Small Cap Value Report (Fri 19 Feb 2021) - Roubini On Bitcoin, TUNE

19th Feb '21 by Paul Scott

253 comments 14492 reads

Good morning!

It's Friday, time to ponder things.

In my view, we are now in the final, manic, euphoric phase of a bull market. It feels *exactly* like 1999 to me. That means there's lots of money to be made, on mad speculations, and it's going to end really badly. Maybe not for a while though, nobody knows. In this type of market, my thoughts on company fundamentals just become irrelevant, as the hot money chases the increasingly silly speculations. Facts & figures go out of the window, as people chase stories.

There are two key things to remember in this type of market - (1) don't believe in the speculative stories, just sell them on for a profit to the greater fool, and (2) cash out of all the speculative junk before the crash happens, then walk away & don't look back.

When things are going well, it's worth pondering, how much money do you actually need? A word of warning here. I was sitting on about £x millions in 2007. Here I am 14 years later, and I'm still not quite back to flat. Why didn't I just cash out in 2007? Greed, and hubris. Simple as that. A big run of luck & success, in a bull market, led to me risking money I needed, to make more money I didn't need. A very harsh lesson. Let's not do that again. It's so difficult, and time consuming, to rebuild from a disastrous downturn.

Bitcoin is the mania of the moment. It's an absolutely classic financial bubble, hiding in plain sight. It ticks all the boxes that previous manias over centuries have done. Here is a brilliant demolition of it by Nouriel Roubini -

What he says is just brilliant, and it's quite obvious to me that sooner or later, Bitcoin & all the rest of these things, are likely to collapse. The danger is what damage that inevitable collapse does to the financial system, which is likely to end up containing a lot of leverage that fed the boom.

Or does it all just end up being picked up by the taxpayer, via QE? Who knows. This could all run & run, for many years. Nobody knows, the rules have all changed.

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Phuntt

20th Feb '21

Guys, just wanted to say thank you for an awesome thread. Particularly to JohnEustace for recommending “Promises, Promises” on the BBC. Listened to it this morning and just couldn’t stop. The conclusions I disagree with (dangerous lefty thinking that the way out is debt forgiveness is appealing but ultimately contrary to human nature and such an anathema to the established order that it can’t happen without a bloody revolution).
As always, Alphaflight has the best links (I’m sure I’ve told him that before somewhere) - his article on reverting to a gold backed money supply is also appealing but ultimately dangerous right wing thinking - I can’t imagine a world where we in the west agree to again work for a living coming to pass without an equally bloody revolution.

The whole thing has left me soul searching for the entire day and a few early conclusions:

1) I don’t currently hold any Bitcoin after having recently sold. While speculating may be worthwhile in the future, there is just no way I can see Bitcoin becoming an alternative to fiat or a viable store of value. The argument below quoted by Alphaflight from Alasdair Macleod “central banks don’t hold any Bitcoin” is impossible to dismiss. Whatever the monetary system is in the future, it will be based on something that nation states control. That might be gold, it might be a new form of fiat, it may be something else entirely but it isn’t going to be something where 95% of it is owned by 2% of the population unless those nation states are the 2%.
2) Inflation is coming and it is going to be big. What remains to be seen is what governments do about it. Do they let it run for a while to reflate then step in to try and control it? If they do, will they be able to? One of the conclusions from “promises, promises” (something I had already learned but failed to appreciate) is that what we think of as money is really debt. And debt is worthless if the debtor can’t pay. And disappears if he does...

3) My central thesis for investing since the Brexit divorce happened is that the UK is a great place to invest right now. My days thinking has led me to conclude that with such macro uncertainty there are risks I hadn’t appreciated. However, I might actually invest more because I’m not sure what the alternative is for any of us.

timarr

21st Feb '21

These transactions would never however happen, as you would actually go from A to C with passing B.

Well, that's the question, isn't it?

In reality you can probably trade in and out of Altcoins using Bitcoin with relatively little risk of being detected. It's once you convert back into sterling then the profits become visible.

Where banks aren't able to verify the source of funds they have a statuatory duty under money laundering rules to block access to your account and report the transaction. At which point you have to reveal how you made the money to the bank and they have to report it to HMRC - and if you don't declare the profits then you can expect a metaphorical knock on the door.

