9/4/17: Oil's Bucking Bull

My recent article for Sunday Business Post covering oil price dynamics and forecasts: https://www.businesspost.ie/business/oils-bucking-bull-382323.

13/3/17: Bitcoin v Gold: Volatilities and Correlation

On foot of the previous post, a reader asked me for some analysis of comparatives between Bitcoin volatility and Gold price volatility. It took some time to get to the answer. One of the reasons is that Bitcoin is traded continuously, while gold prices are listed for specific markets trading dates. So it takes some time to reconcile two data sets.

Here is the analysis. Starting with daily returns volatilities for log-log returns:

Several things are obvious from the above chart:

1. Overall Bitcoin price volatility is magnitudes greater than volatility of gold prices almost always. Historical standard deviation in daily returns is 2.663% and Gold price (log daily returns) volatility is 0.466%, which means that historically, gold daily returns are less volatile than Bitcoin daily returns by a more than a factor of 5. 
2. There are, broadly speaking three key periods of Bitcoin volatility: the period from September 2011 through December 2012, when volatility was extreme and declining, the period from January 2013 through February 2015, when volatility in Bitcoin was characterised by severe spikes and elevated base, and the period from March 2015 on, when both the spikes in volatility and the base of volatility abated. These three periods are associated with the following comparatives between gold volatility and Bitcoin volatility: period through December 2012: gold daily returns volatility 0.520% against Bitcoin daily returns volatility of almost 6 times that at 3.00%; period from January 2013 through February 2015, when Bitcoin returns volatility (3.27%) was almost 7.5 times gold returns volatility (0.479%), and the current period from March 2015, where Bitcoin daily returns volatility (1.421%) was over 3 times daily returns volatility for gold (0.412%). Note: these are log-log returns, so much of extreme volatility is smoothed out and this benefits the Bitcoin.
3. There is a long-term trend difference between gold returns volatility and Bitcoin returns volatility, as shown by polynomial (power 6) trend lines for both. In fact, even in terms of trend, Bitcoin is much more volatile than gold and Bitcoin's volatility is less stable than volatility of gold. 

In very simple terms, Bitcoin volatility is vastly in excess of Gold's volatility, albeit the former is starting to moderate in more recent years.

Now, for the last bit of observations. I also mentioned that Bitcoin is distinct from Gold in terms of its financial properties. And guess what, I did not provide any evidence. Well, here it is. Bitcoin returns and Gold returns are not correlated, or in other words, they neither co-move with each other nor countermove against each other. Here's a chart to prove this:

Average 30-days running correlation for Bitcoin and gold in terms of daily log-log returns is 0.03025 historically, which is statistically indifferent from zero. Across the three periods of Bitcoin volatility structure (defined above), average correlation between Bitcoin and gold log-log returns was 0.0147, 0.0182 and 0.0529 respectively. All of these are statistically indifferent from zero. In history of the Bitcoin, there were only 7 occasions on which daily returns were correlated positively with gold price with correlation in excess of 0.5. and 5 with negative correlation in excess of -0.5 in absolute value None with correlation in excess of 0.65 in absolute value for either positive or negative correlations. 

Bitcoin comparatives to gold hold about as much water as a colander hit by a shrapnel shot.

12/3/17: Bitcoin Pop: Nothing too Dramatic by Historical Comparatives

Few days back, I posted a quick note about the erroneous nature of Bitcoin-Gold comparatives. And yesterday, we had one of those events that highlights the same.

In summary of the event, SEC rejected an application for a Bitcoin ETF.  And Bitcoin crashed. Inter-day volatility shot up through the roof. Which would have been bad enough, except it is the norm for Bitcoin

You can see just how unsurprising the current volatility is for the BTC, consider the following charts:

Pretty much by every metric of volatility, Bitcoin's latests wobble is minor, despite it being dramatic enough to set @Reuters and @Bloomberg folks all hopping with excitement. Thing is, folks, Bitcoin's volatility is in the league of financial widow-makers.

3/3/17: BRIC Manufacturing PMI: Weaker Support for Global Growth in 1Q

The latest BRIC Manufacturing sector PMIs for February are continuing to signal support for global growth albeit at weaker rates than in 4Q 2016.

