We Are Looking Into The Abyss

“Man looks in the abyss, there's nothing staring back at him. At that moment, man finds his character. And that is what keeps him out of the abyss."

-Hal Holbrook in Wall Street

 

“Everybody has a plan until they get punched in the face.”

-Mike Tyson

 

I am starting to get a little worried and quite bored by the whole entire bitcoin/blockchain conversation and the direction it is taking.  Daniel Kahneman warns of the dangers of overconfidence. The overconfidence effect is a well-established bias in which a person's subjective confidence in his or her judgement's is reliably greater than the objective accuracy of those judgements, especially when confidence is relatively high.  Throughout the literature overconfidence has been defined in three distinct ways: 1) overestimation of one's actual performance, 2) overplacement of one's performance relative to others, 3) the excessive certainty regarding one's beliefs- called overprecision.

The amount of hubris in this space is breathtaking, let’s all take a step back and admit that we don’t know the future, let’s also take another step back and admit that the banks aren’t going anywhere. In fact if blockchain succeeds in its core mission it will empower the banks like no time in recent history.

In order to move the conversation forward (at least in my own mind) I have started asking questions. Some I think I have answers to and most I do not. The intention here is to list these questions on a high level as a thought provoking process.

  • Can decentralization work in finance where trusted third parties and governments and super stringent regulation aren't going anywhere?  
  • Private blockchains don't eliminate this problem as one of the nodes will surely be a regulatory body or they will surely be involved in some way and how will clearing and settlement work?
  • Bitcoin's scaling problems and decentralized nature (censorship resistance) make it a non-starter for banks and financial institutions so why even target them?
  • How do you come to agreement in a consortium model?
  • Do some players have more power?
  • Who does and doesn't have read write functions?
  • Will private chains be any different than current banking infrastructure which has left a ton of legacy software built on top of many different architectures. Will we have legacy chains?
  • How will all of these chains interact within a bank and between banks?
  • How do they integrate?
  • The same can be said of the consortium model and how it interactions. If you are not part of the consortium does this mean you are like the kid who didn’t get picked to play football?
  • How does that even make sense when financial institutions interact with thousands of different parties? 
  • Is building from scratch too risky?
  • What happens to all the information that is still on legacy systems?
  • How does this migrate over?
  • The financial world is a complex system, how is risk modeling being calculated into this equation particularly for payments, clearing and settlements functionality as we get to real time settlement?
  • The same can be said of regulatory and compliance risk? 
  • Will people be given one identity or multiple identities depending on what chain they are using with whom? If the answer is no, than the world is flat?
  • Is reddit the best communication platform for having these discussions? I think not. 
  • Does a new one need to be created? I hope so.
  • Is Bitcoin trying to be too much?
  • Is money and payments the the best use case for the bitcoin technology?
  • Is it straying too far from its original vision?
  • Does it make sense using POW to put assets of large value on a it especially if it makes the likelihood of 51% attacks frequent?
  •  Clearly the mining oligopoly is a problem and will continue being a problem as long as hashing power is concentrated in a few hands. How does is bitcoin able to maintain being a decentralized entity while this continues being the case?
  •  What will the incentive structure look like after the the 2016 halving? 
  • Will miners continue to be incentivized?   
  • Sidechains and the lightning network need to go offchain with assets how secure is this?
  •  Should a small cadre of developers and companies and miners and VCs actually control the direction of the greatest decentralization project in our lifetimes?
  • “Does Bitcoin need to go back to being Bitcoin, since as per Satoshi's original vision it seems to have lost its way? Has regulation killed the giant experiment? Irrational expectations? Greed? Something else?”
  • Which leads to a more philosophical question and a really important one can regulation and decentralization co exist? Can they even be in the same room together?
  • Is focusing on banks needs instead if the peoples needs the right approach for bitcoin? The word bank is mentioned twice in the whitepaper and finance is not mentioned once.
  • Are the very offramps that people so desperately want, killing the Bitcoin Experiment? 
  • Bitcoin is a technology solution to global fiat problems not a solution that is in the interest of the powers that be.
  • How transformative will shared ledgers actually be? Is this just an evolutionary step?
  • Where is the real value proposition? Is it the shared ledger/blockchain itself or the tools and apps that will be built on top of it? If so how do those building the bridges monetize?
  • Where are the recurring revenue streams going to come from from the companies building these chains? Will it be a consulting based model? Are they doomed to be the fintech versions of Razorfish?
  • Can chains be built melding pieces of bitcoin and shared ledger technology. Does this make sense? Can it even work?
  • Can the adults in the room please stand up on both sides and engage in intelligent dialogue?  I think there is the a lot to be learned here.

Remember this whole thought experiment would not exist without Bitcoin and its underlying technology.

At this point there are more questions than answers. So everyone needs to stop pretending they know the outcome, start a truly open and intelligent dialogue and just build.  

 

China FX Reserve Depletion Accelerating: Yuan Devaluation To Follow Suit

Circuit breakers, suspending circuit breakers, accelerated devaluation of the yuan, followed by intervention to slow the devaluation, record foreign exchange reserve depletion, PMI contraction and more panic: Just Another Day in China. (JADIC)  In this blog, China watching  has been a major focus for quite a while, particularly with regards to devaluation and its effects. You can read about this here, here, here, here & here.  The steps and missteps of Chinese monetary policy have roiled global markets and have impacted the price of bitcoin.

