How low can crypto go?

The answer is “to zero”.

Over the past two weeks, investors have seen their bitcoins go up 10% in a day, down 10% in a day, down another 10% over 4 days, down 20% in a day, and down 15% in a day.

Having a bitcoin fork (Bitfinex) distributing its own fraud of a cryptocurrency shutting down isn’t helping matters any. There’s plenty of others out there which have no purpose in life to exist except to suck up cash in favour of their incumbent creators.

Stop to think what would happen if you had three-quarters of your networth (measured at the beginning of the year – after all, Bitcoin did go to USD$20,000 at one point) go through a string of days like the above.

I see a lot of obviously young and inexperienced investors in the reddit forums (e.g. /r/bitcoin) that have never been involved in anything resembling a bear market in their lives, and their mentality will be “buy the dips and hold on”. This is financially ruinous when holding an asset going to zero (see: Nortel investors). Another group will be “diversify into other cryptocurrencies”, but what good does diversification do when the entire asset class (if you want to call it an ‘asset class’) is garbage, just like the dot-com stocks in the late 1990’s? Is your bitcoin truly going to be one of the survivors like Amazon (which went down about 95% from peak-to-trough after the tech wreck) or is it going to more likely be like Alta-Vista, Lycos, Excite, Infoseek, or a zombie like Yahoo that never was able to resume its glory days?

My only regret is that they haven’t opened options trading yet on Bitcoin, although the implied volatility on those puts would be extreme.

Canopy Growth

In a nutshell, this is why it is dangerous to short companies on the basis of valuation – something over-valued can get even more over-valued:

Many people lost their financial lives shorting .com stocks in 1998-2000 due to their valuation. Many people will be losing money shorting cryptocurrency and marijuana stocks (if they haven’t already). Timing this is nearly impossible, but whoever gets it right will become quite rich.

No positions in WEED (now nor likely ever).

Shorted Interactive Brokers today

For a very short-term trade, I have shorted Interactive Brokers (Nasdaq: IBKR) today.

There is no excuse for their account management and quotation server system being down for the duration of a trading day, which I believe represents their largest reliability failure at least in the past decade, if not ever.

Their trading systems are still active, but this is probably due to the fact that they need them online in order to liquidate customer accounts that are caught on margin in a timely manner and manage risk. I had issues logging into their trader workstation earlier today.

My suspicion is they got hacked. Perhaps now that Spectre and Meltdown are public knowledge, the people that knew about this in advance are trying to “cash in” on this before the loopholes are closed and major system providers are in the race as well.

If this trade works, it will be a high gainer. If this blows over the weekend, the cover will cost a few bucks but it won’t be anything catastrophic. It is the high risk/reward ratio that I typically like for these sorts of trades, even if the desired result doesn’t materialize. There is a significant amount of information which hasn’t permeated to the public on this and when it does hit, the price will probably take a short-term drop.

(Update, January 5, 2018: They got their data server back up around 1:00pm Pacific Time, which corresponded to the closing of the market… very interesting)

2017 Year-End Report

Portfolio Performance

My very unaudited portfolio performance in the fourth quarter of 2017, the three months ended December 31, 2017 is approximately +5.6%. The year-to-date performance for the year ended December 31, 2017 is approximately +31.2%.

Portfolio Percentages

At December 31, 2017 (change from Q3-2017):

24% common equities (+4%)
35% preferred share equities (+9%)
29% corporate debt (-1%)
13% cash and cash equivalents (-12%)

Percentages may not add to 100% due to rounding.

USD exposure: 46% (-2%)

Portfolio is valued in CAD (CAD/USD 0.7944);
Other values derived per account statements.

Portfolio commentary

In terms of portfolio movement, this quarter was mostly inactive other than adding some cash to a preferred share position that is akin to “parking cash” in something reasonably stable while I wait for better market opportunities.

