Markets Last Week: What Happened?…and Why It Doesn’t Matter (for BTC and Gold)
Fragility in traditional markets signal more trouble ahead. Fixed supply assets took a hit but that seems to be a short term problem.
Well, this past week was a ride regardless of what market you trade and invest in. Markets spiking up, markets spiking down, longs taking drawdowns, shorts getting stopped out on intraday bounces — interestingly, I’ve yet to speak with anyone who made a “real killing” in last week’s trading. The people who fared best are the ones who moved out of assets and into USD/hard currency and now have many options as to where to vest that capital.
Early last week, I wrote a short post on my thoughts around a BTC drawdown from $9200 to $7700 or thereabouts. In it, I pointed out that gold prices were also taking a drawdown along with stocks and rates. My suspicion was there was some sort of liquidity crunch happening causing a cascading fire sale of assets. This more or less played out exactly as one would expect, with all markets tanking later in the week and Fed stepping in with a liquidity injection for short term markets. This liquidity injection included an expansion of the definition of collateral.
Repo Markets — the canary in the coal mine
Having worked in both rates and equities, I’ve noticed that equities traders tend to ignore moves in rates and it’s, unfortunately, a waste of a very powerful signal. Specifically, “significant” or “odd” moves in short term markets signal shifts in the underlying liquidity needs for market participants. While repo markets have many intricacies and dynamics here is a general outline of what they do and how one might use them:
A repo (repurchase agreement) is a short term loan — generally overnight — where one party sells securities to another and agrees to repurchase those securities at a date in the near future for a higher price. The securities serve as collateral, and the price difference between the initial sale and repurchase is the repo rate i.e. the interest paid on the loan. A reverse repo is the opposite of this i.e. one party buys securities and agrees to sell them back later.
Repo markets serve two important functions for the broader market. The first is that financial institutions such as hedge funds and broker-dealers who often own lots of securities and little cash can borrow from financial institutions such as money market funds or mutual funds who often have lots of cash. The hedge funds, etc. can use this cash to finance day to day operations and trades and money market funds, etc. can earn interest on their cash with very little risk. Generally, the securities used as collateral are U.S. Treasuries. The second is that the Fed uses repo markets to conduct monetary policy. By buying or selling securities in the repo market, the Fed is able to inject or withdraw money from the financial system. Since the global financial crisis, repo markets have become an even more important tool for the Fed…and sure enough, the 2008 crash was preceded by odd movements in repo markets.
The Fragility of Our Current Financial System
This past week, the Fed injected liquidity into the short term markets. While some headlines claim the Fed spent $1.5Trillion this past week, those headlines are a bit sensationalist and are trying to equate last week’s actions to TARP — and I say this as someone with very little trust in the Fed.
This wasn’t really bail out but was a move to calm funding markets. Let’s take a step back and think about what that means — short term markets where parties exchange very liquid collateral had funding crisis… either party didn’t have cash or didn’t want collateral in return for cash. There is no way to cut this as a positive. This would go a long way in explaining the wild movements and unprecedented yields hit across the entire yield curve. To make matters worse, there was a funding crisis in September 2019 as well. The repo markets are struggling without the Fed’s intervention.
Given the firesale we saw, and the whip saw in the treasuries markets. I suspect some funds were caught off guard, especially by the move in oil futures, and were unable to get funding. This lead to a sale of assets to generate cash and then a cascade of sales across markets.
What about BTC (and Gold)
To clarify, I keep putting “and Gold” in parentheses because the commentary applies to both markets given the nature of their fixed supply. I consider BTC to be a better version of gold as it is provably scarce, among other benefits. However, Gold has enamored mankind since… well, the dawn of mankind so while I think BTC is the better option, Gold has a place in portfolios not quite ready to take on digital currencies.
Bitcoin had a bad week, retracing much of 2019’s gains but remaining positive on a Y/Y basis. Here are the positives: everything did and because of bitcoin’s newer, more volatile nature, the moves will be extreme, Bitcoin is now trading very cheaply on a USD basis, and the fundamental analysis and value proposition remains unchanged.
However, it’s easy to talk about long term theses and other “hopeium” in the face of a 50% drawdown and ignore the fact that a ton of people lost a ton of money. So let’s consider the short term thesis:
- A “first-level” analysis would conclude that BTC went down, while stocks went down and so, there is no “store of value,” nor does it function as a “safe haven.” I cannot stress how useless this commentary is, and masquerading it as “analysis” is somewhat insulting. Anybody with mediocre programming skills can plot two lines and point to a correlation — what value has this analysis added? None. That aside, consider Gold in 2008. Gold prices fell sharply at the beginning of the financial crisis, only to rally after TALF and other relief measures were implemented and then further bolstered by QE
- The signs of a pullback were building. I personally watch Bitmex leveraged positions to get an indication of where the market is. Whenever leveraged positions build up to an extreme, the market tends to (possibly is forced to) move in the opposite direction and clear out the leveraged positions. There were over a billion USD in leveraged longs on Bitmex and from what I last read, roughly $700mln of those were wiped out this past week. It’s a painful but necessary cleansing.
- Miner inventory had built up. Miners either sell coins to market or build up reserves to sell when prices are more favorable. This is called the MRI (miner rolling inventory). Chainalysis put out this fascinating chart that shows Miner’s generated inventory vs. inventory sent to exchanges. One could assume miner hoarding is a sign that there is an expectation of a price increase, but a liquidity crunch throws all that out the window, AND historical data suggests that returns are better when miners are not hoarding:
So where do we go from here
Losing money sucks, but when you invest or trade, it’s something you should get used to. If you’re a stellar investor, you’re probably still losing money 40% of the time. So the short term shows a buying opportunity as we saw a large capitulation last week. The BTC fear and greed index implies a startling change from last month, and it’s almost always better to buy when others are fearful. However, I would urge caution. Until we see BTC, Gold, and Treasuries dislocate from SPX futures, I am cautiously deploying capital.
In the long term, things are actually going according to plan. The halvening is still some blocks and months away. Miners who are already feeling the pain of this past week will continue to struggle to be profitable as block rewards are halved. In the next 10 days, roughly, we will see an upward adjustment in mining difficulty causing more pain to these miners.
The FED is more likely now than in the past few months to engage in a new form of QE. The money printer is coming, and when that starts fixed supply, assets such as BTC and Gold will do well. The stock market has spoken: it is demanding an economic stimulus and has shown over the past year that without government liquidity injections, it cannot sustain its current growth.
