April 6, 2014

I Was Right. Volatility Edition

Update: Link to the December 12 post when I made the original proposal is now fixed.

It is my birthday tomorrow, so I decided to confirm my undisputed self-proclaimed awesomeness by reminding all of my 3.5 readers that I am, almost always, right. Except for those times when I am spectacularly wrong.

So, back in December 12 of 2013, I made an audacious recommendation to long volatility indexes with expectations of short-medium term uncertainty hikes:
If I had a million dollars I would long volatility indexes, such as the iPath S&P 500.
My rationale was, and still is, that 2014 is a make-it or break-it year for emerging markets as an asset class:
...it is obvious that 2014 will either break or make a new world order. The era of easy money is going away, money stored in stocks will be relocated elsewhere. I don't think that either the US, China, EM, or even the suddenly vivid Japan are amazing alternatives. This all creates extraordinary uncertainty over the medium-term future. And volatility in the markets should rise as a result.
At the time, my implied projection was that volatility would rise by late January-early February, triggered by re-focusing on country-specific fundamentals as key drivers of local asset valuations, as opposed to external factors since most of those were already priced in at the time. The call for volatility on my part was rather bold, since there wasn't much uncertainty expected at all - tapering was a sure thing, Eurozone struggles were and are a given, Japan's resurgence and China's slowdown were fully rationalized. The crucial point is that when focusing, once again, on country-specific fundamentals it takes time for the market to fully digest idiosyncratic factors. Every emerging country has challenges. But some challenges are less important than others. The problem is that we often don't know which ones fall in which category. And the moment we don't know - volatility prospers. Particularly in foreign exchange fluctuations, but with bonds and stocks it is the same principle although not as stark.

So, if someone followed my advice, which I posted on Dec 12, granted that she would smartly exit the position once the volatility rally exhausted itself on Feb 5, would have pocketed a 28% gain.


Happy birthday to me, and happy profiteering to you.

March 31, 2014

A Beautiful Life

Not quite there yet, still a masters student, but describes perfectly nevertheless.


P.S. I am in "exam mode" so blogging is compromised until July 16. Readers will know about how my exams went from the self-explanatory arrogant or suicidal posts which will follow the morning after the grades are released.

February 23, 2014

WhatsApp Shutdown Economics

As of 21:00 GMT on February 22nd, the popular social networking app WhatsApp continues to be in shutdown. Facebook only recently completed the acquisition of this tremendously successful messenger, and it is already experiencing problems. Or is it? The obvious guess is that Facebook is implementing some sorts of technical changes, the details of which I will never know (don't care). However, standard microeconomic theory offers a much more interesting rationalization.

The microeconomics of substitute goods predicts that market demand for a good, for which there exist several perfect substitutes (in the eyes of the consumer) will rise if the price of the substitutes goes up. In theory, if apples and oranges deliver the same degree of consumer utility, then if one's price is doubled then it becomes irrational not to switch to the cheaper good, granted that there are no switching costs.

Now, since WhatsApp belongs to Facebook, Mark Zuckerberg decided to conduct a relatively painless marketing research exercise: kill WhatsApp for several hours and monitor the response from its users. In particular, to which messenger will the people switch to? People simply must communicate somehow, don't we? What is the second best option (or the almost perfect substitute) to the convenient and free WhatsApp? Will people instantaneously overload their usage of Facebook chat or resort to Google hangouts or, God forbid, Yahoo! Messenger? This way, Mark effectively determines whether WhatsApp (which now belongs to Facebook) is actually a direct competitor to its own mother company. In other words, will WhatsApp be cannibalizing the demand for Facebook's alternative to instant chats?

So, by shutting down WhatsApp, Mark is effectively driving its de facto price to infinity - there is nothing anyone could possibly pay to use it at the moment. The genius of this strategy is that Mark is not increasing the actual price/fee on WhatsApp! That move would most certainly cause an elastic demand reaction and force a big chunk of the users to switch to, say, Viber. But it is more than reasonable to expect that almost (if not completely) all of WhatsApp users to return to their favorite as soon as the app comes back to life.

Zuckerberg may have dropped out from Harvard. But he definitely knows his microeconomics 101.

February 11, 2014

Essays Of The Students, By The Students, For The Country

A friend refers me to this announcement. Azerbaijan's ADA University is launching an essay competition in cooperation with The Economist. The topic is the future of the Azerbaijani economy; the oil independent future, to be more precise. Students from Azerbaijani universities submit essays and the winners get their pieces included into conference proceedings. Random thoughts follow.

The presence of the Economist raises the level of the competition, naturally. It is a great opportunity for domestically educated students to add extracurriculars to their resumes. And to attend the actual conference is also a nice prospect. Well done.

