Venezuela’s proposed “petro” cryptocurrency

the petro

Yesterday Venezuela began pre-sales of its petrocurrency, called the petro.  The idea is that each token the government creates will be freely exchangeable into Venezuelan bolivars at the previous day’s price of a barrel of a specified Venezuelan crude oil produced by the national oil company.  According to the Washington Post,  $735 million worth of the tokens were sold on the first day.

uses?

For people with money trapped inside Venezuela, the petro may have some utility, since it will be accepted by Caracas for any official payments.  For such potential users, the fact that the government determines the dollar/bolivar exchange rate and that a discount to the crude price will be applied are niggling worries.

perils

The wider issue, which remains unaddressed in this case, is that the spirit behind cryptocurrencies is a deep distrust of government, a strong belief that practically no ruling body will do the right thing to protect the fiscal well-being of users of its currency.

In Venezuela’s case, just look at the bolivar.  The official exchange rate says $US1 = B10.  But the actual rate, as far as I can tell, has fallen from that level over the past year or so to $US1 = B25000.

a little history

The more serious worry is that the history of commodity-backed currencies isn’t pretty.

Mexico

In the 1980s, for example a struggling Mexican government issued petrobonds.  The idea was that at maturity the holder could choose to receive either $1000 or the value of a specified number of barrels of Mexican state-produced crude.  Unfortunately for holders, Mexico reneged on the oil-price link.  My recollection (this happened pre-internet so I can’t find confirmation online) is the Mexico also declined to make the return of principal on time.

the US

The fate of gold-backed securities around the world during the 1930s isn’t so hot, either.  The US, for example, massively devalued (through depreciation of the gold exchange rate) the gold-backed currency it issued.  It also basically banned the private ownership of physical gold and forced holders to turn in the lion’s share of their holdings to Washington in return for paper currency.

 

In short, when the going gets tough, there’s a big risk that the terms of any government-backed financial instrument get drastically rewritten.  This recasting can come silently through inflation.  But, if history holds true, government backing of a commodity link to financial instruments gives more the illusion of protection than the reality–especially so in cases where the reality is needed.

 

 

 

the amazing shrinking dollar

So far this year, the US$ has fallen by about 14% against the €, and around 8% against the ¥ and £.

A substantial portion of this movement is giveback of the sharp dollar appreciation which happened last year after the surprise election of Donald Trump as president.  That was sparked by belief that a non-establishment chief executive would be able to get things done in Washington.  Reform of the income tax system and repair of aging infrastructure were supposed to be high on the agenda, with the resulting fiscal stimulus allowing the Fed to raise interest rates much more aggressively than the consensus had imagined.  Hence, continuing dollar strength on a booming economy and increasing interest rate differentials.

To date, none of that has happened.   So it makes sense that currency traders would begin to reverse their bets on.  However, last year’s move up in the dollar has been more than completely erased and the clear consensus is now on continuing dollar weakness.

 

Dollar weakness has caused stock market investors to shift their portfolios away from domestic-oriented firms toward multinationals and exporters.  This is the standard tactic.  It also makes sense:  a firm with costs in dollars and revenues in euros is in an ideal position at present.

It’s interesting to note, though, that over the weekend China lifted some restrictions imposed last year that limited the ability of its citizens to sell renminbi to buy dollars.

To my mind, this is the first sign that dollar weakness may have gone too far.

It’s too soon, in my view, to react to this possibility.  In particular, the appointment of a new head of the Federal Reserve could play a key role in the currency’s future path, given persistent Republican calls to curtail its independence.  Gary Cohn, the establishment choice, is rumored to have fallen out of favor with Mr. Trump after protesting the latter’s support of neo-Nazis in Charlottesville.

Still, it’s not too early to plot out a potential strategy to benefit from a dollar reversal.

 

 

cryptocurrency (ii)

Yesterday I observeded that a significant issue for any investor in cryptocurrencies is their relative illiquidity.

Well, CBOE (Chicago Board Options Exchange), the world’s largest options exchange, is about to address this shortcoming.  It recently announced that it intends to offer derivative trading in bitcoin before yearend.

