Tuesday, July 7, 2015

Take that copper!

It's hard not to be excited about the fall in copper prices today, over 5% and dropping as I write. Take a look at the carnage!

Our team has been stalking copper since 2011 when we realized that it was being used in China to skirt their lending restrictions. This was the subject of an interview we did in May 2012 with Funds People magazine (article is in Spanish) where we pointed out the problems with copper prices in Shanghai vs London. Dusting off an old chart from the time, here is what caught our attention - inventories were rising in China and Shanghai copper was trading at a discount to copper in London. This was a big red flag. London is a huge market for copper trading but the use of physical copper obviously would be higher in China. Something didn't smell right.

We were not the only ones looking at this and thinking something was wrong. Standard Chartered did more research on this topic than any other bank I'm aware of and they were coming to the same conclusion as we had, namely that stockpiles were artificially high and thus copper must be getting used for something beyond construction. Sure enough we were right. Copper was being used to obtain letters of credit from Chinese banks. As lending restrictions at the time were being tightened it turns out that credit against commodities as collateral was a great work around. With lending rates in the black market of China being much higher than state owned banks clever importers would bring in copper, obtain a letter of credit, take the money and lend it out into the black market. More sophisticated versions involved arbitraging onshore/offshore Yuan rates and speculating on other investments such as real estate and stock prices.

Zero Hedge has done a great job detailing how the transactions work in China. Please see these articles:



While China may be a huge driver of global growth they have many areas of their markets that remain opaque. As their stock market bursts there will be margin calls on anything that's not nailed down. Expect to see most commodity prices impacted by their continued sell off. We believe copper still has a very long way to go before it bottoms out which is why we've been creating a shopping list for equities in Chile for the last 4 years. Take a look at the U.S. dollar vs. the Chilean peso today. Tell me we are not in an interconnected world!

The dollar is up and because copper is so closely associated with Chile's currency the more copper falls the more the Chilean peso will drop. This is not so different from our observations about oil prices and currencies associated with oil. Chile is a great economy in our opinion. We've been patiently waiting for the current credit cycle to collapse so that we can go in and buy up several things on our wish list in Chile. Seems like we are getting closer. Until then watch out for copper!

Sunday, July 5, 2015

The Hangover Starts Tomorrow

If you haven't seen the movie series the Hangover and in need of a good laugh I suggest renting any of them on Netflix right away. The series is essentially about some buddies that party way too hard during each other's bachelor parties and wake up the next morning so hungover they have to peace back together what happened to them the night before. My personal favorite is The Hangover Part II. After a wild night in Bangkok the fellas wake up in an apartment, one of them with a chain smoking capuchin monkey on his back, another with a tribal tattoo on his face, and the other with a shave head. Wow, the party they must have had suggests long term repercussions! I believe a Bangkok style hangover is what its going to be like for Greece tomorrow morning.

Today Greece held a referendum to determine whether or not they would accept the bailout terms of the ECB, IMF, and EU (the Troika). The result of the vote, and cause for the big party tonight, was a massive "NO" from the Greek people. The citizens of Greece have spoken. Greeks are fed up with austerity measures. This was the vote that both Prime Minister Tspiras and Finance Minister Varoufakis wanted believing that it would give them much greater negotiating powers.

The problem with all the partying as people are being interviewed by Bloomberg, CNN, BBC, and other news agencies is that the people of Greece are not aware of the impact this vote will have on their financial system. I'm not saying that Greece shouldn't have voted "no". In fact I think it was a good move. What I find to be the bigger problem is the promise from Greek politicians that Greece will remain in the Eurozone after such a vote and that they will also continue to use the Euro. The politicians are also promising that pensions and deposits at banks will be fine. They will NOT. How could they be?

What's even more concerning is the contagion factor that we've been warning about for years. Greek debt is either going to be given another massive haircut or it will be a full default with zero repayment. Any haircut on Greek debt at this point will ripple throughout the Euro system. The real overlooked piece of financial news will be the impact Greece's decisions will have on the TARGET2 interbank payment system. TARGET2 tracks claims by various European central banks. Here's why its a problem:

From Wikipedia

The issue of the increasing Target balances was brought to public attention for the first time in early 2011 by Hans-Werner Sinn, president of the Munich Ifo Institute. In an article in ‘Wirtschaftswoche’ he drew attention to the enormous increase in Target claims held by Germany's Bundesbank, from 5 billion at the end of 2006 to 326 billion at the end of 2010, and to the attendant liability risk.[3] In the German dailySüddeutsche Zeitung he put the entire volume of the Target liabilities of Greece, Ireland, Portugal, and Spain at 340 billion euros at the end of February 2011. Moreover, he pointed out that if these countries should exit the Eurozone and declare insolvency, Germany's liability risk would amount to 33% of that sum, or 114 billion euros, relating these sums to the other rescue facilities of euro countries and the International Monetary Fund. Before he made them public, Target deficits or surpluses were not explicitly itemised, being usually buried in obscure positions of central bank balance sheets.[4]
Let's visualize this in a chart. Does anyone look particularly exposed? If you said Germany you are correct. While we're chart gazing take a look at Spain. We've been short Spanish debt for months and it remains one of our favorite trades.

Germany has huge exposure to a Greece exit of the EU. Nonetheless, the Germans are not likely to be in favor of renegotiating terms with the Greeks. The tension in our opinion will increase in the coming days and weeks. While the EUR is seeing renewed selling across most FX pairs, the real pair to watch will be the EURCHF. The Swiss National Bank after allowing their sacred floor of EURCHF 1.20 to be broken has been softly defending a floor just above parity. For those of you that used to read our hedge fund letters you know we had a generously sized position betting the 1.20 floor would break, which it did in a huge way at the beginning of this year wiping out hedge funds and brokers caught on the wrong side. We were on the right side of the trade although sadly we were early by a whopping two years so we had removed the position well before it triggered. Anyways take a look at the chart below. Is the SNB going to defend EURCHF 1.00? If so for how long? This week's market action may give clues. I suspect they don't have the stomach to do much defending this time around.

Meanwhile in China, their market is continuing to crash. Many of you have asked for a post explaining what is taking place in China and promise to write one this week or next. The quick version regarding China is that their entire economy is slowing, they printed money nearly twice as fast as other central banks, and they still have non-performing loans from the 90's buried at their banks. China has so many active retail traders from this last rise in the bubble they are scattering like a flock of pigeons at the first sight of danger. They are very scared right now and even an event like a referendum vote as far away as Greece will be interpreted as a reason to sell. Watch their markets open tonight if you care to and you will see.

Whether you're celebrating Independence Day in the U.S., Independence Day in Venezuela (LOL), or the outcome of the Referendum Vote in Greece this weekend, please party responsibly and try not to wake up tomorrow with a capuchin monkey on your back.

Wednesday, July 1, 2015

Is Oil About to Drop Massively?

By all accounts there is simply too much oil being produced right now and its showing up everywhere. Saudi Arabia is pumping barrels like there is no tomorrow, Qatar is doing the same, Iraq has raised its production and most importantly Iran could be shipping globally again any moment.

Iran is currently in talks with the US, Britain, France, Germany, Russia and China negotiating a deal to lift sanctions. For a quick primer on the Iran nuclear talks click here. The U.S. Energy Information Administration estimates that oil exports in Iran have plummeted from 2.4 million barrels a day in 2011 to 1 million barrels per day currently.

Some oil analysts believe that it will take awhile for sanctions to fully lift and for Iran to ramp their production back up. Our belief is that even a minor ramp up in production and exports will move oil prices dramatically.

Our rationale is that there are other macro factors at play that will hurt oil prices. The biggest in our opinion is a slow down in China's economy. China's stock market bubble has popped and despite multiple stimulus interventions in the last few weeks by the PBOC, China's market is as fragile as its been in decades.

Here is the price of oil since the mid 90's.

We believe that oil will at a minimum retest the lows last seen during the great financial crisis in 2009.

For our friends and clients in Brazil this would add more pressure to an already weak exchange rate. Here's the price of oil (blue) compared to BRLUSD (red).  The Colombian peso and Russian ruble would also be significantly impacted by another large move down in oil. There's lots of interesting trades developing around these themes. You have oil to trade, FX rates, Chinese equities, Canadian and U.S. debt/equities on oil companies. Lot's of ways to mix match.

While not a trade or investment recommendation we have our eyes on a long COP/CAD trade after a big move down in oil. We believe that Colombia's currency has been oversold due to a faulty market perception which over-correlates Colombia's currency to oil prices. Colombia's economy has many other things going for it beyond oil production and exportation. Furthermore we believe that Canada will be entering a recession shortly. Canada has been in a gigantic real estate bubble for a number of years and it will pop just like any other asset bubble. It does not hurt that this trade possesses a nice positive carry of approx 3.75% before applying any leverage.

