Bitcoins as alternative currency

You can read about Bitcoins on its own site, but summarizing the story, some computer engineers developed a currency that rely on peer-to-peer networking to conduct exchanges and also to generate new currency (which has a hard-coded limit to creation). Your ability to generate currency is directly a proportion of how much CPU power you can generate to solve a mathematical problem. With a typical personal computer, your ability to do this is quite limited. However, people with more powerful hardware (in particular, advanced graphic cards) are able to solve these problems.

What I am finding relatively amusing is that this marketplace has an active following with people actively trading bitcoins for cash and vice versa. Over the past year, the market for this product has increased significantly, with about US$500,000 traded yesterday alone:

A currency is only as good as the confidence that people have in it. In this case, they believe a currency that can be minted only by some algorithmic work is something that inspires confidence because the rate of currency generation is relatively pre-defined. In light of this, it is not that different than any other currency. Gold-backed currencies have confidence because they can be exchanged for bits of yellow metal. Some countries can mine the yellow metal better than others. Canadian (paper) currency is valuable because it can be exchanged to pay governments taxes (fundamentally, this is the only true value the Canadian dollar has).

There is also the issue of “counterfeiting”, even if the bitcoin system is technically secure. One problem is that you can create an identical digital currency and call it something different. So in this essence, counterfeiting is a very relevant concern – not direct counterfeiting, but copy-catting. Bitcoin does have a “first mover advantage” which may mitigate against this.

My last point is that generating CPU cycles is not “free” – not only do you have to keep your computer on to doing so, but the watts required to power your processor is higher when it isn’t idle. There is an interesting article about a person in Mission, British Columbia (a suburb of Vancouver, BC), getting raided by the RCMP because his power consumption was typical to that of a marijuana grow-operation. Instead, he was mining for Bitcoins. As people hit the “Bitcoin lottery” and receive a block of 50 bitcoins, this can be liquidated in the marketplace for approximately US$800-900 – not a bad haul for an expenditure of electricity.

The debate here should not be whether Bitcoins are useful as a currency or not, but the lesson here is strictly one in economics – people see value in very strange things, and when people do see value, there will be markets created. In this case, the product is a currency that is only valuable because of its rarity and difficulty of generation, and is not too different than trading artwork or collectibles which have similar appeal.

Rangebound markets

I am not a large believer in technical analysis providing predictive value, but the pattern-seeking eye sees the following trend in the S&P 500 over the past 6 weeks:

We see a downtrend channel. Is this part of a trading range?

Volatility only saw a very brief spike up in March, primarily due to the Japanese earthquake:

We add these two together and see a marketplace betting on a trading range. The swing traders at this point are likely the ones to end up making the money, rather than the trend followers. Not a good time to be taking risk.

What was the big winner in 2011? Oddly enough, nothing more than the 30-year US treasury bond:

Fraud alleged at Sino-Forest Corporation

A specialty research firm, Muddy Waters Research, released a report alleging that Sino-Forest Corporation (TSX: TRE) is essentially a huge fraudulent operation, backed up by quite a comprehensive research report. TRE was slaughtered in yesterday’s trading, down nearly 20% before it was halted for the day.

If the fraud allegations turn out to be true, this will be the biggest fraud story on the TSX since Bre-X. Sino-Forest had a market capitalization of about 6 billion dollars just two short months ago. In an eerie parallel, Bre-X collapsed after reaching a market cap of approximately $6 billion.

My own investment policy on China is simple – don’t. I am sure there are fortunes to be made investing in legitimate Chinese companies that actually have shareholder-friendly management (this is a contradiction in itself) that have been tarred-and-feathered by all of the rampant fraud that is coming out of China today. Such companies might be possible to find when you are across the wrong side of the Pacific Ocean, but how can you ever know without even knowing the local language?

Stock screening methodologies and a market omen

Whenever I do equity research, I perform a stock screen for certain metrics, and then I give a superficial scan of the stocks that get spat out of the screener. It takes about a couple minutes per equity for me to determine whether it is worth my time to look further into the company or not – typically I throw out 90-95% of the companies in this process. For the remainder, I queue them up to look more thoroughly using a fairly standard methodology (a basic guide), and then if I continue to like what I see, I do some more depth on the industry in question and competitors, and other research.

Most of the time, when I do this extensive research, the equity is over my accumulation price target. More times than not you can rationalize why the market is giving the company the value it is currently trading at, so I end up setting a price alert if the stock goes under a certain price. An email gets sent to my inbox when this occurs. I then “set it and forget it”, and usually do not keep the stocks on my watch list until the price target is hit.

Once the stock hits the threshold price, I then re-evaluate the position to see if anything has fundamentally changed in my original analysis to justify the drop. The point of this process is to make sure that the news the market is pricing in is not fundamentally damaging to the business. Once this is done, then I can set some buy limit orders and then accumulate.

The whole point of this post is that there are typically dry spells when nothing reaches the price target. Then there are times where everything you set a limit for has the price target alert hit your inbox. Today was notable in that a couple stocks are now below my alert price – perhaps an omen?

Bank of Canada keeping rates steady

The Bank of Canada has kept the target overnight interest rate steady at 1%. This surprised nearly nobody. Their statement is relatively unchanged from the prior one.

The chart to keep looking at is not the BAX futures, but rather the 10-year benchmark government bond yield:

With the yield spread from short-term rates to the 10-year at about 205 basis points, the bank is unlikely to lift rates anytime soon.

BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 JN 98.695 98.705 98.695 0.005 12727
+ 11 JL 0.000 0.000 98.630 0.000 0
+ 11 AU 0.000 0.000 98.615 0.000 0
+ 11 SE 98.630 98.640 98.630 0.000 31347
+ 11 DE 98.500 98.510 98.480 0.020 37387
+ 12 MR 98.350 98.360 98.310 0.040 24564
+ 12 JN 98.200 98.210 98.140 0.060 13081
+ 12 SE 98.040 98.050 97.970 0.070 3855
+ 12 DE 97.870 97.890 97.790 0.090 809

The market has priced in a rate hike by year’s end, but I do not think this projection will come to fruition – come December, the 98.5 price will be likely around 98.7 – a thin value bet could be placed here.