The chart below shows that China's FX reserves fell for the first time since 1992, but more worrying is the accelerated pace with which they are falling.  December saw the biggest monthly drop on record. This has been the result of keeping a tight yuan peg with the US dollar and capital outflows. Quite simply, it has become too expensive for China to keep a tight peg versus USD because of the dollar strength. Hence they have been loosening the peg as a form of monetary stimulus.  The other problem has been capital outflows.  Despite all the efforts to keep money on the mainland it has not worked. What does this mean?  China has lost control of capital outflows. The policies employed thus far have been ineffective.  As the economy and the currency continue to weaken and the Shanghai implodes, more and more money is moving offshore. 

China has continued to focus on RMB depreciation has has continued fixing the value (mostly loosening) almost daily now.  According to the Financial Times, "the size of FX liabilities that still needs to be unwound is around $300 billion according to our estimate (not including importers USD buying and domestic portfolio diversification) RMB depreciation will continue."  It does not include those moving money offshore. 

The Yuan Continues to be Overvalued

 

The yuan continues to be overvalued.  The the current price of USDCNH (6.69) and estimates that the yuan is ~30% overvalued, a few scenarios have been run below as to what the prices would be if it climbed:

  • 10% = 7.35
  • 15% = 7.69
  • 20% = 8.02
  • 30% = 8.69

As one can see, there is still a ways to go regardless of where it goes.  The other problem is the chances of an orderly devaluation seem unlikely.  As the market begins to sniff how much of a devaluation the PBOC want to go, their hand might be forced by market forces like what happened back in August when they announced a 2% loosening and sheer panic ensued causing it to spike even further.  If Mr. Market gets spooked beware.  Something else to watch for is the velocity of the devaluation.  This could cause major shockwaves throughout global capital markets and something the PBOC could lose control of quickly especially if FX reserves continue depleting. At some point China may be forced into full blown QE instead of all these side moves which aren't getting the response China wants.  That would accomplish 2 things: instant devaluation of yuan and the kind of bazooka monetary easing maybe China needs to stop the bleeding and pacify the international investment community.

 

 

 

 

Valuation Compression in Fintech Hitting Bitcoin/Blockchain in 2016

In 2016, expect what has already become an increasingly difficult funding climate to become even more challenging.  Thus far, fintech has been immune to this but there are cracks starting to form even in the hottest sector in startupland.  The trickle down effect has led to difficulty even amongst VC darlings and the white-hot bitcoin and blockchain segments as well.  This post will explore what has happened to cause value compression in startups and why it is leading to compression all the way down the chain (pun intended). 

Valuation Compression

Throughout startup land we are starting to see valuation compression.  Some of the darling companies of days past have suffered from down rounds (Foursquare), the effects of ratchets (Chegg & Square), going public at prices lower than their last round of funding (Square), being acquired at prices much lower than their last round of financing (Good Technology) or their valuations being written down from where companies invested in them (Snapchat by Fidelity).  Read here for the effects of ratchets on both Square & Chegg. These are all symptoms of valuation compression.

Valuation compression can occur for many reasons. In times of easy money, investors are willing to invest large amounts of money into companies at friendly valuations, multiples expand and this trickles into all startups as whole.  Essentially companies raise money at the valuations they want and this leads other companies to raise at these levels or higher. Investors begin to have fear of missing out (FOMO) and want to get a piece of companies in hot sectors. As more money flows and valuations rise, the expansion continues unabated, until it doesn't.  Private markets follow public markets (or so the theory goes) and as those markets deteriorate or get shaken (as they have been since China devalued the yuan and the Fed raised interest rates) questions start to arise throughout the whole capital spectrum.  This is when VC's and other investors start questioning business models, wondering how companies will make money and looking at the global macroeconomic environment and start wondering if the good times are coming to an end. The real question becomes what is company X really worth and is the industry it is in as a whole really as big as it once appeared. Are there too many companies competing for too little pie?  The answers to these questions are inevitably always yes and that's when the consolidation phase begins but it starts with multiple compression and ends with funding becoming harder and harder. Warnings of a bubble have been heard for years and have gone largely ignored except within the media and some circles. (I am not saying a bubble has formed.) 

It all starts in search of returns and money flows to where it can make money. VC's are always the first ones in and have benefited the most from the spectacular rise in private company valuations. Then a funny thing happened on the way to the theater; hedge funds like Tiger Global, financial institutions like Fidelity & T.Rowe Price started investing in late stage rounds for private companies because they saw opportunities they weren't getting in their other business lines and the public markets. This to me is where the beginning of valuation compression started.

Even some closed-ended mutual funds were formed to capitalize, companies like GSVC Capital (GSVC). GSVC invested in companies like Twitter and Facebook before they were public. GSVC defines itself as:

"externally managed, non-diversified closed-end management investment company. The Company's investment objective is to maximize its portfolio's total return, principally by seeking capital gains on its equity and equity-related investments. It invests principally in the equity securities of venture capital-backed emerging companies. It seeks to deploy capital primarily in the form of non-controlling equity and equity-related investments, including common stock, warrants, preferred stock and similar forms of senior equity, which may or may not be convertible into a portfolio company's common equity, and convertible debt securities with an equity component. It seeks to acquire its investments primarily through Private secondary marketplaces and direct share purchases, and direct investments in private companies." 

With such successes in its portfolios you would think its stock price would be up in this boom for private companies. Ummm not so much.  In fact it trades way below Net Asset Value (NAV). This is commonly referred to as trading at a discount and while there are many reasons for this it's generally not a good thing unless there are extreme market distortions( not to be discussed in this blog post).  Below is a chart of the performance of GSVC since it first started trading.

This is the portfolio of GSVC. Companies like Lyft and Palantir remain it. 

IPO's Are The New Down Round

Another sign of what's coming is that there were only 2 IPO's in total in December. One of them being Atlassian which was a big success. However the numbers for IPO's are shockingly bad according to this article:

"The two measly IPOs in the US in December brought the total for the year to 170, down 38% from 2014, according to Renaissance Capital. By that measure, it was the worst year since 2012.In terms of dollars, only $28.7 billion in IPOs were booked in the US in 2015, down 48% from 2014, and by that measure, according to Thomson Reuters, “their worst year since 2009.”