Specific line items in the portfolio include Genworth MI (TSX: MIC), gaining an appreciable amount during the quarter, and one otherwise undisclosed equity position that I wish I had taken more of a stake considering the excessive cash situation. Although I do not write about it very often, the position in Gran Colombia Gold debt (TSX: GCM.DB.V) has also increased during the quarter, and I expect after the issuance of the year-end financial statements that management will be conducting another debt repurchase at par value, resulting in additional cash that I will find difficult to re-deploy. My initial position was taken at roughly 60 cents.

Gran Colombia is a play on gold prices, but as the debt itself is secured by all assets of the company and has rights to 75% of excess cash flow, I suspect it will be safe. 2018 should be a very eventful year for the equity of the company as their junior debt (TSX: GCM.DB.U) will be maturing on August 11, 2018 – 81% of it will convert to shares and this will result in the issuance of 18.76 million shares (in addition to the 20.9 million currently outstanding). As the company expects $16 million in excess cash flow for 2017, this would be 36 cents per share on an adjusted basis and one can see the equity as relatively cheap.

All debentures in Gran Colombia Gold are currently convertible to 512.82 shares per USD$1000 par value (they are all denominated in US currency, while the shares are in CDN currency).

There is really little else to write about. The year-end portfolio is about as boring as watching paint dry.

My performance for the year can be attributed to the KCG transaction proceeding through, and also some non-trivial increases in the value of Genworth MI (if you can remember, mid-year it got hit by the Home Capital Group fallout). I will note this is the function of two decisions (both MIC and KCG) I made earlier in time (many, many years ago) to purchase. The real decision in the subsequent years was to remain patient by doing nothing.

In 2017, I only bought one stock for the year. This stock is up over 30% since I bought it. Everything else has been minor portfolio adjustments – the risk I have been taking is minimal.

Performance Notes

The last time I had a quarterly loss was in September 2015, making this report the 9th quarter in a row with gains. Normally quarterly performance should be punctuated by losses here and there. This lack of see-sawedness should normally be an indicator of fraudulent reporting, but I assure you it is not.

I observe the S&P 500 and TSX are up about 20% for the year and my portfolio is up even further. I always remember the phrase “a rising tide lifts all boats”, but my job is to ensure that when the tide goes down, my boat is still at the same elevated position. My 2009 performance was only made possible by not being involved with the tsunami of 2008.

Predictions in 2018

These will come in a later post.

Outlook

I know I sound like a broken record when saying this, but presently I do not believe my 2018 portfolio performance will match historical levels (my 12 year hurdle rate of 18% is quite high given what I see out there). Too much of the portfolio is fixed income with limited opportunities for capital appreciation. The only reason why it is in fixed income is because I have nowhere else to put the cash.

My weighted average maturity for my debt portfolio is 2.5 years. A large holding is Teekay unsecured debt (January 2020 – just over 2 years to maturity) and I will not be surprised to see it get called as they now have a re-financing window of opportunity. I am content to hold onto this until they decide to do so as the 8.5% coupon is better than I can receive elsewhere.

I’ve been continually scanning the Canadian debenture market and find entities that are simply too risky to invest – there is an overabundance of optimism that companies that have suspicious balance sheets will find a source of reinvestment. This might be true today, but credit can vanish as quickly as you can say “Cryptocurrency”.

The biggest way to lose money is to force it to work – while I can find some reasonable safe opportunities to earn 4% relatively “risk-free”, it comes at a cost of liquidity and the ability to pounce when the market reaches some sort of crisis. It has been a long time since we have seen a true crisis affecting prices in the marketplace – the inverse can be argued for, we have never seen a period of stability like this.

There are storm clouds on the horizon.

The passage of the 2017 US Tax Cuts was one of President Donald Trump’s signature campaign promises and the lowering of the US Corporate tax rate from 35% to 21% will have significant implications to US domestic investment. Coupled with an increase in short-term interest rates, it should have the effect of increasing the demand for US dollars. My outlook on the Canadian dollar is moderately bearish.

Rising interest rates will also mean that there will be less dollars chasing asset prices, which should put a lid on the overall market. When the US Federal Reserve will continue to raise interest rates, this will also give room for other central banks to do the same – Canada will likely follow.