Former students of my "Models of Economic Development" course at Azerbaijan State Economic University can contribute. As part of the course they were supposed to write weekly essays on a variety of theses, on way or another, offering solutions to the Azerbaijan's long-term economic challenge.

Too bad that Azerbaijanis studying at foreign schools are not welcome to participate. Technically, I am a student, so would have qualified. And of course would have submitted something. The 1500 words limit is an impossimbly limiting ceiling though. 5000 is more realistic, considering my average writing babbling pace of 3 words/second.

On a side note, I have little to add to what I have already said on the topic:

1) Azerbaijan needs to look beyond numbers and deeper into the substance of its growth formula

2) We need to define the brands of Economics in Azerbaijan and of the "Azerbaijani Economist"

2) So far, Ziyadov's (fellow at ADA) transportation hub story is the most appealing economically.

I won't be physically in Azerbaijan to attend the conference. But this appears to be a decent step towards the right direction for our economics education debate.

February 6, 2014

Who ARE You People?

My flag counter shows almost three times as many visitors from the USA (2900) than from Azerbaijan (1100) Come on, Motherland! Support home-grown bloggers. This post is not intended as an obvious self-propaganda.

February 1, 2014

An Idiot's Guide To The History Of Economic Thought

1) On the first day of economic history came Adam Smith and told we were idiots.
2) On the second day of economic history came David Ricardo and confirmed we were idiots.
3) On the third day of economic history came Alfred Marshall and proved we were idiots.
4) On the fourth day of economic history came John Keynes and told we were idiots.
5) On the fifth day of economic history came John Hicks and confirmed we were idiots.
6) On the sixth day of economic history came Paul Samuelson and proved we were idiots.
7) On the seventh day of economic history came Bob Lucas and told we were idiots.
8) So on...

And so since the seventh day of economic history we, macroeconomists, are forced to found every macroeconomic model on fancy micro foundations only to derive basically the same results as on the fourth day of economic history, but just more "serious" and "involved", so as not to be called an uneducated careless idiot.

Morale: think like the fourth day's idiot, act like the seventh day's serious man.

December 27, 2013

Happy Holidays From BakuViews!

Dear friend,

According to UNICEF, 22000 children die from poverty every day. That is approximately 917 children an hour, 15 children a minute, and 1 child every 4 seconds. By the time you finish reading this message, there is a good chance that 10 children will be dead. 

Most causes of vast child mortality in developing countries can be prevented. Consider, for example, that more than 30,000 tonnes of food was wasted by Tesco in the first 6 months of the 2013. I am not a math prodigy but it looks like there is enough food to save a decent amount of children.

While there is little we, as individuals, can do on the global scale to solve poverty - we can contribute to this cause collectively. This is how you can act to make a difference:

Visit the American Red Cross' website now and subscribe to make monthly donations of $10. For most of us, this is almost nothing.

Happy holidays!

[Do you know this kid's name? Neither do I. Should it matter?]

December 17, 2013

Golden Memories

Found some free time amid a very busy week and decided to remind myself and my readers of a very cute observation of mine, which dates back to November 2011. At the time, the State Oil Fund of Azerbaijan (SOFAZ) decided to diversify its sovereign portfolio holdings by purchasing substantial amounts of gold ; partly as a hedging strategy but more likely as an alternative store of monetary value. Right at the spot I knew the strategy, from a purely financial point of view, would backfire in the medium term:
"My problem with gold, and with most luxury commodities for that matter, is that sometimes their valuation is irrational. Sometimes the price is not only determined by pure supply and demand dynamics, but by the public perception of value, not objective value. I think that between 2008 and 2011 there was an emotional element in the growth of gold prices as well. I would bet that gold would not rise [contingent on the] economy starting to recover come 2012, because people would be more lenient to place capital into risky assets. Because gold, as we all know, is one of the most risk-free assets available."
So, 24 months have passed and it is time to look at the data to see how my argument performed:

Source: link

The bullion never crossed the 1800 ceiling and has been bearish for the good part of the past 12 months. This is not surprising considering that easy money and severe risk mis-pricing led to the relocation of assets from the risk-free, utility-generating gold into stocks and selective real estate markets. Given the recent positive news from the U.S. jobs market data, the business sentiment surveys from Japan, as well as PMI numbers from Germany - the G10 consumer is doing better. This is not good news for gold. And for anyone on the wrong side of the position too, for that matter.

December 12, 2013

Time To Long Volatility

I don't usually write about potential investment strategies. But when I do, I prefer unorthodox exposures. So now I feel like long positioning on volatility indexes is one of those controversial but logical moves. This post tries to defend the argument. No time for links and citations, the stuff written here is common knowledge and google-able.

