Panic on the Nasdaq: Is a Tech Stock Bloodbath Approaching?

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For a hot second, Amazon.com (NASDAQ:AMZN) CEO Jeff Bezos was the richest man in the world.

But he didn’t even get a chance to celebrate. After ripping to new all-time highs, Amazon shares reversed and finished the day in the red. The stock dropped almost $7 on Thursday. That’s enough to knock poor Jeff Bezos’ net worth below fellow billionaire Bill Gates.

Sadly, Bezos is worth a paltry $89.3 billion as of yesterday afternoon, according to the Bloomberg Billionaires Index. To add insult to injury, Amazon’s second quarter earnings hit the wire after the bell. Judging by the stock’s initial reaction, investors weren’t impressed.

“The company appears to once again be squeezing out a very small profit on top of its mammoth retail operations, and that will only face more pressure as it looks to wrap up that deal and gain control of hundreds of retail outlets across the country,” TechCrunch notes, referencing Amazon’s $13.7 billion bid for Whole Foods.

To be fair, Amazon wasn’t the only tech stock to hit the skids yesterday. The Nasdaq Composite slipped into the red just after lunch as skittish traders booked profits. All the popular FAANG stocks reversed and moved lower. Even Facebook (NASDAQ:FB) retreated from its all-time highs after beating earnings estimates (although it was the only one out of the group to finish in the green on the day).

The FAANGs aren’t the only stocks taking it on the chin as we close out the trading week. Semiconductors – one of the strongest groups on the market – saw significant pullbacks in several popular names on Thursday, including a 3% drop in NVIDIA Corp. (NASDAQ:NVDA).

Of course, investors are completely freaking out as these popular stocks drop. With the major averages streaking to new highs almost every day, a quick selloff is all it takes to trigger a little panic these days…

After all, summer market action had been downright boring. Stocks have not endured a meaningful correction in a long time. The record low volatility we’ve experienced over the past few months has twisted the herd’s brain in a knot. Investors are now treating every single dip as if it was the beginning of a massive market crash…

Speaking of crashes, remember Amazon’s “flash crash” last month?

Amazon stock dipped below $930 for less than a second during an apparent fat-finger trade back in early June. The stock recovered almost immediately, posting a loss of a little more than 3% by the end of the trading day.

That Friday afternoon was a FAANG bloodbath. Facebook, Amazon, Apple, Netflix and Google each fell by more than 3% by the afternoon bell. The tech bulls were finally rattled… but the bears couldn’t prevail. Traders completely forgot about this little hiccup and went right back to buying tech stocks Monday morning.

Once we start putting these moves into perspective, it becomes clear that we’re not dealing with the end of the world – or even the end of the bull market.

Could stocks fall 5% as we barrel into August trading?

Of course. In fact, the market could chop lower the last few weeks of the summer. Despite what we’ve experienced this year, 5% and 10% market corrections are still part of the game. Anyone who tells you stocks can go straight up forever is either a liar or an idiot.

The market’s notable lack of volatility during the first half of 2017 has lulled many investors to sleep. The little jolts we’re now experiencing are slapping unprepared traders in the face. They’re another painful reminder that stocks can’t rocket higher every single day without encountering some pullbacks and corrections along the way.

Every so often, the market gods must shake out the weak hands. It’s amazing how quickly a confident investor is reduced to tears when a stock that has gone straight up over the past six month takes a big hit.

Futures show the Nasdaq Composite sliding lower again this morning on the heels of Amazon’s earnings miss. We’ll keep an eye on today’s action as it unfolds. It’s nothing to cry about just yet…

Sincerely,

Greg Guenthner
for The Daily Reckoning

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Hegemony is a Three-Player Game

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[Ed. Note: Jim Rickards’ latest New York Times bestseller, The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis, is out now. Learn how to get your own free copy – click HERE. This vital book transcends geopolitics and rhetoric from the financial press to prepare you for what you should be watching now.]

Three-player games are easy to model — it’s always two against one. The art of geopolitics and examining hegemony powers in such situations is to be part of a duo that pressures the remaining player, or, at a minimum, keep the other two players separated.

This is basic balance-of-power politics as practiced since the rise of Napoleon (1799), with antecedents in the Treaty of Westphalia (1648), and Machiavelli’s The Prince (1532).

The case for normalizing relations between Russia and the U.S. rests on the coming confrontation between the U.S. and China. This confrontation stems from China’s refusal to help the U.S. deal decisively with North Korea, which is pushing the U.S. toward a pre-emptive war on the Korean peninsula.