Brazil Manufacturing PMI for February came in at 46.9, slightly less sharp of a rate of contraction than 44.0 in January 2017. This marks 25th consecutive month of Brazil’s Manufacturing PMIs at below 50.0 - the point of zero growth. The rate of decline in Brazil’s case is shallowest since January 2016, but the series are quite volatile and at 46.9, the index is statistically significantly below 50.

Russian Manufacturing PMI moderated from 54.7 in January to 52.5 in February, but the index remained statistically above 50.0, signalling robust growth. This marks 7th consecutive month above with PMI above 50 and the 5th consecutive month that Manufacturing PMI exceeded 50.0 by a statistically significant margin, as the Russian economy continued on its expansion trend.

Chinese Manufacturing PMI cam in at 51.7, still below statistically significant growth line, but above 50.0 nominally, marking 8th consecutive month of above 50 readings (none of these readings were statistically significant, however). 51.7 marks a slight improvement on January’s 51.0.

India’s Manufacturing PMI rose to 50.7 in February from 50.4 in January. This marks the second consecutive month with above 50.0 nominal readings, but the index remains statistically indistinguishable from 50.0 zero growth mark.

Table below uses January-February average PMI for 1Q 2017 reading and compares it against full quarter averages for Manufacturing PMIs for previous quarters.

Chart below illustrates quarterly averages trends:

As shown in the chart above, 1Q 2017 results to-date indicate slightly weaker growth support from the BRIC economies overall, based on Manufacturing sector activity alone. Global growth in manufacturing continued to accelerate in the first two months of 2017, while BRIC Manufacturing posted slightly weaker growth in 1Q so far. The downward momentum in BRIC Manufacturing growth was driven by 

• Brazil (experiencing accelerated contraction in 1Q to-date compared to 4Q 2016)
• India (experiencing sharply slower growth in 1Q 2017 to-date compared to 4Q 2016)

Offsetting these trends,

• Russian growth in manufacturing sector accelerated in the first two months of 2017 compared to 4Q 2016; and
• Chinese growth in the sector remained roughly unchanged in January-February 2017 compared to 4Q 2016.

I will be posting on Services sector PMIs and Composite PMIs once we have data for Brazil.

3/3/17: Sovereign & Corporate Credit Ratings: Slow Motion Disaster Spectacle

Recently, I wrote about the latest Fitch Ratings data showing a dramatic decline in the number of AAA-rated sovereigns over 2016 (see: http://trueeconomics.blogspot.com/2017/02/10217-sovereign-debt-bubble-methane.html). Now, take a look at the Fitch's latest analysis of the trends in A and better rated sovereigns:

Per Fitch: "The proportion of 'A-' and higher ratings in Fitch's global portfolio of sovereigns, corporates and banks remains well below the pre financial-crisis level and could fall further over the next couple of years as the balance of ratings outlooks has deteriorated."

Some numbers:

• In sovereign ratings, the proportion of 'AAA' sovereigns was down to below 10% at the end of 2016, marking its lowest-ever level. "Around 36% of the portfolio is rated in the 'A' to 'AAA' categories, down from 48% at the end of 2006 while 27% is rated 'B+' or below, compared to 20% in 2006."
• Fitch's sovereign ratings also "have the greatest share of negative outlooks on a net basis, at 21%. This suggests downgrades could outnumber upgrades by a wide margin" going forward.
• In corporate ratings, "the proportion of corporate ratings in the 'A' to 'AAA' categories has dropped to 20% from 30% over the last decade, but unlike sovereigns the proportion rated 'B+' and below has only ticked up by 1 percentage point. Instead ratings have become increasingly compressed in the 'BB' and 'BBB' categories."
• "Financial institutions, which have historically had a bigger share of high investment grade ratings, have seen the proportion of 'A' to 'AAA' category ratings slip to 39% from 53%."
• "The trend seems set to worsen, as a net 11% of financial institution ratings outlooks were negative at end-2016, driven largely by outlooks on emerging-market banks, which themselves often reflect the outlooks of their sovereign."