“We will see several unicorns come public below their highest late stage private rounds,” predicts Max Wolff, chief economist at Manhattan Venture Partners. “This is part of an overdue and long-term healthy reset.”

This certainly has implications for fintech. 

Fintech

Fintech has been spared for the most part as it has been one of the hottest sectors for VC/private capital over the last few years. 2014 was a record setting year for investment into fintech according to Accenture, and 2015 will be bigger when the final numbers are out.  In the past 5 years, 10% of all VC money has gone into fintech and those companies have produced 20% of all private companies valued at 1 Billion + (unicorns).

872 fintech startups have benefitted from significant investments in 2015. Some have been huge winners and below is a list of fintech unicorns whose valuations have been lifted to lofty levels: 

- SoFi / US / p2p lending / raised $1.2B in 2015 / valued at $5B
- Avant / US / lending marketplace / raised $725M in 2015 / valued at $2B
- One97 Communications (parent of Paytm) / India / mobile payments / raised $680M in 2015 / valued at $4B
- Lufax / China / p2p lending / raised $500M in 2015 / valued at $10B
- Zenefits / US / insurance / raised $500M in 2015 / valued at $4.5B
- Credit Karma / US / personal finance / raised $175M in 2015 / valued at $3.5B
- Prosper / US / p2p lending / raised  $165M in 2015 / valued at $1.9B
- Stripe / US / payments / raised $90M in 2015 / valued at $5B
- Adyen / The Netherlands / payments / raised an undisclosed amount in 2015 /valued at $2.3B
- Transferwise / UK / payments / raised $58M in 2015 / valued at $1.009B

Many of these companies will probably look to go public at some point to capitalize on these numbers but as the environment starts to change it will be time to separate the wheat from the chafe.  If we look to the top fintech IPOs and the spinoff of Paypal, performance of these companies has been pretty rotten overall.

Top Fintech IPOs

If we look at the charts below, the public companies can be seen as the fintech canaries in the coal mine.  While fintech has been donned as the hottest sector in startupland the performance of many of the darlings has not been so great.  This is what value compression looks like public market style.  The story of Square provides a harrowing tale and while the chart doesn't look terrible since the IPO remember where Square's valuation once was as a private company.  Click here to read the full story of Square in case you aren't up to speed. Of course, time will tell if it's a success but the point of this blog is talk about the beginning of valuation compression for fintech all the way down to bitcoin and blockchain. 

 

Screen Shot 2016-01-03 at 5.50.05 PM.png

 

The Remittance Space as an Example

The SaveOnSend blog is something I read whenever a new post comes out and I highly recommend it to all.  One of the hottest spaces in fintech has been remittance and that's because the market size is massive. (~.6trillion USD) There a couple of behemoths in the space, particularly Western Union and to a lesser extent Money Gram.  The startups have raised an enormous amount of money as the chart below shows:

Xoom was acquired by Paypal at $25 per share, in what the saveonsend blog describes succinctly, despite revenue and gross sending volume falling off a cliff, because Paypal wanted a piece of the remittance pie. The public markets are not always the smart money as can be read in full here.

The main point is that these startups all competing with incumbents and amongst themselves for funding, customers and valuations and there are a few ways to do this: through increasing revenues, through differentiation and by competing on price in top remittance corridors. Competing on price has been the way they have been trying and this has led to declining revenues and margins which can be read in detail here. The point is when the funding dries up these businesses can't continue burning through cash and generating losses. Saveonsend hits the nail on the head:

"So, based on the above, will these and other remittance startups be around for awhile? Only very few like TransferWise. Long-term, current valuations don’t seem to be justified in a market with declining revenues, rising costs, and increasing competition. It has been relatively easy to raise money for “payments-mobile-fintech” startups, but when another downturn comes in 2016, 2017, or 2018, investors will again remember the millennial-old adage: "Eventually all businesses are valued as a multiple of earnings."

This is one example but can be extrapolated to all other sectors of the fintech landscape.

 

VC Funding of Bitcoin & Blockchain

Inevitably this even trickles down to what's been labeled the hottest of the hot: bitcoin & blockchain. While this market is still in its infancy, it has attracted a fair amount of money, although it has not reached levels of other sectors within fintech.  In 2015, 21 Inc raised $116 mill, Coinbase raised $75 mill, Circle raised $50 mill, Ripple raised $32 mill and Chain raised $30 mill.  However, since the Chain raise funding has decreased on both the bitcoin and shared ledger sides of the table; R3CEV, Abra and Align Commerce are the most notable.  The Coindesk VC database shows all the companies and amounts that have raised since September:

 

Tim Swanson of R3CEV provides a nice chart showing bitcoin funding by month over the last two years in his most recent blog post . The chart can be found below:

What Has Happened to Cause This? 

As mentioned above it's a general valuation compression affecting the whole of startup land.  However, it seems that bitcoin and blockchain/shared ledger has run into some problems independent of fintech which has not been hit this hard yet.  In fact the hot blockchain space has hit peak interest as this Google Trends chart shows:

A recent article by Nathaniel Popper in the New York Times has shown that some of the more well known companies in the shared ledger space have run into trouble in their fundraising efforts, despite extraordinary financial leaders at their helms.  The reasons for this range from valuations to technology.  There certainly seems to be a bloat in the shared ledger space as many companies have pivoted away from bitcoin and are looking to work with banks in many areas where shared ledger technology makes sense.  Many new entrants have also entered the space. While there are many companies working on this, banks also have their own internal projects as well working side by side and possibly in competition with some of the companies in the space.  There are also questions on different model types: consortium or private chains. Until the space becomes more developed and projects with financial institutions more defined, it might be a wait and see approach for funding companies if the technology actually lives up to all of its promises.  This could mean a pause in funding until design and implementation are developed properly.  

