How Embarassing

I was going to write a blog about how Paulson has screwed his investors, but there’s plenty of time for that and something more interesting came out today.


One of the fundamental studies used to define the politics of the past few years was a 2009 book by the Harvard economists Rogoff and Reinhard (henceforth R&R) called ‘This Time is Different’. Their most politicised result – backed by extensive statistical analysis – is/was that once government debt reaches 90% of GDP growth basically drops to zero.

The conclusions are obvious: government ‘spending’ should be drastically cut to stay below that red line, and it was surprisingly influential.

How interesting that the calculations have now proven false and the selection of data itself unsound.

I always assumed economics departments were full of the same pedants that prowl chemistry labs. Apparently not – R&R conveniently provided their own data and it’s taken until now for someone to actually check their premier conclusion.

The wrong approach anyway

Unfortunately it’s basically impossible to do meaningful statistical analyses on the national data that everyone actually wants to look at. We would all love simple answers to questions like, ‘how many people do I need to fire to hit a total spending number, or should I just not bother?’

As far as I can tell this is intrinsic. For example, there have been only a handful of distinct global cycles in the past century, and each was associated with a ‘phase’ of the economy. How can you compare GDP data for a country that was mobilising for Word War 2   – prepared laboriously by hand – with today?

It is sheer folly to compress a whole economy into a handful of statistics: GDP, inflation, crude measures of weath, and expect to come up with anything actually useful.

Typically you have to ignore the basically unquantifiable effect of changing political structures and environments to come up with one relationship, say, the impact of debt on GDP.

It’s almost funny

The absurd reality that this argument was used to fire people, cut benefits, shelve investment plans and screw funding for things like basic scientific research. Ofcourse, there book was so successful as it resonated strongly with the times, and in particular a brand of conservative politics, so it wouldn’t make sense to give them too much credit.

But it would only be a mild exaggeration to say their research formed the academic bedrock of respectability for the austerity movement.

A constant irritation

The whole thing reminds me of the ‘stocks v bonds’ debate that got way too much airtime a couple of years ago. These arguments all depended ENTIRELY on your start and end point.

If markets halve over a six month period, it  doesn’t matter how far you go back, you are still not going to get a meaningful answer. To put it another way, when markets double, all your results change. Even if you took an entire century of price history the problem remains.

Even the better ways of doing this kind of research are invariably dependent on the inclusion or omission of a particular decade.

There is no god hidden in the data. Things do happen for reasons though, and wouldn’t it be better to get as broad and understanding as possible, with as much granularity in the reliable data we actually have?

The whole thing depended on the kiwis

Instead, it turned out that incorrect statistics for four years of New Zealand’s history  completely reversed the story.

To be fair (and I read the book years ago) it didn’t seem as they were thumping any particular bible. Unfortunately the same is not true of their supporters and the likes of Paul Ryan who earnestly paraded their research as evidence. Now the facts have changed, what will happen to his opinion?

Austerity for Losers

The moral flavour of the discussion is a little nauseating anway. Those who agree saving is prudent and profligacy immoral (and who could disagree with virtues like that) naturally support austerity, barely bothering to consider the rather numerous differences between, say, a person and a state. 

Not that I have anything against Cameron et al using this to win an election – they are, after all, politicians – but I remember thinking it was kind of silly that they had backed themselves into such a corner. They could have stayed the moral party and still left themselves the wiggle room that they could now use to create something of a legacy .

The state should have cashed in on the weird markets of the day

The crisis was incredibly harmful across swathes of society. It was also an opportunity to invest as cheaply as will likely be possible in our generation, and that opportunity has largely been squandered.

Projects with marginal economics but substantial societal value could actually have been done profitably. Not only woudl that have improved things, but it would actually lower your future tax burden. 

There is a huge difference between money spent and debt swapped for an income generating asset. With the oversimplifications of R&R and their like, this is mostly ignored.

A Settled Debate

Since a number of countries took varied, almost graded approaches to the crisis, perhaps future academics will come up with the right answer to what we should do now, though by then naturally it will be too late.

Most likely they will then write a pithy book, publicise false generalisations and get the problems of their own time completely, utterly and harmfully wrong.