Other flashpoints with China include conflicting claims in the South China Sea, currency manipulation, trade subsidies, theft of intellectual property, and cyber-warfare.

These conflicts were held in abeyance while China was given “100 days” (from the Mar-a-Lago summit on April 6, 2017 to July 15, 2017) to help with North Korea. Now that the 100 days are up and China has failed to deliver, the gloves are off. The months ahead will witness increasing tension and specific actions by the U.S. aimed at China.

To secure the U.S. position in this conflict and as a simple matter of statecraft, the U.S. needs improved relations with Russia as an offset to deteriorating relations with China.

Russia can assist the U.S. is numerous ways. First and foremost is Syria. Russia and the U.S., along with indigenous forces from Iraq, Jordan and the UAE, are well down the path of eliminating ISIS as a political entity. (ISIS will remain as a terrorist incubator along with Al Qaeda franchises and their respective sympathizers).

A modus vivendi can be reached where Russia and their Ba’athist allies, U.S.-backed rebels, Kurds, and Turkey all have separate spheres of influence in Syria. The loser in this scenario is Iran, which has been a leading backer of Syrian dictator Bashar al-Assad.

Russia can also help the United States on the North Korean dossier even though China has proved unable or unwilling to do so. Russia has enormous economic leverage in North Korea. Private intelligence service STRATFOR reported the following on July 11, 2017:

Russia shipped $2.3 million worth of oil products to North Korea between January and April 2017, a 200 percent increase, Yonhap and Korea Times reported July 11. Last year, North Korea reportedly turned to Russia after experiencing difficulty securing oil supplies from China. A North Korean defector suggested Russia supplies North Korea with 200,000 to 300,000 tons of fuel annually via a company in Singapore. North Korea’s increased dependence on Russian fuel indicates its anticipation of tougher international sanctions following its recent intercontinental ballistic missile launch on July 4.

By stepping into China’s shoes as a supplier to North Korea, Russia has increased its leverage over North Korea and therefore has increased its ability to assist the United States. This type of leverage is one of the few paths to a resolution of the North Korean nuclear issue without resorting to war. It is of enormous value to the U.S. and argues in favor of improved U.S.-Russian relations.

The foregoing is an overview of the greatest political struggle in the world today. The nationalists and realists want to improve U.S. relations with Russia. The globalists are horrified at the prospect and want to maintain warm relations with China while isolating Russia.

Hegemony and Geopolitical Struggle

The White House has already decided in favor of Russia. The problem is how to execute that plan in the face of withering attacks about phony scandals from the media, Democrats, resistance and globalists.

The standard globalist attack on Putin says he is an autocrat at best, a dictator at worst, who murders some political enemies, jails others, and suppresses dissent in Russia. This is all true.

The rebuttal is that China is worse. President Xi is an actual dictator, not a presumed one. He presides over a top-down Communist dictatorship. China slaughtered thousands of innocent protestors in the Tiananmen Square demonstrations in 1989 and has refused to allow any acknowledgement of it ever since.

The Chinese dissident, Liu Xiaobo, won the Nobel Peace Prize in 2010 for his efforts to advance the cause of human rights and political freedom in China. He died while in custody on July 13, 2017 after decades in prison and political reeducation camps. Xi’s political enemies, such as former Chongqing party chief Bo Xilai, have been arrested and subjected to torture and imprisonment.

In short, human rights and respect for political dissent leaves no basis for choosing between Russia and China. Both Putin and Xi are thuggish, with Putin being subject to slightly more pluralistic constraints, while Xi basks in the glow of globalist approval.

The choice between them boils down to power politics, not who wins a globalist beauty contest. Trump is tilting toward Russia for good reasons of realpolitik.

As evidence for this tilt, following the July 7 meeting between Trump and Putin at the G20 summit in Hamburg, Germany, Trump said:

People said, ‘Oh they shouldn’t get along.’ Well, who are the people that are saying that? I think we get along very, very well. We are a tremendously powerful nuclear power, and so are they. It doesn’t make sense not to have some kind of a relationship.

The bottom line is that relations with Russia will improve materially while relations with China will deteriorate materially in the months and years ahead.

This has huge implications for capital markets and your portfolio.

It is up to the United States to defend its monetary ground. However, the likelihood of that is low because the U.S. does not even perceive the problem it’s facing, let alone the solution.

