wknd
notes


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               The Ferocious Beauty of Truly Free Markets

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wknd
notes

Each Sunday morning for over a decade, One River’s CIO, Eric Peters, has published “Wknd Notes.” It is an unorthodox take on markets, politics, and policy that’s widely read across our industry and within global policy/political circles. Eric has written for as long as he has traded and the discipline is part of his investment process. Drawing on wide-ranging, multi-disciplinary research, historical study, and discussions with interesting characters throughout the world, Eric collects those things he finds most thought-provoking each week and distills them into a concise letter. At times the ideas and views are consistent with his own, but just as often, they challenge his positions and it is this openness to opposing views that helps him maintain a flexible mind in the search for emerging opportunities and risks. His writing is a reflection of how he thinks, and as such it is as focused on identifying the right questions to ask as it is on seeking answers. The publication of this work is Eric’s way of exchanging ideas/information and developing dialogue with a network grown over his thirty-one-year career.

wknd note: The Ferocious Beauty of Truly Free Markets

“The growth of the Internet will slow drastically, as the flaw in ‘Metcalfe’s law’ becomes apparent: most people have nothing to say to each other! By 2005, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine,” wrote Nobel economist Paul Krugman in 1998. “Bitcoin isn’t a new innovation; it’s been around since 2009, and in all that time nobody seems to have found any good legal use for it. It’s not a convenient medium of exchange; it’s not a stable store of value; it’s definitely not a unit of account,” tweeted Krugman this week to his 4.6mm Twitter followers.

Overall: “Technology based on the use of highly polluting fossil fuels needs to be replaced without delay. There is reason to hope that humanity at the dawn of the 21st century will be remembered for having generously shouldered its grave responsibilities,” tweeted Pope Francis, condemning Bitcoin and its heretical offspring, sparking another burst of panic selling. Now, the Church has not exactly draped itself in glory when it comes to embracing the world’s most important scientific advances. Just ask Galileo who died in jail, then waited 300yrs for an apology from the Vatican. But it wasn’t just the Pope. You see, Elon’s tweet that criticized bitcoin mining’s use of fossil fuel spurred every ageing Luddite who has been consistently wrong about bitcoin’s ascent to pen yet another scathing op-ed. That’s natural, of course. Critics are always loudest in the hole. But this time they were crowded together with Fed officials, the IRS, US Treasury and the Chinese Communist Party. Beijing seemed to announce a new law to outlaw bitcoin mining every time the price staged an intra-day bounce. In human history, no single asset has come under such coordinated assault by the very global institutions that perpetually inflate asset prices in the name of securing prosperity. And yet, through it all, digital asset trading carried on, obliterating the leveraged longs, wiping out the weak. For the first time in decades, we saw the ferocious beauty of truly free markets operating at scale. Efficiently. Ruthlessly. These assets inhabit a world without a buyer of last resort to bail out its bankers. It was a remarkable display of antifragility. To appreciate it fully, simply imagine how today’s equity, bond and credit markets would withstand a withdrawal of government support, let alone a full-frontal assault. It is this independence and resiliency that underpins the longer-term attractiveness of digital assets. But like all powerful new technologies, their promise is poorly understood by most pundits. And amongst the many benefits that such technologies will produce, one of the more ironic is that despite today’s outcry, they have already begun to spur and finance an accelerating global transition to renewable energy.