This has caused many bitcoin startups to suffer as well because there are now questions of which chain will win as there has become a great divide between using bitcoin's blockchain or the shared ledgers being developed.  This has probably left many VC's on the sidelines to see what shakes out.  Other problems with bitcoin as far as funding goes could be around the blocksize debate and how that shakes out from a community perspective and a technology perspective. Many of the older companies continue to look for ways to monetize and for the "killer app".  While the bitcoin price has grinded higher in the last quarter of 2015, this has not caused a renewed interest in funding companies as of yet.  In fact interest in bitcoin over time remains low despite the price in an uptrend.

The reality is we are starting to see valuation compression happening to fintech and bitcoin and blockchain startups will not be spared of this fate.  There always comes a time when you batten down the hatches and build. Execution becomes the key and metrics begin to matter.  It seems the time has come.

 

 

 

 

 

 

 

 

 

A Blockchain Can Help Improve CAC and CLV for Banks

This post is inspired by a question I asked to Bradley Leimer, Head of Innovation at Santander Bank. The question asked the following, "What are the onboarding costs of new customers for banks when opening new accounts?"  The answer, "In general you're looking at $150-$400 per checking account - while that seems huge compared to CAC (Customer Acquisition Cost) of a startup at $10-$40 it's tough to get people to switch banks ."

With CAC being that expensive for banks, it's not surprising traditional retail banking products are losing money (leaky buckets) at banks.  

"Checking accounts are estimated to have gone from contributing US$ 12.59 (1992) to losing US$ 196.46 (2012). Debit Card revenue loss is estimated at nearly US$ 8 billion in  the United States."

It's a well known fact banks are seeking to dramatically cut costs (Deutsche Bank, JPMorgan, HSBC, to name a few)  and become more digital while still trying to acquire and retain end customers. Regulatory oversight (which has led to non-stop fines) has dramatically increased the cost of service while it has depressed revenue growth. To name a few of the new regulations banks must follow:

 

As one can imagine this is causing banks to assess their Customer Lifetime Value (CLV) for each and every customer across all of their products lines.  The main goal is to decrease CAC and increase CLV. In order for this to happen, banks need to look at Profit/Loss Statements for their customers in order to acquire new customers, retain old customers and expand relationships into other product lines that may be more profitable and cross sell to these clients.

Pascal Bouvier's blog Finiculture touched on this when discussing Challenger Banks vs traditional banks.  He makes some great points on traditional banks biggest problems:

"First, a challenger bank is in a unique position. As a startup without dependency on a traditional bank, it can focus on customers’ needs from the start, using data tools. A challenger bank is in a position to advise its customers as to which products and services are the most appropriate. Focusing on customers’ needs first and foremost ensures the gap between those needs and product offerings is either miniscule or nonexistent. It also ensures strong engagement – something incumbents struggle with either at a branch or online.

Second, a challenger bank enjoys the benefit of creating its technology from scratch. From a high level point of view, we are dealing with newish core systems, usually a refresh or newer version of traditional software. Challenger banks also benefit from specialized data hubs that allow them to acquire, analyze, monitor and act on data in a holistic way. Unlike a traditional bank, data does not sit passively in a silo after having been acquired."

I would take this a step further beyond just challenger banks, which will still require regulatory approval and proper licensing, while traditional banks are powerful because they sit high around regulatory moat, to mention all fintech companies. Challenger Banks are only attacking a few product lines of banks which have recently become less profitable for big banks, fintech startups are also formidable and are attacking specific product lines (payments, remittances, fx, advisory services etc) with appealing digital and technology solutions that are focused on data-driven analytic models. These models allow them to focus on specific niche markets with laser sharp focus on customer behavior allowing them to acquire costumers cheaper and provide them with ongoing services cheaper.  As startups, they also can test new technologies in a much easier and less complicated way. The multiple product lines of banks are spread globally in these functional silos giving the exact opposite effect.  Further complexity gets added by things like M&A.

A Cost Cutting World

It is no wonder traditional banks are on the defense and buying into the promise of blockchain. In no particular order shared ledgers can help banks:

  • cut costs- in both the back office and in settlements, FX & remittance
  • replace legacy infrastructure
  • become more capital efficient and improve liquidity ratios
  • reduce redundancies and get rid of operational and functional silos
  • reduce regulatory risks
  • become more digital/become more like technology companies
  • reach finality of settlement

Popularity of blockchain is not just a VC Hype Cycle but it is also becoming a self fulfilling prophecy on the banking side.  Euromoney recently surveyed the banking market to see whats next.  Bankers are buying into blockchain in big way as these charts below show.

 While most of these are out of the scope this post, bankers are becoming believers on the impact that blockchain  can have on their businesses and by adapting shared ledger technology there will be some  "spillover effects for banks" such as  decreasing CAC and increasing CLV.

