Book Title: The Anti-Bubbles – Opportunities heading into Lehman Squared and Gold’s Perfect Storm
How strongly I recommend it: 3/5 Stars
An easy read which I was able to read in one sitting. This book is basically a structured critique on modern monetary theory with practical applications on how to trade an eventual market correction.
The central premise in this book is that we are going to (eventually) see somewhat of a doomsday scenario because Central Banks have taken monetary policy to extreme levels and they are not infallible. Fortunately, there are ways in which investors can trade the ‘anti-bubbles’ that will show up.
I liked the application of economic theory to real world investment ideas but this book did feel a little poorly written with a lot of repeating and quotations from notable investors without enough explanation.
Amazon Page Link: Click Here
How I discovered it? The Ultimate Masterclass for Macro Investing (Youtube Link)
Who should read it? Aspiring Macro Investors
Starting with Ben Bernanke’s decision to cut interest rates to zero in response to the 2008 financial crises, Central Banks across the globe have become addicted to low rates, Quantitative Easing (buying Government Bonds) and direct monetary injections (buying high yield credit). Parrilla argues that these tools are extreme applications of monetary policy which have created bubbles in the economy that will need to eventually correct.
As a result of these extreme policy responses, Parrilla argues that; 1) Currencies have become over-valued due too much money printing, 2) Volatility is underpriced as Central Banks continue to prop up markets and 3) Due to the widespread impact of monetary expansion, assets are going to be increasingly correlated to one another.
So how do you trade this? Parrilla offers three trading strategies to respond to the above. 1) To be long Gold (preferably through ETF’s), 2) To be long implied volatility through long biased options and 3) To be long tail risk by betting on contrarian outcomes (e.g. being long Gold and short non-USD currencies).
- Currency Wars
It is not possible to look at monetary policy in a single country, in isolation. The reality is that when countries devalue currencies, this basically exports deflation to other countries. In turn, other economies need to either lower their own currencies (via reducing interest rates) or become uncompetitive. This incentivizes currency wars and even more extreme policy action which creates a destructive cycle.
- The Search for yield
‘Risk-Free interest’ has been turned into ‘Interest Free, Risk’ in a zero interest rate environment. In other words, in the search for yield, money managers have lended to worse borrowers, for longer maturities. This search for yield in an extremely low yield environment, has benefited the weakest borrowers the most and has encouraged speculative bubbles.
- False Diversification
Money managers have incorrectly assumed they are diversified because they own different asset (e.g. equities, property, credit). However, when Central Banks are effectively propping up asset prices (through the ‘Central Bank Put’), this is not diversification – everything will go up and down together.
- Low Implied Volatility
‘Central Bank Put’ puts a floor under prices and insures the market that the Central Bank will step in as soon as things go wrong. This then artificially lowers implied volatility in the market. As most VAR models use implied volatility to calculate risk, it then encourages more leverage and risk taking.
- Ways out of this financial predicament
There are three ways out of this monetary mess we have got ourselves in. First option is for Central Banks to reverse policy as the economy begins to improve and we see inflationary pressures. However, the problem with this is that the sequence and extent of reversal will be harder the most unconventional policy becomes.
The second option is for Central Banks to hold Government Bonds till expiry and then decide what to do i.e. basically just buys the Central Bank more time to make a decision.
The third and most likely option is that eventually, all this debt will need to be monetized and therefore, there will be a massive devaluation of currencies and a rebasing that will need to happen. This will prop up real assets such as Gold.
‘Paper currencies eventually converge to their intrinsic value: paper’ – Voltaire
The official Gold Reserves of the Bank of Japan would buy less than 5% of Apple’s Market Cap
Currency experiments have tended to give bias towards monetary expansion and Central Bank excessiveness.
In 1933, the US decided to go off the Gold Standard and gold was no longer accepted as legal tender. By 1934, most private possession of Gold was outlawed, forcing individuals to sell it to the treasury.
In 1944, the Bretton Woods system fixed currencies to the USD which was effectively, tied to Gold but once again, in 1971, due to worsening balance of payments, depleting Gold reserves and the financial burden of the Vietnam war, Nixon put an end to the coverability of the USD to Gold, which basically ended the Bretton Woods system of fixed financial exchange.
Reflexivity Theory – George Soros
Fundamentals dictate prices but prices also dictate fundamentals – it goes both ways.
In contrast to rational expectation theory that only real world fundamentals drive real world supply/demand, reflexivity theory argues that it is actually expectations that drive real world behaviors which then lead to new expectations. This explains financial bubbles and excessive speculation.
Gold Equities as an ‘up and out call’ on Gold
People normally think that buying Gold Equities = being long Gold. They are not one and the same. A good way to think about Gold equities is that they are an up and out call option on Gold – if the price rises too high, then Gold equities are likely to underperform e.g. they face extreme political risks especially in politically sensitive countries or companies with Gold hedges may actually end up distressed due to margin calls. So Gold equities basically cap your upside on Gold and it’s much better to buy ETF’s or calls.