Rising interest rates generally does not mean good news for gold, but gold has been surprisingly non-volatile in the past few years and seems to be an increasingly non-correlated hedge against all of this financial distortion we are seeing. I believe the decoupling of gold to traditional metrics is rational.

I continue to remain bearish on the Canadian oil and gas market. Canadian governments continue to remain hostile to oil and gas investment and differentials for mined product continue to be at record highs (as pipeline and train capacity issues continue to plague deliveries). It is very difficult for capital to flow into an industry where it faces arbitrary hurdles everywhere. This oil and gas money will continue to flow down south, all capital choices remaining equal. This will also involve the continuation of the exportation of expertise from Canada to the USA. As such, I do not see the equity side of Canadian oil and gas to receive too much of a positive reception in 2018. The tide may change in 2019 and onwards (world demand for crude oil still continues to rise), however, but we will see then.

The rampant speculation of cryptocurrencies will undoubtedly resolve in 2018. Companies have been trying to raise money like mad and strike while the iron is hot. Eventually this craze will die down and investors will start to demand a return on investment. Likewise, the full economic reality of marijuana production in Canada will probably prove to be a bust once provincial governments implement legislation to govern the sale of it – I think one of the surprises will be projections of profitability being far less than expected for all players involved except for the government – confusing sales and profitability is a huge difference here.

Where to I see avenues for extraordinary returns?

Ironically, cash might be one of them.

I wish I had more to write, but with a market that is flush with speculative gains, I am finding it very difficult to find genuine opportunities. It’ll probably be easier to take the pickings from the wreckage than contribute to the mania.

Portfolio - Q4-2017 - Historical Performance

Performance and TSX Composite is measured in CAD$; S&P 500 is measured in US$. Total returns indices are with dividends reinvested at time of receipt.
YearDivestor PortfolioS&P 500 (Price Return)S&P 500
(Total Return)
TSX Comp. (Price Return)TSX Comp.
(Total Return)
12 Years (CAGR):+18.3%+6.6%+8.8%+3.1%+6.0%
2006+3.0%+13.6%+15.6%+14.5%+17.3%
2007+11.7%+3.5%+5.5%+7.2%+9.8%
2008-9.2%-38.5%-36.6%-35.0%-33.0%
2009+104.2%+23.5%+25.9%+30.7%+35.1%
2010+28.0%+12.8%+14.8%+14.5%+17.6%
2011-13.4%+0.0%+2.1%-11.1%-8.7%
2012+2.0%+13.4%+15.9%+4.0%+7.2%
2013+52.9%+29.6%+32.2%+9.6%+13.0%
2014-7.7%+11.4%+13.5%+7.4%+10.6%
2015+9.8%-0.7%+1.3%-11.1%-8.3%
2016+53.6%+9.5%+12.0%+17.5%+20.4%
Q1-2017+18.6%+5.5%+6.1%+1.7%+2.2%
Q2-2017+0.6%+2.6%+3.1%-2.4%-1.6%
Q3-2017+4.3%+4.0%+4.5%+3.0%+3.5%
Q4-2017+5.6%+6.1%+6.6%+3.7%+4.3%

Looking at the losers of 2017 (TSX)

Purely for reference – look at the victims of 2017 market action. A lot of gold, oil and gas, and Aimia!

Some of these are also on the September 2, 2017 screen I did. The only difference with this table is that I did not restrict revenues and had a minimum market cap of $25 million.

Entities included also are ones that have not been delisted (e.g. Sears Canada).

Any pickings on these entrails that are worth looking at?

