I’ve not been making predictions for a long time. Let’s play with Bitcoin!

Mail Order Blow

Blockchain technology may end up replacing stock exchanges — brokers running a peer-to-peer permissioned ledger —  in a few years but Bitcoin the prototype may only see limited use.

It is useless as a currency for legal businesses: it is too volatile, too hard to use unless you use a third-party wallet that removes the benefits of peer-to-peer while keeping the costs, and transaction fees are too expensive at the moment. Cherry on the cake, the irreversibility of transactions gives too much power to merchants to rip off buyers: the dominant business model is to set up a fake shop that takes payments and never delivers anything.

It has found a niche on the dark web, and either Bitcoin or a clone are indeed the best way to pay for mail order cocaine or grey market meds. The idea that it could have an investment or legal retail use is actually a part of what makes it usable here: if mail order cocaine was the only use, legal exchanges that allow to buy Bitcoin with a credit card would be banned. Thing is Bitcoin leaves lots of traces so at some point it may lose market share for dark market use to more privacy oriented crypto-coin like Monero or Zcash.

Tulips Galore

So, it’s now clear the current trajectory of the price is due to speculative “investment”.

It has multiple strands reinforcing each other: speculation on Bitcoin itself, speculation on crypto-currencies in general, and now the ICO (Initial Coin Offering) craze, which effectively is a form of regulatory arbitrage. It’s like issuing securities or bonds without regulation, and sometimes anonymously. Most ICOs are likely illegal under reasonable interpretations of current law, and the only reason it is still going is because authorities are slow at enforcing something which looks superficially novel. It’s also very easy to execute fraud, and as in any bubbly environment easy to hide it while everything is going up. So it’s only a question of time before fraud and regulators kill the scene.

When, I know not. The bonus ball here is the first stage of the crypto-token scene implosion should mean people run for the exit by first selling their failing tokens for Bitcoin. A similar run-to-safety can happen in the regular alt-coin world. So in the first stage of the end of the bubble, Bitcoin should go up further and faster, as it will become “harder to get” for a while, until at a later stage people try to exit Bitcoin itself.

Tethered Away

A separate phenomenon is the alleged fraud with pegged crypto-currencies. It’s been better covered elsewhere, but in a nutshell here’s how it works:

Whenever some kid opens a legal fiat/crypto exchange, what do they do? They register a company and get a regular corporate bank account that clients use to deposit and withdraw regular currencies. After a while the exchange is a little bit successful. The cash flow through that account is much bigger and weirder than a regular small business’ account and the bank notices. Or it notices when some illegal wire transfer is called back and they see it’s gone down a crypto black hole. Then the exchange loses their banking relationship. They can play a cat and mouse game for a little while, repeating the same process with new banks or new entities, but here the end game has only two options: stop allowing fiat in and out of the exchange (become crypto-only) or become like a bank (doing full due diligence on clients and taking fraud risk).

Many exchanges took the former option, using a crypto-currency pegged to fiat to keep allowing trading fiat/crypto prices (pairs like  BTC/USD). Pegged crypto-coins work by breaking the peer-to-peer model and having a party (or a group acting in concert) in control managing the currency by issuing new coins or withdrawing from the supply to keep the pegged, like currency boards do in the old-school world (e.g. how the Danish Crown or Hong Kong Dollar keep their respective euro and dollar pegs).

Of course, in a bubble nobody is particularly interested if the peg is backed by sufficient hard currency funds to be able to support the peg should there be a flood of people selling (redeeming) the pegged token. In that case the controlling party needs to have enough hard currency to support withdrawal. Capping the price by issuing more coins is trivial. If Bitcoin collapses, the risk of a mass exit from pegged coins is greater, so it’s in the interest of the pegged coin owner to do “whatever it takes” to support not only the peg but also the bitcoin price. They can do that by printing more of their coin and using it to buy Bitcoin. It also works if they do it on a crypto-to-crypto exchange — good idea to have one as part of the project — because under arbitrage rule prices can’t differ too much between exchanges, and price pressure from BTC/Pegged-to-USD will flow to BTC/USD on above-board exchanges which still allow withdrawals. Controlling the BTC price to the upside is also fun and a great way to make some (paper) profits on the way.

The end game is clear here: at some point there will be an outflow that’s too big to control, trust will be lost in the pegged coin(s), which will kill crypto-to-crypto exchanges. Without support the BTC price balloon will deflate, creating its own stampede.

Money Shot

So, let’s put numbers on the prediction: the Bitcoin price will be below $1000 (for at least a week) at some point before January 1, 2020.

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Another set of belated capsule updates to the stamp collection.

