners lose to currency effects before they start to hit the sell button?


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, this blog post 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!

 

Long Day’s Journey Into Night: A Bear’s Search For Proper Shorts

Long Day’s Journey Into Night: A Bear’s Search For Proper Shorts

As a pessimistic China observer (naive western perma bear), I’ve wanted to short emerging markets for sometime. For my sake I’ve been very patient on this trade and haven’t fancied a go on the dark side, unless you count my 2nd failed attempt to short the Superhuman Canadian Banks. Luckily there was an ongoing implosion in US retail industry that has kept me busy. But even that trade appears less appetizing these days. So here I am, a bear without anything to short, which is partly why I’ve turned my attention to the rip roaring Emerging Markets, but I swear I have other good reasons.

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Whatever happened to Brendan Fraser? I guess the same question could be asked about the dollar bulls.

 

Anyway you slice it, USD positioning is not only incredibly bearish, but just 9 months ago incredibly bullish. The shift in investor positioning  is enough to give a person mental whiplash. Why the sudden shift you ask?

Such a shift in sentiment is not without a narrative to support it.

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I’m not mocking the proponents of this theory, although it certainly seems like I am, I swear (see previous Mummy reference) that I’m not. I just happen to sincerely doubt the speculators who switched from net long to net short are capable of such deep thought and will only come to their sense after they realize they’ve overreached.

As the infinitely evil DarthMacro likes to argue the USD will lose reserve currency status eventually but until then there are likely to be a few tradable scenarios in which we don’t have to sell the dollar into oblivion. Now MIGHT just be one of them…

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Because last time I checked, the USD is still THE world’s reserve currency.  As much as certain countries want to shift to a new regime, the high levels of debt and fragilities built into the current system make that virtually impossible. A clear example is the EU and the Euro. Although recently, some rather smart people have started to suggest that in fact the EU can handle a stronger Euro.

The note was from September 5th, but little did I know, 2 days before I made this tweet that in fact the French had begun to protest the much needed labor reform, although not in “great” numbers. There’s a star wars reference in here somewhere…

And yet, despite the mild protests, if your are an exporting economy and your currency strengthens 15% against a major trading partner, it’s going to hit you no matter what. Just look at the German DAX (blue) versus the Euro (black).

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By the way, before I go any further, is there a more bullish sign out there than a heavy exporting economy’s stock market moving up in lockstep with a stronger currency?  I’m sure some really smart macro guys picked up on this, unfortunately I was not one of them. But I digress because right now the DAX is having trouble rallying into this “excessive” Euro strength.

It’s bad enough for Germany, but what about countries like Greece, Spain, and Italy who were already suffering under a currency too strong for their own good. Fellow European exporter, Sweden has seen its economy take a turn for the worse.

Why is this significant?

After doing a little digging (aka a simple google search), I found Sweden’s top ten export markets to be as follows: Germany (10.3%), Norway (10.1%), US (7%), Denmark (6.9%), Finland (6.7%), UK (5.9%), Netherlands (5.3%), Belgium (4.5%),France (4.3%), China (3.8%) and Poland (3.2%).

Sweden mostly exports to Northern European countries. Meanwhile a large part of the resurgent EU story is actually a southern rebound story. Countries like Italy and Spain even Greece have started to show signs of life. Of course the Euro was already too strong for these countries. One can only imagine what the 15% rise YTD has done to their future growth prospects.

It is important to remember that the level of a currency is not as important as the magnitude and direction of change. The last time the dollar was at this level in 2014, emerging markets were undergoing a massive correction, commodity markets were in complete disarray and china was seemingly on the verge of a complete implosion. Once again I reiterate this does mean I think the EU is about to implode under a stronger Euro, just that the monetary union’s economies are about to take a breather…

Speaking of China, the rising power seems to be making trade deals every day to wean itself off its dependence of the US and the USD.

Have any of the dollar bears asked why China needs to do these trade deals in the first place? Oh yeah, because the US is a key trade partner and the USD is an ESSENTIAL cog in global trade as it stands right now. Removing the USD from the global economy would be tantamount to bleeding the global economy dry. Global trade would grind to halt, and everyone would be worse off. No one wants that. But I digress…

Because China’s economy has been running hot on the back of a poop ton (technical term) of stimulus and the weaker dollar.

What is often missed in this post Jan 2016 correction world is that China has gone from an exporter of deflation to an exporter of INFLATION, and given the fall in the USDCNY this should show up in the US in a big way towards the end of the year catching a lot of people off guard.

