Wednesday, June 11, 2014

Three interesting morning newsbits

Here's some stuff to get you rolling:

Bloomberg View - the $VIX is not a great way to measure "complacency". He lays it out in a hilarious manner. Here's a taste:
A basic story that is told over and over again about financial markets is:

  • Things mean-revert.
  • A thing is away from its mean.
  • Therefore that thing will mean-revert.
  • Soon and horribly.
This is I think roughly the way to read the notion, which my Bloomberg View colleague Mohamed El-Erian examined today, that low readings on the VIX -- an index of implied volatility in short-dated S&P 500 index options -- mean that the market is "complacent." So:
  • Equity volatility is basically a mean-reverting thing.
  • The volatility index is below its long-run average.
  • Therefore volatility will go higher.
  • Soon and horribly.
  • Run, you fools!
  • Why are you being so complacent?
The important thing to note is that just because something is supposed to happen doesn't mean it's going to happen instantaneously - anyone who thinks everything in the market has to happen instantly has no fucking clue how feedback systems operate and how much inertia there is in them. And if you don't understand feedback systems then you don't understand markets, in which case you shouldn't be allowed to handle other people's money or offer investment advice.

As far as the rest of the article, he simply and elegantly explains why $VIX has nothing to do with "complacency": it is no more than an index of the amount of insurance bought against perceived volatility over the approaching month. So if the $VIX is low right now, it's simply because the market perceives that there will be very little volatility over the next month.

FT beyond brics - big risks still stalk EM markets. Wherein they summarize the basic EM bear market thesis:
“Tighter global financial conditions over the next five years as monetary policy is normalized in high income economies is inevitable…And it will imply weaker financial flows and rising costs of capital for developing countries.”
EMs are capital-hungry: they can't grow without capital. So they have to generate capital inflows: either from investment, or from exports. China does a good job of maintaining inflows from exports - the way South Korea did when it was an advanced EM - and thus China might be a "different kind of EM". Other EMs rely heavily on foreign capital inflows - e.g. to buy local debt and fund growth projects, or to fund business expansion - and thus an increase in interest demanded by DM capital will reduce potential growth in that EM.

To clarify:
“If interest rates rise too rapidly or there are sharp pullbacks in capital flows, economies with large external financing needs or rapid expansions in domestic credit in recent years could come under considerable stress.”
And that is the general thesis against EMs. Strangely enough, the report suggests it's LatAm that is most vulnerable: I'd think they're fairly safe unless we see a collapse in commodity prices, since they're all great raw material exporters. But what do I know? And thus this particular case illustrates how you break the rule of thumb - EMs will be more or less affected depending on their need for external capital.

And then you have to ask if this time might be different due to my Piketty/Summers thesis? I mean, if Capital is running out of people to lend its money to, are we going to see a new long-term low-interest regime?

Mineweb - China announces world's second-largest gold resource. And Williams cribs a point I've made on my blog:
With its centrally planned economy and its gold mining companies also effectively all state controlled, profitability may well not pose the same kind of issues it would for shareholder-owned companies as in much of the rest of the world. One would thus expect Chinese mining companies to mine gold according to government, rather than shareholder, needs[.]
That is what happens in EM secular bear markets. Production of a commodity is increased beyond profitability, for political reasons (e.g., in some cases, to earn USD from exports). Thus secular EM bear markets are able to drive secular commodity bear markets.

And the funny thing is, the exploration side of the gold industry has already been failed by capitalism - it's just not possible for Capital to earn any return on exploration investment, with the gold price where it is and the lack of profitable gold deposits to find. And so we may even see free-market exploration (i.e. Vancouver) disappear in favour of state-run (i.e. Chinese) exploration.


  1. Do you still support that EM bear market thesis?

    EEM has been above the 200-DMA for over two months now and that 200-DMA is rising.

    1. I'm agnostic, because things might be different this time. But EEM doesn't mean shit: the fund owns 17% China, 15% Korea, 12% Taiwan, and those countries will perform differently than the other EMs. Actually Korea isn't even an EM now, I just read that today.

      Also, the EM bear thesis is a secular thesis, in which case you can ignore short-term movements. It plays out over a decade, not 2 months. Since 2011 the trend is obviously down already, and we haven't even seen the expected spread widening yet. Watch what happens to EMs when the US comes decisively off the lower bound.