Start 1

The startup atmosphere is not what it was six months ago.

Even the flagship successes are going to have to make tough decisions and gamble their existence.

 

It came out last year that Uber is losing a billion dollars on 1.7 billion of revenue. So they are spending $2.7 billion.

 

They raised a total of US$8.8 billion most recently at a valuation above $60 billion. These investors need over 60 billion in profits to break even on an absolute basis.

 

Uber is clearly the best taxi company ever. It’s a relief not to spend hours waiting for a taxi driver in a smelly car who insists on being paid in cash and refuses to drive to Bondi.

 

VCs and other investors dumped cash on Uber’s balance sheet that is now being used to ‘invest’ in growth. But when Uber says invest they don’t mean set up offices in new countries and buy plant and equipment, though there is some of that.

 

What they really mean is they’ll cut prices below profitability to keep Uber cheaper than taxis and anyone else who dares to compete.

 

To make a decent economic return on current revenue they would need to lift their fee by, say, 60%.

 

Soon enough there will be a point where it makes sense for every driver to be on a  congregation app. An app that out-platforms Uber.

 

Anyone looking for an idea?

 

“I prefer building rather than fundraising,” Kalanick added in the interview with Betakit. “But if I don’t participate in the fundraising bonanza, I’ll get squeezed out by others buying market share.”

 

Fintech
 
Fintech is hot right now. No-one has more money than the banks. I mean the banking system literally has all our money. This was always going to attract attention from the startup community.

 

But finance is a poor candidate for start-ups. I do wonder how many of the kids setting up a ‘new kind bank’ would have the stomach to take a home off a family in default.*

 

 A few guys and girls in a room can build a world-changing app – there’s no doubt about it. But picture sharing is very different to lending someone amounts that might take a lifetime to pay back.

 

Some parts of fintech are incredibly promising (and proven): crowdfunding of all shapes and sizes, data analytics, security, wealth management.

 

But some revolutionary start-up thinkers manage to do full circles of logic, such as in P2P lending, where anyone can borrow and anyone can lend. We are all banks now.

 

P2P
 
The idea was that:

 

– the borrowers would be able to find cheaper loans
– the lenders would have access to new markets that were previously closed to individuals.

 

It quickly became too complicated to have individuals lending to people. Too risky and painful to see innocents lending at 8% to someone who won’t pay back. Default rates are still low, but we are at the very end of the credit cycle, precisely when you’d expect financial innovation and new people coming to the market. A bad time to be picking up pennies. So the P2Ps started  dividing the borrowers into tranches according to secret credit rating profiles with uniform default rates and returns.

 

 

The next step most P2P lenders have taken was to gather all the loans together and sell them to institutions.

 

So now we have exactly what we’ve always had – a provider who pools the lending of large amounts of money to different people. This is basically a bank, only without the infrastructure and experience of bankers.

 

The attempt to revolutionise lending ended up at securitised mortgages with all those hazards familiar to Americans who let mortgage brokers in Florida determine credit. Round of applause.

 

Still, the volumes are trivial compared to the trillions of dollars on the lending books of major banks and it’s certainly something new. Good luck to them.

 

Bitcoin
The first time I heard about bitcoin I was fascinated for at least three months.

 

But somehow I – and anyone you hear talking about bitcoin – managed to overlook these incredible flaws:

 

1. It takes 10 minutes to process a transaction

 

2. If one mining pool controls 50% of the computing power, they have total control to reverse transactions and cause mischief. This has happened before.

 

3. There are two groups of chatroom bandits debating how to progress. So instead of having a regulator appointed by politicians, who at least have to win votes every now and then, the bitcoin community is dependent on an indefinite group of anonymous, amorphous, and unelected hackers.

 

4. Immense amounts of electricity is required to process the transactions. The system is literally designed to require increasing amounts of energy, the more energy you put in. So this will get worse rather than better.

 

The economics encourage miners en masse to operate at a loss. There will always be a student with access to a university’s computing power, or punters ready to miscalculate and/or ignore electricity costs.

 

The amount of power used to verify bitcoin transactions is obscene. This is all totally wasted of course – there are no benefits to the broader system of spending huge amounts of energy calculating something that only needed to be calculated because so many other people were trying at the same time.