3/3/17: Gold vs Bitcoin: Prices vs Values

Marketwatch reported earlier that Bitcoin is currently being priced at above the price of gold in USD terms: http://www.marketwatch.com/story/bitcoin-is-now-worth-more-than-an-ounce-of-gold-for-the-first-time-ever-2017-03-02?siteid=bnbh

The comparative is somewhat silly, because, as Marketwatch article notes, Bitcoin market cap is much much smaller than that for gold, which implies that any valuation of Bitcoin to-date incorporates a hefty liquidity risk premium compared to gold. In addition - unmentioned by the Marketwatch - Bitcoin lacks key financial properties of gold, including:

1. Established safe haven properties: gold acts as a safe haven instrument against large scale or systemic risks. Bitcoin is yet to establish such property with any conviction. There are some indications that Bitcoin may be seen in the markets as a hedge against some systemic risks, e.g. capital controls in China, but this property is yet to be fully confirmed in data. Beyond such confirmation, there is no evidence to-date that Bitcoin acts as a safe haven for other systemic risks (e.g. sovereign debt crisis risks in the Euro area, or political risks in the EU, etc).
2. Hedging properties: Bitcoin shows no hedging relationship to key asset classes, in contrast to gold.

The above points mean that in addition to liquidity risks, Bitcoin price is also factoring in premium for lacking the broader safe haven and hedging properties.

While the continued evolution of Bitcoin is a great thing to watch and take part in, immediate valuations of Bitcoin are subject to severely concentrated risks, including the currently extremely elevated risk of Bitcoin demand being severely skewed to China (http://trueeconomics.blogspot.com/2017/01/18117-bitcoin-demand-its-chinese-tale.html) and the supply and legal rights issues with Bitcoin. Hence, as it says on the tin: the comparative to gold is silly, even if entertaining.

28/2/17: Sentix Euro Breakup Contagion Risk Index Explodes

Sentix Euro Break-up Contagion Index - a market measure of the contagion risk from one or more countries leaving the euro area within the next 12 months period - has hit its post-2012 record recently, reaching 47.6 marker, up on 25 trough in 2Q 2016:

Key drivers: Greece, Italy and France.

Details here: https://www.sentix.de/index.php/sentix-Euro-Break-up-Index-News/euro-break-up-index-die-gefaehrlichen-drei.html.

25/2/17: Eurocoin February 2017: Another Acceleration in Growth

A quick update on Eurocoin, the lead indicator for economic growth in the Euro area. In February, Eurocoin rose from 0.68 in January to 0.75 - hitting the highest level in 83 months and marking 10th consecutive monthly rise. The index has been now in a statistically positive growth territory every month since March 2015.

Implied 1Q 2017 GDP growth, as signalled by Eurocoin indicator is now at around 0.7 percent, which, if confirmed, will be the fastest pace of economic expansion since 1Q 2011.

The above chart shows that there is now a mounting pressure on the ECB to taper off its QE programme.

24/2/17: Cybersecurity Threats: Business Survey

An interesting insight via https://www.bloomberg.com/politics/articles/2017-02-21/threat-of-cyber-attack-is-biggest-fear-for-businesses-survey on the rising importance of the cyber-security risks and changing business perceptions of the risk. Goes handily with our findings here: http://trueeconomics.blogspot.com/2017/01/23117-regulating-for-cybercrime-hacking.html.

24/2/2017: Baltic Dry Index is Still in a Disaster Territory

All of the discussions about the Baltic Dry Index - a proxy for global trade flows - in recent weeks was centred on the alleged recovery in the index valuations from the historical lows of 1Q 2016. Much of this recovery was predicated on the cost of fuel that went to inflate the cost of shipping, rather than the genuine uptick in global trade.

In fact, as the most recent data suggests, uptick in global trade volumes is nowhere to be seen:

Source: https://www.fxstreet.com/analysis/global-trade-disaster-nearly-certain-201702220646

But here is a look at the trends in the Baltic Dry Index confirming the simple fact that whatever recovery there has been, the index readings remain deeply in a trade-recession territory:

Worse, Suez Canal traffic is still trending down: http://www.hellenicshippingnews.com/suez-canal-revenues-decline-in-wake-of-sluggish-global-trade/, although Panama Canal volumes are hitting new records http://www.tradewindsnews.com/andalso/1213246/panama-canal-volumes-hit-new-record (the data is not adjusted for the capacity expansion since June 2016). Even with that expansion, Trans-pacific trade is up only 4.3% y/y in 2016, an improvement on 3.7% growth in 2015, but much worse than 5.9% growth in 2014 (see http://www.hellenicshippingnews.com/volume-recovery-in-far-east-europe-and-transpacific-trade/).