Can rates in Europe and Japan going to follow the US higher? With the NIRP and QE programs still in place I’m not so sure. Draghi certainly has the potential to tighten, so I won’t count the euro out. But the yield curve controlled Yen in this scenario?

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At the very least, it seems like we are setting up for a bit of 2016 Q4 redux, where rates in the US rise higher than they do in the EU and Japan and the dollar strengthens. Given investor positioning, rising rates and a stronger dollar could set up for quite the pain trade. Not only are investors very bearish the USD, they are also very long UST duration.

Retail investors going hard in the paint for that $TLT.

Should probably ask some of my millennial friends what they think of dividend stocks.

And just so we are clear on the size of the potential tinder available to such a pain trade…

 

If you’re an EM investor it might even get worse, because China’s economy due to base effects and waning stimulus is set to slow into the end of the year.

Did Klendathu find his desired short trades? Perhaps. It seems that higher US rates are in the cards, and given USD positioning, we could see a rebound in the USD, but I wonder if we have in fact seen the highs for the USD this cycle.


 

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, this blog post 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!

 

Buy Low: Cripples, Bastards and Broken Things

Buy Low: Cripples, Bastards and Broken Things

I’ve struggled to write this article for over a month now. Thinking about the most clever way to talk up the bull case for oil. With the potential breakdown in the USD I thought about just saying dollar bear market = commodity bull market. But let’s face it, that’s far too obvious and I’ve already done that

” 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.”

Then I thought about incorporating the oil bull case with the fiat bear case. Because when every central banker is behaving like the Mad King Aerys Targaryen, shorting fiat in terms of real assets is a no brainer (maybe some other time though).

Instead, I thought it important to focus on something Opa used to tell me:

 “Buy low.”

riggssss.png

RIG, a company we own through the ETF OIH, is down over 95% from its ATHs and was recently trading at the lowest point in its 23 years. To put that in perspective, RIG fell 50% FOUR times. The multi year trend of rising RSI momentum and repeated failure to mark a new low is reminiscent of the pattern in the Euro we saw at the in December of last year. To be clear this trade is not without risks.

But as contrarians we welcome such news. If we look at the broader OIH ETF which includes as basket of these names. We’ll see a similar pattern bottoming pattern to RIG’s.

OIH123.pngThink about what this chart is telling you. Think about the statement the market is making in regards to the oil industry. Offshore oil drilling is dead.

If US shale is really a technological revolution, why have the producers underperformed the commodity since the bottom in 2016?

And yet we are led to believe that oil prices will be contained in a 40-60 range. As Jawad Mian recently noted, complacency towards this mythical range is reminiscent of the view from 2011-2014 that oil would remain above $100 in perpetuity. And with the largest cut in capex since 1998, this seems unlikely to say the least.

Screen Shot 2017-09-13 at 2.23.31 PM.png

Meanwhile, it’s been up to US shale to make up the difference in capex. I’ve recently read a couple of skeptical reports on the technological revolution that is the US shale industry. One of which comes from my friend @IndiePandant who makes a strong case that the shale revolution is not all it’s cracked up to be.

Then there’s a man who is as smart as he is skeptical, Russell Clark, who brings up a number of key questions in a recent piece such as the rapid decline rates of US shale, the heavy concentration in the Permian and Eagle Ford plays, and the incredibly poor returns on capital. And then of course there’s the plateauing US rig counts.

If the rig count is plateauing, why are predictions for US oil production growth continuing to rise?

 

And if the bearish oil case was only a bullish US shale case, that might be enough, but it gets better much better…

Screen Shot 2017-08-22 at 6.16.14 AM.png

In case you haven’t learned to zig when The Economist zags yet…

The “Electric Vehicle crushing oil demand” story is completely overblown. Mass adoption, or even marginally higher rates of adoption continue to be pushed further and further out into the future. Meanwhile oil demand is booming baby.

It is likely that the weaker dollar combined with China’s fiscal stimulus have reawakened global oil demand. Although Emerging markets are not booming like they used to, they are still growing, and require more and more energy to fuel their growing economies. So not only is it likely that have we overestimated future oil supply, it’s likely we have underestimated future oil demand as well.

At a time when the all knowing oil gods cannot survive,
perhaps it is time for contrarian millennials who know nothing to thrive.


 

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, this blog post 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!