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


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).

The recent discussion about high denomination banknotes has extended into the merit of paper cash.

In so far as paper cash is needed, does it need to be done the old school way? For buying goods in legal market, probably not, an alternative would be to use “bearer numbers” (implemented as QR-code or barcode) that could be printed on paper if people want that.

The way it would work would be something like:

  • ATMs are replaced by an online banking facility that debits the client’s account, credits the bank’s account at the central bank (or whoever is the barcode cash clearer), which in response issues a new random number associated with the amount. The number is printed in computer readable form on a ticker the punter puts in their wallet.
  • In a shop the punter shows the number (the ticket) which the cash register redeems with the central bank computer. A new number is issued for change and printed on the receipt. These numbers can then be spent at other shops.
  • People can also simply give away the printout to others, as long as the recipient trusts the giver not to spend a copy before them.
  • Splitting a ticket would require an online app similar to the shop’s cash register.

This reproduces something similar to paper cash but without the need for actual ATMs with a stock of high value banknotes, or a banknote printing and processing infrastructure.

The principal disadvantage is that it requires all non-trusted-parties transactions to be online, to check the value and validity of the number with the centralised issuer/redeemer computer system.

The issuer could be a Bitcoin-like system — you can indeed do all of the above with Bitcoin — though current blockchain technologies add a delay to transaction authorisation that’s impractical for most shop-style settings.

It could be argued this is less anonymous than paper-cash because all redeeming transactions are logged (like in Bitcoin).  Technically that could be done with current cash as well: banknotes have serial numbers that could be tracked to produce interesting meta-data — a government could easily mandate the use of some scanner widget in the cash registers of all legal businesses.

So, I’ve totally failed to follow my “blog before trading” rule these last couple of months. Maybe at a cost. Let’s catch up.

Obliquity London

Regular maintenance here, exiting Rexam which is (very slowly) being taken over by American competitors. Big mergers tend to be overpriced, though the long regulatory process has forced them to sell some assets which may mitigate that. But I’m not keen on having US mid-cap positions in this portfolio where they’re expensive to trade — although I have kept Steris when it reverse merged into UK-based Synergy Health last year.

A mid-cap position in Sthree, a plain regular classic quality-style recruiter was added to the portfolio. Exposure to the recruitment sector, along with Manpower, is probably complete now.

Stamp collecting

The position in Ascent Resources was halved during a speculative spike on news they might be taken over. This is a single project natural gas rights in Slovenia, from a notoriously accident prone company with a long history of failed projects — hence a discount to fair value, I’m betting.

The one remaining project has been stuck in a regulatory and funding conundrum for year and they’re making noise it might unlock this year. The takeover attempt produced a spike in the price, with hindsight it may have been better to sell the entire stake but now it’s gone back to earth I’ll sit and wait in case it either works out (the project start producing gas and the shareholders are not completely diluted) or perhaps more likely there’s another speculative spike.

The corporate structure is interestingly convoluted: Henderson Investors (and a few minority partners) own about £10 million of convertible loan notes (used to keep the company on life support while waiting for permitting to progress all these years) that they can convert to shares (at 100 shares per pound of loan value) thus diluting current shareholders to about 20% of the company. But if they did exercise in full, they’d own the company outright, which is unlikely to be either legally possible or simply desirable for fund managers. So in an exit they may have to negotiate their stake at above the loan value but possibly below the theoretical full dilution value.

Penguins on a beach

Investors in Falkland Islands Holdings waiting for returns.

On a more rule-based adjustement, I doubled the position in Falkland Islands, a most eccentric mini-conglomerate which has been perennially cheap. They’ve sold their oil shares and are reducing Falklands exposure, which is just retail and services by now, probably changing name, so might decouple from being seen as an oil-linked stock which might help towards a re-rating, perhaps. The rule triggered here was to either sell or re-weight positions falling below 50% of target.

I couldn’t resist adding to my collection of falling knives with Snoozebox, who also incidentally have some of their container rooms stuck in the Falklands. The already depressed price sank after the CEO departure and a profit warning with the dreaded “going concern” notice.