Gold Crush

Well it looks like Sell-in-May is apparently a couple of weeks early this year, though without wanting to repeat myself too much, lower commodity prices will quite likely end up being a good thing. It always pays to pay attention to commodity markets – when managers feel queasy and reconsider investment plans, they pause commodity buying months before anything shows up in official statistics. The sell-off is broad based, the most spectacular facet is gold:

Gold meltdown

(Source: Izabella Kaminski at Alphaville)

On the plus side this is bit of a relief – if the loony libertarians and anarchists who bought both large hordes of gold and chronic amounts of  Bitcoin kept making so much money I might have had to throw in the towel and join them.

What’s the story

As always, the price is set by who’s buying and selling. In this case we have:

    • 1. Central banks
    • 2. Real demand (jewellery, industry)
    • 3. Speculators

Gold Demand Trend 2012

1. Central Wankers

In the gold market central banks have proven true to form and have screwed their populace through poor market timing (though I do think Bernanke and Glenn Stevens have done some excellent work)

UK readers may know that Gordon Brown decided to sell 60% of UK’s gold reserves in 1999-2002 at around $300 per ounce. He even told the market what he was doing before he did it. Needless to say, commodity markets tend not to rally when a government announces it’s dumping the majority of its stock. This was at a 20 year low.

Not that we can be particularly smug down under. Typically our politicians follow the political trends coming from overseas, and in this instance we certainly played by the rulebook. We sold our lot at around $360.

Australian RBA sold gold


If central banks were selling at around $300 range, what were they doing the past few years when prices ranged between $1600-1900? Naturally, they bought more gold than at any time since 1964.

Central bank purchases of gold

2. Industry

While the central banks sold at the bottom and have been buying at the top, the fact that industrial and jewellery demand (mostly jewellery) moved in opposite direction to the price restores some faith in economics, despite what you may hear about an Indian/Chinese gold rush. In terms of picking price drivers, relatively steady industrial use pales in comparison to the huge swings in speculation and the movements and hoardings of central banks.

3. Speculators

This is where it gets interesting, as a quick inspection of the demand chart above shows what you would have assumed anyway – recent years investors have piled into ETFs and physical gold.

It’s amazing how otherwise intellectually rigorous individuals so easily accept silly notions and accept bizarre illogical statements of faith on the topic.

a) Gold does NOT protect you in a sell-off (necessarily)

Since 2001, this trade has worked very well. But nothing lasts forever, and in recent days this paradigm has completely changed. All the people who bought for this reason (e.g. Jim Cramer ‘you should always have some gold in your portfolio’) if they have any logical consistency, should now be selling.

b) Gold is NOT an inflation hedge 

This oft-expounded theorem-as-fact is easy to disprove – take a look at the picture:

Screen Shot 2013-04-16 at 11.07.24 AM

As you can see, while there has been some truth in the statement in the past, without overstating it there has been a considerable divergence lately. While we’ve been about as close to deflation as you can get without calling it such, the gold price has rallied strongly.

If anything that implies a negative correlation – but the reality is it has nothing to do with it. There is no mysterious hand here – the price is determined by real factors: who turns up to buy and sell each day. No rule of thumb or market is going to make up for actually understanding who these people are and why they are doing so.

c) Gold is a better and safer store of value than cash in a bank

While certainly true when the gold price is going up, in a nutshell, it simply makes no sense to hold gold when (real) interest rates are positive

When banking cash in the UK, US and Europe gets you close to zero, then perhaps it makes more sense than usual to swap it for bullion. But when rates normalise then holding gold makes no sense at all. Think about it – if rates hit 5% (and that is well within norms – you’ve been able to get that in Australia throughout the crisis), then effectively government guaranteed increase in wealth of 5% beats the hell out of (negative) storage costs.

Should inflation pick up and purchasing power erode, central banks will jack up rates. Cyprus aside, you are safer in a too-big-to-fail bank.

So in summary, all the main speculative reasons for holding gold make very little sense right now. Now imagine what would happen if the speculators chasing capital gains start to unwind their positions that have been building since ~2001…

But what about hyperinflation!

Pundits fall over themselves trying to predict the next time this will happen.

A cursory flip through the history books shows hyperinflation is actually far rarer than everyone seems to think. This is something of a cognitive bias – the results can be so horrific that it’s easy to overstate the actual occurrence.

And no matter how inclined-toward-conspiracy you are, there is no indication that the major central bankers in the world are sulkily printing cash to plea poverty while keeping full employment a la Weimar , or are as brazenly thieving and felonious as the villainous Mugabe and his cronies in Zimbabwe.

