Weekend Reading #189

This is the hundred-and-eighty-ninth weekly edition of our newsletter, Weekend Reading, sent out on Saturday 8st October 2022.

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What we're thinking.

Remember the old Warren Buffett quote about what happens when the tide goes out? The water levels have certainly been falling dramatically this year, not surprisingly in tandem with the withdrawal of liquidity from markets from Fed action (making it a rather apt analogy). But as long as calls for the draining to be stopped remain ignored by a Fed that is strident about bringing inflation down through demand curtailment and protecting its credibility as a central bank, the falling tides are starting to reveal some pretty serious carcasses that have settled on the ocean floor.

This week itself, it emerged that crypto “custodian” Celsius, which operated a borrowing/lending platform for crypto and which halted withdrawals earlier this year in the wake of the Three Arrows situation, saw its former CEO and CSO withdraw a combined US$17m from the platform prior to freezing withdrawals. Celsius owes roughly US$4.7bn to users but doesn’t have the money to pay them back, and the stories that have emerged about depositors who are desperately trying to recover some of their money are absolutely heart breaking.

But perhaps even more to the chagrin of those involved in Celsius was that in the court filings now made public lies a 14.5k page PDF document containing the names of active users on Celsius and their transactions (mostly those occurring in 2022). No, it wasn’t a hack, it was a public disclosure.

It is incidents like this which underscore the seemingly tacky, but absolutely necessary, need for disclosures and communications that are clear, fair and not misleading as we write in our post this week. Would anyone at Celsius, after saying what they said on their marketing and promotion materials, dare to look at any of their depositors and say “that was not financial advice, you should’ve done your research” with a straight face?

As always, the temptation is always to think of what happens in crypto as its “own thing” - but it’s not, it is simply a microcosm on steroids of what’s happening in the broader markets.

Speaking of markets, it seems like another “strange quirk” (to borrow vocabulary from clickbait headline writers) has become mainstream. In 2021, it was the discovery of “Gamma”, “Vanna” and “Charm” in options dealer positioning. No surprise that the moment everyone learnt of the existence of “Gamma”, “Vanna” and “Charm”, knowledge of that bit of the market was no longer a material edge. It was important, but it wasn’t important enough to be a standalone edge.

This year, it’s “CTAs”. CTAs have been around for a long time – while called a “Commodity Trading Advisor” as a function of what they used to do (trade futures and derivatives mainly in commodities), the term now broadly refers to hedge funds that adopt a momentum trading strategy: buy when the market’s moving up, and sell when the market’s moving down. Effectively, they are the equivalent of additional negative gamma. And there are levels that trigger these systematic strategies flipping from buying to selling.

Monitoring CTA activity had previously been a good indicator of where markets have a tendency to inflect, but in recent months, it seems like everyone’s caught on to it. If you know, that I know, that you know that everyone now knows, does it still count as an edge? Probably not as much as it did before.

Finally, there’s the wonderful topic of geopolitics – we're no experts but from our simple perspective here, the fractures in what was hitherto a unipolar world with the US at its helm are become uncomfortably clear. Just this week OPEC+ agreed to reduce oil production by 2m barrels a day, not from their targeted levels (which they were already underperforming), but from their CURRENT levels.

This coming at the same time as Nord Stream 1 and 2 suffering major damage, alongside another pipeline leak for Petronas in Malaysia, is a concoction that gets the juices flowing if you’re an energy trader. The US has voiced its disapproval of OPEC+’s decision, asserting that this is them “aligning with Russia” - at least that’s the narrative they are trying to spin, much to the annoyance of none other than the Saudi Oil Minister Prince Abdulaziz who was recorded flatly rebuking a Reuters journalist.

Who knows what really goes on behind the scenes. But what is becoming clear is that around the table, sides are being taken, and there being more than one side is when things start to get tricky.

For now, at least in the US, there remains the “Strategic Petroleum Reserve” which the President can continue to draw on to help manage rising energy prices – but that reserve isn’t unlimited, and it’ll need to be topped up. To say the drawdown has been liberal is a huge understatement:

Source: https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCSSTUS1&f=W

Closer to home, Europe, for all its green positioning, is now becoming the largest importer of coal as Russian gas supplies dwindle into the wintertime.

How dare they.

What we're listening to.

