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Thoughts on Bitcoin

As most of our readers are probably aware, Bitcoin is a digital currency that relies on an internet-based peer-to-peer network. Here is the link to Bitcoin's Wikipedia entry: http://en.wikipedia.org/wiki/Bitcoin. And here is a synopsis of our thoughts on this digital currency:

In a free economy there would be numerous competing currencies, where a currency is something that is regularly exchanged for goods, services and assets. Bitcoin would potentially be one of these currencies. Most of these currencies would serve market niches, but one would become far more widely used in commerce than all the others. That is, one would become money, where money is defined as the general medium of exchange or the most widely used currency within an economy.

Bitcoin will never be money, and neither will any other currency that only exists within the memory banks of computers. This is not only because such currencies will only ever appeal to people with computers, internet access, and confidence in the security of their computer and the internet. It is mainly because for something to become money in a diverse and free economy it must widely be perceived to have value outside of its role as money. That's one of several reasons why gold was money in many economies for many centuries. Gold is something that most people around the world want to own regardless of whether it happens to be money or not.

Our current money doesn't have any value outside of its role as money, but our current money has not been chosen by the market; it has been imposed by government. In the US, for example, only the US dollar is legal tender. Offering serious competition to the US dollar is not against the Constitution and is possibly not against the law, but it may as well be unconstitutional and illegal considering the reaction you will get from the government if you attempt to do it.

Although Bitcoin is described as a digital currency, an argument could be made that it is more of a "trading sardine" than a genuine currency. For those who aren't familiar with the term "trading sardine", as explained in Seth A. Klarman's book "Margin of Safety" it comes from "the old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, 'You don't understand. These are not eating sardines, they are trading sardines." Our point is that although it was originally intended to function as a currency, Bitcoin has become more of a speculative plaything. That's why its exchange rate (see chart below) has experienced a 'roller-coaster ride'. The first parabolic rise in the relative value of this "currency" occurred during April-June of 2011 and ended in a crash after incidents of Bitcoin theft spawned security fears. The second parabolic rise began in January of this year and is still in progress.


                                      Chart Source: www.bitcoincharts.com

We have nothing against Bitcoin and have no opinion on what will happen to its exchange rate. Our view is that it will never be money and that right now it is more of a speculative plaything than a currency.

Broker Survey

The Stock Market

A myth? Not exactly.

From John Hussman's latest Weekly Comment:

"Myth 1: As long as quantitative easing is underway, stocks will advance indefinitely.

This first myth is embodied in statements like "since 2009, there has been an 85% correlation between the monetary base and the S&P 500" -- not recognizing that the correlation of any two data series will be nearly perfect if they are both rising diagonally. As I noted last week, since 2009 there has also been 94% correlation between the price of beer in Iceland and the S&P 500. Alas, the correlation between the monetary base and the S&P 500 has been only 9% since 2000, and ditto for the price of beer in Iceland (though beer prices and the monetary base have been correlated 99% since then). Correlation is only an interesting statistic if two series show an overlap in their cyclical ups and downs.

If you want to talk about causation, the case for X causing Y is more compelling if the fluctuations in X precede fluctuations in Y. Even in that case, we say that X "causes" Y only if observing X gives us additional information beyond previous movements in Y itself. In the case of quantitative easing, much of what we observe as "causality" actually runs the wrong way. Market declines cause QE in the first place, and the result is a partial recovery of those declines."

There's nothing wrong with the above outline of how QE and the stock market are inter-related, but it is only part of the story. Three important aspects are missed. First, while it's true that there generally won't be a strong correlation between money-supply growth and stock market performance over a complete cycle, there is a strong tendency for major changes in the money-supply growth rate to lead major stock market trends. Unfortunately (from a practical speculation standpoint), the lead-time varies greatly. For example, the 2000-2002 and 2007-2009 bear markets were both preceded by substantial declines in the monetary inflation rate, but the lead-time was less than one year in the first case and almost three years in the second case. Second, once an equity bear market is in full swing it will typically run its course even if the Fed ramps up the money supply. For example, sharp increases in the rate of US monetary inflation commenced in Q1-2001 and September-2008, but in the first instance it didn't prevent an equity bear market from continuing until Q4-2002 and in the second instance it didn't prevent the stock market from crashing during September-November of 2008. Third, while it is normal for a large market decline to precede the introduction of monetary stimulus, the QE programs of last September and December were introduced when the stock market was near a multi-year high. This makes the current situation unprecedented.

In our opinion, the on-going monetary stimulus hasn't eliminated the risk of a large stock market decline, but it has increased the risk of being short the stock market.