Pain Points for Banks in Achieving  Lower CAC and Higher CLV

The following are the pain points banks face when trying to figure out CLV that came from Everest Group Research report:

  1. Silos. Traditional banks offer a variety of products and services that are poorly integrated internally from an operational and systems perspective. Effective CLV analytics requires inputs from multiple systems which is difficult when those systems are different and siloed. This problem is made worse by the non-uniform level of granularity across systems and inconsistent definitions.
  2. Lack of quality and standardized data. Having a unique customer identifier can be used to track all customer information across all the systems a bank has, and enable creating a single-view of a customer's history and interactions with the bank. However the underlying systems' fragmentation makes it hard to get a common customer definition. Moreover banks need to track online behavior to build a forward looking assessment of CLV which is challenging.
  3. Lack of ongoing feedback mechanisms.  CLV analytics need to be fluid and dynamic, as customer profitability calculations are not one-time exercises and need ongoing updates and refinements. In order for the bank to maintain reliable accuracy of these CLV models, a continuous feedback mechanism is required from frontline systems, which is hard to implement.
  4. Determining "cost to serve" per channel. "Cost to serve" is normally a "one size fits all" average number that is used.  However, there are segments of customers who appear profitable based on usage, but when actual cost incurred in servicing is overlaid, they turn hugely unprofitable. The banks therefore need to track customer interaction data across channels and attribute a "cost to serve" interaction, which flows into the Profitability calculation.  Channel preference, frequency of interaction and stage of lifecycle are huge drivers of cost to serve and can throw dramatically different results, from what might appear on first glance.

Blockchains Can Help CAC and LTV

Siloed databases are one of the major pain points for achieving proper CLV analysis. When banks implement a blockchain,  a shared database where multiple people can write to, gets created.  Assuming banks will used shared ledgers, all nodes will be known and trusted.  This allows for consistency of definitions and provides for that elusive unique customer identifier that is needed to track all customer information across all the systems a bank has, and enable creating a single-view of a customer's history and interactions with the bank.  Essentially establishing a chain of custody. Once this view is established, one can have ongoing feedback mechanisms to understand customer profitability based on customer behavior across all banking departments and services, which in turn will allow for banks to better understand and serve their customers. Not to mention get rid of those annoying calls from multiple departments in a siloed bank asking for the same information. 

 

 

 

 

 

 

Another Twist in China's Continuing Devaluation: Yuan Basket

China has announced another surprising move in its efforts to further decouple from the US Dollar peg and let the yuan to continue to float more freely. The PBOC announced on Friday that it would value the yuan by tracking it against a broad range of currencies while bring the dollar's weighting down.  There have been no specific details on how this will be implemented. According to Bloomberg: 

""The new yuan index will be composed of 13 currencies "to help bring about a shift in how the public and the market observe RMB exchange rate movements,"" CFETS said in a statement released late Friday."

 

Below is a chart of the currency weightings in the China Foreign Trade Exchange System (CFETS) Index.

This is happening as the Fed meetings begin today and an interest rate rise is expected for the first time in nearly a decade.  It appears China is afraid of a strong US dollar because that would be a form of monetary tightening at a time when China is implementing monetary stimulus to try and strengthen its extremely weak economy.  

Yuan Continues to be Overvalued

The chart below shows how overvalued the yuan is versus other emerging market economies. The chart clearly shows the yuan needs to continue devaluing to come to a proper value.  As mentioned in the last blog post, this could be up to 20% vs USD which would be much more in terms of the currencies on the chart below.

As the PBOC continues to devalue the spread between onshore yuan and offshore yuan continues to widen and this as has been mentioned is bitcoin positive. 

As the yuan continues to devalue and more and more wealthy Chinese move money offshore at a time when strict capital controls are starting be enforced, bitcoin is becoming a bigger way to get money out of the mainland. If more Chinese wake up to this reality, the price of bitcoin will continue moving higher.

Yuan Devaluation Continues: Will it Begin to Accelerate?

This will be the final part of three with regards to the yuan being overvalued and its impact on bitcoin. The other two can be found here and here.  As has been mentioned, many experts are coming out and saying the renminbi needs to devalue further, with some experts seeing a gradual loosening all the way to the other side of the spectrum of a complete "unpegging" from the band with the USD. Regardless, if this loosening begins to accelerate it will be bullish for bitcoin. Let's assume based on a piece that came out today, that the yuan is overvalued by 20%. It has already gone up in price by 3% to 6.50. Another 17% from that level puts it at 7.60, as the chart below shows.

Screen Shot 2015-12-10 at 1.26.08 PM.png

China's hand is being forced by an extraordinarily weak economy and a persistently strong USD. This has led to the entire emerging market and commodity complex getting crushed. If China continues to devalue this will only exacerbate the situation, especially if the USD remains strong. The chart below shows that commodities have broken major support and are sitting at 20 year lows.

The toxic mix of USD strength, commodities getting crushed and emerging market local debt denominated in USD has been talked about in another blog post I wrote. Brazil was used as the textbook example for this. They also happen to be one of the countries with the highest uptake of bitcoin as well.

Defending the Yuan Peg

In order to defend the peg, China has been emptying its FX reserves, at a time when according to a Royal Bank of Australia (RBA) report, capital outflows have reached record levels.

"China has been a net recipient of large amounts of foreign private capital over the past two decades......These trends in capital flows reversed last year. Between early 2014 and mid 2015, around US$450billion of private capital flowed out of China in net terms and the PBC reported selling or letting mature US$75 billion of its foreign exchange reserves as private capital outflows began to exceed the country’s current account surplus. The move towards private capital outflows and reserve sales accelerated sharply in August following the PBC’s decision to allow the US dollar-RMB fixing rate to become more market determined. While official data are not yet available, partial data suggest that private capital outflows increased to around US$300 billion in the September quarter (10 per cent of GDP) and that the PBC sold or let mature a further US$200 billion of its reserves."

Below is a graph showing this trend and simply put it has become extremely expensive and now unattainable for China to keep a tight peg. Loosening is the only way forward. Not only will it relieve pressure from the relentless selling off of FX reserves and US government bonds but its a form of monetary stimulus.  Ambrose-Pritchard points out that:

"Defending the currency on this scale is costly. Reserve depletion entails monetary tightening, neutralizing stimulus from the cuts in the reserve requirement ratio (RRR). It makes a soft landing that much harder to pull off."

