I finally cracked 100% on the trading performance – a private goal for the past few years. Purple is me, blue line is Australian stocks, yellow and green are the US and the UK.

27 month performance Michael Frazis

It’s been a bad period for a number of hedge fund heroes. Einhorn hasn’t made money in about a decade, despite his fresh-faced appearances boldly plugging such uniquely intelligent trades as long dated call options on Greek banks (lol). Ackman’s arrogance (‘I’ll donate all the profits on this trade to charity’) was justly and rightly punished. Paulson got everything wrong for maybe the fifth year in a row.

Since he paid himself a 3.5 billion dollar bonus one year he’s got almost everything wrong. Gold, oil, pharma, stock picks… You could have made a fortune just taking the opposite side of his bets. It’s incredible bad these guys really are at picking stocks. And these are the good ones.
As in most parts of life it’s better to be known as a brilliant investor than to actually be one.

Nobody has any business investing in hedge funds, though I’m about to set one up so I should probably stop saying that.

Anyway, pride goeth etc, though I like to think I’ve been sufficiently chastened by the market to last a lifetime. I’ve lost every cent to my name twice, and nearly everything a third time.

At least now in dollar terms I am very much ahead. It took four years to make back everything I lost in 2011 when all my option trades went sour a couple of weeks before finals.

Then I had a fraction of the capital and my trades were more than ten times the size they are now. The good news is I haven’t worried about the markets since and don’t even check them most days so it was probably worth it. Back then, most of the stocks I picked went fantastically but I lost money. These days I can’t catch a trick on the stock selection but the portfolio has been printing coin. Go figure.

Time to put more cash behind these trades.

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.