Week-in-Review (expressed in YoY terms): Mon: Musk rattles crypto assets with series of weekend tweets, Israel / Gaza conflict rages on, Chilean constitutional committee elections surprise as left wing holds majority, Hungary CB deputy gov says must prepare for hike at June meeting, Huarong secured funding through August, Walmart says vaccinated staff/customers can go mask-less, India covid cases drop below 300k/day, US covid cases reach 14mth low, Taiwan reports 333 cases/day (highest ever), EU/US agree to settle tariff dispute over metals, Taiwan bans foreigners for a month, Japan PPI 3.6% (3.1%e), Singapore non-oil expts 6% (11.5%e), China ret sales 17.7% (25%e) / IP 9.8% (10%e) / GDP -2.6% (-3.3%e), US empire mfg 24.3 (23.9e), S&P -0.25%; Tue: Amazon in talks to buy MGM studio, Pelosi proposes diplomatic boycott of 2022 Olympics in China over human rights violations, Huarong bondholders to face “significant losses” in reorg despite recently secured funding, Taiwan stabilization fund said it’s monitoring the stock market after recent crash, Japan GDP -5.1% (-4.5%e), UK unemp 4.8% (4.9%e), EU GDP -1.8% as exp, US housing starts -9.5% MoM (-2%e), S&P -0.9%; Wed: Digital assets crash, FOMC minutes show cursory reference to future tapering discussions, EU votes to freeze its Chinese investment pact, Australia wage price index 1.5% (1.4%e), UK CPI 1.5% as exp / RPI 2.9% (2.4%e), S. Africa CPI 4.4% (4.3%e), S. Africa ret sales -2.5% (2.5%e), EU CPI 1.6% as exp, Canada CPI 3.4% (3.2%e), S&P -0.3%; Thur: Columbia’s credit rating cut to junk by S&P (largely expected), Biden approves vaccine exports, Australia unemp 5.5% (5.6%e) / emp change -30.6k (20k as exp), German PPI 5.2% (5.1%e), HK unemp 6.4% (6.6%e), US init claims 444k (450k exp), US leading index 1.6% (1.3%e), S&P +1.1%; Fri: Israel/Hamas ceasefire (ends 11-day conflict), US Treasury releases proposal for 15% global minimum tax (down from 21% previously), US Treasury proposes payments in crypto greater than $10k must be reported, a deadly fungal infection in India is considered a secondary covid ailment, Australia composite PMI 58.1 (58.9p), UK cons conf -9 (-12e), UK core ret sales 37.7% (31.7%e), Japan CPI -0.4% (-0.5%e), EU PMIs: mfg 62.8 (62.5e) / serv 55.1 (52.5e) / comp 56.9 (55.1e), UK mfg PMI 66.1 (60.8e), Mexico ret sales 2.5% (-0.1%e), US PMIs: mfg 61.5 (60.2e) / serv 70.1 (64.3e) / comp 68.1 (63.5p), S&P -0.1%.

Weekly Close: S&P 500 -0.4% and VIX +1.34 at +20.15. Nikkei +0.8%, Shanghai -0.1%, Euro Stoxx +0.4%, Bovespa +0.6%, MSCI World +0.2%, and MSCI Emerging +1.7%. USD rose +57.6% vs Ethereum, +30.2% vs Bitcoin, +2.6% vs Chile, +1.8% vs Brazil, +1.1% vs Indonesia, +0.5% vs Australia, and +0.4% vs Mexico. USD fell -1.2% vs South Africa, -0.6% vs India, -0.5% vs Russia, -0.4% vs Turkey, -0.4% vs Sterling, -0.4% vs Yen, -0.3% vs Euro, -0.3% vs Canada, -0.1% vs Sweden, and flat vs China. Gold +2.0%, Silver +0.5%, Oil -2.5%, Copper -3.3%, Iron Ore -4.8%, Corn +1.8%. 5y5y inflation swaps (EU -2bps at 1.59%, US -11bps at 2.43%, JP +6bps at 0.38%, and UK +3bps at 3.77%). 2yr Notes +1bp at 0.15% and 10yr Notes -1bp at 1.62

YTD Equity Indexes (high-to-low): Venezuela +62.4% priced in US dollars (+334.5% priced in bolivar), UAE +29.2% priced in dollars (+29.2% in dirham), Austria +22.6% in dollars (+23.8% in euros), Saudi Arabia +19% (+19%), Canada +18.3% (+12%), Sweden +17.5% (+19.5%), South Africa +16.2% (+10.7%), Norway +15.4% (+13.1%), Czech Republic +15.1% (+12.8%), France +14.5% (+15%), Hungary +14.4% (+10.3%), Spain +13.4% (+14%), Euro Stoxx 50 +12.8% (+13.3%), Russia +12.7% (+11.3%), Mexico +12.6% (+13%), Netherlands +12.6% (+13.2%), UK +12.6% (+8.6%), Poland +12.4% (+11.6%), Russell +12.2%, Belgium +11.6% (+12.1%), Germany +11.4% (+12.5%), Taiwan +11.2% (+10.7%), Italy +11.2% (+12.3%), S&P 500 +10.6%, Israel +10.5% (+11.8%), Finland +10.3% (+11.4%), Ireland +9.7% (+10.2%), MSCI World +9.4% (+9.4%), India +8.8% (+8.5%), Singapore +8.7% (+9.6%), Denmark +7.5% (+8.5%), Australia +7.1% (+6.7%), Greece +6.7% (+7.2%), Korea +6.1% (+9.8%), NASDAQ +4.5%, HK +4.4% (+4.5%), Switzerland +3% (+4.9%), Thailand +2.3% (+7.1%), Portugal +2% (+2.5%), China +1.8% (+0.4%), Brazil -0.4% (+3%), Argentina -2% (+9.8%), Japan -2.3% (+3.2%), Chile -3.3% (-2.3%), New Zealand -5.2% (-4.8%), Indonesia -5.6% (-3.4%), Malaysia -6.8% (-4%), Philippines -13% (-13.2%), Turkey -13.1% (-1.7%), Colombia -21% (-13.5%).

