Category: Finance

I have not written too much lately, but the short-term research focus continues on stocks that are generally trading at 52 week lows. If you are into gold mining companies, let me tell you, there is no shortage of research to be conducted.

Fortunately, I do not focus on the gold mining industry and can let other intelligent people harvest opportunities in that category. One would think, however, that large-scale entities like Barrick (TSX: ABX) and Kinross (TSX: K) would have some sort of value, given that they are trading at lows they haven’t seen in a decade. That said, just because a large corporation has traded at a certain level in the past doesn’t mean they will continue trading at that value forever – the market is full of survivor bias, which is why you don’t see Polaroid or Kodak trading anymore.

There is another focus which I have been slowly shifting my attention to, and this is territory that is generally unexplored for me: international stocks, beyond those in English-speaking jurisdictions. My natural investment aversion to non-English speaking jurisdictions is colliding against the general belief that there seemingly are entities trading out there that are at relatively cheap valuations. I can easily see right now, however, that I am the person around the poker table that everybody wants to take a dollar out of, so I am very wary treading into this direction.

I did find a particular investment candidate in the early part of the quarter which I pounced on with two feet and this unexpectedly has boosted the performance of the portfolio considerably and I hope to find others. I might write a report on this one after year-end.

Bitcoins are once again making headlines, for exceeding US$1,000 per Bitcoin on various exchanges.

I wrote about them back in 2011 when they were trading at around US$20 a piece. The analysis is really still the same.

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.

More people are seeing something valuable in something very odd and this is apparently spreading world-wide to anybody with a computer.

As for answering the question as to what Bitcoin’s peak is, I do not know for sure. This reminds me of when I asked myself when the dot-com bubble is going to burst, or how far the US stock market was going to plunge in late 2008/early 2009.

There are a few headwinds I see for Bitcoin, and they generally deal with hitting the law of large numbers.

The first deals with liquidity.

There are 12 million Bitcoins outstanding, but the reported liquidity is quite thin. Right now if you wanted to liquidate 5,000 Bitcoins and raise a cool $5 million, according to the liquidity chart you would move things about 13% if you wanted to hit the bid with everything you have. Obviously you would want to fragment the order and leak it out over a period of time over multiple exchanges, but I would suspect that there are some component of technical traders that are simply out there to scalp dollars and not actually give a hoot about the currency.

The reported market cap of Bitcoin is about $11 to 12 billion and when looking at a typical equity trading with the equivalent capitalization, Bitcoin’s liquidity is nowhere close.  How many dollars can you actually extract out of the market if you had 100,000 Bitcoins and wanted to liquidate in a timely manner?

Another issue deals with the ability to control the blockchain (the accounting equivalent of the general ledger, with the notable exception that the blockchain contains ALL information of transactions since the history of Bitcoin).  Without getting into a lot of technical details, there are collusion opportunities to corrupt the blockchain if you control a majority of Bitcoin miners.  Bitcoin mining has become a very specialized art and to effectively compete in mining, you need to own arrays of specialized devices for the purposes of mining Bitcoins.  Since the difficulty of Bitcoin mining increases as a function of both time and the amount of computational power on the Bitcoin network, there has been a technological arms race, with the following result:

Please observe the y-axis is logarithmic – mining Bitcoins has been over a hundred times more difficult than it was at the start of the year.  This is like your typical 10MBps residential high-speed internet connection scaling down to twice the speed of a dial-up modem.

The technology to do the proper calculations are application-specific integrated circuits (ASICs) that have their sole purpose in life to mine Bitcoins, but as these are permeating the Bitcoin marketplace, there are limited opportunities for exponential improvement to Bitcoin hash rates through technological innovation – most performance improvement from this point is going to be linear as more machines get added to the cluster networks that are solely dedicated to Bitcoin mining.

I note with amusement the announcement that somebody is producing a 20nm process ASIC rig that can do some insanely high hash rate, but this will be the end of the line: 20nm semiconductor processing is the peak of the current technology limit – even Intel is still working on perfecting the 14nm process.  Even then, the company has already announced the product (which apparently will be shipped in Q2-2014) will be at the threshold of the limits that a typical household power supply can handle.

So when you get into industrial-level operations to run arrays of computer hardware solely for the purpose of mining Bitcoins, some group is going to consolidate a majority of miners and be able to corrupt the network.  With billions of dollars of market capitalization, it is getting to the point where that group is probably thinking about implementing some scheme to control the blockchain.

The blockchain concept also creates a scaling issue as eventually it becomes impractical for it to be maintained by distributed “retail” computers – “institutional” resources are increasingly employed to maintain the blockchain as they will be the only ones to have sufficient computational muscle to be relevant.