Current Market Situation

It seems that North Korea's first family gets crazier with each new generation. Kim Il-sung was crazy, Kim Jong-il was crazier, and the recently-enthroned Kim Jong-un is showing signs of being the craziest yet. The youngest Kim has recently threatened to destroy neighbouring South Korea, declared "null and void" the 1953 armistice that ended the Korean War, and ordered 'his people' to prepare for war. Unlike the average lunatic this one has a nuclear arsenal at his disposal. The arsenal is small and of dubious quality, but still...

Although the stock market isn't always good at discounting risks, we expect that an increase in the probability of Kim Jong-un attempting to make good on his threats will be reflected by pronounced relative weakness in South Korea's stock market. We are therefore paying a lot more attention than usual to the performance of South Korea's stock market, as represented on the following chart by South Korea i-Shares (EWY).



EWY has had a downward bias since the beginning of this year, but its weakness to date hasn't been out of the ordinary. We note, for example, that the Emerging Market ETF (EEM) has also had a downward bias since the beginning of this year and that Hong Kong's Hang Seng Index (HSI) is near a 3-month low. Charts of the EEM and the HSI are displayed below. In other words, at this stage the markets don't believe that Kim Jong-un's war of words will turn into a war of bombs and missiles.

Gold and the Dollar

Gold

Nothing of significance happened in the gold market over the first three days of this week. The US$ gold price bumped up against minor resistance at $1600, but resistance-wise the big test lies at $1625-$1650. A solid break above $1650 would signal an end to the correction.

Market Vane's bullish percentage for gold remains near a 10-year low.



Gold Stocks

The HUI hasn't negated last week's reversal but also hasn't provided us with any additional evidence that a sustainable price low is in place.

There has recently been a lot of discussion about the sorry state of the TSX Venture Exchange, the stock-exchange home of about 1400 small-cap mining companies. It has been pointed out by knowledgeable sources that about half of these junior mining companies have dangerously low cash reserves (working capital of less than $1M) and are therefore at risk of going out of business, or at least being de-listed from the TSXV, within the next 12 months. Some will be able to arrange the financial deals needed to keep themselves going, but it's a good bet that around 500 of these tiny cash-strapped companies will go bust and/or be de-listed unless there is a dramatic improvement in the market environment over the next several months, that is, unless it soon becomes much easier to raise money at a reasonable cost. Such an improvement is not out of the question, but it's not a high-probability outcome.

As an aside, the well-financed stocks will benefit from the elimination of many cash-poor companies. As companies go out of business or are de-listed there will be less competition for investor interest.

An improvement in financing conditions for small exploration-stage mining companies will be preceded by a clear-cut upward trend reversal in the TSX Venture Exchange Composite Index (CDNX). As illustrated by the following chart, the CDNX is presently near its lowest level since mid-2009.

A trend reversal could occur at any time, but there is no evidence that it has already occurred.



Most of the exploration-stage mining stocks in the TSI List are fully funded through to at least the final quarter of this year and none of them have an urgent/immediate need to raise new money.

Update on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Index changes go into effect on Monday 18th March. Due to index-tracking funds repositioning themselves in preparation for the changes, this could result in stocks that are being added to indices rising sharply and stocks that are being deleted from indices falling sharply on Friday 15th March. Friday's moves in reaction to index changes would likely be retraced early next week.

Sabina Gold and Silver (SBB.TO) is the only TSI stock that will potentially be affected by this round of index changes. SBB is being deleted from the S&P/TSX Global Mining Index and the S&P/TSX Global Base Metals Index. This could lead to a sell-off in SBB shares on Friday. Whether it does or not will depend on whether new buying on the part of value investors is sufficient to counteract the selling of index-tracking funds.

An index-related SBB sell-off on Friday should be viewed as both a short-term and a long-term buying opportunity.

    Rye Patch Gold (TSXV: RPM). Shares: 146M. Recent price: C$0.425

We added RPM to the TSI Stocks List last October as a speculation on the outcome of a court case involving the disputed ownership of mineral claims. At that time the court case was scheduled to happen before year-end, but Coeur d'Alene Mines (CDE), RPM's opponent, managed to delay the proceedings until the second half of 2013. We think that RPM will win the case and that the legal victory will lead to a large increase in its stock price, but due to the fact that this was supposed to be a short-term trade we've been looking for an opportunity to exit.

As a result of the extreme sector-wide weakness a good opportunity to exit never materialised, but the opportunity presented by RPM's recent strong rebound is good enough considering the overall market environment.

We have removed RPM from the TSI Stocks List and recorded a loss of 18.3% based on our October-2012 entry price of C$0.52 and the 13th March 2013 closing price of C$0.425.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html