Monday, September 15, 2008

A Financial Requiem

With apologies to Kenny Rogers

On a warm summer’s evening in a bar in the City

I met up with the banker; we were both too tired to weep.

So we took turns starin’ out the window at the darkness

‘Til boredom overtook us , and he began to speak.

He said, “Son I’ve made a life out of readin’ people’s faces,

And knowin’ what their trades were by the way they held their eyes.

So if you don’t mind my sayin’, I can see you’re out of winners

For a taste of your drink I’ll give you some advice.”

So I gave him my mojito and he drank down my last swallow.

Then he bummed a Montecristo and asked me for a light.

And the bar got deathly quiet, and his face lost all expression.

He said, “If you’re gonna play the game, boy, ya gotta learn to play it right.

“You gotta know when to hold ‘em, know when to Fuld ‘em*

Know when to walk away** and know when to run

You never count your money when you’re sittin’ at the table

There’ll be time enough for countin’ when the deal is done.***

“Now every trader knows that the secret to survivin’

Is knowin’ when to hit the bid when the market is a rout.

‘Cause every trade’s a winner and every trade’s a loser

And if it all goes wrong just hope the Feds will sort you out.”

So when he’d finished speakin’, he turned back towards the window,

Stubbed out his fat cigar and walked out through the door.

And somewhere in the darkness, the banker he broke even.

But he gave me a position that I’ve kept forever more.

You gotta know when to hold ‘em, know when to Fuld ‘em

Know when to walk away and know when to run

You never count your money when you’re sittin’ at the table

There’ll be time enough for countin’ when the deal is done.

* Memo to AIG: Now is probably not the time to to refuse an equity injection because you'd have to give up control

**Not when some Koreans offer you $26/share for a quarter of your company

*** Unless you're Jimmy Cayne and emerge from yet another bridge tournament to find that your firm is insolvent

Macro Man extends his best wishes to all of his friends and counterparts at Lehman Brothers.


Anonymous said...

"A tragedy of hubris and nemesis"

mikarsky said...

From the article cited above:
"dark, obstinate Lehman loyalist"

A friend of mine in London left Lehman a couple of years ago to start his own business on the other side of the world. By doing so, he said, he could serve his clients and still look them in the eyes. I guessed he couldn't do that at Lehman. Evolution is unforgiving.

Anonymous said...

This could be your best writing ever, MM. Or maybe I am just in a great mood because I have my entire portfolio set up for a day like today. Your short equity exposure should give you a good day, too.

dblwyo said...

anon@10:12 - presumably that was Portnoy's column ? The URL got chopped and took me to a story about the kidnapping of Pakistan's Afghan ambassador. Interesting and perhaps there are some similarities...of wishful thinking.

Try this:
Hopefully that'll take anyone else suffering the same problems to the column you had in mind.

Anonymous said...

Requiem was great, MM. Read it with laughter and sadess --thinking of my LEH friends who trusted their management til the bitter end. The Gambler has long been the anthem of this business, in my view; working with that lyric was particularly appropriate. I hope that AIG takes your advice. The market may soon run out of white knights. I beleive that this assessment was Thain's salvation. His list of possibles after BOA could not have had more than a couple of names.

Macro Man said...

I had to run this ditty by one of my Lehman friends yesterday...didn't want to offend him/them.

Buffett is supposed to bid for AIG; I have every confidence that he might bid for the good bits of AIG, but I'm also quite certain that he has no interest in bidding for the mountain of turds sitting on (and off) AIG's balance sheet.

Charles Butler said...

Anon 10:32-

cf chorus, line three

Anonymous said...

Some justice!

mikarsky said...

Is it enough for the tipping point scenario to unfold or should we stick with optimists?

I like: "Risk Decline as Weaker Financial Players Exit" or perhaps better: "Recovery please, because we had enough misery"

Joke aside. Who buys equities nowadays? Or gold with no inflation on (investor) radar? Or US treasuries backed by.. erm.. by what? Is anyone buying anything and if so what and why?