My new favourite pod is The Acid Capitalist with former hedge fund manager, Hugh Hendry. Hendry takes no prisoners and any guest on his pod runs the verbal gauntlet. Last week I forgot to write about an episode that literally had me chuckling to myself so hard I almost had to stop my run. It was an episode entitled “I believe I believe?” and the blurb of the episode is “saving retail one podcast at a time”. Regular readers will know the disdain we have for so called financial "experts” who liberally dispense advice on social media (read todays blogpost). Their intro is usually something like “content creator, author etc”. The episode featured an unsuspecting chap named Brian Feroldi who’s search results show a blurb of author, Youtuber and writer. Now I don’t know anything about Mr Feroldi other than from this podcast appearance and I must say he was an incredibly good sport who somehow never lost his cool despite immense provocation. But wow was this fun to listen to. Hendry tore him apart. Part of me felt sorry for him but in truth this type of deep inquest is necessary to strip out the personal brand experts from the investment experts.

And then this week the polar opposite. I listened to Hendry chat to Cem Karsan, who is an absolute beast of knowledge when it comes to derivatives and market structure. We’ve been following Karsan for some time in our quest to unpack market structure and to be honest sometimes his sophistication is so high we (well me actually. Eugene gets it in 2 seconds) actually don’t even get it. The conversation was proper with deep insights into unlocking the market puzzle. I loved this episode almost as much I love the sheer no BS approach of Mr Hendry. World class insights and entertainment all in one. DC

What we're watching.

Since Disney acquired the rights to George Lucas’ Star Wars back in 2012, they’ve gone on to recoup much of their initial investment through a whole new trilogy of films and a number of spinoff mini-series and related films. One such mini-series that recently released was the 6-episode Obi-Wan Kenobi series, heralding the return of Ewan McGregor, a fan-favourite character from the Star Wars prequel trilogy released between 1999 and 20005. Set just 10 years after the events of Episode III (Revenge of the Sith), the series follows Obi-Wan as he sets out to rescue a young Princess Leia from the clutches of the Empire. As one would expect, there are many a call-back to the movies, and also stars Hayden Christensen once again reprising the role of Darth Vader, returning for some fantastic lightsabre duels that put the visual fx of the early 2000’s to shame. HS

What we’re reading.

Despite recommending many science fiction books in this very newsletter it may surprise many of you that I am a fairly recent convert. The Three Body Problem trilogy were the first sci-fi books I’d read and quite clearly had a major influence on me and my business partners. As such I had never read Frank Herbert’s legendary granddaddy of sci-fi – Dune. So, when I picked it up to read recently, I was expecting to be disappointed given the fanfare of die-hard sci-fi fans for it. I had deliberately avoided watching the film, hoping that I would get the undiluted, original epic in all its glory. And let me tell you, that it got me. It took a while to get up to speed through the initial scene-setting but my word it was just spectacular. I love sci-fi because it’s timeless. Dune was first published in 1965 and Frank Herbert’s world could have been imagined even today with the same effect. What an absolute pleasure to read. I cannot wait to stuck into the next ones.

This week, Epsilon Theory’s Ben Hunt released a primer called A Brief History of the Past 10,000 Years of Monetary Policy and Why Last Week Was a Big Deal. Ben has pretty much predicted every single development in the macro for many years, most notably the return of inflation and its potential impact on markets. And for this reason (and many more) one should pay heed to his warnings. His view (and ours) is that what happened in the GILT market a couple weeks back now is only the beginning of the trouble that is coming. We think that 13 years of feast and debauchery needs to be followed by a commensurate famine and the real problems will begin with ILLIQUIDITY. This is one of the opening salvos. This note is a MUST READ. Even if you are a professional investor, it is beautifully pieced together and clearly illustrates where we are and where we are heading. As we have been saying for a very long time now. It is a time to be liquid and certainly not a time to be heroic.

And finally, a new twitter account I stumbled onto which has given me great joy this week is Susie Dent, who posts a word of the day each day. Two struck me this week with excellent timing

Bayard (16th century) – one who has all the self-confidence of ignorance. - This went well with our influencer theme this week
Ramfeezled (18th century) - feeling worn out, used up and particularly enfeebled. I think we all have been feeling like that for some time in these markets. Even for the few they have been good for.

Edward PlayfairOctober 10, 2022