This evolving state of affairs creates enormous opportunities for investors in the coming months ahead.

Regards,
Jim Rickards
for The Daily Reckoning

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Make the War on Cash Pay You

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Earnings season is upon us.

Once again, the world’s highest profile public companies dance across the earnings minefield. One little slip – a penny missing from the balance sheet or a stray comment during the conference call – and investors will smash the sell button and move on to the next hot trade.

Strong trends are created and destroyed as shot-sighted speculators jump in and out of positions. It’s all too easy to get caught up in the soap opera.

But we shouldn’t complain…

One of our core positions released second-quarter numbers yesterday. Payments mainstay PayPal Holdings (NASDAQ:PYPL) went into last night’s earnings report having beaten expectations for every quarter that it’s been a public company, Barron’s notes.

I’m happy to report the winning streak remains intact. Not only did PayPal beat expectations, the payments leader raised its 2017 guidance thanks to a growing user base. Shares should open at new all-time highs this morning.

PayPal remains our top play as the war on cash heats up. It’s the perfect “old school” way to play the market’s obsession with digital currencies right now. Even though PayPal shares are up almost 50% year-to-date, we still think this trend has a long way to go before it slows down…

If you’re looking to ditch cash but you don’t have any interest in figuring out how to open a bitcoin wallet, PayPal’s popular new payment app has a solution for you.

The app is called Venmo. And it’s quickly becoming an everyday name in the mobile payments game.

Getting started is as easy as adding a new credit card to your Amazon account. The app automatically syncs your contacts through your phone. Then you’re ready to make payments to friends, coworkers, and family.

To make a payment, all you have to do is pick up your phone. No checks, cards, or cash necessary. It’s that simple. Folks are using the app for everything from buying a cup of coffee to paying rent.

Venmo’s growing success makes PayPal the top dog in mobile payments. When we first jumped into PayPal earlier this year, we told you that mobile payments make up nearly 30% of PayPal’s business. PayPal has also teamed up with Facebook and even Snapchat in the latest innovations for peer-to-peer payments. These partnerships should have a big impact on PayPal’s growth over the next couple of years as more consumers flock to mobile payment options.

Cash is dead. Whether you like it or not, currency is going digital. The days of pulling a wad of greasy bills out of your pocket are numbered.

For the tech-savvy, cryptocurrencies are all the rage. And we’re seeing more developments in the global war on cash that could act as powerful price catalysts. China’s crackdown on money laundering and demonetization in India have both help increase bitcoin’s popularity. It’s not my area of expertise – but it’s also not some fringe idea anymore.

You can fight this powerful trend. Or you can profit from it. It’s as simple as that.

So far this year, you’ve enjoyed quite a ride as our PYPL position has launched to new highs. When it comes to explosive growth, this stock remains one of our top picks heading into the second half of the year.

Cash isn’t king anymore. But that doesn’t mean you can’t bank gains.

Sincerely,

Greg Guenthner
for The Daily Reckoning

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Flash Crash Alert: Klarman Weighs In On High Frequency Trading

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Jody ChudleyBuckle up folks!

Baupost Group’s Seth Klarman just issued a warning, and it would be a BIG mistake to ignore it.

Klarman believes we are headed for a stock market event that will knock your socks off.

And you won’t even see it coming, as it will be over in the blink of an eye.

Don’t panic though. After reading this, you’ll be more than prepared. And you may even profit…

You’ll likely be surprised to learn that today, that we have a higher percentage of computer-generated trades than trades that are made by humans like you and I.

And what’s even more surprising is how much higher that percentage is…

Analysts believe that today, as much as 90 percent of market trades are the result of computer algorithms.1

That means that you and I are not the source of market-changing moves anymore. It’s the endless rows of servers who have the control…

rows of servers

Source: simanaitissays.com

Isn’t that insane?

The purpose of the stock market is to provide a supply of capital for worthy businesses.  That is something that all of this non-human trading has nothing to do with…

Think about it.

90 percent of transactions in the market involve zero thought given to things like valuation, business prospects, balance sheet leverage, management quality, or essentially anything related to the underlying company.

A computer algorithm doesn’t care if it is paying two dollars or two trillion dollars for the shares of any given company. There is literally no application of common sense.

This type of trading is exactly what Seth Klarman’s warning to investors talks about — the time bomb that algorithmic trading funds are building in our stock market. 

