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Monthly Archives: December 2014

Russia’s troubles are now well documented. From a monetary viewpoint they’ve been reasonably restrained, they could have done lots of silly things, like blowing all their foreign reserves, which probably would have just been given away to speculative traders. Capital controls may be another possibly bad idea, though it’s somewhat surprising it hasn’t, so far, been the natural instinct of such an authoritarian regime.

Russia clearly would have a hard time maintaining a dollar peg (not enough dollars), or say a gold peg (not enough gold). But they’ve got a lot of oil. And the Rouble, like most commodity country currencies, is strongly correlated with the flagship export — incidentally I’m not convinced this should be the case as often as it seems to be in practice, there may a self-fulfilling prophecy element in these correlations.

Revenue from oil sales are a large part of the Russian government’s income. So if they peg the Rouble to oil, they get constant income from this (assuming constant pumping volume) matching constant(ish) nominal liabilities (pensions, civil service salaries set in sticky nominal roubles). Remarkably this to an extent naturally happened: the oil price chart in roubles is much flatter than in dollars.

In normal times, the oil price might be considered too volatile to be used as a mean of payment but in crisis times, it may be less volatile than a free floating lame duck currency. And a peg can be undone in quieter times.

So I suggest that the Central Bank of Russia declares the Rouble convertible to a fixed quantity of oil.

Petrol Station with Cental Bank of Russia logo

Putative petrol station operated by Central Bank of Russia (credits: CBR logo from website, petrol station from Flickr user minaletattersfield, CC by-sa licence, collage commentisglee on same.)

They don’t even need to actually deliver oil for people wishing to redeem roubles directly — or only as a last resort. Delivering internationally traded oil futures would do fine. Indeed the rouble could become a well regarded, highly liquid, oil derivative in its own right, that just happens to also buy you a cocktail in Moscow.

Looking back at my short tipping exercise from February this year, the results are remarkable:

Stock Symbol Performance Feb 2 to Dec 12
Globo GBO -27%
Quindell QPP -91%
Wandisco GBL -69%
Naibu NBU -79%
Judge Scientific JDG -48%
Mean -63%

So that’s a full hit, every stock in the set declined markedly and £100 invested equal weighted in this short portfolio would have returned £63 profit in less than a year. Unfortunately shorting is a pain due to the unlimited downside if you get it wrong, and I haven’t actually shorted anything. I did get the time frame wrong, given that we didn’t have to wait for 2016 to see results. In a real portfolio I would have probably exited all the positions by now, except perhaps Globo which may have some more downwards potential.

Fireworks

Fireworks (credit: Maciej Lewandowski on Flickr)

The small cap markets are missing an instrument for limited risk shorting, for instance put options, perhaps with fewer strikes than normal options  — e.g. a logarithmic ladder —  and fewer expiries — quarterlies would be more than frequent enough. It could be either something tradable like certificates or spread bets, or as an OTC keep-to-maturity product. The market for this is small but a niche operator could do well. They could hedge by selling discounted call spreads (calls with truncated upside at the put strike) to bulls to match their put portfolio with a small amount of capital needed to market make the inventory. With the right risk management this is a low risk business that can be operated with no price risk, and it would offer a more useful service than open ended spread betting. Shorting is essential to functional markets.

That said there are some mitigating factors: it has been a bear market for small caps, during which basket cases often don’t do well. They can conversely do spectacularly, for a while, during bull markets, which can be quite testing for shorters. That said the iShares MSCI UK Small Cap ETF, as a proxy for the market, is flat on that same period so a hedged long/short portfolio would have returned about the same. That hedge may not work fully in case of a short squeeze or bullish market where the basket cases race far ahead.