Steve said...

5-year TIPS breakeven inflation now at 1.26%, 75 bp below fed funds. If the Fed doesn't cut tomorrow (and I think they will) they will very soon have to. The inflation beast has morphed into deflation, and Bernanke knows it. Trichet's stubbornness is our gain, bunds and bobls are the cheapest assets in the world, even after today's rally.

Mencius Moldbug said...

I just wanted to note the brutal decorrelation of gold and oil - as described, if not exactly predicted, in this space last week. Will this stick? It's anyone's guess.

But somebody was holding this bet together. And that somebody might be feeling a little punked today. Will he make it all back and more tomorrow? Impossible to say.

But, within the PMs, note the extremely interesting fact that gold and silver decoupled from the PGMs. Ie: the core PMs went up with the banking bomb. The broad ones declined with the commodities.

Concentration! We have a positive reading on that, Houston. We're detecting concentration. Of course, the sensors could just be acting up.

But extrapolating, does this portend a future G/S decoupling? A bit of that has already occurred. But it could easily be a headfake. G/S dual hegemony is remarkably stable. And a dual hegemony would mean an SGR much more favorable to silver than present rates - perhaps even approaching the old classical range, 15 or 20 to 1. The acceleration could even overshoot. Or silver could just turn out to be a kind of overpriced, white copper. A dangerous market in this number, the GSR.

Remember: a PM is different from an ordinary commodity, even a reasonably storable one, in that an arbitrary amount of "momentum" can crowd in and stay indefinitely.

Ie: any PM is a scalable medium of saving. Ie can be used as money. Without blowing out new supply and collapsing in a bubble, as seems to have happened in oil. Earlier this summer you heard a lot of people asking whether oil can be used as money. The answer seems to be no.

Of course the general caution is that the fact that a commodity will be used as a medium of saving, does not imply that it must be used as such.

Therefore, its monetary premium - the ratio between its price as a monetary commodity, and its price as a raw material - can vary between, essentially, 1 and infinity. (This is a gold-to-gold ratio: unitless.) Considering the gigantic stockpile said to be extant, I'd guess gold's monetary premium is somewhere around 5 or 6.

Note that this model of PM prices has nothing to do with the CAPM or with conventional commodity-price models. But I believe its game theory is a lot more plausible. PMs are simply their own asset class. They demand their own class of model. And woe to those who pile in on a false correlation.

Basically what you see under this model is that the PM/dollar exchange rates should (a) fluctuate violently, (b) be extremely prone to momentum effects, (c) be extremely prone to forming false correlations (like "oil and gold"), and (d) display a Schelling effect, wherein the best metal to be in is the metal that everyone thinks is the best metal to be in.

This would imply a concentration inward from the PMs with the weakest tradition of monetary use, toward those with the strongest. I think it's pretty clear that the order is Rh-Pd-Pt-Ag-Au.

So if we were looking for a natural validation of this Schelling effect in the precious metals, we would expect to see (a) a strong negative shock in the competing fiat currencies (basically artificial PMs), such as a sudden fall in interest rates; and (b) a tilt of the PM axis which favors the right, or monetary, side of the group.

Of course this is exactly what we saw on Monday. But this could, of course, be just a coincidence.

And even if it isn't, other forces could reverse it trivially at any time. So please do not use this as a trading model! Because if you do, you'll probably be sorry. Doh.

Mencius Moldbug said...

Also, note that gold stocks got trashed today, have been trashed for ages, and will continue to be trashed.

I don't make calls, but if I did, I would say: don't buy gold stocks. If bullion goes up, gold stocks will go down. If bullion goes down, gold stocks will go down. At least according to my secret theories, which Alpha Centauri has confided to my right rear molar.