The problem, according to Klarman, is that the main mathematical formula behind many of the algorithmic trading patterns is exactly the same — the formula involves using volatility as the trigger that determines how much risk to take on.2

When volatility is low, the computers get more aggressive. When volatility is high, the computers back off.

But it gets worse…

When market volatility decreases, these computers are not just buying stocks outright. They use debt to increase their buying power. Basically adding fuel to the fire…

And as you are likely aware, volatility has been low for a long time, which has given the computers the message to buy, buy, buy – while using debt to do so.

So what happens if volatility rises?

Computers Have No Regard For Your Retirement

Unfortunately, the same thing will happen in the other direction. Only much, much faster.

All it’s going to take to start the elevator ride down is one little spike in volatility. Maybe a geopolitical event causes this, maybe an unexpected rate hike does the trick.

I don’t know specifically what it will be, but it will happen eventually.

A computer can’t tell if the actual event is important — it will only care about the increase in volatility.

But you need to be aware, we don’t need a huge spike in volatility. Volatility just needs to move towards historically normal levels from the current incredibly low levels.

When that happens, it will trigger the deleveraging bell for the computers.

The algorithmic programs will all begin selling at the same time, which will snowball into even more selling.

All of a sudden, we’ll have a self-fulfilling selling loop that is going to feed on itself.

Anything can happen. No price is impossible for a trading algorithm that can’t tell the difference between a business that gushes cash and one that is on the verge of bankruptcy.

Once the algorithmic selling starts, investors who have been pouring hundreds of billions into index funds are going to panic and start selling too.

It is going to be spectacularly terrifying.

But there will be opportunities…

The Washout Will Be Devastating, The Opportunities Created Will Be Wonderful

Twenty-five years ago we got a taste of what can happen when the robots take over the market.

Over the five days beginning on October 14, 1987, the Dow Jones lost 31 percent of its value.

23 percent in a single day. Can you imagine how it feels to see the entire market lose a quarter of its value in one trading session?

And then just as quickly as the crash arrived, it ended. Things went back to normal and the market gradually recovered.

The 1987 Crash And Then The Calm

That’s what widespread systemic trading can do. It can create selling upon selling upon selling.

In 1987, the cause was trading systems that utilized the concept of “portfolio insurance”.

If you looked at the chart of the stock market in 1987, you would think that the United States had been attacked, that the banking system had collapsed, or that some other terrible event had occurred.

But that wasn’t the case. The robots all just changed direction at the same time.

Today, 90 percent of our stock market trades are done by machines. Just imagine what could happen next time the robots change direction. The 1987 drop may look like a gentle decline.

Baupost has been building up a large cash position so that it can pick up the bargains that the frantically deleveraging robots create.

You may want to consider doing the same.

Here’s to looking through the windshield,

Jody Chudley

Jody Chudley,
Chief Credit Analyst, The Daily Edge
EdgeFeedback@AgoraFinancial.com
Facebook: @TheDailyEdgeUSA

1 Rise of the billionaire robots: how algorithms have redefined hedge funds, The Guardian, Suzanne McGee
2 Baupost Readies Dry Power Amid Frothy Markets – Letter, ValueWalk, Mark Melin

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“If You’re Not a Contrarian, You’re a Victim”

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The Daily Reckoning has taken up temporary headquarters in the fair (and humidity-free!) city of Vancouver, Canada…

We’ve alighted upon these blessed climes to cover this week’s annual Sprott Natural Resource Symposium.

It is here where some of the world’s brightest stars in finance and natural resources gather to spot market omens… read tea leaves… and announce the way to riches.

Our own Jim Rickards and David Stockman are keynote speakers this week here in Vancouver.

Jim’s senior geologist, Byron King, also takes the podium.

Your editor enters this week’s proceedings in the role of fly on wall.

We’ll be reporting findings… leaking critical intelligence… and issuing private dispatches from behind closed doors.

We hope you can put the information to good use.

It’s the next best thing to being there yourself, we dare say — without having to purchase an admission ticket that can only be described as expensive.

The Sprott conference tends to attract what you may call “contrarians.”

No surprise, that, given the mantra of Rick Rule, Sprott’s CEO and conference host:

If you’re not a contrarian, you’re a victim.

Many fancy themselves contrarians. Few are in reality.

The embrace of the herd proves too seductive for most — safety, they intuitively sense, lies in numbers.

But there are certainly some contrarian-looking folks on hand.