  

 

 

As has been mentioned in other blog posts this has led China to instill capital controls in an effort to stem the bleeding. They have not worked as well as hoped and Chinese have found creative ways to get money offshore. Bitcoin has been one of the major beneficiaries and will continue to be especially if the the devaluation takes even 10%-20% higher.  This will continue to erode purchasing parity onshore and we may see the spread between onshore and offshore yuan continue to blow out from its current levels shown below. 

Argentina

With Mauricio Macri, the new president of Argentina  coming into power today, expect major reforms to happen.  Argentina's economy has suffered greatly in recent years and it has one of the highest inflation rates in the western world at a little under 20%. Capital controls have been in place for a while and buying US Dollars has been restricted.

Macri has promised to lift these restrictions on the USD. Argentina LocalBitcoin volume has been growing as a result of a tightening of these capital controls  throughout 2015.  Exchange volume has been up as well.

If these restrictions are lifted and other economic reforms begin to occur expect a devaluation of the peso.  This may lead to higher upticks in bitcoin buying and certainly in USD buying as a hedge.  

Devaluations, Capital Controls, Strong USD

It hasn't just been the rise of the USD that has been problematic, but the velocity with which it has risen in a rather short time. On top of this, it has stayed at elevated levels without respite. This has led to global consequences which are only starting to be felt.  As countries are forced to adjust their economies and currencies to the new environment and purchasing power continues to be lost, alternatives will be sought to evade capital controls and devaluation.

 

 

 

 

More Chinese Monetary Policy: Renminbi Depreciates Further

The People's Bank of China (PBOC) has loosened the band that the renminbi floats in further Easing monetary policy further as more bad economic data continues to pour out of China.  As the mentioned in the last blog post, yuan depreciation is bullish for bitcoin.

The chart above shows that it has risen above 6.40 which was where it spike to when back in August the PBOC allowed it float by a further 2%.  This is significant as it shows the PBOC is determined to get ahead of a Federal Reserve interest rate rise and to continue economic reforms which lead the mainland from an export driven economy to a consumer led economy.  With yuan depreciating and capital controls tightening in China, bitcoin has been used as a way to get money out of China. As the bitcoin price has risen, speculators have stepped in as well and momentum has propelled it higher.  This is even more obvious by looking at the spread widening between onshore yuan and offshore yuan as the chart below shows. 

This widening spread is bullish for bitcoin.

One final relationship to watch is between the Shanghai Composite and the price of bitcoin. It is uncanny how inversely they move, when one goes up the other goes down. A best guess would be that speculative money is shifting back and forth between them.  A lot momentum traders chasing returns after getting burned in the Shanghai and bitcoin earlier in the year.  The chart below is labeled with up and down arrows, showing this relationship.


Continue watching monetary policy out of China, particularly when it comes to the currency and as this loosening of the band continues, the bitcoin price should continue higher.


China Now Part of the Special Drawing Rights (SDR): Bullish For Bitcoin

The Chinese Renminbi has been approved by the IMF to be a part of the basket of currencies that make up the Special Drawing Rights (SDR).  The other currencies include the US Dollar, the English Pound, the Japanese Yen and the Euro.  What is most surprising about this move is that the yuan now makes up more of the basket (10.92%) than the Yen (8.33%) and the Pound (8.09%).

In order to get the yuan included, china has had to make economic reforms and open up transparency to its central bank. It also has had to devalue the yuan (vs UAD) as well as cut interest rates (6 times)  in order to promote economic stability as it transitions from an export driven economy to a consumer led economy. China's central bank allows the yuan to float in a very tight predetermined ranged versus the USD.  On August 11th as the chart below shows, China allowed the yuan to depreciate by its widest margin vs USD as part of ongoing efforts of monetary reforms and easing to help an economic slowdown. This triggered an even sharper selloff in the yuan as global investors started to worry about a Chinese meltdown, which has not come to fruition.

It was widely accepted that the PBOC manipulates the value of renminbi and that its overvalued. In a recent article from MarketWatch a prominent investor had this to say:

"The slowdown has also dimmed investor enthusiasm for the yuan. Mr. Zhou of Bin Yuan Capital said the yuan is overvalued by about 20% and keeping it at the current level would only hurt the economy. In a Nov. 19 report, Goldman Sachs Group Inc. listed a "significant depreciation" of the yuan as the biggest risk facing emerging-market assets next year. A drop could help China's export sector but raise new criticism from the U.S. and elsewhere that Beijing is playing politics with its currency."

Banc of America's Richard Woo has made an even bolder prediction:

"After the SDR they no longer have the incentive to prop up the renminbi," he said Friday in an interview in Taipei. "A December hike by the Fed would give the Chinese a perfect excuse to let the renminbi go because they can make a strong case that they need to decouple their monetary policy from that of the U.S."

Supporting the yuan by keep it in a narrow band vs USD (and overvalued) has cost the Chinese greatly in FX reserves and has become unsustainable policy moving forward as China seeks to open up and become a global power.

Bullish For Bitcoin

Regardless of whether the yuan is overvalued by 20% or will be let go from its informal peg, it is clear that the Chinese are moving in the direction of letting the yuan float freer.  This effects onshore yuan holders dramatically and as the currency is less controlled by the China, market forces will determine its true value. It's time to expect further weakening of the renminbi vs USD. The Chinese authorities have instituted capital controls in an effort to stem money leaving the mainland as has been mentioned in blog posts in the past.  One of the ways, Chinese have been able to avoid these controls and get their money/assets offshore and out of yuan has been through bitcoin.  Expect for this to continue, particularly as the yuan begins its depreciation vs USD, and the purchasing power of the average citizen and the super rich begins to erode. 