Overall, even the improved Baltic Dry Index current average for 2017-to-date is at around 831.6, which is below all 2009-2014 annual averages. Not exactly a sign of booming global economy.

24/2/17: Distributed ledger technology in payments, clearing, & settlement

A new research paper from the U.S. Federal Reserve System, titled “Distributed ledger technology in payments, clearing, and settlement” (see citation below) looks at the rapidly evolving landscape of blockchain (distributed ledger technologies, or DLTs) in the financial services.

The authors note that DLT “is a term that [as of yet]… does not have a single definition”. Thus, the authors “refer to the technology as some combination of components including peer-to-peer networking, distributed data storage, and cryptography that, among other things, can potentially change the way in which the storage, record-keeping, and transfer of a digital asset is done.” While this definition is broader than blockchain definition alone, it is dominated by blockchain (private and public) typologies.


Impetus for research

Per authors, the impetus for this research is that DLT is one core form of financial sector innovation “that has been cited as a means of transforming payment, clearing, and settlement (PCS) processes, including how funds are transferred and how securities, commodities, and derivatives are cleared and settled.” Furthermore, “the driving force behind efforts to develop and deploy DLT in payments, clearing, and settlement is an expectation that the technology could reduce or even eliminate operational and financial inefficiencies, or other frictions, that exist for current methods of storing, recording, and transferring digital assets throughout financial markets.” This, indeed, is the main positive proposition arising from blockchain solutions, but it is not a unique one. Blockchain systems offer provision of greater security of access and records storage, higher degree of integration of various data sources for the purpose of analytics, greater portability of data. These advantages reach beyond pure efficiency (cost savings) arguments and go to the heart of the idea of financial inclusion - opening up access to financial services for those who are currently unbanked, unserved and undocumented.

In line with this, the Fed study points that the proponents “of the technology have claimed that DLT could help foster a more efficient and safe payments system, and may even have the potential to fundamentally change the way in which PCS [payments, clearance and settlement] activities are conducted and the roles that financial institutions and infrastructures currently play.” The Fed is cautious on the latter promises, stating that “although there is much optimism regarding the promise of DLT, the development of such applications for PCS activities is in very early stages, with many industry participants suggesting that real-world applications are years away from full implementation.”

Per Fed research, “U.S. PCS systems process approximately 600 million transactions per day, valued at over $12.6 trillion.” In simple terms, given average transaction cost of ca 2-2.5 percent, the market for PCS support systems is around USD250-310 billion annually in the U.S. alone, implying global markets size of well in excess of USD750 billion.

DLT Potential 

Fed researchers summarise key (but not all) potential (currently emerging) benefits of DLT systems in PCS services markets:

• Reduced complexity (especially in multiparty, cross-border transactions)
• Improved end-to-end processing speed and availability of assets and funds
• Decreased need for reconciliation across multiple record-keeping infrastructures
• Increased transparency and immutability in transaction record-keeping
• Improved network resiliency through distributed data management
• Reduced operational and financial risks

One of the more challenging, from the general financial services practitioners’ point of view, benefits of DLT is that it is “essentially asset-agnostic, meaning the technology is potentially capable of providing the storage, record-keeping, and transfer of any type of asset. This asset-agnostic nature of DLT has resulted in a range of possible applications currently being explored for uses in post-trade processes.”

The key to the above is that blockchains ledgers are neutral to the assets that are recorded on them, unlike traditional electronic and physical ledgers that commonly require specific structures for individual types of assets. The advantage of the blockchain is not simply in the fact that you can use the ledger to account for transactions involving multiple and diverse assets, but that you can also more seamlessly integrate data relating to different assets into analytics engines.

Due to higher efficiencies (cost, latency and security), blockchain offers huge potential in one core area of financial services: financial inclusion. As noted by the Fed researchers, “financial inclusion is another challenge both domestically and abroad that some are attempting to address with DLT. Some of the potential benefits of DLT for cross-border payments described above might also be able to help address issues involving cross-border remittances as well as challenges in providing end-users with universal access to a wide range of financial services. Access to financial services can be difficult, particularly for low-income households, because of high account fees, prohibitive costs associated with traveling to a bank. Developers contend DLT may assist financial inclusion by potentially allowing technology firms such as mobile phone providers to provide DLT-based financial services directly to end users at a lower cost than can (or would) traditional financial intermediaries; expanding access to customer groups not served by ordinary banks, and ultimately
reducing costs for retail consumers.”