The HUI/bullion ratio, while of course very noisy, gives us one number that we cannot otherwise know: the gold/gold interest rate, the price of future gold in present gold. Obviously, gold stocks derive their value from future gold payments, and that future is often a long way away - as in the case of juniors, especially. This is a very crude indication of maturity. But juniors represent very-high maturity payments; so, in the case that this Alien Centauri Molar theory is correct and gold stocks are falling because gold interest rates are rising, they should be sucking even harder. As they are.

You would expect the futures market to make this forecast. But it cannot - because arbitrage prevents it from forecasting any contango above the interest rate at which it can be financed and sold forward. Of course, when said interest rate is a 21st-century, OECD, ZIRPy monstrosity, the gold market's forecast of future appreciation is likely to be considerably above the fiat rate - now heading for Hades as we speak.

And thus, this forecast is not represented directly in any bit of market data (Kitco's "gold lease rates," for example, are pretty much just noise as far as I can tell; ETF flows are slightly interesting, but not extremely so). It can only be inferred from indirect indicators.

(Another such indicator, of course, is dehedging. Duh.)

Anonymous said...

PGM have always had a tendency to trade as industrial metals. The primary demand is from the automotive industry.

Mencius Moldbug said...

Sure, but physically the PGMs are just as suited for monetary use as gold and silver - storage cost is negligible. Pt and Pd even have ISO currency codes. There is no reason at all why the world could not function on a Pt standard, except for the fact that it won't.

mikarsky said...

I agree Re: the Schelling effect (shock in competing fiat currencies + tilt favoring gold for monetary use)

Not clear about the gold interest rate. Wouldnt the "interest rate" be the goods you can exchange for a unit of physical gold? Let's say today you get 1.00 donut for 1 unit of gold. You're saying tomorrow I only get 0.xx donut for 1u of gold? So what is getting scarce are critical goods (e.g. donuts) relative to gold and currencies? Somehow plausible because gold does not diminish (money even expands) whereas donuts do. So the price of donuts would rise relative to gold. Is that what you're saying? But relative to currencies, gold should still do fine?

Mencius Moldbug said...

An interest rate is a unitless number - no donuts involved. The 1-year interest rate in dollars can be expressed as the price of a 2009 dollar in 2008 dollars. Unless some awful ZIRP thing is going on, this should be <1. Similarly, we can express the price of a 2009 gold ounce in 2008 gold ounces.

This gives us a gold yield curve for all maturities. But no market data reveals this curve if it is steeper than the minimal contango allowed by dollar interest rates, because the two curves are clamped by arbitrage which buys gold now and sells it forward. Thus the rough inference from HUI/bullion.

kenny.rg said...

you actually listen to kenny rogers?\?

j-berg & go said...

Beach Boys – I get around

The Bailout Boys - I get bailed out

Out out,get bailed out
I get bailed out
Get bailed ooooooot
I get bailed out
From house to house
Get bailed out out out i get bailed out
Im a friend of fed
Get bailed out out out i get bailed out
Im making real good spreads

I'm gettin' bugged taking on another credit hit
I gotta find a sovereign fund to buy this shit

My buddies and me are getting real high yields
Yeah, the rating guys know us and they leave us alone

I get bailed out
Get bailed out out out i get bailed out
From house to house
Get bailed out out out i get bailed out
Im a friend of fed
Get bailed out out out i get bailed out
Im making real good spreads
I get bailed out
Get bailed out out oooo
Wah wa ooo
Wah wa ooo
Wah wa ooo

We always take the limo cause it's never been cheap
And we've never paid less for the girls we meet

None of the guys will sell cause it wouldn't be right
To leave Dick Fuld in charge on a Sunday night

I get bailed out
Get bailed out out out i get bailed out
From home to home
Get bailed out out out i get bailed out
Im a friend of fed
Get bailed out out out i get bailed out
Im making real good spreads
I get bailed out
Ah ah ah ah ah ah ah ah