 

Several points:

–just by offering a derivative, CBOE will give legitimacy to bitcoin with traditional investors that it didn’t have before, even though CBOE likely has its eye mostly on trading commissions

–it wouldn’t be a surprise to find that the true price setting will occur in the options market rather than in that for the underlying bitcoin

–one of the first arbitrages that will likely occur is between options and the bitcoin etf, GBTC.  The result will presumably be for the still-substantial premium of GBTC to its net asset value to erode

–presumably some form of ether will be the next cryptocurrency derivative on offer.

cryptocurrencies

This is not a subject I know much about, although I’ve gotten a lot of excellent information over the past half year from one of my my sons and from my son-in law.  So I only have three comments:

–the past few months have shown all the characteristics of a speculative mania in the cryptocurrency world.  The rash of recent ICOs (Initial Coin Offerings), done in incredible speed with scanty documentation and in which buyers seem to receive nothing useful for their money, remind me a lot of the final days of the internet mania of late 1999-early 2000

–the secondary market, that is, trading by parties other than the the original creator of the tokens, is very illiquid and woefully inadequate.  I think this is the main reason the bitcoin etf, GBTC, trades at a huge premium to NAV

…but

–some form of cryptocurrency (at this point, the chief contenders seem to be bitcoin and ethereum) may end up being the new gold.  We can already see their flight capital attractiveness in the collapsing economy of Venezuela.

There’s a wider point than just this, though.  Ultimately, national currencies depend for their viability on belief in the integrity and fiscal soundness of the governments that issue them, and the economic prospects of the economies that form their tax bases.

The big issue with governments, however, is their seemingly irresistible urge to wriggle out from under their sovereign debt by inflating away the real value of their borrowings.  Venezuela’s current inflation of 1000%+ means that if you lend Caracas the price of a car today, a year from now the bolivars you get back won’t cover much more than a Big Mac.

Yes, this is a crazy example, but the point remains, I think, that most governments (Germany–and maybe China–being the only exceptions that come to mind) are more than willing to “debase” their currencies, as gold bugs would put it.  Look at Japan.  What about the UK?  Even the US had a go at this in the 1970s.

 

To be clear, I’m not advocating buying bitcoin (I do own a miniscule amount through holding shares in the Ark Invest Web x.0 ETF (ARKW)).  I think it’s something to keep an eye on, however.  I can see that something like bitcoin could ultimately replace gold as an alternative investment.  After all, when you get down to it, gold is just a shiny kind of dirt.

I also think that even in stable economies investors are beginning to look for a way to hedge their dollar holdings, thinking that the post-WWII world order led by the US is nearing the end of its useful life.  No clear replacement is in sight.  And the three national currency contenders, the dollar, the euro and the renminbi, all have rapidly aging populations–meaning, if Japan is any indication, an imminent slowdown in economic growth power.

 

 

 

…finally, internet again

I’ve been travelling in the rural Northwest the past week and have had only intermittent internet access   …until now.

Stepping back from the day-to-day, has its advantages, though.  Having little up-to-the-minute data, I’ve been forced to look at the longer-range stock market picture. 
The first two or three months after the election, the dollar and stocks both rose as investors celebrated the presidential results.  The strongest groups were Energy, Materials and Industrials–the ones that would benefit both from an acceleration in economic growth and implementation of the professed Trump agenda of tax reform and infrastructure spending.

This period ended rght around the inaguration.  It was replaced by a market that embraced secular growth areas of Technology and Healthcare.  The dollar began to drift downward, as well.  This sector/currency shift was partly, I think, a rotation from leaders to laggards that happens in every market that’s not going sideways.  Part was also concern that delivering on the Trump agenda might not be as easy as investors had supposed over the previous months.

During 2Q17, the stock market began to understand how deep the problems are that the Republican party and the adminstration are having in getting anything done.  The main direct consequence of this loss of confidence has been a sharp fall in the dollar, I think, on the idea that failure of the administration and congress to engineer fisal stimulus would translate into a slower pace of interest rate increases by the Fed.  A weaker dollar benefits multinationals, so IT continued to be a winner, along with many members of the Staples group, which also has large foreign exposure.

This last movement has also played itself out in recent weeks, I think.  The market as a whole, and major tech stocks in particular, have begun to move sideways, expressing Wall Street’s belief (mine, too) that they’ve gone up enough for now.  As I see it, action has been based chiefly on relative valuation– rotations deeper into IT via smaller stocks and back into the Trump stock winners of late 2016.  
The kind of movement described in the last paragrah doesn’t typically last long.  At some point, the market will return to the question of whether structural reform in Washington is possible.  As I see it, the underlying notion investors now have is that important change can and will happen, although people may have substantially different pictures of how this will occur.  