Yellen's First Rhapsody.

So, Bernanke is going away but the era of loose money won't necessarily vanish so easily. The December job report in the States overshooted expectations, putting additional pressures on the Fed to taper sooner than their dovish members would probably want. Yellen is an ultra-dove, or at least in disguise. I honestly don't know how she will bow to the pressures from statistics and pursue a course she might disagree with. The Fed did actually state a while ago that their policy shifts would not necessarily reflect actual data movements or market sentiments. So, it is possible that Yellen will keep the bond buying program unchanged, although it is growing more and more unlikely. She will probably taper in January. December less likely in my opinion, but I wouldn't be blown away. Also, the scale of tapering is under question - is cutting down the monthly bond buy-up by 10 billion really considered a contraction?

Emerging Markets in Limbo

OK, so the good thing about EM is that they didn't completely melt down in 2013 in the anticipation of the inevitable tapering by the Fed. This suggests that EM consumers will more or less tolerate higher interest rates in the big markets as well as their own. If EM can tolerate higher rates, then arguably consumers in the UK and US will as well (and with more flexibility, in theory). The problem is of course that everyone knew that the era of easy money is coming to an end. So firms began to disinvest from emerging markets long before Dec/2013. Capital withdrawal puts appreciative pressures on the prices of imports, depreciates the local currency. This is a dangerous combo since the purchasing power of a typical EM consumer, who spends a big chunk of her spending portfolio on imported goods, will feel the higher prices. In the meantime, it is unclear what the policy response will be since further stimulus in the EM will put the market into a dangerous inflationary environment, but contraction will hit at the already struggling consumer.

China Being China

China will either drag us all from this mess or help destroy what is left from the global economy. Recent data suggests that consumer spending in China is up. I don't really buy this since the spending was driven by idiosyncratic one-time massive retail discounts and things like that, so I don't feel there is a systematic element to this story. Fixed investments in China are down, and that's worrysome. The biggest problem however is that numbers coming out of China should be always taken with a pinch of salt (sometimes a kilogram or two won't hurt). We will have to wait until March, when the next official forecast on national GDP will come out from the Party, and until then everything is unreliable.

Eurozone: Hope after Hope

Ukraine is messing with the Eurozone's hopes for a recovery. Shorting Ukrainian government and/or sovereign fixed income assets is obvious, and the market knows it. How will the Ukrainian mess affect European energy security? A deal involving Ukraine, Russia, and Lady Ashton would certainly be welcome. The bigger problem is still the shaky situation in Italy and Spain. High unemployment, especially among the youth, current account deficits. In the meantime, Germany is enjoying a surplus and refusing to help the struggling periphery. Higher inflation would certainly be nice. Bundestag is rather go through 5 years of pain than a 3-4% inflation in the core and the periphery. This is all the same, isn't it? It feels like 2011 all over again. There is some news coming out that they are close to finishing up a deal that would apparently save the banks, but until they throw away the ridiculous new capital requirements I don't think European banks can be competitive.

So, one eye is on the Fed's decision on when and how to begin tapering. The second eye is on the Eurozone's institutional games. And the remaining two eyes are on China and the responses from emerging markets. Given these uncertain times, it is obvious that 2014 will either break or make a new world order. The era of easy money is going away, money stored in stocks will be relocated elsewhere. I don't think that either the US, China, EM, or even the suddenly vivid Japan are amazing alternatives. This all creates extraordinary uncertainty over the medium-term future. And volatility in the markets should rise as a result.

If I had a million dollars I would therefore long volatility indexes, such as the iPath S&P 500. I know this is insane, considering how badly they performed in 2013. But hey, the world is governed (or destroyed) by the clinically damaged.

December 4, 2013

Shrimp Economics (Also Chicken)

This post was included into The Alchemy of Economics. Advanced content warning! Very few will fully understand what is written here. Even I don't always get it.

There has been some noise around the not-so-recent-anymore rise in the prices of chicken and, less so, shrimp. In particular, the usual advocates of hyperinflation hysteria are shouting that monetary easing has somehow caused inflation in these two troublesome markets. They are, of course, completely wrong. This is business as usual for me as I have been fighting against inflationophobia for the past two years. As always, a quick but careful look at the actual data and facts behind the story puts this ideological nonsense where it belongs - trash bin. This post lays out a systematic attack at the proposition of monetary policy somehow causing inflation in the prices of either shrimp or chicken. Instead, the underlying causes for the price increase are market-specific, supply-driven, and have nothing to do with loose monetary policy.

