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December 1, 2014 (Monday)
Since Inception – June 2014:
Equity/Futures Account: +11.40% ($11,136,659)
FX Currency Account: +50.20% ($15,020,245)
Benchmark: S&P 500: +4.90%
Equities/Futures
Year
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
YTD
2014
+2.01%
-‐1.02%
+2.02%
+6.28%
-‐2.52%
+4.29%
-‐0.03%
+11.36%
FX Currency
Year
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
YTD
2014
-‐0.15%
+4.84%
+7.24%
+20.17%
+6.01%
+4.47%
+0.36
+50.20%
2. Changing Winds
(Written on Nov. 17th, 2014)
One subject of history that I’ve really enjoyed since I was a kid was alternative history. “What if” scenarios intrigued
me, such as wondering about an alternate world in which the Battle of Stamford in 1066 never took place before
the Battle of Hastings a month later. William of Normandy losing to King Harold would’ve radically changed the
trajectory of both English and European power. I believe global-macro is largely similar in the sense that imagining
a narrative and envisioning a world different from what we know to be true today requires the same mindset that
derives joy from such an exercise.
Chart 1 (US Dollar Index stretching back to 1985)
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3. Chart 1 – The charting software, wouldn’t allow me to go back more than to 1985, but in actuality the trend shown
has been intact since the 1970s, when the U.S. formally moved away from the gold standard. If South Korea,
China, Brazil and Mexico were to be included in the weighting of the index, the breakout would have already
occurred.
Regardless, given that the two main drivers of the index (the euro and the yen) make up 70% of the weighting, I
don’t think the conversation of whether the dollar index is technically extended or not matters very much if the two
underlying currencies have more room to run.
Chart 2 (Euro-Dollar dating back to 1999 when the currency was introduced)
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Chart 2 – The Euro-Dollar breaking all support levels in the last 10 years is becoming a highly probability event –
which also happens to be the level at which the Euro was introduced to the markets in January of 1999.
Chart 3 (Dollar-Yen since 1985)
Chart 4 – Dollar -Yen has already broken out of the multi-decade slope.
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What’s exciting about these long-term charts is that they all hint at a possible liquidation event that also gives rise
to highly probable and favorable risk trades.
Breakdowns or breakouts of this magnitude can trigger liquidation events, as anyone who has bought or sold
within that vast time period could all become underwater on their positions. Take the Euro-Dollar for example.
Around 1.20, you are taking out every level of everyone who has bought in the last ten years. As Japan trashes its
own currency to support growth or blatantly monetizes its own debt, that will likely force others in the region to
devalue its currency in order to compete with the yen (South Korea - USD/KRW looks very interesting).
An unwind of the decades-long carry trade in which people have borrowed dollars and bought assets abroad –
specifically Asia – can have massive ramifications when growth is already fragile in the region. Such disruptions
would likely run parallel to the Asian financial crisis in 1997. Regardless, the U.S. dollar breakout is a high-probability
event and it makes little sense to be long Asian EM equities, including Japan. It’s better to either short or avoid the
second derivative trade of the current monetary policies of the region (equities) and keep the trade simple by
focusing on the currency aspect. Another way to play it would be to be long US-equity and short EM.
Finally, all roads lead back to the shiny stuff. I believe it’s very possible that gold will decouple from its traditional
relationship with the U.S. dollar, ironically due to the uncertainty and disruptions that are created as the dollar
continues its ascent. The currency war among regional Asian nations should also cause the demand for gold to rise
in the region as the forced currency devaluation continues.
I laid out the case in the Nov. 3rd note that gold’s move has always been centered on financial stability. Gold’s
move from $700 to $1900 (from 2008 to 2011) in my opinion was driven by the fear of financial instability and the
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perceived inability of central banks to calm the storm. Whether it’s extreme inflation or deflation, start of a bubble
or end of a bubble, the very existence of either extreme is a knock on the system and an erosion of confidence in
central banks. It wasn’t until 2012, after several years of stock markets’ steady rise, that those fears were placated,
which also marked the top in gold. And I believe we are again setting up for an environment where gold should
perform like it did in 2008.