Snoozebox delisted today, killed by the debt burden for their hard-to-place posh container hotel rooms. I don’t think there’s much to learn here, it was a recovery play, which would have likely paid off well (it was bought at a distressed price) had it survived. Fair enough bet, you can’t win them all.

A similar bet was Surgical Innovations, which is in modest profit so far, and not at risk of insolvency any more. An error here was to buy too early, on the early profit warnings. Distressed situations tend to get worse before they get better, and listed vehicles tend to take some time to run out of bargain hunters.

Since the last updated I also doubled down on Photonstar Holdings, a perennial disappointer that is cheap as chips by now. Somehow I think the chance they get some commercial traction for the current variation of their strategy is higher than implied in the price. Hopefully this is the last top-up. Now it’s perform or exit.

Less controversial top-ups in Aukett Swanke and Braemar Shipping, with the same investment case being available for significantly less money.

The holding in quirky Falkland Island Holdings was dumped after a takeover offer for by some entity with Argentine links was rejected on silly nationalist grounds. Too quirky by now. I was also becoming uneasy with the controlling shareholders. Thankfully the price seemed to get stuck around the takeover price even after its rejection.

On the new acquisitions front, we have Tracsis, a long time watchlist favourite that had got a little bit cheaper; Oxford Metrics, SQS Software Quality Systems, while not particularly exciting, seem reasonable matches for our criteria; and Walker Greenbank seems cheap and solid, maybe due to the factory event last year, which was well covered by insurance.

A more special situation is GAME Digital, a UK-centric retailer of video games that has emerged out of bankruptcy. Their strategy to become more event-centric seems promising, and basically comes for free with a cheap retail business with a relatively safe balance sheet.

 

 

The stamp collection has been mostly left alone since the last update, but let’s catch up with the few changes.

Life line

Lifeline Scientific, a maker of organ transplant transport kit, was taken over as the business was starting to become profitable. The price was decent if not spectacular, but the return from the distressed buy price is pretty satisfying

Tyratech stock class rotation

Tyratech is one of the more speculative stocks in the portfolio, whose product seem to be slowly on its way to some success. The thesis here is that the price is depressed by enough investors being sick of waiting. Having gone down since I bought, it was ripe for re-weighting up to the portfolio standard weight. The growing gap between the two classes of shares represented another opportunity: despite the big spread, the ask of the restricted share (which gets automatically converted to normal shares within a year or so) was well below the bid of the normal share, so I sold all my normal shares and replaced them with restricted shares. The double share class is due to some obscure US listing rules (it’s a US company listed on AIM) that seem harmless to anyone willing to wait for the conversion.

Toxic radiations?

Kromek was added to on the occasion of a fundraising, allegedly but reasonably plausibly to make the balance sheet bullet-proof for institutional customers. They also seem to be slowly on your way. I invested too early here, which is now less likely to happen due to the introduction of the minimum net income rule (> £1m).

Spaces without people

Another reweigthing was Space & People, which has not been doing too well but seems priced for bankruptcy, which seems unlikely. A modest recovery should provide a handsome return.

Last gas

I finally threw the towel on speculative Slovenian gas explorer Ascent Resources on  news of “first gas” being very close, because I expect operations to encounter a series of possibly price-sinking difficulties.

Bye-bye Minotaur

I have also sold out of Minoan, whose management I’ve lost trust in and which is seemingly perpetually loss making (already breaking two of the portfolio rules). Even if the Crete project works out in the end, they’ll likely manage to squander the proceeds.

Delivery failed

Last stock being waved good-bye is DX Group, a recovery situation which seems to have become hopeless. It would have been better to run the legacy business in run-down mode and stop trying to transform into something else, a common sin of legacy businesses.

Acquisitions

Three stocks were acquired, matching our rule sets and looking like they’re on an interesting path at a reasonable price: Scientific Digital Imaging (scientific instruments), Elecosoft (architecture and construction software) and Airea (carpet manufacturing).

Special case: solar lawyers

As a special situation, PV Crystalox was acquired, because of the option value based on the possibility of a favourable settlement of a contract conflict in their favour with  a blue chip customer, which seemed to be excessively discounted by the market.

Perhaps more surprising than the results itself was the market’s reaction to Britain’s exit from the European Union: for such a momentous event, it was very mild, not getting materially out of recent trading ranges, and with the FTSE100 (though a poor proxy for the British economy) back where it was before the vote at the time of writing, with only the rather modest GBP re-rating remaining material.