First, let's talk about dead shrimp. Over quite some time the price of farmed shrimp has been on the rise. In conjunction with the aggressive monetary easing of the U.S. and Japan, an easy but erroneous conclusion would be to link the two phenomena together. Escalating monetary base in theory leads to an inflationary environment. But only if the helicopter money is actually being circulated around and spent in the real economy. Multiple data sources prove that money printing in the U.S. has resulted in an almost one-to-one increase in non-obligatory bank reserves (essentially commercial mattresses for banks). So, on a macroeconomic level shrimp price hikes cannot be systemic.

But let us assume it can. For the moment, let us assume that the demand for shrimp is stable. It is a fairly normal good, not quite a luxury, so it's a fair assumption. So, conjecturing that all the extra money created by the Bernanke-Abe axis flows safely into commercial vaults (reserves), this is clearly a supply-side problem. 5 minutes on google prove the intuitive hunch. Farmed shrimp production suffers from a friction which is rather unique for this particular food commodity - early mortality syndrom, or EMS. Shrimp, suffering from EMS typically under-develop and are not edible for regulatory reasons. I am not a shrimp expert, and I suppose neither are 99% of my readers. The take-away point here is that shrimp die in huge numbers, causing the supply to fringe. More information on EMS here.

So, the demand is stable. Supply falls. Producers decide to switch to alternative industries (most production sites for shrimp are located in Southeast Asia; this is not a very technologically intensive skill; expertise is easily transferable to similar areas) such as agriculture or orthodox fishing. Due to the outbreak of EMS and labor switching, shrimp price rises. This has absolutely nothing to do with monetary easing, either in Asia or in the US or anywhere else on the Planet. Moreover, if the price increase was indeed caused by monetary policy, then the effect would be observed in equal fashion across all related goods and services. And so if shrimp prices are rising due to monetary easing, then prices of substitutes like, say, fish or oyster would rise too. It does not make sense for a universal monetary expansion to be discriminatory towards shrimp inflation and not in the clam or crab market.

The snapshot below is taken from IndexMundi. The X-axis is time. The Y-axis is the Shrimp/Fish price ratio. The idea is that if I am wrong and inflationistas are right then the the SF ratio must have remained relatively stable over the past 6 months. If I am right, then the fish price was pretty constant while the ratio was dragged upwards thanks to the aforementioned supply-driven shrimp price hike. I am right. The ratio has almost doubled over the past two quarters. Fish and shrimp - substitute goods, did not experience a symmetric price movement. They could not have possibly reacted to the same stimulus (monetary easing), ruling out this possibility and leaving the EMS outbreak as the only logical explanation.


Let us now switch to starving chicken. Broiler chicken prices have risen quite dramatically in the past year but I will argue and prove that this again has nothing to do with monetary easing. The macroeconomic rationale used in previous paragraphs is similar so, without sounding redundant, I will offer some more original thoughts specific to the production of chicken only.

What do chicken eat? It depends. So let us arbitrarily name the food that chicken eat as "feeders". When producing broiler chicken in scale amounts, producers must buy feeders to feed their chickens before they grow to the right size and get successfully slaughtered. We won't entertain the latter part. So, the cost of feeders fits in nicely in the profit generating function of chicken producers. Should the price of feeders skyrocket, then the costs of chicken production will rise, causing the prices of the final good to increase as well.

The well-documented global warming and one of the worst agricultural outputs in recent memory collided to yield an inflation in chicken feeders pricing. In particular, the example for which I will provide a graph below, is corn. Corn is used in a variety of ways in modern manufacturing, but chicken feeding is just one important variation. Corn is effectively a complement to the production of chicken - corn prices rise, feeders are more expensive, chicken is more expensive. Higher costs of feeding cause profit margins for producers of goods which use feeders as inputs to shrink. However, rising the price for the final good (broiler chicken) is impossible to accomplish at time t. It takes a time lag to re-adjust contracts to reflect new market conditions. Typically, it takes 6-12 months for prices to begin to reflect underlying microeconomic changes.

So, what we should test for empirically is several things. 1) Corn inflation 2) A 12-month lag before broiler prices begin to rise. Below is another graph from IndexMundi. The Y-axis is the Poultry/Corn price ratio. Stable at first, we see how the ratio bottoms out in August 2011. Precisely the time when agricultural production hits its lowest. The price of corn is high, for any given price of chicken. Then, corn prices remain high for about a year. In about July-August 2012 a positive trend in the PC ratio begins to materialize. For any given price of corn, the price of broiler chicken begins to rise very fast. The time lag, reflecting contractual frictions, is now over and producers are adjusting final product prices to image the rise in costs (feeders). Simple microeconomic exercise with a touch of data and common sense. Nothing related to loose monetary policy.