It seems to me that as long as investors hold this belief, the US stock market will move sideways to up, driven by earnings gains.

the Trump rally and its aftermath (so far)

the Trump rally

From the surprise election of Donald Trump as president through late December 2016, the S&P 500 rose by 7.3%.  What was, to my mind, much more impressive, though less remarked on, was the 14% gain of the US$ vs the ¥ over that period and its 7% rise against the €.

the aftermath

Since the beginning of 2017, the S&P 500 has tacked on another +4.9%.  However, as the charts on my Keeping Score page show, Trump-related sectors (Materials, Industrials, Financials, Energy) have lagged badly.  The dollar has reversed course as well, losing about half its late-2016 gains against both the yen and euro.

How so?

Where to from here?

the S&P

The happy picture of late 2016 was that having one party control both Congress and the administration, and with a maverick president unwilling to tolerate government dysfunction, gridlock in Washington would end.  Tax reform and infrastructure spending would top the agenda.

The reality so far, however, is that discord within the Republican Party plus the President’s surprisingly limited grasp of the relevant economic and political issues have resulted in continuing inaction.  The latest pothole is Mr. Trump’s refusal to release his tax returns–that would reveal what he personally has to gain from the tax changes he is proposing.

On the other hand, disappointment about the potential for US profit advances generated by constructive fiscal policy has been offset by surprisingly strong growth indications from Continental Europe and, to a lesser extent, from China.

This is why equity investors in the US have shifted their interest away from Trump stocks and toward multinationals, world-leading tech stocks and beneficiaries of demographic change.

the dollar

The case for dollar strength has been based on the idea that new fiscal stimulus emanating from Washington would allow the Fed to raise interest rates at a faster clip this year than previously anticipated.  Washington’s continuing ineptness, however, is giving fixed income and currency investors second thoughts.  Hence, the dollar’s reversal of form.

tactics

Absent a reversal of form in Washington that permits substantial corporate tax reform, it’s hard for me to argue that the S&P is going up.  Yes, we probably get some support from a slower interest rate increase program by the Fed, as well as from continuing grass-roots political action that threatens recalcitrant legislators with replacement in the next election.  The dollar probably slides a bit, as well–a plus for the 50% or so of S&P earnings sourced abroad.  But sideways is both the most likely and the best I think ws can hope for.  Secular growth themes probably continue to predominate, with beneficiaries of fiscal stimulation lagging.

Having written that, I still think shale oil is interesting   …and the contrarian in me says that at some point there will be a valuation case for things like shipping and basic materials.  On the latter, I don’t think there’s any need to do more than nibble right now, though.

 

 

a French sovereign debt default?!?

First there was the surprise Brexit vote in the UK, after which sterling plunged.

Then there was the improbable victory of Donald Trump in the US presidential election, which sent the dollar soaring.

Now there’s France, where the odds of a far-right presidential victory by the Front National have improved.  A competing right-of-center candidate, former frontrunner François Fillion, has been hurt by allegations that his wife and children did little/no work in government jobs he arranged for them (with aggregate pay totaling about €1 million).

If Marine Le Pen, the FN leader and standard bearer, were to win election in May (oddsmakers now give this about a 1 in 12 chance), her victory might conceivably snowball into a similar sea change in the National Assmebly election in June.  Were the FN to win control of the legislature too, the party says it will leave the euro and re-institute the franc as the national currency.  In addition, it intends to, in effect, default on €1.7 trillion in French government bonds by repaying the debt in new francs, at an exchange rate of 1 Ffr = 1 €.

Improved prospects for Ms. Le Pen–plus, I think, President Trump demonstrating he means to do his best to keep all his campaign promises–have induced a mini-panic in the market for French-issued eurobonds.  Trading at a 40 basis point premium to similar bonds issued by Germany as 2017 opened and +50 bp in late January, they spiked to close to an 80 bp premium last week.

my take

At this point, the conditions that would trigger a French exit from the euro and its refusal to honor its euro debt instruments seem high unlikely.  Still, the possibility is worth thinking through, since the financial markets consequences of Frexit would likely be much more severe than those of Brexit.

More tomorrow.