 

5.The bitcoin merchants are mostly crooks and fools. It turns out that – like normal money –  you have to use providers to store and convert your bitcoin. These people promise to store your bitcoin strings and charge to do so. More than banks ever would. So how, exactly, is this a step forward?

 

But the problem is not just high costs, though it still surprises me to hear intelligent people talk about costless transactions in bitcoin, when the exchange margins would make American Express blush. The issue is these firms are juicy targets for all sorts of crime.

 

Often the owners just spend the bitcoin they were supposed to protect, but usually they just go bust and you lose everything. Trusting your spending power to these kinds of startups is a very poor decision.

 

You’re not just up against backroom hackers but entire states. I wouldn’t bet on a commercial security team against North Korea’s cybercrime unit.
Finally the whole thing is kind of absurd.

 

I mean, we already have electronic, instant money that is extremely secure and backed by all kinds of insurance, as well as implicit and explicit government guarantees, and we can transfer it for free – certainly within countries.

 

Anyway, I’m sure some people made a bundle out of this particular mining boom by selling shovels, however.

 

The good stuff: Data analytics

 

A better example data analytics – there will always be ways to fine-tune and improve credit ratings of individuals and companies.

 

But even this is dodgy territory: most of us would be very uneasy if we knew that the bank was monitoring our purchases and developing comprehensive character profiles of us. Banks could easily delve deep into your purchases and get an extremely good idea of how likely you are to pay a loan.

 

This might be fine if it means extending credit to people who would otherwise be cut off, but it gets a lot muddier if you’re only lending to certain types of people because they are more likely to pay it back.

 

Banks already could already figure out if you’re gay or straight, and have a good idea of your national background. How would you feel about this information being used to adjust your credit score and deny you a home loan? What if Chinese immigrants prove better borrowers than the Greeks? What if a bank used that information?

 

But despite the pitfalls this is definitely an area where the tech genii should be playing.

 

User interface
 
I have bank accounts in the UK and Australia. Using UK banks is like surfing web pages from 1995 – they are ugly, slow and the whole thing looks like it was put together by a child. (Don’t ever sign up with HSBC).

 

Australian banks seem decades ahead. I doubt any startup has the billions to match CBA’s or any of the other banks investment in technology.

 

The major Australian banks each spend about as much on tech as Uber loses in a year. Competition will be stiff, but it’s more likely to happen between these firms than from new outsiders. Could be wrong. But if I wanted to compete with these guys I’d do it be starting a bank, not building an app.

 

Wealth Management
 

 

There are companies like Wealthfront that will do well. They use generic portfolios of stocks and bonds to replicate the asset management of the ultra wealthy – the ones who hold on to their wealth anyway.

 

There are very few ways to make money in the market and this is one of them.

 

Asset allocation works by holding fixed percentages of different assets.

 

A lot of ink has been spilled on this kind of thing – all about volatility and efficient markets. I studied it once, it’s dry, even as far as these things go.

 

But that whole branch of academia kind of misses the point. Turns out efficient horizons are orthogonal to what we actually want our investment portfolios to do: make money and not lose it.

 

It’s actually the fixed percentages that do the magic.

 

Say you have 50% cash and 50% stocks. As the stocks fall, the percentage drops, so you use some of your cash to buy shares. As stocks rise, their percentage increases, so you sell some stock and increase your cash holdings.

 

The total effect is what basically defeats everyone who tries their hand at it: Buying low and selling high.

 

This isn’t just stock and bond portfolios. It’s highly effective in currencies. In my own portfolio I ramp this up by betting against markets, while holding a core portfolio of stocks. It’s the above dynamic on steriods. I wouldn’t recommend trying it unless you want to spend a few painful years losing money learning how to do so.

 

My favourite aspect of the miserable euro crisis was that all the horrible hedge funds who had massive bets against the euro largely lost out, while those with fixed currency ratios (sovereign wealth funds) made fortunes.

 

Similarly, at the peak of the crisis when financiers were collectively losing their minds and their shirts, pretty much every Australian was buying at the lows. Why? Because we all have compulsory investment portfolios that almost all work on fixed percentages. We were all selling bonds and buying stocks right at the bottom.