I think they had a good concept with very poor execution: the original container rooms were not adapted to short term events, their core proposition, as the cost of moving them and setting them up will be too high. Current management understands that they need to redeploy this stock of container rooms on semi permanent assignments, and do the event accommodation business with more appropriate products, which they have just finished developing (foldable trailers, inflatable rooms). They’ll need funding to scale the latter, and or support the legacy business if it doesn’t get enough tenants to break even. Failure and/or dilution is a clear possibility, but success is also possible and it’s now priced as an option with odds towards failure. The price sank further the day after my first buy, possibly on a sell recommendation from Investor Chronicle, so I added up some more.

On the art of knife juggling

It may be too early: falling knives are probably better caught when they start getting better, after a few years, as it not only avoids those who sink straight down, but the market seems to have memory of the failure and to take time to accept good news after a few years of poor results. This would combine well with my new “net income > £1m” rule (here catching things emerging from losses). I will still keep this position as the trading spread is huge and I’d be upset if it does recover quickly, but I should perhaps avoid that in the future. Having blogged it first might have helped moderate speculative urges, as would perhaps being fully invested (so that buying something requires selling something with worse prospects). Thankfully my position sizing for small caps is very modest.

I’ve been an oil bear since last year, which has worked out quite well so far. It may be a good time to summarise my case. I should have written about it earlier, as it’s starting to become mainstream!

Demand and supply

On the demand and supply front, the big shock is increased from US shale. This is well known, but it seems to have taken some time to make an impact. Besides, many US exploration ventures are funded by a lot of debt, so not flexible as they could be — they’ll keep pumping as long as operational cost are break even. Exploration and setup costs are sunk costs, and leveraged structure prevent waiting for better times. Rapid technological improvements in extraction add to the price pressure.

Shale also applies to natural gas, which has seen it’s own supply boom, likely taking market share for some oil applications (NG vehicles?). For electricity, renewables have been getting from insignificant to a minor player, which is also more competition.

On the demand side, it seems merely steady, or facing downward pressures (“China”, austerity). With all that no surprise the price has to come down.

Besides known reserves are vast on a human lifetime scale. If we keep facing static or slowly increasing demand, speculative exploration could be totally suspended for thirty years or more, and the world would be unlikely to run out. This is a challenge to new exploration, which is merely adding to the glut.


On the politics side cartel agreement seems harder to obtain than in past cycle bottoms. US producers and OPEC agreeing seems very improbable. Even the recent partial deal between Russia and Saudi Arabia — keeping production at the current relatively high level — might be difficult to maintain as producing more to compensate for lower revenue per barrel will be a temptation difficult to resist.

Climate change policies may work out in reducing demand (at least some).

Cycle timing

Commodity cycles — over-investing when prices are high and under investing when they are low — tend to be quite long (5-10 years) as it requires project planning to flow through to reality on the ground and there’s lot of inertia around.

There are several signs of not being at the bottom, like high volatility, media interest, bullishness of traditional oil sector investors although this may be turning.

A strong contango (higher prices on contracts for future deliveries) is a sign of probably excessive hope, and keeps supporting production at above-spot prices — until it doesn’t.

The money shot

Not making any precise forecast, but let’s say that WTI is probably going to stay in a range $20-$35 until at least the end of 2017, with perhaps short lived escapades on both sides of the range.

Back to the trading floor

This post is really just an excuse to make a portfolio update less boring: in addition to selling BP and Total, as previously discussed, I’ve sold Petrofac. Although they seem well equipped to survive a downturn, the market will probably ignore that for a long while (the name of the company may be a curse). I’ve added more Amec Foster Wheeler, which is a more diversified (and further diversifiable) engineer at a distressed price (hence being underweight in the portfolio).

This is despite not being supposed to do significant sector bets in the Obliquity portfolios, but I make an exception in order to minimising regret: I’d be pissed if I’m right on oil while owning sector losers. It’ll be easier to accept missing a sector rebound (if possibly costly).

On the trading front, I’m short contango and long crude carriers (the speculators will need storage, while the carriers’ share prices have been moving down with oil) via options.