Portfolios almost unchanged

I couldn’t find any noticeable distressed prices in my watchlist(s) and only sold Panmure Gordon, in the Stamp collection, on the grounds that being a small broker focussed on the London small cap market may not be very promising, as business is delayed or shifts to other places. Companies I hold are are biased towards exporters and  otherwise not UK-centric stocks, which has worked reasonably well despite the London listing bias.

Is the market right?

Is the market dominated by trading noise, or is it successfully predicting that Brexit will have little negative impact? Uncertainty will certainly be there but the outcome is hard to predict. Negative scenarios are all other the press, but one can imagine a few positive ones as well:

  • On consumer confidence, ex-UK consumers will probably ignore it, or plan holidays to the UK. UK consumers might prove stoic, optimists perhaps balancing pessimists. It’s hard to imagine that it wouldn’t at least slow down the housing market (in transaction volumes if perhaps not prices).
  • Business investment should be down, from some plans being frozen or moving elsewhere, though the outlook seemed pretty positive before the vote, down a bit from there may remain positive.
  • Sterling devaluation, if it persists, which is not a given, may help a bit. It could also remain at a sweet spot: big enough to help but small enough not to trigger enough inflation for the Bank of England to have to tighten monetary policy. Indeed, business investment slowing down may be all the tightening that’s needed.
  • Last but not least, there may be positive impact from EU re-focussing (see below).
Doc Marteens with Union Jack toe

Britain kicks arse? (credit: I Ransley via Flickr)

The European Union becomes the Eurozone

A potential positive side-effect of Brexit is that it might help refocus the European Union on improving its institutions, in particular finishing off building the Eurozone.

The United Kingdom was perpetually only half-way in, making the whole system an unwieldy variable geometry construction, both adding complexity and slowing down integration as exceptions piled up, and other member states had a strong incentive to get their own special case deals. When membership was irreversible this made sense, but if it turns out leaving has a precedent, that is not an unmitigated disaster, then there’s a way out. Then, variable geometry need not be inside the EU but between EU membership and the various forms of association around it (e.g. Norway or Switzerland style deals).

This enables the EU to become the Eurozone: the Eastern European states are committed to join; Denmark is de-facto in economically as they operate a fixed exchange rate system with the Euro; Sweden entry seems permanently suspended due to a failed referendum, but then they, or other reluctant members, could choose to either come in or leave and get a UK style deal.

So we have both a simpler and clearer framework institutionally, and an incentive to escape the current deadlock on Eurozone construction, as the choice between further integration or dismantlement becomes clearer and clearer. If this works out, it could be of great benefit to everybody, including the UK, which would be (much) better off with prosperous partners.

As a short term little bonus, if some business, financial or otherwise, moves from London to the continental financial centres, it’s a mini-Keyneysian stimulus programme for the Eurozone, which may help accelerate the recovery process.

Maybe the whole world will in the end need to thank UK voters for their selfless, if unwitting, sacrifice.

A few portfolio updates:

Volex reweighting

Doubling down (once again) on Volex, the troubled cable manufacturer. As this was under half weight, this is under the scope of the “sell or top up” for stocks below half of the reference allocation. This is in Obliquity London.

This is a classic obliquity-style stock, and priced on a distressed basis. The recovery process has produced serial disappointments, rotating top management at a frantic pace. Major shareholder Nat Rothschild is now full time in charge, as executive chairman, and I think he seems to have the right long term vision so I’ll give him another chance. Short-term funding issues seem resolved as well.

Plastic is fantastic

fox-prilep-sivec-blocks

Anybody buying? (credit: Fox Marble)

In the stamp collection, speculative marble digger Fox is out. It was a fun punt from a couple of years back. On reflection it fails most of my current small cap tests: I wouldn’t trust the somewhat slimeballey CEO with my wallet, it’s not obvious whether it’s a long term operation or a stock promotion, takeover potential is probably limited as there isn’t an obvious buyer for whom it would be a good fit (it’s not really mining, and other marble market operators may not want Kosovo exposure), and banks would probably not loan due to the country risk (expropriation, corruption, etc), and it’s far from being profitable, let alone make a million a year. So actually it’s almost a complete mismatch!

The cherry on the cake was the company PR emphasizing a deal with a distributor, which on cursory research with Companies House and web searches, seems to be a one-man shop created last year…

Of course it’s gone up 15% the day after I sold, but that’s par for the course.

Ascent and descent

Lest we have no fun at all, I’ve topped up again with speculative punt Ascent Resources (see previous episodes). At 0.6p, this is well below exercise price of the recent batch of executive options (around 1.5p) and below the credit notes’ option value (1p). A few days later main creditor and fund manager Henderson topped up at the exact same price, which I find reassuring. They had a setback on getting permission for an on-site processing plan, but they have a plan B (now plan A) of sending it off to a neighbouring country with a partner with a use for it there, that might still work out.