When will this blow up?  I’m not sure, but I’m reasonably sure we’re within an order of magnitude (i.e. not higher than US$10,000/Bitcoin) just because of the law of large numbers – liquidity (the quantity of dollars Bitcoin is able to extract from others) and blockchain dynamics.

The current phase in Bitcoin is still adding people with money into the system, which is required for the scheme to continue, but those that have caught onto the scheme earlier will presumably be continuing to diversify their Bitcoin holdings into harder currency.

When reading Reddit’s Bitcoin chatter, I see a lot of financial illiteracy out there, which doesn’t bode well for those that have high hopes for Bitcoin.

I do not own any Bitcoins, nor will I, but I am watching this with curiosity.  It is indeed is fascinating to watch non-financial people get involved in what is inherently a financial specialty product with a touch of well-designed technology sprinkled in.  Whoever conceived of this did their homework and never would have guessed the technology arms race that has developed as a result.

If not, you are lagging behind the S&P 500 and are UNDERPERFORMING. So those sitting in a paltry 20% year-to-date return may think they are sitting pretty, but hedge fund managers out there know they are lagging and their customers are demanding heads to roll. Looking at my year-to-date performance, I’m barely ahead, but this is because I’m Canadian and can cheat a little via the amazing accounting practice of mark-to-market for currency translation, (i.e. my returns are always denominated in Canadian dollars, and the Canadian dollar has gone lower this year hence I get a little boost up in performance for having the audacity of holding US-denominated stocks and cash during the year). In my defence, however, is the fact that I’ve had a relatively large quantity of zero-yielding cash in the portfolio for financial Armageddon’s sake.

In the last phase of a bull market (which we are indeed going to be entering, if not there already), all of the naysayers (such as myself and “professional market analysts”) warning of a market crash and chronic over-valuation will suddenly start shutting up and believing there is some sort of new economic paradigm that has caused the markets to go wildly up. I’m pretty close to reaching that point myself, which probably suggests that the end is near. I had these visions of the world entering into a 2009-like economic crisis again when the Greek Debt thing hit in August 2011, which was probably one of the worst calls I made over the past decade, and it indeed cost me.

Of course, the whole world knows the asset inflation is primarily due to the federal reserve pumping trillions of dollars of liquidity into the system, only to end up as bank reserves for JP Morgan and Bank of America, but who cares at this point? Politicians know the general public does not know the true implications of free liquidity, and here in Canada, the government knows that if the central bank raises interest rates, they will end up crashing the entire economy because our debt-to-income ratios are sky high.

There’s clearly no vulnerability or risk here.

For memory’s sake, here is a chart of the Nasdaq from the beginning of 1999 to the end of 2000:

I remember these days as being wildly irrational. I got my start in the public markets a year or two before this and even when I was beginning my journey to compounding assets on my balance sheet, I realized that things were frothy and I had better stick my capital in anywhere but dot-com technology, and that I did. Even when I ventured into technology it was relatively “value-based” – the first company I owned that got bought out was Sterling Commerce, and they were trading at a relatively modest P/E of around 20 at the time. I didn’t keep proper records during the 2000-2002 timeframe, but I do distinctly recall that the overall hit to my portfolio was quite modest compared to the market averages, similar to my performance in 2008.

Let’s pretend we’re sitting at the year 2000 and the Nasdaq is sitting around 4000 (where it is presently). The world discovered the computer systems did not melt down and bidded up the markets another 20% before finally collapsing down to earth again.

A repeat of that scenario would mean the S&P 500 would go to 2160.

So just before somebody thinks “things can’t go higher”, in bubble-type situations, they usually do, a lot longer and a lot farther then most people rationally expect, especially with the winds of the federal reserve still clearly behind the market’s back.

Does it feel like 1999 to anybody out there? Basically if you invested in high beta, momentum type stocks (especially those .com companies with as little revenues and high negative incomes) you would have made like gangbusters. If you actually invested in anything that made financial sense, you would have seriously underperformed, if not seen depreciation in your asset values.

People investing in Apple currently must feel like that. There is a lot of stuff out there that has seen substantial price appreciation and very little change in the fundamental thesis in the first place – e.g. has the story with Netflix (a triple since the beginning of the year) changed any over the past 10 months? Priceline (nearly doubled)? Even old technology, like Hewlett Packard, has seen appreciation that doesn’t seem to correspond with any real change in their underlying structure.

Just because markets are trading wildly higher doesn’t mean that they won’t stop doing so – momentum in the marketplace has amazing power that will confound even the most seasoned of investors. Its already happened elsewhere, such as the Nikkei 225:

Investors in the month of May saw appreciation and depreciation of nearly 20%.

We are in strange, strange times. The trick is to not lose money on the way down.