But even so, there are actually some excellent ways to deal with hyperinflation

For example you could:

  1. Borrow in local currency and buy real assets overseas. The currency will be on a oneway trip to hell and the value of the loan will erode just as fast.
  2. Borrow and buy real assets for which there will always be demand – like central housing. Again the face value of the debt will erode in real terms, but the living space will be worth something regardless of the payment terms

What you should not do is have any savings whatsoever, or even worse, be on a fixed rate pension. Apparently the much-maligned veterans of World War I (who could hardly have picked a worse time to be born) were particularly screwed by this one.

So in conclusion: sell your gold (if you have any) and keep some cash ready for the far more interesting opportunities the market is about to throw up.

Next post: Hedge Fund Villain #1: Mr Paulson.

FYI: A chemical anomaly

Gold has always fascinated, not really due to its rarity (after all, many things are more scarce) but due to its colour and lack of reactivity, that suits it perfectly for beautiful and lasting jewellery.

Apparently an (admittedly hand-wavy) explanation is that at the lower ends of the periodic table, the increasingly (positive) charge of the nucleus causes (negatively charged) electrons to approach relativistic speeds. By the time you reach Au,  the energy levels have been pushed to the point where gold is coloured differently to the other metals – one of the many periodic crossovers that chemistry examiners love to probe.

Cryptocash and Assassinations

  1. One of the more startling scenes in markets recently has been the stunning rise (and today’s fall) of bitcoins


Since  the hackers, smugglers, armadillo hat-wearing conspiracy theorists(1) and submarine builders that actually use  these are now all millionaires,  it would be good to know if we can join them.

For those unaware (and advance apologies if you’re all over this) bitcoins are a digital cryptocurrency. Not digital in the sense that they can be transferred online – which they can – but digital in the sense that defines their whole DNA.

They were created by Satoshi Nakamoto who published a brilliant paper in 2008 outlining how the whole thing would work. Suitably he had never been heard of before, has barely been heard from since, and probably doesn’t exist.

In a nutshell it makes clever use of hashing, where you apply an algorithm to some data (text, numbers, a timestamp) to come up with the ‘hash’: a series of random numbers. Since changing one part of the original data completely changes the ‘hash’, you can tell if it’s been tampered with.

Of bitcoin there is much to like. You can ‘mine’ them, they can be transferred anonymously, stored and encrypted on any private hard-drive and every transaction is confirmed by the whole BTC community.

Modern Silkroad 

If you haven’t heard of the Silkroad (great name) its existence may surprise you. It’s a dark, dingy hole of the internet were dealers and unsavouries make a brisk business in illicit substances only accessible through a secure Tor browser.(2)

For pure interest’s sake, it’s worth taking a look. This is the link. You will see everything from heroin to OTC medicines, all at very reasonable prices, and bitcoins are the only accepted tender.

Silkroad Snapshot

(taken from Businessweek)

You place your order encrypting your mailing address with a public key, pay in bitcoin, and the dealer sends you your purchase hidden in an envelope or box. As with any self-respecting online marketplace, you can see feedback from other purchases and an average rating. Amusingly, many also have clearly laid out repayment policies.

While the dealer is relatively secure – he passed over no defining or incriminating data – there is still a crack or two. If you place an order, at some point you’re going to have to take delivery, and herein lies the risk. But I’m sure you can think of some clever ways of getting around that, and a cursory glance suggests business is booming.


With some fanfare, newspapers recently noted that the value of bitcoins in circulation was worth over 1 billion dollars and apparently this is supposed to be impressive.

Everyone from Forbes to people who should no better, like Felix Salmon, rushed over themselves to apply that tired and rusty word ‘bubble’ to the case at hand, as though noticing that something has gone up significantly and saying ‘Look! A bubble!’ somehow makes up for the vast majority of market calls they’ve got completely, utterly and publicly wrong.

How big do you think the market for illicit drugs is?

Supply Supply

Whenever it looks like something is running short and the price is going to rocket, the narrowly-read point to Mlathus and invariably miss the supply response that pushes the price below what it was initially.

At some point I’m going to write a post on this. The ‘instability’ of our much maligned market system gleefully pointed at and criticised by well fed critics is precisely why, with nearly 7 billion people on this planet, we haven’t run out of food yet, and why in the 90s, billions were lost laying uneconomic cable across vast oceans that set up the next decade of growth, development and ‘bubbles’, and there are similar examples across the economy, from railroads to ships to mining.