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Positions (listed in reverse chronological order):
1) Short Emerging Markets (iShares MSCI Emerging Markets ETF – initiated on 11/14) -
2) Long US Dollar/Korean Won (initiated on 11/14) -
3) Long U.S. Large Cap Tech (PowerShares QQQ ETF – initiated on 11/14) -
Sideways price action seems to suggest that the U.S. equity market is gearing up for a possible year-end run.
Although it’s not something I had expected or predicted a few months ago, there’s nothing wrong with having a
flexible view. But it also hedge out bit of the risk in being short EEM (long U.S., short EM).
Overall, looking to capture higher beta from the tech sector than the all-encompassing S&P 500.
4) Short MSCI South Korea (initiated 9/4/14) –
Written on Sept 4th – There are three major headwinds for the country: 1) weaker yen 2) over-reliance on chaebol
and the subsequent lack of diversification, and 3) demographic time-bomb.
Korea is a trading powerhouse. It derives 55% of its GDP from exports and is the seventh largest exporter in the
world. The majority of goods that fall into that export figure are electronic & electric equipment and automobile
and transportation equipment. That puts South Korea in direct competition with Japanese multi-nationals that play
in a similar field (the likes of Sony, Toyota, and Honda) who are again getting a renewed boost from the yen’s
weakness, likely to come at the expense of Korean rivals.
This exposes a structural issue within the South Korean economy. The chaebol system (chaebol refers to a family-controlled
conglomerate) has made South Korea the 12th largest economy in the world but it’s also its biggest
threat. In order to bring about quick modernization and economic growth, since the 1960s, the South Korean
government has groomed companies within certain sectors of the economy via protectionist policies and state
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subsidies. This path has helped bring rapid growth to South Korea and allowed companies like Samsung, Hyundai,
and LG to become giants on the world stage.
The economy that was ultimately created was one dominated by very few players. Thus, the country’s reliance on
too few companies to be its drivers of growth gambles its economic fate in their hands. Subsequently, the over
dominance by the chaebols stifles competition, creativity, innovation and entrepreneurship (which is
excruciatingly low for a country of its size) and although the effect of, let’s say, lower creativity is difficult to
quantify, without a doubt the longer-term implications are negative.
To grasp how sorely the Korean economy is in need of diversity, one just needs to look at the components that
make up the weighting of the KOSPI Index. By industry, Electronic & Electric Equipment accounts for 29%, and
KOSPI Transport Equipment accounts for 16%. In total that’s 45%. The top 20 companies with the largest market cap
amount to 49% of the KOSPI Index (Samsung alone accounts for 18%). If you break it down further by chaebol
ownership, for example, Samsung’s Lee family controls 3 out of the 20. More comprehensively, 4chaebol families
(Samsung, Hyundai, LG, and SK) control 12 of the 20 largest companies, or roughly 40%.
Samsung Electronics recently reported disappointing shipment numbers for its flagship Galaxy smartphone. Q2
earnings were disappointing due to declining smartphone sales (revenue declined from 57.46 trillion won to 52.35
trillion won) and the outlook for the second year is likely to be worse. With the expected launch of the iPhone 6 in
September – Apple going after the category of larger screens' turf that Samsung has dominated since the launch
of its Galaxy flagship line and other trinkets such as Apple iWallet – there’s a chance that Samsung will lose a
tremendous amount of market share.
That should serve as a reminder of how vulnerable South Korea is in terms of how concentrated its economy is
around a few companies. Technology is an extremely competitive space where an advantage or leadership can
quickly turn on its head within a single cycle. Margin compression is the name of the game since all devices quickly
become commoditized through competition and saturation. It's scary that Samsung Electronics alone makes up
17.5% of the KOSPI or 21% of the assets in the ETF: EWY (Samsung as a holding company roughly accounts for one
quarter of South Korea’s GDP).
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As for the auto industry, South Korean companies such as Hyundai and Kia (Hyundai Motors and Hyundai Mobis
account for 7% of the weighting in the index) have been able to gain market share in the last decade from their
Japanese rivals through aggressive pricing that was partly aided by the strengthening yen. But now the situations
have reversed and Japanese carmakers should be able to compete better on price (every 1% weakening in the
yen boosts Japanese automakers’ operating profits by 2-6% - which is significant given that Toyota exports roughly
2 million vehicles that it produces domestically).