Lower costs are key to achieving financial inclusion because serving lower income (currently unbanked and unserved) customers in diverse geographical, regulatory and institutional settings requires trading on much lower margins than in traditional financial services, usually delivered to higher income clients. Reducing costs is the key to improving margins, making them sustainable enough for financial services providers to enter lower income segments of the markets.

Incidentally, in addition to lower costs, improving financial inclusion also requires higher security and improved identification of customers. These are necessary to achieve significant gains in efficiencies in collection and distribution of payments (e.g. in micro-insurance or micro-finance). Once again, DLT systems hold huge promise here, including in the areas of creating Digital IDs for lower income clients and for undocumented customers, and in creating verifiable and portable financial fingerprints for such clients.

The Fed paper partially touches this when addressing the gains in information sharing arising from DLT platforms. “According to interviews, the ability of DLT to maintain tamper-resistant records can provide new ways to share information across entities such as independent auditors and supervisors.” Note: this reaches well beyond the scope of supervision and audits, and goes directly to the heart of the existent bottlenecks in information sharing and transmission present in the legacy financial systems, although the Fed study omits this consideration.

“As an example, DLT arrangements could be designed to allow auditors or supervisors “read-only access” to certain parts of the common ledger. This could help service providers in a DLT arrangement and end users meet regulatory reporting requirements more efficiently. Developers contend that being given visibility to a unified, shared ledger could give supervisors confidence in knowing the origins of the asset and the history of transactions across participants. Having a connection as a node in the network, a supervisor would receive transaction data as soon as it is broadcast to the network, which could help streamline regulatory compliance procedures and reduce costs…”

Once again, the Fed research does not see beyond the immediate issues of auditing and supervision. In reality, “read-only” access or “targeted access” can facilitate much easier and less costly underwriting of risks and structuring of contracts, aiding financial inclusion.


Key takeaways

Overall, the Fed paper “has examined how DLT can be used in the area of payments, clearing and settlement and identifies both the opportunities and challenges facing its long-term implementation and adoption.” This clearly specifies a relatively narrow reach of the study that excludes more business-focused aspects of DLTs potential in facilitating product structuring, asset management, data analytics, product underwriting, contracts structuring and other functionalities of huge importance to the financial services.

Per Fed, “in the [narrower] context of payments, DLT has the potential to provide new ways to transfer and record the ownership of digital assets; immutably and securely store information; provide for identity management; and other evolving operations through peer-to-peer networking, access to a distributed but common ledger among participants, and cryptography. Potential use cases in payments, clearing, and settlement include cross-border payments and the post-trade clearing and settlement of securities. These use cases could address operational and financial frictions around existing services.”

As the study notes, “…the industry’s understanding and application of this technology is still in its infancy, and stakeholders are taking a variety of approaches toward its development.” Thus, “…a number of challenges to development and adoption remain, including in how issues around business cases, technological hurdles, legal considerations, and risk management considerations are addressed.” All of which shows two things:

• Firstly, the true potential of DLTs in transforming the financial services is currently impossible to map out due to both the early stages of technological development and the broad range of potential applications. The Fed research mostly focuses on the set of back office applications of DLT, without touching upon the front office applications, and without considering the potentially greater gains from integration of back and front office applications through DLT platforms; and
• Secondly, the key obstacles to the DLT deployment are the legacy services providers and systems - an issue that also worth exploring in more details.

In both, the former and the latter terms, it is heartening to see U.S. regulatory bodies shifting their supervisory and regulatory approaches toward greater openness toward DLT platforms, when contrasted against the legacy financial services platforms.


Mills, David, Kathy Wang, Brendan Malone, Anjana Ravi, Jeff Marquardt, Clinton Chen, Anton Badev, Timothy Brezinski, Linda Fahy, Kimberley Liao, Vanessa Kargenian, Max Ellithorpe, Wendy Ng, and Maria Baird (2016). “Distributed ledger technology in payments, clearing, and settlement,” Finance and Economics Discussion Series 2016-095. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2016.095. 

24/2/17: 2016 to 2017: Continuity of Risks

My article for the Cayman Financial Review covering the transition in strategic and systemic risks between 2016 and 2017 is available here: http://www.caymanfinancialreview.com/2017/02/01/the-continuation-of-a-horrible-year/.