In this case, the creation of bitcoins has been carefully and tightly designed.

Digital Moria

If you were wondering if you could create bitcoins that were accepted by everyone else, you certainly can. It’s called mining (whoever coined the terms really nailed the language).  Anyone can apply their computer’s CPU to discovering new bitcoins, which become harder and harder to calculate. Naturally, all the low lying fruit has been collected, and you’ll need to join a pool to do this with any chance of success.

Everyone has gleefully noted that this market is very efficient. The amount of bitcoins you mine almost precisely matches up with the cost of electricity to run your mining software. As bitcoins become harder and harder to mine, the supply impact on price will naturally diminish, and for mining to make any sense, the price will have to rise for the process to be economic.

Interestingly, this means that coins mined today will be worth far more CPU and electricity tomorrow by design of the system.

An additional restriction is that the total supply of bitcoins is capped at 21 million. 


Bitcoins have so far proven secure by the only known method: publishing the entire system to see if anyone can hack it. As you can imagine, a pool of anonymous digital money is about as tempting as anything is ever going to be to the shady state and private players capable of doing this.

While bitcoins themselves seem to be secure, there are weaknesses in other parts of the ecosystem. Your personal bitcoins can be stolen if not encryped properly, and the largest USD-BTC exchange, Mt Gox, has been attacked before and is apparently under severe DDoS attack now. There has been plenty of speculation that hackers attack these exchanges to manipulate the market, dash confidence and give themselves a chance to buy BTC on the cheap.

If governments were serious about shutting down the Silk Road and the like, attacking  vulnerabilities in the  architecture would be quite a good way of doing it.

But as long as the Bitcoins themselves remain intact, then this will work, and having gone up 4-5x in the past 30 days, dropping 50% or more is not so much a surprise.

Note: talking about market percentages using percentages can be very misleading, as the denominator changes every time.

Supply and Demand

So, on the supply side we have mathematically restricted and limited mining, at rates that are barely economic, while on the demand side we are left with a market full of 1) armadillos hoarding everything they buy/mine in preparation for the end of the world and 2) drug dealers, arms smugglers and their clients for whom there are simply huge inherent advantages of transacting in bitcoins.

You don’t need to be an economist (I’m not) to realise that $2.5 billion BTC in circulation is small-fry for these guys. So… which side of this trade do you want to be on?


Once you start googling things like this, you invariably come across some pretty whack stuff.

One of the more chilling was the concept of assassination markets.

Imagine a site accessible only through Tor, with public key encryption and all payments were made in bitcoin, much like the Silk Road.

A user could submit someone to be assassinated, either a public figure, or simply their photo and details. Other members would be able to contribute bitcoins to the cause. If that person was taken out, the whole sum would go to whoever could prove they would do it. This would be the hard part, but there are ways, for example, by revealing a pre-encrypted explanation of how you intend to do it.

If this had been set up a year ago, the kitty would  be worth many times more than anyone actually contributed. A disturbing thought.

A saving grace, to use a silkroad analogy, is that the same way a delivery always puts the purchaser at risk but hides the sender, the hit man would still be subject to the usual methods of law enforcement. We can only hope that state resources would have more success in shutting down a site like this than they have with the Silkroad.

Taking this further:


(1) Don’t ever wear or eat an armadillo, they carry leprosy.

(2)Tor allows you to surf anonymously, and by routing your surfing through a number of computers, each only aware of the identity of the one in front and behind, your ID is intrinsically and securely encrypted. Also of interest, you can specify what location you want the final computer to access the internet from. This would allow you, were you so inclined, to watch geographically restricted TV – occasionally very handy for Australians. Read all about it and download here.

(3) There are ways to make things properly secure. For example in codebreaking, a letter-substitution one-time pad is uncrackable, a concept that most people I’ve mentioned it to don’t believe. There are still system weaknesses.. for example, where you keep your one time pad or in this case, how you take delivery, but the actual system itself is fundamentally secure.

Also, my favourite bitcoin post is this one.

Speculations on the Currency

I’ve spent the last few months working in the principal investment area of a bank with typically harsh restrictions on social media and comment of all sorts, and as such have been unable to post. With that episode now over (and I’ll comment on the experience when the dust has settled), it’s time to wade in to the national pastime of speculating on the aussie dollar (forgive any repetition from previous posts).

