Professional Documents
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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%
+0.96%
+7.85%
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%
+1.16%
+44.91%
Seeing as the gold-related positions were single-handedly responsible for the horrific loss in October, it cast doubt
on my mind as to whether Im way too early on the trade or whether Im completely wrong.
My interpretation of golds move has always been that its centered on financial stability and is an indictment of
central banks perceived ability to calm the storm. Hence why focusing on QE itself as the reason to be bullish is
missing the bigger picture. Golds move from $700 to $1900 (from 2008 to 2011) in my opinion was driven by the
fear of financial instability and the perception that central banks had lost control in handling the crisis. It wasnt
until 2012, after several years of stock markets steady rise, that those fears were placated. In other words, the
argument could be made that QE had the opposite effect on the expected price of gold.
What made the drawdown in October scary was that those exact fears reared their ugly heads again and
appeared credible. What allayed those fears was when Bullard hinted that the end of QE should be delayed. The
day Bullard made that comment corresponds with when the market made a sharp U-turn. Not because the
market believed that the Fed would immediately scrap its plan to end QE in the Oct 29th meeting, but because the
belief that the Fed wont let the stock market fall (in control) was somehow restored. From Yellen to Draghi to
Kuroda, statements such as whatever it takes feed into the myth that central banks are all powerful. But nothing
in this world works that way, and as with anything, the pendulum will eventually swing back in the other direction.
The BOJs decision to revamp QE last Friday, as much as the markets cheered its actions, actually delivers a
psychological punch to the discussion of whether QE is the right tool. The 5-4 split decision only reinforces the
ongoing doubt about the efficacy of quantitative easing. I wrote back in Augusts positions summary (found below
in #3) that Kuroda has been a cheerleader for the policy despite being well aware that the data doesnt support
his upbeat outlook. Hence Fridays action is equivalent to waging a thermal nuclear war by wholly monetizing its
own debt, or as millennials like to say, YOLO. With that, Japan wrestled and won back the perception that
central banks are in control. But it also reiterated to many that deflationary pressure might be exported out of
Japan, which also brought out sellers of gold who may hold it as purely an inflation hedge.
But if continued deflationary pressures can be equated to delivering psychological punches to the notion of
central bank omnipotence, as it is a reminder of the inefficacy of its policies, its difficult to see how the selling of
gold by those who dont see inflation is actually a death nail for the asset class. The longer the deflationary
pressures exist and growth remains anemic, eventually that will again breed the fears of instability and that central
bankers dont have the level of control that we thought. That will take us back to the environment gold was in
between 2008 and 2011 this time without hope and without a central bank solution. Ultimately, gold is an
indictment on the central banks.
So I ask myself, which scenario is scarier considering my current positions?: one in which the central bankers end up
holding onto their divinity or one in which they fall from grace?
Whats certain at this point is that the devaluation of both the yen and the euro will continue, and those positions
will be more than enough to ease pressure on the current losses incurred in the equity and futures gold positions, so
I dont necessarily have to wait for the entire thesis to play out to profit from it.
Prcis:
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.
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. Despite this, there will be market swings of excess in both directions and thus I will be able to embrace plenty of
opportunities to make money.
This exposes a structural issue within the South Korean economy. The chaebol system (chaebol refers to a familycontrolled conglomerate) has made South Korea the 12th largest economy in the world but its 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
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 countrys 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, lets 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 thats 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, Samsungs 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 theres 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 Koreas GDP).
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. Its 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 Koreas birthrate is actually lower than Japan and equally South Koreas 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.
3) Long USD/JPY (initiated 8/20/14) - 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 Japans 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.
4) Short German DAX (short ETF:EWG initiated 8/18/14) Flipped the position from being long and shorted the
DAX as insurance against Putin (a peace deal where Putin washes his hands clean of Ukraine goes against all that I
know about Russian history and the man I studied in college an extended analysis on this was written for 8/27
update and have been archived on scribd) and against continuing deterioration in economic conditions in the
Eurozone. The bet is that it is more likely for the DAX to break 9000 than it is likely to hold the line.
Finally, to reference George R. Martins Game of Thrones, Winter is coming and Putin will likely play one of his
trump cards with his most prized weapon natural gas.
5) Short EUR/USD (initiated 6/17/14) 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
USD/JPY
DAX
5) Daily updates will be simple and short, as youll 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.