CompanySymbolYTD (%)
CPI Card Group Inc.PMTS-T-82.5
Platinum Group MetalsPTM-T-80.67
Asanko Gold Inc.AKG-T-79.37
Intellipharmaceutics Intl. (D)IPCI-T-74.41
Concordia International (D)CXR-T-74.39
Electrovaya Inc.EFL-T-70.89
Painted Pony EnergyPONY-T-69.85
Aralez Pharmaceuticals Inc.ARZ-T-69.37
Condor PetroleumCPI-T-68.65
Neovasc Inc.NVCN-T-67.67
Oryx Petroleum CorporationOXC-T-66.98
Mandalay Resources CorpMND-T-66.88
Bellatrix ExplorationBXE-T-66.09
Euromax ResourcesEOX-T-60.77
Western Energy ServicesWRG-T-59.68
Dundee Corp.DC.A-T-58.49
Pine Cliff EnergyPNE-T-58.41
Eldorado GoldELD-T-58.1
Perpetual EnergyPMT-T-57.87
Aimia Inc.AIM-T-57.83
Red Eagle MiningR-T-57.33
Crew Energy Inc.CR-T-56.86
Newalta CorpNAL-T-55.6
Peyto Exploration & Develop.PEY-T-54.17
Western ResourcesWRX-T-53.89
CRH MedicalCRH-T-53.84
Bonavista Energy Corp.BNP-T-53.22
Birchcliff EnergyBIR-T-53.04
Tahoe ResourcesTHO-T-52.57
NeuLionNLN-T-52.17
Cardinal Energy Ltd.CJ-T-51.65
TAG Oil LtdTAO-T-50.65
Storm Resources Ltd.SRX-T-50.57

Raw transaction costs – Commissions

I’ve been compiling some data for the year-end.

One statistic I track is my transaction costs (i.e. commissions of transactions).

If I’m generating performance that is below the market averages, I should immediately quit and just invest in a bunch of low cost indexes (Canadian Couch Potato is mostly cited in this respect – I will not offer opinion on it, and Vanguard Canada in general is quite low cost). In general, you can invest in a basket of well-diversified stocks and bonds at a management expense ratio of roughly 0.1-0.15% of assets.

It actually isn’t readily obvious whether higher transaction costs is a detriment to performance when one’s performance is higher than the market averages. Can one instead make a case that lowering the volume of transactions will actually increase performance?

The way I try to measure performance is applying the “What if I were to be struck by lightning at any point in time, how would my portfolio fare” test, where if I would arbitrarily freeze things at one point in time – e.g. January 1, 2016, how would I have fared today compared to my present value had I not conducted any transactions since that date? (I don’t answer this question in this post, but consider it for your own portfolios – it is an interesting exercise when you discover that you have two-year streaks where clicking buttons is negative alpha!).

Getting back on topic to transaction costs, over the past decade, this number (as a function of year-ended assets) has been between 0.05% to 0.81% (the 0.81% year was in 2008, which for understandable reasons, was a very volatile year for trading – while losing 9% for the year, I out-performed the S&P 500 by over 25%). The number should decrease over time as asset values have increased.

2017’s year-end number (I do not anticipate making any trades on the last day of the year) is quite close to the low end of my past transaction cost range.

Commissions these days are so low that trading execution is a much more dominant factor in terms of reducing the frictional costs of transactions, but keeping records on raw trading costs I find fascinating. I cannot be accused of over-trading, but always look for methods to optimize how I scale in and out of positions – every basis point of performance counts, especially in today’s non-volatile markets.

Reviewing predictions made in January 2017

I’ve been slowly assembling my year-end report. One segment of the report is my predictions for the year, which is issued at the beginning of the calendar year. They are mainly for fun and not for serious investment purposes. Some years my crystal ball is clear and in some other years it is very opaque. This year, the crystal ball was not only opaque, it had huge cracks!

For reference, the predictions were made in my 2016 Year-End Report. I will grade them as follows:

If absolutely everything works in 2017, the gains should be in the low teens. It is more probable that it will be a mid-single digit percentage year for me. My research pipeline is relatively thin at the moment (not a good sign for gains). Keeping my past 11 year record of 17% right now is a pipe dream.

Failed. Barring a catastrophe in the remaining 8 trading days of the year, the year-end percentage gain figure is going to be well north of the +17% previous 11-year CAGR.

1. The 1st half of the year will contain the high water mark for the S&P 500, Nasdaq and TSX. (The TSX’s high water mark was on the last trading day of the year!).