We observed an eccentric or two yesterday, some with odd crotchets easier witnessed than described.

There was this one fellow who — no — we’d better not say.

But given the price of an admission ticket… these must be wealthy eccentrics.

But to the conference itself…

Several fellows spoke yesterday. These included Rick Rule himself and other CEOs of precious metal companies.

If there was one central nugget to emerge from their briefings, it is this:

Projected mining supplies will struggle to meet rising demand for precious metals in the years ahead.

For example, David Garofalo, CEO of Goldcorp, claimed that the gold sector has seen a one-third decline in its reserves over the past five years.

He further projects that gold production industrywide will decline 15–20% over the next few years.

Heaping Pelion upon Ossa, Garofalo says it takes some 15–20 years to add new capacity.

That is, gold production will decrease, and it could be years and years until new gold reserves come to market.

We thus confront the possibility of “Peak Gold”:

This is exactly the drum senior geologist Byron King of Rickards Gold Speculator has been pounding for quite a while.

Byron noted earlier this year that 2016 was the first year mine production fell since 2008.

And quoting a Thomson Reuters report, Byron notes there are:

Few new projects and expansions expected to begin producing this year, and those in the near-term pipeline are generally fairly modest in scale, hence our view that global mine supply is set to continue a multiyear downtrend in 2017…

Add it all up and you have a recipe for falling production.

Patrick Donnelly, president of First Mining Finance Corp., confirmed yesterday that no major gold deposits have been discovered in the past 15–20 years.

The conclusion seems clear:

Falling gold production and rising demand, all things being equal, translate to higher prices.

Possibly much higher prices.

But it’s not just gold facing critical shortages…

Robert Friedland is the founder and executive chairman of Ivanhoe Mines.

A capital fellow, this Friedland. A speaker of the first cut and caliber.

He struck every note precisely in the middle.

He told thumping tales and commanded a crowd of hundreds as easily as gravity commands a cannon ball.

Robert Friedland

And Friedland says the demand for metals like platinum, copper and cobalt will soon vastly outrun supplies.

Why?

Clean energy.

Friedland flashed a picture of a sunny day in Beijing.

It looked like a foggy day in London.

Pollution now chokes the air of China’s major cities so badly a person can barely take the oxygen out of it.

“Airpocalypse” Friedland terms it.

And he said this pollution’s effects cost some $5 trillion every year.

60% of urban air pollution is caused by the internal combustion, he added.

So places like China will be spending mountains of money on clean energy to liberate the lungs and restore the sun to its throne in the sky.

What does that have to do with platinum and copper?

Because the critical components of many clean energy technologies require metals like platinum and copper.

Friedland said mass-produced electric cars will be in operation by 2023 — six years from now.

He said it will be a “massive disruption.”

He compared it to the speed with which the automobile replaced the horse around the turn of the 20th century.

And that of course presents a handsome opportunity for investors…

Friedland said a serious platinum shortage will enter effect by 2020 as surging demand outstrips supplies.

Once again… a recipe for dramatically higher platinum prices.

Related question:

What has been the best-performing metal for the past 12 months, according to Friedland — better than gold or any other metal?

Cobalt.

Cobalt is used in lithium batteries for electric cars.

No coincidence it would seem.

Meantime, electric cars also require oodles of copper — a nice point to put somewhere.

For these reasons, Friedland expects metals prices to rise substantially in the coming years.

Yesterday’s presenters hammered the shortage theme time and time again.

And by our lights, their case is compelling…

Tomorrow, the most important ideas from day two…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Off-the-Radar Biotechs About to Break Out

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Some big scientific breakthroughs are set to take place this year.

And fortunes could be made with a few off-the-radar biotech pioneers.

What I am talking about are the handful of small biotech companies applying regenerative medicine platforms to degenerative diseases and ailments like paralysis.

These degenerative diseases have always been tough to treat, and few therapies are available. That’s not surprising, since we’ve lacked — until recently — the ability to create healthy and functioning human cells to replace ones lost in the body to injury and disease.

Now, though, a handful of breakthrough companies are aiming to correct that lack with new pluripotent stem cell technology.

Stem cells have the ability to reproduce and change into functional cells and tissues. And pluripotent stem cells are the most potent. They can turn into any cell type in the human body. Furthermore, they can divide and reproduce without end.

This makes them an ideal starting point for manufacturing cell-based therapies.