The decentralised nature and anonymity of Bitcoin mean that a certain amount of transactions can probably be hidden, but large scale frauds can be tracked. However, I doubt most of the people trading Bitcoin are doing it out of a libertarian fantasy of an unregulated financial system, they're doing it because they see it as a way of making money.

The main issue with tax will be cross-border - if I can spend my Bitcoin in (say) Bermuda to buy a house how would the UK authorities ever know?

timarr

Martin VT

I think we will have collectively got it out of our system now; roll on Monday for SLP.

pieRsquared

Pretty much agree with all that, although I see less fantasy in uk small/mid caps than elsewhere. I try to run an index (S&P) risk reversal (short call long put) as my exit / hedge and live with the correlation risk to my longs.

As I am sure you know the Fed put has created the risk always pays attitude you mention, and now with rates so low, the inflation threat, stimulus checks....people feel they have no choice.. is a Schumpeter style crack-up-boom on its way or already happening?!

mojomogoz

Hee hee! Interesting Phuntt. I've been bearish since approx 2016 and cautious for a few years before that....however my bearishness from a macro (and political perspective with rising 'populism' which is a sign of system dysfunction) was also when I decided that being fully invested was the least risky strategic route.

I disagree that debt forgiveness is dangerous lefty thinking. When practiced in the millennia before modern capitalism it was not socialist utopia driven. Jubilee was a way to ensure that society functioned, didn't revolt due to unbearable 'rents' placed upon the lowly and that after a short hiatus the king/chief/etc could collect his due at a suitable rate again as everyone came up to breath. Often the wealthy classes also had debts so whilst net losers in a jubilee they could offset some loss and overall stay whole (after all they didn't need to forego tangible assets and this was a tangible asset time). (TBC I'd suggest some caution at the moment as the environment is highly speculative and investors very sure they know how to make money)

To some extent magical central bank balance sheets could be viewed as a form and tool of modern jubilee. With QE restricted to financial market operations it's been a poor proxy to jubilee...but as we move away from monetary policy dominance to fiscal dominance we move to a new flavour of QE as espoused by the MMT crowd and we will have ongoing and more significant direct monetary financing of fiscal. A conventional route to fiscal balance requires an amount of austerity that is not feasible. In the 2010s we pretended austerity was viable but post covid and all the 'mad' new policy implemented we will no longer pretend.

I propose that occasional jubilee by political fiat may be a healthy thing for a capitalist society. It means that lenders and other asset rich 'extractors of rent' from the masses must assess the economic viability and burden of their actions rather than mere credit checking (which on the whole is a trend following dangerously endogenous risk management process that rewards those that borrow more but haven't gone bust...yet).

If you are into reading more then I recommend JK Galbraith's 'Money: Whence it came, where it went' https://www.amazon.co.uk/Money...

IMO JKG is a great chronicler and the beauty of this book is that illustrates without political or economic bias just how mad money has always been...and not very reliable.

Bitcoin believers and gold bugs suffer from a delusion that their talents and worth can be safely stored in an immutable thing. I have previously labelled this as millenarian thinking. It is magical thinking based on an extrapolation of some chosen facts. But history teaches that only productivity and forward movement really counts as guarantee of value retention through making new value.

At danger of sounding contradictory I actually have a decent exposure to gold at the moment not as I'm a bug but as I view there to be big dissonance in the pricing...I've had this since approx 2015/16 and my shift to fully invested bearishness...the payout was great in summer 2020 and I reduced somewhat and then the success of other things has reduced some more...I think I'll be adding to some gold-y positions soon as I think I can see the next leg of the surprise.

Hello again. I sort of answered you too unknowingly in replying to Phuntt.

I agree that crack-up boom may be in play. However, my market spidey senses are tingling on just how many people are now signed up to the inflation is inevitable and it's going to play out now in unstoppable juggernaught fashion and at least reflate the system and perhaps hyper inflate.

The crack up boom 'theory' I believe applies to much more closed and non globalised financial markets than we have today and where physical product and services dominated over financial markets. This is no longer the case. So my worry is about the crack up boom being rather sloppy and in effect some variation of classic EM crisis happening. Why?