 

This is perfect for fintech . Managing simple portfolios at low cost is a totally realistic goal for a small number of tech-minded people.

 

Wealthfront, Betterment and their ilk have a rich future – but not for their investors. They will all have to compete on price though, so don’t invest in the companies themselves. But definitely take a look at their products.

 

Interestingly the people running these programs generally misunderstand why they work.
Hedgeable is an example. The CEO claims to have a “proprietary investing technology called the ‘Dynamic Advisor’ “. If you ever find yourself reading something like this, run for the hills! These people always choose almost exactly the same name and never work out.

 

In this case they just move client portfolios to cash when volatility rises. So just when the fixed-percentage portfolios tell investors to load up on stocks and buy low / sell high, Hedgeable will step in and do the reverse, selling low after buying hi.

 

Congratulations Hedgeable ! In a different way you have also done a full circle of logic and are going to do the exact opposite of what you should be doing.

 

A similar sort of mathematical inevitability means you should put all your money in property, but that’s for another blog post.

 

Stock trading: Everyone loves a punt
 

 

Punting shares is a national pastime in most Western countries. You’d be hard pressed to find a red blooded male who hasn’t tried his hand.

 

This is a rich, fat market, desperate for research, desperate for someone to tell them what to do.

 

Have some ideas on this, but this post is already too long, so, you’ll have to read about it next time.

 

ps I haven’t actually seen uber financials so don’t quote me quoting random pages on the internet.

 

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

(source)

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

bitcoin2 

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.

Bubblecrap

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. 

Security

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?

Postscript

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: https://adamantic.wordpress.com/2013/05/16/thriving-hive-2/

Notes

(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.

Don’t be hasty

1. Xivvie has prone true to form and is up about 400% since I sold my entire position at around $8 last year, proving once again stop losses are the devil’s work and have no place in anyone’s strategy. Whoops.

XIV 1 year

On the flipside, the world has proven remarkably good at knocking down risk markets, so there’ll almost certainly be another chance to pile back in, though if we have a few years like 2003-2006 (likely) I’ll probably have to watch one of my favourite plays quadruple again from the sidelines.

Typically the lack of market volatility over the past year is the exact opposite of what (dare I say) everyone was predicting a year ago. Even lil Kim hasn’t been able to shake things around. The commentators gleefully stating that the Korean markets are at ‘four month lows’ completely miss the point: big picture there’s barely been a ripple.

10 year KOSPI

(Kospi, Korea’s market index)

Fortunately, having watching XIV and it’s ETF cousins for some time now (of particular interest ZIV – it’s like a smoother version using futures further down the curve that inherently jump around less than the front end) and actually read their legal docs, at least I now have a firm strategy and some level of confidence to put on a position that, in my weak defence, I just didn’t have this time last year.

2. While I’d prefer it didn’t, that sort of opportunity may come relatively soon. There’s hints of the now-typical mid year slow-down in the US, Eurozone statistics are somehow managing to worsen, and there are signs wherever you look that market exposure is at extremes. This all suggests the annual Sell in May and Go Away collapse might happen once again, for what must be something like the fourth year in a row now.

Eurozone unemployment:

Eurozone unemployment 2013

3. Meanwhile the broad road-map has been playing out according to plan. The Eurozone hasn’t collapsed as the pundits predicted, and it will take far more than economic statistics to shake it now. Meanwhile the shale story played out more or less as expected, and while this hasn’t resulted in the fall in crude I was expecting, I think downward pressure is a relatively safe bet over the next few years.

Pressure on commodity prices will likely be the theme of the next couple of years, and you don’t need to be an expert to guess what impact the wave of supply will have on commodities like iron ore.

The second and third order impacts are harder and more interesting to ascertain. Most likely prices will stay low (as will inflation statistics) and those who need cheap fuel and cheap raw materials will benefit. Perhaps steel makers will finally have their time in the sun, and some of the pressure on airlines, shipping and transport companies will be alleviated.

4. To be honest though, considering the run so far, to be long in this market is not a clever move. Better to be patient and wait for a real opportunity. If you were set at much lower levels last year, or better yet, at any point in the four years preceding, that’s a different story, but this bandwagon is not for jumping.

Enough with the boring recap.

Next post: Anarchy and Bubblecrap