Digital Market Comments (internal) – 5/19/21 (One River Digital – Marcel Kasumovich, Head of Research)

1/ This is a broader crypto trading washout. It is worth benchmarking the Bitcoin downturn to previous ones. We are approaching the percentage drawdown of the Feb-Mar 2020 period. A price decline to $23,700 or so would replicate the initial 2017-2018 downturn. The patterns thereafter of those two downturns were vastly different obviously. After the initial bottom in 2018, Bitcoin fell another 55% and it took nearly four years to recover the 2017 high-water. It took only months to recover the 2020 downturn.

2/ The role of Grayscale lockups remains poorly understood. This was arbitrage demand for Bitcoin that now needs to be absorbed. In the next ten days, 33mm shares become unlocked and will need to be sold as the unwind of the original trade. Through the end of August, 151mm shares will be unlocked (22% of total supply). At a Bitcoin price of $33k, that is $3.2bln of supply to be absorbed. There can be high profile stresses in the ecosystem of players engaged in this trade. The Grayscale discount is fairly stable around 20% discount through the latest downturn, suggesting some institutional demand willing to absorb supply at prevailing prices.

3/ We learn a lot from the ecosystem data. Take stablecoin prices. USD.T and USD.C are incredibly steady through this downturn. Dai shows a bit more volatility, trading to as low as 0.995 (to put into real world numbers, on $1mn of collateral we’re talking about a $5k haircut from Dai at the low in prices, which was quite brief). It is not nothing, particularly in violent markets. But overall, this element of the ecosystem is performing very well. Trading volumes in USD.T are running $64bln in the past 24 hours, roughly 3-times the start of the year.

4/ The liquidity shock in leveraged trading markets is easily evident. Deribit is a good example. The bid-offer pricing on $10mn Bitcoin in the perpetual swap market (leveraged forwards) was wider than 30% earlier today and is currently around 10%. Other exchanges were trading at a fraction of this price tiering. You see the same in implied yields across exchanges. The 1-month annualized yield on the Deribit exchange plunged to -75% annualized at its worst point today. Ether is similar, though not as extreme as Bitcoin relative to last March.

5/ There has been a rapid inflow of Bitcoin back to exchanges. This is an indicator of holders preparing to sell. In turn, cash holdings through markets like USD.T also show a rise. Large wallets or “whales” are not responsible for flows in the past month. Flipside Crypto does a terrific job of documenting these flows day by day. Smaller wallets and exchanges overwhelm the flow, accounting for 550k of Bitcoin token flows compared to 17k for whales. Ether flows are an entirely different architecture, even though the outcomes are correlated. The moves are between decentralized exchanges and smart contracts, such as ETH embedded in Dai.

6/ Where do we go from here? The speed of moves and ecosystem make it clear this is a speculative risk move, with a liquidity component. Is the macro backdrop intact? Yes. Are there near-term challenges to overcome? Absolutely. Grayscale locks and FATF (Financial Action Task Force) guidance on decentralized finance are big ones. Not a crypto winter, more of a cold front from Washington. A recovery slower than March 2020, but much faster than 2018 would be my benchmark.

Anecdote: The Fed cut rates to what had once seemed an impossibility. It then left them there. Skepticism that rates would remain perpetually low eventually gave way to acceptance, which was soon followed by financial engineering. Back then, in 1993, with overnight rates held at 3.00%, yield-enhanced structured products offered 4.00% yields, 5.00%, sometimes higher, but only if overnight rates remained unchanged. To generate those higher yields, the structured notes sold options. If overnight rates either fell or rose, those options would lose a lot of money. But investors didn’t care, they couldn’t buy enough. And this depressed implied volatility and forced the products to take on ever greater leverage to maintain the benchmark-beating yields. When the Fed hiked rates in 1994, the bond market crashed. Salesmen who sold structured products cried. Literally. What a terrible way to lose money. It seemed like the kind of market to get short, at least until the mess got cleaned up. I chose to bet short term UK interest rates would head higher. It was a big position for me. But then one morning, UK rates inexplicably collapsed. A Tory MP had been found dead, hanging from his kitchen chandelier, with a drug-infused tangerine stuffed in his mouth, dressed only in women’s stockings (not terribly unusual for British MPs). The police quickly concluded poor Milligan died of autoerotic asphyxiation. Whoever first got information on the Milligan news correctly concluded it would embarrass John Major’s government. To divert attention, his Treasury would cut interest rates. This is how a politicized system works without an independent central bank (the Bank of England only gained independence in 1997). It was my biggest one-day career loss. And helped me learn that absolutely anything can happen. There is no such thing as fair or unfair. Markets simply are. You take them as they come.

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.

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