The various basic income proposals floating around are often criticized for being unrealistic, and let’s face it, they often are. In a recent column, John Kay is asserting that “either the basic income is impossibly low, or the expenditure on it is impossibly high.”

This includes an implicit dismissal of the Keynesian arguments — that the basic income would create demand that would snowball into economic growth — of some basic income proponents. I happen to agree that this aspect is unlikely to deliver miracles, so let’s assume no such effect here.

Too high

It’s easy to agree that spending half of GDP on basic income would not be acceptable, but it’s also a good problem to have: humans are scarcity animals and do not work well when too far from need, as can be seen in the often sorry state of people benefiting from windfalls (third generation heirs, lottery winners, small “first nations” in rich and guilty countries, etc). Thus a basic income should probably be high enough to remove fear of survival (food and shelter) but not to so high as to remove the need to get out to the world to improve one’s lot.

Impossibly low is desirable…

In Western countries what some would describe as “impossibly low” does provide pretty decent survival standard. The Ikea/Lidl/Primark lifestyle is pretty okay, and way more comfortable than what the richest slice of society could afford a century or two ago. So a basic income in the region of say $500 a month for a tier 1 developed country would probably do the trick (assuming social housing and healthcare are not subsumed into it).

… and possible

Would simple arithmetic work for that? To design a realistic basic income we need some premises:

  • Assume the net expense on welfare remains constant, because it reflects what a society is ready to accept in redistributive pressure. This allows isolating the effect of the basic income as a redistribution technique from other ideas about changing the amount of redistribution (which can be done through any mean).
  • Assume the wealthier members of society (say the top half) do not get richer out of it, that is the (income) tax system is adjusted to increase the tax they pay by the amount of basic income they receive.
  • Some existing welfare mechanisms are abolished (such state unemployment benefits, child benefits) or restricted (e.g. pension age could be pushed forward) as the basic income replaces them.

Then what basic income is possible? It’s simply equal to:

basic income = removed welfare services budget + tax equalisation

Detailed number crunching would be required, but I’d expect it to come to $300-$600 per adult, again for a tier-1 developed country.

The main variable here is what services get replaced (and to what extent) by basic income so it computes at all times.

Radical realism

A realistic scenario is probably better thought with social housing, public education and public healthcare arrangements untouched, but the basic mechanism also applies should someone wish to privatise some or all of these services: then the fewer services are left, the closer you get to a basic income equal to the tax take, though the higher basic income might then buy less, depending on the distributional profile of each service (a most tricky issue on its own).

What are the benefits of a survival income?

A survival basic income wouldn’t abolish poverty, in so far as this is more or less defined as inequality — how much less one has than others, rather than the absolute level of what one has — but still have some interesting properties:

  • Improve the bargaining power of low-paid workers not forced to work for mere survival
  • Remove net tax discontinuities (being a net loser when taking a low paid job)
  • Simplified administration (some)
  • Increased acceptability of redistribution

The welfare illusion

The latter point is perhaps the most neglected while the most powerful point in favour of basic income. It makes no difference in pure economic terms whether the cash flow between the state and the citizen is done through tax or benefit payments, it’s the net that matters.

But, like with the money illusion in the monetary realm, optics matter. This can be observed today in the difference in perception between universal benefits (like child payments and some healthcare in many developed countries) and means tested ones (typically unemployment and safety net income). The former are often popular and well accepted, even by net payers, while the latter are seen as prone to abuse, and divisive. A basic income, even if compensated by tax, would probably quickly become part of the societal furniture.

Even if it was the only benefit, it’s probably worth doing for that alone.

A little add-on to the London Stamps portfolio today, with write up before buying for once.

Titon Holdings is a little window fittings manufacturer, seemingly on a good enough path, especially relative to its valuation. It passes all my small caps criteria and there’s really not much to say about it, which is fitting. The main risk seems that their products or sales fall behind the competition, mitigated by down to earth management.

It’s particularly illiquid (7% on the LSE, 3.5% according to my broker’s live quotes) which I like as that can be unlocked if the company grows gently or is taken over — which seems pretty plausible here given the market segment and unchallenging valuation. Maybe it is worth a TON.

Unusually it’s an AIM style stock listed on the main market (thus stamp duty applies). I wonder if that might help making it less visible, although it shouldn’t matter. Quick scan with a screening tool finds half a dozen companies (>£1m profit, <£20m market capitalisation, LSE Main Market). Nothing on racy valuations here. Might be a dusty corner worth monitoring (although with Creightons and now Titon I’m well exposed to this segment now).