One Step Ahead of the Rest

One company using this platform to help heal spinal cord injuries and paralysis is already heaving great success in FDA trials with a new cell line.

Their recent FDA Phase 1 trial data shows that patients treated with a new cell line are seeing a significant return of nerve function thanks to these grafts.

And last month, this same company announced nine-month follow-up data for patients that were given a 10 million cell dose to their injury. Even though this is only half of what researchers believe will be a full dose, at least 50% of patients have already shown signs of recovery.

This includes two levels of improvement in motor function, as well as improvements in arm, hand and finger function.

The nine-month data confirms what the company reported at three and six months, too.

Showing us that the new cell therapy has great durability. The introduced cells help heal the injury, and the result is more than temporary.

Under the accumulating evidence, the FDA has also decided to approve an expansion to this trial to include patients with spinal cord injury at the C4 location — which is in the middle of the neck.

This is a very significant development.

The C4 spinal location is one of the most common locations for a spinal cord injury, and it often results in paralysis from the neck down.

And now the FDA is allowing the company to expand its treatment window from 14–30 days after injury to 21–42 days.

Small Companies, Big Market Share

All these data bode very nicely for the future.

And not only for the developers of this specific cell therapy, but for other small biotech companies also trying to carve out market share in the pluripotent stem cell therapy space.

According to the National Spinal Cord Injury Statistical Center, there are some 17,000 new spinal cord injuries per year. This represents a large potential market for any company that masters this new technology and provides viable treatments for degenerative injuries.

Even more promising is that this new cell technology may also be used to treat cancer. And another group of tiny biotech companies are leading the way in research for this application, too.

We hope to see the data from these other FDA trials focusing on developing cancer vaccines during the second half of 2017.

If any of these new trial results comes back positive as early indications are showing, then we’re looking a tsunami sized wave of new opportunities in biotech. And for the handful of small companies and their investors, this should be a game changer.

As it stands currently, most of the companies making the push into regenerative medicine using new stem cell technology remain largely undiscovered.

As the FDA data become more actionable and these treatments move closer to market introduction, there will be some great plays to make.

And when that happens I’ll be right here to make sure you have the best chance for the big score with this new technology.

To a bright future,

Ray Blanco
for The Daily Reckoning

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Bitcoin: Fake Asset or Security?

This post Bitcoin: Fake Asset or Security? appeared first on Daily Reckoning.

[This post on Bitcoin: Fake Asset or Security? was originally published on The Institutional Risk Analyst from R. Christopher Whalen.]

“I came of age on Wall Street when the Chairman of the Federal Reserve Board—he was William McChesney Martin — condemned even trace amounts of inflation as an economic and moral evil.  In the interval of 1960-65, there was not one year in which the CPI registered a year over year rise of as much as 2%.”
—Grant’s Interest Rate Observer

Below is my latest commentary on housing finance reform in American Banker, “Fannie, Freddie are irrelevant to a government-backed mortgage system.” I’ll be participating at the CoreLogic Risk Summit next week in Dana Point, California. Come say hello!

We’ve all heard of fake news, but consider the growing possibility of fake or at least virtual assets.  Investors face a deliberately orchestrated shortage of real investments c/o global central banks in markets such as stocks and real estate.

Is there any wonder that the financial engineers of Wall Street have again begun to manufacture new derivatives leveraging the real world?

Case in point, bitcoin.  The most recognized “digital currency,” bitcoin is a form of high-tech gaming instrument that fulfills just one of the traditional roles of money, but is among the world’s fastest appreciating – and most volatile– “asset” classes.

Adherents call the limited supply of bitcoin the ultimate expression of Milton Friedman style monetarist discipline.  They view the digital medium as a rational response to the fiscal and monetary chaos visible in most of the industrial nations.

But despite the huge gains seen in bitcoin vs conventional currencies, Jim Rickards says he’s sticking with his preferred investments: gold, cash and silver.  “I don’t own any bitcoin, but for those who have a preference for bitcoin, good luck,” he told Kitco News.

Bitcoin has been blessed by a federal regulatory agency in Washington.  “On Monday, a bitcoin options exchange called LedgerX won approval from the U.S Commodity Futures Trading Commission (CFTC) to clear bitcoin options, making it the first U.S. federally regulated platform of its kind,” reports The Wall Street Journal.

LedgerX’s chief executive Paul Chou is on the CFTC’s Technology Advisory Committee.  Not surprisingly, a CFTC spokeswoman said “no committee, including the Technology Advisory Committee, plays any role in any registration decision.”  OK.