In the chart below you can see the Colombian peso (green) vs the Canadian dollar (purple). We'd like to see these spread a part a bit further to reach maximum attractiveness. Anyway you get the point. There's lot's of strategies that are all far more interesting than the usual long only approach of just holding a mix of stocks and bonds.

Sunday, June 28, 2015

It's OFFICIAL Greece is financially on fire!


When I was a kid one of the first things my father said I needed to understand about life was that governments lie. I was so young when he first told me this I could not at all understand why a government would lie nor what impact their lying would have on their own citizens and those of other countries. As my career in finance and study of economics and history deepened I realized he was right. It seems to be in the DNA of governments to lie and make promises they cannot possibly keep.

Greece has been lying a lot over the last few years and arguably they've been lying since they invented democracy. Today it became official; the banks and stock market in Greece will not open at all next week.

Some of the headlines rolling in from mainstream media right now:

Greek debt crisis: Banks to stay shut, capital controls imposed

Greece crisis could be a Sarajevo moment for the eurozone

For any of you that know my firm and read our views, Greece's latest news will not shock you in the least. Greece has been experiencing unprecedented deposit flight for months and they banks do not have the money available to give to depositors.

Now capital controls are in place and the real crisis will begin. Greece will return to the drachma as we discussed in our February 16th post EURGRD The FX Pair Everyone Should be Talking About . There is no way around it. And ultimately the entire EUR currency will eventually burn to ashes as well. It was flawed like so many currencies before it and will meet their same fate with a value of zero.

Of course this is not the first time nor will it be the last time Greece is on fire.

Let this be a lesson to investors out there regarding the incredible amount of risk built up in our system right now. And if you think Greece is an isolated case keep an eye on markets opening all over the globe in the next 24 hours. The EUR is already down 1% and when markets open in Asia we expect the screens to go red. China's stock market was already having a record sell off last week from being in its own risk bubble. The news of Greece will just add fuel to an already burning fire.

We expect our short Spanish bonds position to continue to perform handsomely under these conditions. We still can't believe that 10yr Spanish debt was trading below a 2% yield just a few months back! Everyone needs to carefully consider risk in their portfolios. The usual nonsense of a diversified portfolio doesn't mean anything if all asset classes start falling in tandem. Global macro matters.

This is now decidedly a "risk off" market. Trade accordingly. You've been warned.

Thursday, May 28, 2015

Venezuela's Currency Approaching Escape Velocity

In early November last year we had made a bet with clients that Venezuela's bolívar fuerte would weaken to USDVEF 200 by January 1st of this year. We were wrong. It hovered in the 175-190 range. 

Today, however, the Venezuelan bolívar fuerte has sailed past 200 and set a new record of USDVEF 423. That means that had you put your money in a bank in Venezuela at the beginning of the year you've now lost half its value.

[Technical note:  bolívares fuertes are often abbreviated as Bs.F. however the ISO currency code is VEF. As traders we always reference the exchange rate by using the ISO code.]

As many of you know we have long covered the situation in Venezuela. We have numerous friends and clients that are Venezuelan and we continually see the pain they endure as they watch their country sink further into economic ruin.

The currency is now very close to hitting escape velocity. When that happens it will be depreciating by enormous amounts every day until it is literally worth less than the paper it is printed on.

The human mind tends to be better equipped to grasp linear trajectories. This mental flaw has been one of our largest competitive advantages in predicting market moves. 100% of the time when currencies head towards terminal decline they move exponentially. Venezuela's currency is already on an exponential trajectory which means the terminal stage is now in motion. Our next post will probably be an eulogy. R.I.P. Venezuelan bolívares fuertes.

 Here's a view of the black market currency rate for the last 5 years. Historical data courtesy of www.dolartoday.com.

If you'd like to read more of our blog posts about Venezuela you can find them here.

Monday, May 11, 2015

Is Miami real estate in a bubble?

We live in Miami and the one question we get from investors all over the world is "should I invest in Miami real estate?" Our go to response is that we don't advise on real estate investments. As of late this doesn't seem to satisfy anyone. Clients want our view. Clients want to know if we own Miami real estate and if so where and why. Ok so we surrender! You asked for our opinion so we'll give it to you.

To begin with  NO we don't own any real estate, at least not directly. If you buy real estate all cash you're tying up a lot of equity in a non-liquid asset. If you leverage the real estate investment with a mortgage then you are adding leverage on a non-liquid investment. Even with a 20% down payment you are leveraging your investment 5:1.

