Brad Setser has a disturbing post about the risks that the hedge fund industry is taking, and which might cause a market crash. Puts are looking cheap these days, and I’m buying a modest amount of them just in case.
Investing
Book Review: Intangibles: Management, Measurement, and Reporting by Baruch Lev
It isn’t easy to make a book about accounting interesting and uplifting, but this book comes fairly close to accomplishing that. It provides a clear understanding of why it matters how well accounting rules treat intangible assets, and gives some good guidelines on how to improve them.
Some of the proposed improvements are fairly easy to evaluate, such as breaking down R&D into subcategories for basic research, improvements to recently released products, etc., but with some of the book’s suggestions (e.g. trademarks) I’m puzzled as to whether there’s little to be gained or whether he has a good idea that he hasn’t adequately explained.
Alas, accounting standards are a public good that few people have an incentive to create. The improvements suggested by the book could generally be adopted without first being approved by a standards committee because they mostly involve adding new information to reports. But the first company to adopt them gains little until investors can compare the information with that from other companies. And accounting standards committees tend to attract people whose main concern is preventing harm rather than creating new value. And that tendency is currently being reinforced by investors who want a scapegoat for their complacency at the peak of the recent stock market bubble.
Tyler Cowen claims that market prices say the “demand for raw materials will continue to outstrip the supply”. But I don’t see the market prices saying that. Tyler seems to be extrapolating from trends of the past few years.
He seems to be ignoring what futures contracts for delivery several years out are saying. Here’s what I see for commodities with futures contracts several years out:
| Commodity | Nearest future contract | Farthest future contract |
|---|---|---|
| Silver | $7.307 | $7.848 (Jul 2009) |
| Crude Oil | $51.15 | $42.41 (Dec 2011) |
| Natural Gas | $6.304 | $5.721 (Dec 2010) |
| Copper | $1.477 | $1.255 (Dec 2006) |
Gold and silver prices are expected (as usual) to maintain their purchasing power, while prices of other commodities that have had big run-ups recently are expected to fall.
I’ve been making some investments that are based on the belief that markets are underestimating Chinese/Indian demand over the next 5 years or so. But markets are clearly saying that the Hubbert Peak arguments are either wrong, or unimportant due to the likelihood of a switch to alternative fuels. And with metals, it sure looks like we are seeing merely a combination of asian demand and a weak dollar.
I returned home from a weeks vacation and discovered on Friday morning that one of my investments (Phazar Corp, symbol ANTP) had doubled since I had last looked at it. While there is a slight chance that this was due in part to buyers with inside information that it’s likely to sell equipment used in new tsunami warning systems, it looks like most or more likely all of the buying came from momentum players whose connection with reality is more tenuous than normal. So if I had been following the stock instead of snowboarding, I would almost certainly have sold before Friday at a lower price. As it happened, I had the patience to postpone my sale until Monday morning, getting what I expect will prove to be an unreasonably good price, and also delaying taxes on the profits. This is not the first time I’ve seen evidence that slightly slower reactions to price changes would be profitable, but it’s certainly the most dramatic.
The latest issue of my favorite investment advisory newsletter, The Whitebox Market Observer, has a good point about industrializing countries:
It is nonsense to think that China as a whole will become rich because the Chinese individually are poor. The ugly truth is that poor people don’t matter. They don’t matter as consumers because they don’t have any money; they don’t matter as producers because once they start producing they do not stay poor for long. Show me a persistently poor factory worker and I will show you a rotten factory, no threat to the U.S. or anyone else.
and goes on to note the similarities with Japan of the 1960s and Taiwan and South Korea of the 1970s, which started competing with U.S. companies using low wages to make up for their mediocre reputation for quality, and within about two decades switched to competing on quality.
Here’s an interesting paper (pdf) by economists Obstfeld and Rogoff on the prospects for the dollar, arguing that the differences in savings rates between countries will be important in the continuing decline in the dollar relative to other currencies. I don’t put too much faith in their attempts to forecast the size of the decline (in part because of the problems with measuring savings rates), but the basic ideas behind the paper seem sensible. It makes me wonder whether I have a big enough position in gold (the short-term outlook seems unclear, but my long-term outlook is that gold is a pretty good investment).