Regardless of whether you view bitcoin as an investment or the electronic version of tulip bulbs, the fact of a traded options contract is intriguing.  It allows speculators to take a flutter on bitcoin without actually touching the ersatz currency or the varied folk who are said to traffic in this ethereal world.

To be fair, drug dealers, terrorists and members of organized crime organizations in nations like China, Russia and North Korea are not ideal counterparties for a US bank or fund.  But a US traded option contract may allow you to play the bitcoin game, pay your taxes, and sleep at night.  A lot of managers may find that degree of separation attractive.

Of note, less than 24 hours after the CFTC announcement, the Securities and Exchange Commission has declared that “tokens” such as bitcoin can be considered securities, and therefore, may be need to be registered unless a valid exemption applies,” Reuters reports.

“The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, the co-director of the SEC’s enforcement division.

Part of the “problem” with bitcoin is that it is not easy for an individual to move in and out of the stateless, “offshore” market.  It will be interesting to see which financial institutions are willing to provide the infrastructure to allow a bitcoin options contract to settle in dollars and in size large enough to satiate institutional players.

But the more interesting question is how investors will deploy capital in this volatile and entirely opaque market.

The idea of an option on bitcoin certainly seems to have some utility.  Bitcoin may not be a store of value or a unit of account, but it serves that same purpose as the dollar in terms of acting as a means of exchange.  Like the dollar, bitcoin promises to pay, well, nothing, so the two moneys have rough equivalence in that regard.

Our guess is that a successful launch of the bitcoin option contract could significantly increase cash trading volumes, which will manifest in higher value vs traditional currencies.  But the real issue is how to gauge the ebb and flow of demand for the bitcoin tokens.

A large portion of the “float” in bitcoin cannot trade because the “owners” have lost their ID numbers, thus measuring how much supply is available to meet a given amount of demand is a challenge.

Additional bitcoin cannot be issued beyond the 21 million limit of the system, although the coins can be subdivided.  In the short run, the only variable that can change with demand is the spot price.

Also, high and sometimes variable settlement costs add to the complexity of trading bitcoin.  In many respects, a conventional option contract may be significantly more efficient than the cash market for bitcoin driven by the clunky blockchain technology.

While the news of the CFTC’s approval of the bitcoin options contracts may turn out to be good news for the digital currency, please note that our dim view of the blockchain clearing technology that enables bitcoin has not changed.

The Journal reports that CFTC Acting Chairman Christopher Giancarlo states publicly that he’s optimistic about blockchain technology’s future. We’d like to see him explain why, paying specific attention to operational efficiency and cost.

A derivative contract on a derivative digital currency has a lot more promise that the technological dead end known as blockchain.  To date, we have yet to see a single commercial application of what people call “blockchain” that has real commercial potential.  The same robust and expensive encryption technology that helps the bitcoin market ward off attempts at manipulation also makes blockchain unsuitable for other business uses.

As Saifedean Ammous wrote in American Banker last year:

“[D]espite banks’ attempts to test and use blockchain technology for their own commercial gain, it is outside the realm of possibility for the technology to serve any useful purpose for the intermediaries it was designed to replace. That is akin to burdening horses with engines in the name of technological innovation: the approach would only slow down the horse and alleviate none of its problems. Such a ridiculous notion will find no real world demand.”

In simple terms, blockchain is just a form of industrial grade encryption tied to a bulletin board for the public portion of the keys.  When it comes to clearing options contracts, the existing centralized technology solutions are far more attractive in terms of speed and cost.

Indeed, it will be interesting to see how LedgerX manages delivery of bitcoin as contracts expire or whether it will require cash settlement, as is customary with gaming instruments.

So let’s keep our eyes on this bitcoin options contract.  It promises to expose a far greater number of investors to this global gaming instrument. We suspect that the SEC is right when they refer to them as tokens, albeit ones that can only be settled electronically.

If bitcoin are eventually determined to be securities by the SEC, however, it both validates and changes the market forever.  With recognition comes regulation and reporting.

What the success of bitcoin says about the world of dollars, euros and yen is unsettling at a number of levels, but then again, bitcoin is ultimately just a brilliantly designed virtual market that, initially at least, promised security and anonymity.

Whether those qualities can endure as the audience grows is a very intriguing question that investors need to consider.

Regards,
Christopher Whalen
for The Institutional Risk Analyst

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