As a society, the intense focus Koreans put on education produces far more negative outcomes for quality of life
and demographics. It props up the inexcusably high suicide rate (the highest in the world – 38.3 per 100,000) and
fuels the corruption in its educational system. The intense competition and structural education issues focused on
entrance exams for its prestigious SKY universities have created an arms race where parents are forced to spend
additional disposable income on hours of private lessons outside of normal school hours. It’s normal for Korean
students starting from 12 years of age to have an additional 6 hours of tutoring after school.
All of this fuels additional downward pressure on the birth rate on top of the usual pressures that take place in
developed/developing countries. The cost of raising a child in such a competitive environment is astronomical.
Thus, South Korea’s birthrate is actually lower than Japan and equally South Korea’s working age population is
falling by 1.2% annually (the fastest decline among OECD) and it will see the biggest jump in its elderly population
compared to any other developed nations (61% of the population versus 10% today). In essence, South Korea sees
Japan when it looks into the mirror – in fact, one could make the case that the demographic issues of Korea are
worse.
The breakdown of the weighting in the Korean indices and within what the instrument I have access to ETF:EWY (I
hope to explore other ways of expressing this bet), makes it a compelling longer-term short. But what makes the
trade more attractive is that the country as a whole seems to be oblivious to its problems and the image it sees in
the mirror is eerily similar to Japan.
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5) Long Gold (SPDR Select ETF:GLD and Junior Gold Miner ETF:GDXJ – position initiated on 9/30) -
Written on Sept 29th – It may not feel like it in the last few years, but the world has become a more dangerous and
fragmented place. As I wrote in my analysis on the future of the European integration & geopolitics (8/28), since
the financial crisis in 2008, there has been a reversal in the grand march toward globalization/integration since the
fall of the iron curtain two decades ago. Nationalism is starting to rear its ugly head again in global hotspots, states
are preoccupied with domestic issues and increasingly going back into their shell when it comes to broader
international issues, and finally, the unilateral framework of the world order established by the U.S. post-Soviet Union
exhibits serious signs of falling apart under the current structure without further restructuring or strengthened
commitment by the western world (for which there is no appetite).
On the monetary side, the world is about to double the size of its sovereign debt load from 2007 supported by little
more than half the growth when the debt load was half the size. And the final word has yet to be written on the
unprecedented monetary policies in U.S., Europe, and Japan and whether the world's largest economies are in
fact playing musical chairs. If the threat of deflation is real, central authority will continue to rely on the printing
press to reflate.
Thus, perhaps the biggest threat to the market is when the music actually stops, when the realization sets in that
the panacea isn't in financial engineering and when the childlike innocence and trust in central banks' ability to fix
problems shatters. Hope becomes the biggest enemy of the market as it creates wild swings and extreme
positioning. It's likely that hopes will be crushed as the next cyclical downturn takes inflation, bond yields, and
equity valuations to new destructive lows until things become severe enough that central planners outdo the
previous method. Rinse, repeat.
Down the line, the insane debt levels all around the globe will do everyone in. Such a prognostication is
excruciatingly gloomy. But I also accept that within it, there will be market swings of excess in both directions and
plenty of opportunity to make money in either direction.
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6) Long USD/JPY (initiated 8/20/14)
Written on August 20th – It was only a matter of time before the yen moved lower on the backdrop of dollar
strength as well as the divergence in central banks' policies -- they've been in different stages of easing for quite
some time now. The prospect of additional easing seems more likely to combat the continued lukewarm data
points in Japan. Kuroda may be publicly positive and appear to be excited about Japan’s growth prospects, but
inspiring confidence is part of his job as he is trying to amplify the effect of his policy – being downbeat would have
the opposite impact.
USD/JPY cross has been on the radar for a while as it's been in a tight trading range since February of this year. The
position was initiated as it broke out of consolidation and given how long it has consolidated, it will retest and likely
close higher above the previous high of 105.43.
It is likely that this move might be the next leg lower for the yen – part of the larger macro move that has occurred
since late 2011.