For all the doom and gloom surrounding the humble aussie, and considering it basically halved in 2008, then doubled again, it has been remarkably stable. Over the last three years, every time things have gotten a little shaky, it has traded as traded things should trade: plunging sharply, causing a price driven market reaction, and getting pushed back to – dare I say – equilibrium.

Yet everyone seems to think the aussie dollar has somewhat peaked and is heading downhill. The argument seems strong: the comprehensively heralded coming collapse of the iron ore price will reduce the multi billion dollar bids of AUD.

This misses the point. The reason ore prices are heading downhill is due to increased supply – the demand growth side is quite strong. Fortunately, as a command economy, China actually tells you what it’s going to do, five years in advance, and the urbanisation story is by no means complete.

So as dirt cheap Australian ore comes online, while there will almost certainly be a price reaction southward, what matters s the total flow of cash, and the lower price will be counteracted by the increase in total export. Where the balance ends up is anyone’s guess and unmodelable.

There’s another part of the picture. Australia has a major export that has barely got of the ground: natural gas. Australia is not exactly a low cost producer, but tens of billions have already been sunk into these projects. As with all mining and high capital investment, once the initial expenditure has been made to build the mine, gas plant, liquification terminal or ship, the economics are hugely in favour of continued production, even if it ensures the project makes a loss. Better to recoup at least part of a failed investment rather than write the whole thing off.

Time and again analysts are caught completely off guard and have to hastily and humbly restate their forecasts when their object of expertise falls straight through its arbitrarily declared ‘price floor’. I think I’ve harped on about htis before.

And no matter how low aussie interest rates seem from a seat in Sydney, or how much chest-beating there is from armchair economists, they are still substantially above the rest of the developed world, even compared to our Northern Hemisphere economic equivalent, Canada. The carry trade is still on – from a yield perspective it makes sense to hold AUD.

So, as although the iron ore price will almost certainly fall to the industry’s pressure point, it will be balanced by the huge increase in total ore exports will easily accomodate it. The stability of the AUD is likely to continue. In fact, once you take natural gas into account, there is actually a feasible case for a higher aussie dollar.

And finally, there’s a mathematical quirk that increases stability in the AUDUSD, as well as pairs like EURUSD that almost noone ever seems to consider. The giants in the room – central banks with huge foreign currency holdings – determine their weightings as percentages. To keep it simple, if an Asian bank holds half its currency in EUR, and half in USD, as one falls relative to the other, it buys the falling one. In enormous size. This rarely considered stabilising impact can barely be overstated. As foreign central banks have diversified into the AUD (as they should), this natural steadier comes into play.

To put it another way, if a central bank has set percentage holdings (as they generally do), when there’s a sharp shift in a currency movement,) you can guarantee there will be a market-moving order in the opposite direction. Typically hedge funds have been the losers on the other side of the trade – think of the fortunes lost in bets against the Euro every time the continent flares up.

Unfortunately neither being long or short the aussie is a particularly interesting trade right now. If you want to bet against the recovery (we are, after all, about five years into it) or perhaps more rightly, commodity deflation, then there are other places to look.

Turnaround Tuesday

But for the first time in a while, I feel like walking away for the market. Something’s not right..

Let me count the ways:

1. Chinese inflation figures where high, making monetary easing that much harder

2. No mention of QE3 from the Fed.. given their communication policies, I’d say that’s now looking quite unlikely

3. Germans are talking about fiscal discipline again – as if inflation has anything to do with anything right now, or their loose talk and inopportune rate rising didn’t screw things over last year

4. Rising spanish debt yields – predicator of the annual euro slump we’ve come used to

5. Expectations for a very good US jobs number which massively underperformed on Friday.

6. There has just been a stonking rally.

Finally, the Chinese market is getting dicked, and for the past five years that has meant stay the fuck away from risk.

There’s not much to be positive about, save to hope April is a wipeout and that sets us up for a ripping second half of the year. ‘Sell in may and go away’ can’t work every year.

I’d say copper’s looking pretty exposed from here (yes that is a head and shoulders pattern)


In fact, the whole market is a head and shoulders pattern.

I’ve had a pretty good run since december (well, less good after the past couple of days) but now face the age old dilemma with all the tricks for the unwary and general mindfucks contained within: hold them or fold them.