The narrative is US is screwed and must inflate to survive -> weak $ -> positive global inflation and risk appetite as US stimulates itself and weak USD stimulates everything else. But this a shift to a new paradigm very quickly. Its assumed that the US is the weak link in this due to its 'vulnerabilities'. This is intellectual joke. The US is the only significant industrial country on earth that could embrace autarky and be roughly okay compared to its prior existence as it has all the resources and abilities within its borders to support...

The rest of this world is hugely reliant in each other and ultimately the massive 'over extended' US end market...

As the inflation surges and ricochets as part of the crack up boom cracks and stresses open up this will not be manageable by many weak systems (global and local) -> this is likely on balance to create tighteness and dysfunction through financial markets. The system plumbing means this causes USD strengthening....this is contra to the crack up boom.

I too believe that significant and durable inflation is coming...but I think the trajectory to it will be quite rough.

Don’t get me wrong - I agree that some level of debt forgiveness is necessary. It’s clear that the levels of debt currently being taken on just don’t make any sense if we plan to have a growing economy moving forward and we need a reset with our monetary system just as happened continually through financial history. The question is how to do it in the current environment.
To some extent we have already started. Very few of the government backed loans will ever be repaid, negative interest rates if they ever come could be viewed as a form of debt forgiveness, inflation without a corresponding interest rate rise could be seen as debt forgiveness by devaluing the currency (debt) in real terms. But all of these are an attempt to prolong the current financial system by reducing or managing but not eliminating the debt. I just don’t think it will be enough to keep the train on the tracks but maybe I’m incorrect.

The UK seems to be an outlier here. Back at the beginning of this chat, I pointed out that sterling is now above $1.40. We currently aren’t devaluing as fast as the US and it’s starting to show. What I don’t know is whether this will continue. Maybe I’m just assigning too importance to what might be a temporary movement. I would point out that historically whenever there has been a global economic reset the UK has devalued less than global peers. Maybe this is a continuation of this trend. My guess is however this will be addressed before long as reflation/ inflation will be extremely hard to achieve if import prices continue to fall and our exports become ever more expensive. This March 3rd budget just keeps taking on more and more importance in my mind.

The UK has many problems and weaknesses but we seem to have two things that have tended to help us forestall the death spiral often predicted for us (which has been evident in the most fervent anti-brexiters):

1) Adaptability

2) Stability

They may seem contrary but they are perhaps an outcome from our odd political and legal structure -> 5 year dictatorship but with real constitutional checks and balances. Our 'constitution' upsets a lot of people as they see a mess that could be tidied up...but the beauty and durability is in the mess.

I forecast that the UK will do okay through the 2020s. The Tories seem to be ditching the ridiculous austerity idea along with rest of world...aside from mercantilist Europe and China who both rely on us rather gauche anglos around the world to consume their excesses whilst moralising about out profligacy ;)

As long as the UK invests in itself and doesn't go crazy relative to others on the monetary financing then overseas capital and people will flow as we are 'safe' etc.

My dream is that the govt introduces a policy whereby they will underwrite bank credit losses for specified type of lending (SME, start-ups, renewables, environmental projects, farming productivity, local power gen, etc etc). The banks have balance sheet expansion potential and the country outside of Mayfair could do with a refresh.

Alphaflight

Hi timarr,

SHA 256 (the hash function or cryptographic hash function I should say) generates a hash from the input data fed into it. This hash output looks random which of course it is not.

At present, we cannot get the inverse of this SHA 256 hash function. That is to say, the hash can’t be reversed using current mathematics (no inverse solution is known).

So to find the input data based on the output hash, currently the only option would be to use some sort of laborious “brute force” approach, trying random (2^256) guesses. This would take a long time! People point out that a quantum computer could one day perhaps do this very quickly.

More importantly however, the point I was trying to make was that mathematicians have yet to produce a solid proof that the SHA 256 hash function can’t be reversed. In other words it is quite feasible that there is a mathematical solution to simply get the inverse of the hash function. If this is the case then some nefarious character could turn our digital security (SSL/SSH et al) upside down rendering it pretty much useless. To be honest, I wouldn’t be surprised if someone at bletchley park / NSA has a known solution much like the Heartbleed vulnerability in openSSH that was exploited by the NSA.