7) Short German DAX (short ETF:EWG – initiated 8/18/14) –
Revised on Nov. 14th – I still remain short EWG in part because I see limited upside for the Eurozone (explanation
offered on 8/27 update) but also I still worry about Russia’s next move. Russia has largely been removed from
investor’s worry-list, investors have largely ignored the deep rooted suspicion the Russian bear has towards the west
since the Crimean War in 1853 – which officially marked the radical shift in European geopolitics as the continent
went from French containment doctrine to the one focused on containing Russia.
Without firing a single shot, the West has inflicted an economic pain on the country and it has without a doubt has
hurt the country’s ego.
That exactly is the source of my worry. Putin’s ego is essentially a wild card. And I also worry that the West would
take it too far to drive a point: which is to remind Russia that there’s no benefit in territorial expansion through force.
12. But the risk of that message getting lost as the rouble continues to tumble and as the country starts burning through
its $400 billion reserve. Which seems like a lot, but given that half of the annual budget (which is based on a
$100/bbl) is dependent on oil revenues is certain to anger the Russian bear.
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And that is bad news since history has long shown that over-punishing a nation can lead to unintended violent
outcome.
8) Short EUR/USD (initiated 6/17/14) –
Written on June 17th – The short euro trade has been the most highly concentrated (and the longest held) position
since I began this trading simulation. The divergence in central banks’ policies (Fed vs. ECB) and the growing
divergence in economic data points have been the main reasons for holding a negative view on the euro against
the U.S. dollar since May of this year.
I believe short EUR/USD trade has been one of the few macro trades where all elements of the trade (historical
analysis, policy analysis, economic data, trends/technicals and etc) all line up favorably to be short.
For extended analysis on the Eurozone – please refer to the 8/27 update (archived on scribd.com/flatpeak)
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Current Equity Positions (as of 12/1/14 - Monday)
iShares MSCI Emerging Markets ETF: -80,000 shares = $3,264,000
IShares MSCI Germany ETF: -50,000 shares = $1,440,750
IShares MSCI South Korea ETF: -50,000 shares = $2,822,500
Market Vetors Junior Gold Miners ETF: +95,000 = $2,626,750
SPDR Gold ETF: +35,000 = $4,079,950
Powershares QQQ ETF: 0 = $0.00
Account Cash Value: $11,136,659, Total Exposure: $14,233,950, Leverage: 1.27x
Current FX Positions (as of 12/1/14 - Monday)
Euro/US Dollar: -14,000,000
US Dollar/Japanese Yen Spot: +18,000,000
US Dollar/Korean Won = +8,000,000
Account Cash Value: $15,020,245, Total Exposure: $40,000,000, Leverage: 2.66x
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12/1/14 – Platform Snapshot (Optimized for viewing on iPhone, iPad, or Android)
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Trading Account Rules:
1) Starting Account Size:
a. Cash equities/futures/option: $10million
b. Forex: $10million
2) For the cash account (non-forex), macro views will be reflected using listed equity indexed ETFs with deep liquidity/volume and
net assets of $1 billion or greater in order to best represent the odds of the strategy being scalable (single-stock, company
specific stocks will not be traded).
3) Most of the speculative positions can also be accurately expressed using futures, but because the volume is more constrained at
different times and because the platform fails to take volume into consideration (hence the trades' impact on the actual price),
the use of futures will be limited. Positions that I deem to be core/longer-term would be better expressed via equities. But for
commodities such as crude oil, silver, copper, etc., they will solely be expressed through the futures contract market due to
contango/decay issues that most commodities ETFs suffer.
4) The overall goal is to identify attractive opportunities with goals of holding the positions for multi-week/month periods.
Importance will always be put on liquidity and risk exposure. Also, being able to realistically liquidate all positions by end of
trading day or vice versa, scale up risk, will be an advantage of the strategy.
5) Daily updates will be simple and short, as you’ll receive a time-stamped screenshot of the account summary where detailed
positions and P/L will be all within a single image.
6) Leverage for spot currency position will be limited to 2.5x the underlying cash
Leverage for equity/futures account will be limited to 1.3x the underlying cash – with net aggregate overnight risk exposure (“net
liquid value”) often falling well below that limit.