Miami real estate started to recover in 2011. If you bought Lennar Corp stock at the close September 1, 2011 at 13.54 and were still holding it today where its trading at 47.10 you'd have a 348% return on your money. If you leveraged that 5:1 like you might have done with physical real estate you'd have a 1,740% return.

Some might argue that stock prices are more volatile than property. We've used Lennar, a South Florida home builder here in this example but you could just as easily buy into a publicly traded REIT. There are REITs for every possible real estate strategy and region you can imagine. You could also buy call options on REIT's or stocks of home buyers to capture upside while limiting downside. Try doing that with a physical property! Physical properties require maintenance, management, and lack liquidity. That's too much headache for our appetite when we can replicate similar exposure with better risk/reward characteristics.

Now let's get into Miami specifically. Every developer is always going to tell you that "this time is different". Every day I hear that foreigners are buying condos for cash and that will support the Miami market. People have such short memories. That was the same thing that was said in the last real estate bubble. No doubt Miami is a haven for flight capital but there is nowhere near enough flight capital coming here to support 300 new condo towers (see below). Flight capital is also not immune from circumstances in their local markets. Emerging market currencies have been crushed this year. Most foreign investors are investing offshore capital that they have generated from a local business situated in their home country. If that local business really begins to struggle they will rein in their offshore investing.

The number one thing propelling the resurgence in Miami's real estate market is the same thing that is propelling asset bubbles around the world - unprecedented credit injections by the world's central banks. The mistake everyone is making is believing that you can cure a debt problem with more debt. You can cure a debt problem by refinancing existing debt with cheaper interest rates but you can't cure debt by significantly growing the total amount outstanding.

As the Federal Reserve has ballooned its balance sheet we've seen that assets around the world have soared!

Here's some other notable data points:

Imagine that nearly 40% of new residents are going to pay half or more of their income to rent. This is not at all sustainable and like the last bubble has all the tell tale signs of a burst coming any moment.

We believe real estate is an important asset class. Owning your home is a great idea if you've found the one that you plan on being in for awhile. If you're in the real estate business and that's where you derive most of your income then that makes sense too but if you're just dropping your investment eggs into physical real estate for speculation like buying Miami pre-construction then you should really think twice about what you're doing.

Monday, February 16, 2015

EURGRD The FX Pair Everyone Should be Talking About

As I write the powers that be in Brussels debate Europe's future and how Greece plays a role in it. There has never been a question in our mind as to whether or not Greece will leave the EU, it has always been a matter of when. Will that be today? We'll soon see. Either way its time for markets to start thinking about the implications on FX rates and specifically the soon to be reintroduced EURGRD rate.

On February 28, 2002 Greek Drachmas stopped trading in Greece and Euros took their place. The exchange rate at the time was EURGRD 340.750.

Depending on how they default on their debt obligations a rough guess would be the exchange rate reopens north of EURGRD 500.000. That number may seem a little scary and represents a large devaluation from when Greece entered the EU. An exchange rate of EURGRD 500.000 is less concerning than where it might be 30 days or 6 months from there. Will we see hyperinflation in Greece?

Hyperinflation in Drachmas is not new to Greece. Jim Grant does an excellent job sharing the history of Greek hyperinflation in his most recent article The Greek Monetary Back-Story. The history also helps to explain the understandably tense relationship between Greeks and Germans.

Greece's current finance minister Yanis Varoufakis is a fascinating character currently found at the heart of Greece's negotiations with the Troika. Considered an expert in game theory many believe Varoufakis to have a clever plan for leveraging Europe's desire to keep the EU and it's currency the Euro from falling apart, in favor of  Greece. After watching and reading interviews with Varoufakis we think that his approach is pretty direct and clear, even rational in many regards. Varoufakis knows Greece is drowning in debt and he is right to suggest that adding more will not solve the problem. Prime Minister Alexis Tsipras wrote a letter to the German tax payers saying exactly the same thing.

What doesn't square for us however is both Varoufakis and Tsipras's desire to implement socialist policies highly in favor of labor groups and their unions. This does not bode well for an economy that needs to foster mutual exchange and innovation. The end result in our opinion is further devaluation of Drachmas and a HUGE default on pension obligations. Labor unions, government employees and seniors will suffer the most which is tragic considering that they were the voters that brought Syriza to power.

For anyone wanting to take a deep dive into the problems that are currently impacting Greece and the EU I highly recommend Philipp Bagus's book The Tragedy of the Euro. The book is an enjoyable read and will clarify for any reader the exact reasons that the Euro will not stay intact.