"The main thing to note is that although Bitcoin is touted as anonymous that's probably no longer true. "

It is a well know fact that Bitcoin is not anonymous. The "Private Coins", and there are only two solid ones that I am aware of (Monero and Pirate Chain) are however anonymous. Other coins masquerading as private have been shown to have security holes (e.g Dash). Pirate Chain has better security features Vs Monero however Monero has a market cap 70 times larger rather interestingly. See comparison below.

Private Coins: Monero Vs Pirate Chain

Bitcoin is useless in terms of avoiding government control whereas these Private Coins are actually potentially very dangerous as they allow people to bypass any capital controls imposed by government and move wealth undetected even avoiding exchanges for trading. Impossible to tax and impossible to track. KYC and so on are an issue of course but then these Atomic Swap Contracts may mitigate some of those issues perhaps, I haven't bothered to look into the details. I predict the true Private Coins will be shortly outlawed once the powers that be realise what they represent...

The key thing to note about CBDCs is that they will have to be backed up by something tangible in order to get people to accept them. So the digital Russian Ruble could be 85% backed by gold plus Russia has a strong military to boot and little debt, so their CBDC could be a defacto gold standard. Ditto for China, they haven't printed money in the last 2 years (unlike the rest of us) and of course they are greedily stockpiling hard commodities right now, gold being one of them...

When a country is invaded, such as the Romans in Britain, part of their method of rule was to require taxes in their preferred currency. This forces the locals to cooperate to be able to pay the taxes, and is a large factor in establishing a currency. Which is further why Bitcoin will probably be banned in a few years, competing currencies will not be welcome.

ISAallowance

"Frankly, I'd buy as many Teslas as I can before they figure out how to deal with this :-)"

I'm pretty sure the depreciation on the Teslas would be a bigger hit than the CGT!

Phuntt,

I changed my investment outlook about 10 years ago after reading various (slightly depressing) books such as "The End of Growth: Adapting to Our New Economic Reality - Richard Heinberg", "Limits to Growth - the club of Rome", "Long emergency - James Kunsler" and so some others...

Governments and fiat currencies have bad track records if you study history.

As for gold, believe it or not I don't particularly like it. However I think I understand it. Gold is pretty much like a gun. Completely worthless for 99.9% of us, with money better placed elsewhere. Until we actually need it...

Gold is a good inflation hedge (no inflation right now however but it is probably coming). Actually to be more specific, gold is a good "real negative rate of return on US longer term treasuries".

For me gold has taken the role of the fixed income (bonds). i.e. a defence against weakness in equities. Since 2008, equities & bonds have frequently moved together rather than moving in the opposite direction. When equities are weak, gold tends to go up. Gold's main role right now. When equities are strong gold can do anything...

Gold is a good protector of long term inflation. Counter intuitively, during deflation, gold loses value less quickly than other assets. Gold doesn't like a gradual reduction in the inflation rate however.

As a result I have 30% exposure to gold / precious metals now. Most would argue that I have far too much exposure to PMs, they may be right!

The strengthening USD theory is I believe currently called the 'Dollar Milkshake' (not sure why). Have you read Disunited Nations by Zeihan (you sound like you have)?

Hi Alpha, I was listening to someone during the week (can’t remember which podcast) who used the analogy of a portfolio where each of the constituents was a member of a rugby team, with gold being the star back who may do nothing or win the game. I don’t know whether that makes sense during so called “normal times” (do they ever exist?) but at the minute, it’s a no brainier for me to overexpose to gold. My team certainly needs a star player...
I did well last year Highland Gold Mining (LON:HGM) and Polymetal International (LON:POLY) during the rise, swing traded Polymetal International (LON:POLY) repeatedly during Q3/Q4 of 2020 and over the last week have adding exposure to Pan African Resources (LON:PAF) and Polymetal International (LON:POLY) and plan to add several other miners during the next week. Gold has been flirting with its 1776 base so I’m going slowly at the minute (it may well break lower) but the current macro environment only has one outcome as far as I’m concerned which is a very large break higher (just not sure when it’s coming). I dismissed it earlier last year but I starting to believe that the current Bitcoin fixation is having an effect on gold pricing (it’s becoming the bolt hole for those who want inflation protection rather than the traditional gold). Still, the break will come (either because BTC fails or inflation risk or because US markets crash or anyone of a hundred other reasons) and it will be large.

