Spot The Horse

Authored by Kevin Muir via The Macro Tourist blog,

Yesterday after writing my piece about Tesla and Bitcoin, I received an email from one of the smartest guys I know.

“Funny that you wrote about shorting Elon’s science project and GBTC. I just bought both this morning. Thanks for the extra liquidity. Always appreciative of those willing to sell me more on the cheap.”

I had to laugh. We hadn’t talked in a while, and yet here we were on the opposite side of the trade on the exact same day. And to give my pal credit, he was mature enough to not bother calling me an idiot, but instead realized that having someone on the other side of his trade is essential (See you on the Board), so he welcomed my skepticism.

My buddy is a big crypto currency bull. I am talking Ghostbusters-Stay-Puft-Marshmallow-Man size bull. He is so convinced that crypto currencies are headed to the moon, he is involved in creating another bitcoin listed fund. So when he gave me the next tidbit of information, I was smart enough to listen,

“I agree with your short term views on the valuation of both (TSLA and GBTC), but I will let you in on a little secret. There are not a lot of BTC bitcoin funds in the queue, and since we are one of them then I think I speak with a little more insight.”

If my pal is correct, then that is indeed good information. I had assumed there was a huge lineup of Winkelvii type bitcoin ETF’s waiting in the wings, but if I am wrong, then maybe the GBTC premium will persist for longer than I imagined.

And some of my astute readers correctly noted that the borrow fee on the GBTC is quite excessive, so the perceived premium to NAV is not as “capturable” as I made out. Full Circle tweeted that the 80% premium was roughly the annual cost of borrow.

That means that if you were short GBTC, and the NAV was unchanged over the course of one year, even if the premium fell to zero, the borrow would negate your profits. Here is a pro-tip for the Bitcoin bulls out there. If you are long GBTC, then consider enrolling in a program where the borrow earned by the broker is shared with the client. I am not sure how many brokers offer this option, but Interactive Broker has a program called the The Stock Yield Enhancement Program that enables clients to participate in picking up extra yield by allowing their shares to be lent out. Obviously, that carries risk, and you should spend some time understanding the details of the program, but hey, why let the broker earn all that extra juice from the expensive borrow?

Other plugged in readers have emailed to pass on whispers about a certain big dog of a client, enamoured enough with cryptocurrencies to offer the ability for their employees to pay for their lunch in bitcoin, as the persistent buyer of GBTC. That makes sense. Right now there is no way for most funds to be long bitcoin outright, so buying the one listed instrument is the only real option. These fund buyers are probably not going away anytime soon, so the premium on GBTC might persist longer than I forecasted.

Back to my pal, the Bitcoin bull. He finished up his crypto call with the following warning:

“BTC going to 500k or higher….short BTC for a trade but don’t fight the GBTC premium. Most of the big guys have to buy it by ETF, or closed end fund, because they are not allowed to own the crypto itself.”

I know what you are thinking. And no, my pal is not notorious tech entrepreneur John McAfee (who is also so confident that Bitcoin is heading to $500,000 that is willing to do the following if he is wrong):

WTF? I know this guy is a piece of work, but good god man, can’t you come up with a better line than that? What the hell is he smoking in between tweets?

When I asked my buddy if I could use his email commentary in my post today, he agreed with the following caveat. He insisted I include the following details:

From the Institute for International Finance:

• Global Debt US$217 trillion
• Global Debt to Global GDP 327% (implies global GDP of US66.4T which I think is low but keeping the stats consistent…)
• So the only solution out of the debt spiral is inflation (i.e. FIAT currency depreciation) unless Global growth is greater than the coupon on the debt by a factor of 3.3X (which is essentially an impossibility).

And with this comment, you can instantly see why he is my kind of guy. He had a look at the absurd global debt situation, and instead of concluding that it will end in a 2008 style deflationary collapse, instead deduced that an inflationary reset is the most likely outcome. And this point is where we completely agree. He thinks you should own crypto currencies to hedge against this reset, I happen to think there will be other, better assets. But we are both concerned about the same end game.

A year ago we had an email exchange, and his comments hit home so much, I saved them:

As a trader who has spent 25 years trading junk and distressed corporate credits, I can tell you with no hesitation that the worst “true” credits I have ever traded are G-7 government debt. Look at the operating cash flow/interest coverage ratios of any G-7 credit and it will land squarely in the mid single B range based on S&P “credit metrics”. The only strength of the government is they can tax (which one can argue we have now reached a point of diminishing returns) or they can print money.

Moreover with total debt/GDP levels approaching 100% in most g-7s and 250% in Japan, UNLESS THE ECONOMY GROWS FASTER THAN THE INTEREST COST then the debt spiral will continue. It’s only math.

So the solution is to lock in long term funding at these low rates and then inflate, inflate, inflate. The burden will be borne by the idiot 30 year lender whose capital loss on the term debt will fund the circular logic so that the math works.

This is just a derivative of the Brady Bond solution for LDC debt from 30 years ago.

Yup, spot on. We are completely on the same page, he just expressed it so much more eloquently.

My pal is much more courageous than me, grabbing onto crypto currencies as a means to hedge this inflationary reset. And who knows? It could be that I will be clinging to my barbarous yellow rock while he enjoys the coming fiat currency reset that sends Bitcoin to the much talked about $500k target.

But it is not surprising that he has embraced bitcoin as he is a believer in disruptive technological change. His other big theme is the death of gas cars. Basically, his argument centers around the fact that human beings always underestimate the rate of change at important turning points.

He is fond of reminding investors that in 1905, New York City was filled with horses ferrying everyone around. If you look closely at the picture below, you will notice there is one car in a sea of horses.

But look at the next picture, taken 8 years later. The horses have all been replaced by cars, except for the one lonesome horse.

And this is why although my pal will admit Tesla’s valuation is expensive, he argues that it is justified given the change our society is about to experience. There are a bunch of counter arguments, but I don’t want to turn this into a post about Tesla’s long term investing merit. Instead I just wanted to take a moment to highlight my buddy’s thinking. Between Bitcoin and Tesla, he is much more of an outside the box thinker than anyone I know.

As soon as I wrote yesterday’s post, I worried that I sold the hole. When my pal emailed me to say he was on the other side of my trades, I became even more concerned.

Will his views prove correct? I don’t know. I just thought they would be nice to share. His thinking requires the ability to imagine the world as a much different place. Is he mad, or genius? You decide. But I will remind you of one thing – “poor people are crazy, the rich are just eccentric.”