Category: Economics

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.

This is a rambling post, so be cautioned that there is little rhyme or reason to the thought pattern here.

I look at the following chart of the 30-year treasury bond:

The risk-free return is very low at present. Relative to other sovereign entities (e.g. Euro-zone, Japan, Canada, etc.), however, the US 30-year bond actually still looks cheap and this can explain why it is the best performing asset class in 2014 to date.

As an exercise to the reader, please reconcile what we are seeing in front of us:

– S&P 500 is at all-time highs (approximately 1,900 as I write this)
– The economy appears to be plodding along at a low real rate of return
– Inflation is rising but not at ridiculous proportions (yet)
– US currency appears to be making a comeback
– Short-term rates are still basement low (fed funds target is 0-0.25%, but the effective daily rate has been closer to around 0.09%)
– Long-term treasury rates are relative low (see above chart)
– US government is still projecting $500 billion deficits although this is quite better than previous years; other liabilities (e.g. social security) and various other entitlements (e.g. pensions) generally remain huge liabilities and difficult to get a good rate of return
– Almost every retail Joe that is not involved in stock (lottery) picking is dumping their money in a variety of index funds that invest in the same things in the same proportions (Typical Canadian allocation: 40% TSX 60, 30% S&P 500, 30% some fixed-income ETF)

The demographic story is that the bulk of the population pyramid is entering in the stage of life where they are transitioning their capital into income-bearing instruments, which accounts for the very high cost of yield at present.

It remains very difficult to say whether we are entering in the Fairfax world of upcoming deflation despite everything (which would guarantee low interest rates for some time to come), or whether we’re entering some sort of inflationary world (because of all of the available credit, which would presumably translate into spending and consumption).

Although my style of investing does not depend on macroeconomic outcomes, it is always nice to know where you have the winds at your back. In terms of the big world-picture view, it is difficult to tell where these winds are blowing at present.

The only real convictions I have at this point is a general aversion to commodity-related products and a realization that those that are paying for yield are likely paying a premium beyond what the risk/reward ratio would suggest.

In other words, you are more likely than not to find the “hidden gems” amongst the list of zero-dividend yielders (or very low) on the equity side. Due to the “rising tide lifts all boats” phenomenon that we are encountering at present, until we see defaults of junk debt issues that go out for insanely low coupons and high durations, finding these gems is not easy. Most of them have been bidded up.

This leaves potential investment candidates in very un-ideal categories: the nearly illiquid and special situations (e.g. spinoffs, emerging from Chapter 11/CCAA, SEC/SEDAR “fine-tooth comb required because GAAP financials simply don’t explain the story” companies, closed-end ETFs, etc.). Not a lot of pickings here.

NYSE Data has margin borrowing at $401 billion, which is an all-time high.

The record level before this was back in July 2007, about 9 months before Bear Stearns went belly-up. The amount of margin debt then was $381 billion.

Negative interest rates have a very odd effect on the financial math. Certain European countries are selling short-term debt at negative yields, which is somewhat odd. Specifically if you bought a bond from Germany with a 2-year term, you would receive a yield to maturity of -0.06%. If you just held your Euros under the bed, you would receive a yield of 0%.

This is somewhat of an interesting statement by the market in that holding Euro cash is more risky than holding German debt. The decoupling of sovereign debt and its underlying currency is quite steadfast in Europe, while it is highly unlikely you will see such an occurrence in Canada or the USA unless if investors have a good reason to believe that the Canadian dollar or the US dollar will be broken.

I will not talk at this point about Quebec separation and the impact to the Canadian dollar.