Note for Paul in case he missed it regards Saga (don’t think it anything to worry about)

https://bit.ly/3ujE4TX

I have read Zeihan. Good book with some good perspectives though he’s a bit of a drama queen. But I do have my own views ;) For example, I realised in the late Noughties and early 2010s whilst travelling in Asia and EMs a lot that no empire rises unless the natural resources are within its borders or very near abroad. Once you are established and dominant you can trade and exist beyond your local means without being too vulnerable to attack!

At that time I concluded that Brazil and/or a latam confederation would probably be the dominant power some point later this century. I do not think China can sustain it as it’s too vulnerable ultimately across too many factors. Zeihan is interesting in pointing out the relative geographic strength of Argentina relative to Brazil and neighbours. I know both countries well and I see his point! Argentina for all its ailments has some real dynamism beyond the state. (Zeihan's analysis of natural geography re waterways, nature of land etc whilst I knew already...think Japan and its history...I didn't weigh enough -> maybe Argentina is the blessed place).

I know the milkshake well. I’d say it probably originates in the eurodollar work of Jeff Snider. Overall I think the milkshake theory is wrong as the shortage of dollars is not structural but a passing blip in the system (but as people think money is real and dominant they focus on it and endow it with more power than it deserves). Dollar shortage is perversely most acute in the USA with the massive fiscal deficit and net international investment position it had (NIIP is >50% of GDP and is unprecedented at such scale...it means that foreigners own US...they may be short of liquid dollars at points but that then blows rapidly into a US domestic problem when they sell assets for dollars...and that’s what happened in March 2020 -> the Fed knows this now and won’t let it run again)

So this invalidates the milkshake theory. However it doesn’t mean that we cannot have strong nominal and hopefully real growth with inflationary pressures. The efficient, rich and important US economy handles this but less balanced and robust ones might have a fail (eg India, China, Argentina, N Africa, ME etc).

I do believe we will have a weak dollar for a sustained period but I think people are plotting too straight a line on that. This is reflection of our times where market participants think trends go in straight lines

(Edit: Just corrected a lot of the above...did it on phone and when I re-read i realised quite a lot of typo gibberish)

BattleOfBrit

Hey, that's a great article and incredibly humble re: Paul's comments on his journey.

I confess to having traded one of the bitcoin miners (ARB) myself a few times, luckily modestly profitable, though I'm unlikely to repeat it, for lack of courage after this read.

simoan

22nd Feb '21

Hi Phuntt,

Yes I too held some of those stocks in the past, Highland Gold was a great stock before the take over...

Identifying gold mining companies with low AISC (All in Sustaining Cost) is wise, some (Centamin) will suffer badly if gold drops far enough. BTO for example has an AISC of just over $700, Barrick is around $1000. I don't see Gold going <=$1000/oz.

The quality Royalty companies in my opinion are the safest way to gain Gold/Silver exposure (other than vaulting metal). So Franco Nevada, Wheaton, Sandstorm, EMX Royalty Corp., Royal Gold. Ditto for base metals, see Altius Minerals (Canada) for example, this is one of my favorite long term investments.

Most of the Gold/Silver ETFs are sketchy at best in my opinion except for the solid "Sprott" funds. For example, see this article pertaining to Aberdeen Standard Physical Silver Shares ETF (SIVR)

-Alphaflight

Read the final edit so no gibberish encountered. Your perspective on USD shortage being most acute in the US is very interesting, one that doesn't get much airtime. The proponents of the milkshake seem to acknowledge a structural decline of the dollar but are happy to bet on an interim, vicious squeeze. I suppose if you can tackle this with the right leverage/structure then the gains could offset timing issues. Thanks for your very full and thought provoking replies.

The Phoenix

Hi Pan African Resources (LON:PAF): has turned up on one of my screens today would you mind sharing what you see as the bull points other than the current fact mining on a run due to economies opening up and possible inflation hedge.

Regards Andy

Small Cap Value Report (Fri 19 Feb 2021) - Roubini on Bitcoin, TUNE

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