Failed. As I write this, December 18, 2017 is the high water market for the year for all of the indicies! (the prediction was looking good until September).

2. The Bank of Canada will not raise the short-term interest rate (0.5%), UNLESS if the 10-year bond yield rises above 2.5% (right now it is 1.72%).

Failed. The 10-year never got above 2.2% and rates rose twice to 1.0%.

3. The Canadian dollar will depreciate below 70 cents USD at some point during the year.

Failed. It got to just below 73 cents but that’s it.

4a. Kevin O’Leary becomes the next leader of the Conservative Party of Canada, first-ballot victory with around 60% of the vote.
4b. He will speak better Français better than the media expects (think about Facebook’s Zuckerberg speaking Mandarin).

Failed, and failed! Even if he stuck around, he would have received nowhere close to a majority of the vote on the first ballot.

5. The 2017 Budgetary proposals as written above (I’ll consider this prediction successful if at least 4/7 occur).

Failed. 1/7 correct.

6. Spot WTIC pricing will spend the majority of its time around the USD$50-65 price band.

Somewhat failed. The chart dipped well below 50 for a good chunk of the middle of the year. (Update: A commentor below, Live from London, said this is not the case)

7. If China experiences something akin to Japan’s early 1990-type economic malaise, there will be significant ripple-down effects on Vancouver real-estate (let’s define this as a Teranet average of less than 220).

Not graded. The conditional “if” statement never occurred.

8. The US federal reserve will raise interest rates once to 1%, but will relax the interest re-investment policy on their balance sheet assets during the year and retain a tightening bias.

Mostly failed. They raised rates three times. While they certainly altered their re-investment policies on their balance sheet items, they continue to retain a tightening bias and it is predicted there will be 3 additional rate increases in 2018.

9. “Canada Recession” will register a Google Trends search index rating of higher than 10 sometime in 2017. This is basically a prediction that by year-end that it should be fairly evident that we are close or going into recession.

Failed. The measurement parameter was ambiguous on this but it would have been in relation to the five-year chart (as it is a relative index and not an absolute index). It got up to 3.

10. Minister of Democratic Reform Maryam Monsef will get shuffled out of her portfolio (in addition to others from theirs) during 2017. There will be some “face-saving” measure applied for the justification (e.g. she suffered an injury, or something to explain it other than her performance).

Mostly correct. I think the widely recognized excuse was incompetence on the democratic reform file.

11. In the May 2017 BC election, the BC NDP win 20 seats or less (down from the 35 they currently hold). I note polling now has them neck-and-neck with the governing BC Liberals.

Failed. However, to my credit, during the campaign period I completely flipped my prediction and got it mostly correct in this post. Take this advice from a political student: campaigns matter.

12. There will be at least one volatility spike (VIX index) that will take it above 30 as a result of some geopolitical (not economic) event.

Really failed. This one was a mile away, with a peak of 17.

13. (Added January 2, 2017) Canopy Growth Corp (TSX: CGC) trades below CAD$9.14/share (2016 year-end closing price) at 2017 year-end (background info).

Really failed. Good thing I wasn’t shorting this, as it is CAD$2021/share today! Don’t know what investors are smoking when they’re buying this, but what do I know? (Update December 28, 2017: One week later, WEED is north of CAD$30!)

Summary:
Correct – 1
Failed – 13

Sometimes when you make predictions, they all turn out to be wrong. Indeed, the only correct prediction I thought was a lay-up.

Fortunately, I do not invest my capital on the basis of these predictive whims, so my yearly performance doesn’t reflect the dismal record displayed above!

Small notes on random equity research

I’ve been looking at some existing holdings and companies that I do not own, specifically what has been doing well and not doing well year-to-date. Some miscellaneous thoughts that are not so illuminating:

1. Natural gas has been getting killed lately. I’ve been looking at Birchcliff Energy (TSX: BIR) (I own the preferred shares but not the common shares), and they are going to face significant revenue compression in relation to past financial statements because AECO natural gas pricing is really, really, really low. We’re seeing continued pain in equity pricing (also looking at Peyto and others) and no signs of this getting better – demand isn’t rising that fast (especially since the dreams of the product being exported across the Pacific is completely dead), and supply is plentiful.