China has led the bitcoin market both higher and lower and continues to lead the market.  Therefore any policies coming out of China should be watched closely and followed; particularly those that affect the people's ability to move capital freely.  Anything that depreciates the onshore yuan (like a freer floating currency vs USD), should cause Chinese investors to move assets into vehicles that get their money offshore. If the bitcoin price begins to climb as a result, speculators will pile in as well.

 

 

 

 

 

 

 

Regulation Is Propagating Financial Exclusion: Blockchain Technology is a Key Solution

According to a recent report by the Center for Global Development (CGD) entitled, "Unintended Consequences of Anti-Money Laundering Policies for Poor Countries", extreme regulatory and cost pressures caused by Money Laundering (ML), Terrorist Funding (TF) and Know Your Customer (KYC), have caused financial institutions to stop servicing areas which are deemed extremely high risk.  One of the fallouts of de-risking has been to cease activities using a  wholesale approach to the problem rather than on a case by case basis. (ie Middle East) This de-risking has led to de-banking as well. In this scenario, banks unilaterally shut down accounts of businesses and individuals which are in areas deemed too high risk.  

The Problem

The costs and fines associated with AML/CTF/KYC have grown dramatically in recent years as the charts below show.  

Compliance has become a major cost center for banks and financial institutions so de-risking and de-banking has been an easy approach to take in order to ensure not falling afoul with the regulatory authorities.  While the Financial Action Task Force (FATF) makes policy recommendations that are generally accepted globally, enforcement becomes even more complex in jurisdictions like the United States (although Europe is not much better) where there are multiple governmental organizations involved in the regulatory process and each can define the rules differently. Bureaucratic inconsistency in the aforementioned jurisdictions has made it more difficult for these institutions.

The wholesale de-risking approach has had unbalanced consequences for financial inclusion because the poorest countries have been deemed the most high risk. This has been a result of nations being deemed terrorist hotbeds, individuals not having a  verifiable identity, no access to credit for businesses and individuals, and the perception of the risk of money laundering.

SaveonSend does a great job of explaining why banks are shedding this business and all the complexities that are involved, including the high cost of AML/KYC for banks which is problematic. Its highly recommended reading and can be found here.

Three Sectors Most Affected

The three sectors of the global financial system most affected by regulation are: Money Transfer Organizations (MTOs), Non Profit Organizations (NPOs), and correspondent banking relationships which affect trade finance and letters of credit.  The chart below shows the capital flows associated with each of these areas.


MTOs (remittances) have historically been labeled as risky by regulatory authorities, particularly in today's world where costs outweigh benefit.  The CGD report states that many MTO's have allegedly been outright de-banked, but that hard figures are hard to get as banks do not share terminated account information publicly.

Some remittance corridors have been flagged more than others as well and these corridors have been shunned outright by financial institutions. The CGD report states:

"A significant share of world remittances now flows to countries that are deemed to be high risk by regulators. Nearly one in every three dollars remitted in 2013 was sent to a country currently listed as a high risk or non-cooperative jurisdiction by FATF. 13% went to countries in the top 25% riskiest countries as measured by the Basel Institute’s index of money laundering risk, and 6% went to countries actively covered by an OFAC sanctions program."

This has made it an easy choice for financial institutions to use a wholesale regulatory policy when assessing MTOs. As the saveonsend blog states, remittance is just a tiny fraction of all banking revenues.  Another worry in the report is that while remittance costs are low now, by de-banking many of the smaller players, this gets rid of competition, which in the longer run could lead to higher prices once again. Higher remittance costs lead to less flow, which also doesn't help financial inclusion and generating economic activity.

Non Profit Organizations (NPOs) have also suffered greatly. Donations and aid come in all forms including cash and anonymous.  Regulators have deemed that internal AML/KYC within NPO's falls weigh short of standards and its not hard to see why: to them a donation is a donation.  On the other side of the equation making sure that money gets into "good" hands in countries that are flagged is difficult. This presents a lot of headaches for financial institutions in banking NPO's and then releasing that money to aid, charity and assistance organizations in the targeted countries.  These countries tend to be poor, disaster stricken regions.  

The final area affected is correspondent banking and trade finance. Moving money across borders is something banks do all the time and in high volumes.  These include FX, remittances, letters of credit etc.  Banks are not omnipresent even though they seem to be, so when they don't have a branch in a country where they need to trade in local currency, they form partnerships and open accounts with local banks to conduct their activities. Not only do you need to know the correspondent bank you're dealing with (KYC) but you have know your customers' customers. (KYCC) In many of these high risk regions, that is hard to do and in many cases the local banks are dealing with people or institutions that have been flagged, hence the risk runs high.  Correspondent banking is central to economic activity in many of these countries where trade finance/letters of credit and cross border transactions are essential. Many of these relationships are built on trust and this is eroding due to super aggressive regulation making basic economic activity difficult.

The real unintended consequence of whats happening to all three sectors is less transparency. If one cant use a traditional financial institution or small business for remittances, donations and aid, and correspondent banking, one uses whatever sources are necessary. These sources don't discriminate in who can access money from them and sometimes they are involved in illicit activity. (terrorists, money launderers).  This spillover is being caused by overarching regulation and the wholesale approach to compliance.  

CGD Proposals

The solutions proposed by CGD report are:

1) The World Bank should make publicly available both the results and, if possible, the underlying anonymized data from its de-risking survey of banks, MTOs and governments as soon as possible.

2) Government agencies that keep detailed registries of regulated MTOs and NPOs should make available headline statistics about the numbers and nature of such organizations.