The stock market rose in reaction to Bush’s victory, which wasn’t much of a surprise. What was moderately unusual was that the dollar sank relative to many other currencies and relative to gold, and a steady sinking trend seems to be continuing. In fact, measuring the S&P 500 relative to gold, it went down the day after the election and is a tiny bit lower now than before the election. I doubt that this indicates any belief that Kerry would have been better than the typical Democrat at reducing inflation. It seems to imply that the Bush (or the Republicans in general) have abandoned the fiscal responsibility that we used to associate with Republicans.
The decline of the dollar seems to be overwhelming the Chinese attempts to prop up the dollar to the extent that it is stable relative to the yuan. It seems strange that government officials think they can manage a gradual and widely anticipated change in the exchange rate. If interest rates on dollar-denominated holdings was higher than yuan-denominated holdings, people might expect the two to be equally good investments. But dollar interest rates seem to be a good deal lower, which makes it obvious to anyone who believes the official hints that yuan holdings are a better investment. And there are reports that China has bought increasing amounts of dollars from people who realize this. This suggests to me that a sudden collapse in the dollar relative to the yuan is not too far off when the Chinese government realizes a slow decline is expensive.
The 2004 Accelerating Change Conference focused much more on current changes than last year’s attempts at providing long-term visions led me to expect.
The one topic that excited me was a virtual world called Second Life. While it might sound superficially like just a virtual Burning Man, the designers are serious enough about their nationbuilding to encourage commerce, both within the system and via currency exchanges such as The Gaming Open Market with other worlds. Their VP of Product Development Cory Ondrejka described Hernando de Soto’s book The Mystery of Capital as "must reading". They have been careful to insure that people have few incentives to take disputes arising in the virtual world to meatspace courts. For instance, they once banned a vandal from the game who owned a fair amount of land; they auctioned off the land and sent him a check for most of the proceeds – $1600.
Some of their customers are doing well enough in the virtual world that the company that runs Second Life has trouble offering them a salary good enough to compete with what they’re making in virtual life.
They don’t seem as concerned about the highly deflationary effects of their monetary policy as I expect they ought to be. Why will people buy their land (the sale of which seems to be their main source of income) if they can earn a safe and sure return by just holding the local currency?
The responsiveness of the company to citizen complaints (e.g. simplifying and later abolishing taxes in response to tax revolts) is fairly strong evidence that a non-monopolistic dictator is better than a democracy with monopoly power.
Once again, I feel somewhat humbled for underestimating the accuracy of presidential election markets. At least I was cautious enough to mainly bet against Bush winning states where he appeared to be behind, and against him winning 400 electoral votes, which made up for what I lost betting that Kerry would win the election and popular vote.
Assuming the preliminary results are accurately indicating the final results, Tradesports did quite well at predicting the elections (except for a few hours on Tuesday afternoon when it mistakenly reacted to exit polls). It’s Monday evening prices correctly indicated which presidential candidate would win each state. And it did a good job of indicating which states were closest (saying Iowa and Ohio were the least certain).
Alex Tabarrok writes about the apparent attempts to manipulate the Bush re-elected contract at Tradesports.com (which just dropped to exactly 50!), and CNBC has mentioned the same report today (with a denial from George Soros that he is responsible).
I want to warn people not to treat the failure of this manipulation as strong evidence that manipulation won’t have much effect on the reliability of the prices. If an experienced trader such as Soros tried to engage in this kind of manipulation, he would use a much more patient and cost-effective strategy than quickly driving the price down from 55 to 10.
To estimate the harm done by manipulation, we need to look at careful studies of how accurate markets have been, plus experiments such as the one Robin Hanson arranged. Note also that Robin’s attempt at a theoretical argument on this subject is unconvincing because it unrealistically assumes that traders aren’t risk-averse.