2. Any company with the word “blockchain” in the press release, no matter how junky, is getting a market reaction upwards as it is obvious there is algorithmic trading designed to pick up such releases, hit the “buy” button and sell an hour after.

3. Pulse Seismic (TSX: PSD) is a very interesting business with incredibly lumpy revenues. Their balance sheet is misleading in that they amortize their accumulated data, so the remaining asset is not really present in its monetarily realizable format. I am not interested in them with their existing valuation but from an analytical perspective an interesting business. They made a relatively large sale to a customer and they gave a lot of cash away to shareholders both in the form of a special dividend and a significant share buyback.

4. Other energy service companies have also been hammered. There’s a few that look interesting, although it is clear they are all still suffering from large amounts of overcapacity – it appears revenue margins are still quite low.

Macro: US Federal Reserve Balance Sheet

I rarely make investment decisions as a result of macroeconomic analysis. I find that it is too easy to confuse correlation and causation, and also it is too easy to miss data that one should be considering as part of an analysis – i.e. it is the things that you don’t know that kill any way to glean superior insight.

I still try my best to piece together certain pieces of information to strengthen my belief on where the market currents are headed – even if something gives you a half percentage point edge on a coin toss, while you might not notice it if you flip a coin a few times, over a period of time it will give you a statistical edge. Better having it than not!

The Federal Reserve yesterday raised interest rates another quarter point. Given the reaction in the fed funds futures, this was entirely expected, but the details are in the implementation note. In this note, I draw attention to the two paragraphs:

The Committee directs the Desk to continue rolling over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during December that exceeds $6 billion, and to continue reinvesting in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during December that exceeds $4 billion.

Effective in January, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $12 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $8 billion.

Normalization started in October 2017 with the $6/$4 billion in maturities. The new information is the step-up in January 2018.

We look at the Federal Reserve’s actions since 2007 and observe during the economic crisis they have pumped a gigantic amount of money into the economy (mostly held up in banks, but still available nonetheless):

(On the top graph you can see a tiny, tiny dip in the holdings on the right hand side – this is the start of the “normalization”).

(If you wish to play with the data yourself, just go to https://fred.stlouisfed.org/categories/32218 and have fun).

As of today we have 2.454 trillion dollars of US treasuries held and 1.767 trillion dollars of mortgage-backed securities. The mortgage-backed securities are an artifact of buying off garbage assets from banks that were afraid that securitizations of such debt would fail – the federal reserve essentially back-stopped this marketplace until it normalized (and given real estate valuations, it has mostly succeeded in doing this, and more).

The point here is that there is $4.221 trillion in cash floating around, mostly in the vaults of banks, but this money has been creeping its way into the asset markets, causing considerable inflation of asset prices (but not inflation of consumer prices, which is why the reported CPI is still so low).

The Federal Reserve has been reinvesting proceeds of these securities until now – they will be maturing off another 0.010 trillion in December and 0.020 trillion in January. For the next two months that will amount to 0.71% of the Federal Reserve’s balance sheet. If they keep the January 2018 pace for the rest of the year, it will amount to about 5% of their balance sheet drawn off.

The question that I am asking is when this will have an impact on asset prices. Cash is still cheap to obtain, but clearly it is going to get more and more expensive as the year continues.

For comparative purposes, the Bank of Canada is relatively boring – they hold roughly a hundred billion in government debt. Most of the financial action in Canada is with the “big banks”. The only on-balance sheet action the Bank of Canada took with respect to real estate-related financial activity was the $35 billion they accumulated in securities purchased for resale in 2008, and the majority of off-balance sheet actions were in the form of guarantees during the financial crisis.

My suspicion is that the Canadian dollar will weaken, but correspondingly US equities as an aggregate will have their gains capped. There will of course continue to be opportunities, but the headwinds are starting to build up.