3) On behalf of central banks and private financial institutions, SWIFT, CHIPS, CHAPS, BIS and other entities tasked with managing and collecting data on cross-border transactions and relationships should make available data on bilateral payment flows and the number of correspondent banking relationships between countries.

4) Banks and other financial institutions should accelerate the global adoption of the Legal Entity Identifier scheme.

Developing globalized and national standards for regulation and compliance can be achieved through generating better data and sharing that data with other jurisdictions. This would include detailed registries of MTO's NPO's and correspondent banks. This would also lead to a "chain of custody" in which tracking and marking/flagging suspicious activities of these organizations can be monitored by all those who are sharing the information in a quick and efficient manner.  Once consensus is achieved on nefarious activity this can develop a more case by case basis on which entities should be banked and which de-banked. This increases transparency for both the regulators and financial services industry.  What also goes a long way is standardizing definitions for AML/CTF that both regulators and the private sector can understand.  These can be determined by size and scope of the business.  This along with proper identification methods could lower the cost and certainly the risk  of conducting compliance and doing business. 

Verifiable Identification for businesses and individuals is the biggest onramp to financial inclusion. Legal Entity Identifiers are the result of a partnership between regulators and the private sector, including financial institutions. The Legal Entity Identifier (LEI) is a 20-digit, alphanumeric code used to uniquely identify legally distinct entities that engage in financial transactions.  The report suggests scaling this form of identification quickly for global adoption.

The individual side is a bit trickier and harder to implement at present. The report suggests, 

"National governments should provide citizens with the means to identify themselves in order to make reliably identifying clients possible for financial institutions and other organizations"........"National governments should ensure that appropriate privacy frameworks and accountability measures support these identification efforts while ensuring the free flow of information related to identifying ML and TF."

Another suggestion is for better messaging standards and KYC documentation repositories.

"Banks and other financial institutions should redouble their efforts, with encouragement from the FSB and national regulators, to develop and adopt better messaging standards and implement KYC documentation repositories."

Why Blockchains?

The above solutions should make it apparent that blockchain/distributed/shared ledger is a real solution here.  First of all as one can see in the existing system information is not shared and replicated and duplicated over multiple regulatory bodies and financial institutions. Eliminating replication and duplication over multiple databases can be accomplished.  Once the information is shared, confirmation can be made in a timely fashion based on AML/KYC/CTF.  If one goes from a good actor to a bad actor, instantaneous changes can be broadcast over the entire network, thereby allowing for a more case by case basis approach, and allowing regulators and institutions to act in tandem. Thereby lowering the cost and fees of regulation and allowing for more businesses and individuals to be accepted and be banked. This is proper de-risking in action.

Storing transactions and records in one automatically shared database eliminates the need for complicated procedures making sure banks and regulators have their records in sync. The above description saves time and money while reducing the risk of error.  Trust becomes distributed over a network (be it private or public) in which the participants can determine through self organization and standards, if "they are who they say they are". This will get rid of fear of big fines and overreaction since the network will consist of all interested parties. 

An argument can be made for using a shared/distributed ledger to perform the tasks outlined above in which a consortium of financial institutions and government regulators are included. The information is not controlled by one entity but shared amongst all in the interest of promoting financial inclusion and economic activity for all parties who are not flagged, rather than shutting down indiscriminately.  

On the other hand,  a decentralized censorship resistant ledger like Bitcoin for identity, particularly when it comes to all that private information being centralized in a database. A security leak could be completely devastating. The world is filled with identity theft and governmental surveillance.  By allowing citizens to control their information and identity in an immutable database where they hold their private keys allays such fears.  

Regardless, the challenge of identity and regulation can be solved using this technology.

 

Blockchain and Financial Inclusion: From the Last Mile to the Last Meter

A recent report by Accenture, shows the massive opportunity in banking the unbanked. It estimates a $380 billion annual opportunity for financial inclusion. When thinking about the unbanked and where most are located, there is very little infrastructure and technology solutions trump brick and mortar when it comes to delivering value to the end user.  There is no branch banking and this truly is at the edge of wireless.  If existing financial services companies and banks want to grab these end customers (which they do), solutions that comprise mobility, identity & security will be necessary.  I believe a big part of this solution can be blockchain(s).  

In this article, a blockchain network will be defined as a secure, low cost payment rail for moving assets peer to peer over the internet.  These assets are more than just bitcoin (which will be explained in detail below) but rather any assets that have value and therefore these blockchains are permissioned/distributed/consensus as well.  

The Features of a blockchain network are as follows:

  • It's peer to peer: assets transfer directly between the parties who control the assets.
  • It doesn't need a bitcoin currency: the networks are built for specific markets and can issue and transfer any asset.
  • No Mining: transactions are ordered by trusted parties that form a federation.
  • Very fast: confirmation happens in seconds not minutes.
  • Scalable: 1000s/sec (transactions)

This article presupposes that existing financial institutions will be a major part of the solution involved in tackling financial inclusion and that permissioned ledgers will be what they use because of the censorship resistant nature of the bitcoin blockchain. The complexity of regulation imposed on banks means within the network all parties must be known and trusted.  Other issues which are beyond the scope of this article include settlement, anonymous global miners and increasing likelihood of 51% attacks as more and more assets are available. Distributed ledgers will facilitate getting  to end customers whom are unbanked (as a major new revenue stream) in a mobile, branchless banking world and bring major benefits for both financial institutions and customers. I believe this opens up mobile banking to fast peer to peer asset transfer using private and public blockchains, without the need for traditional financial and physical banking infrastructure.

The Opportunity

According to The Global Findex, there are still over 2 billion people unbanked globally. 46% of adults in developing countries are without a basic account, while 50% of women do not have an account.  The chart below shows the giant revenue opportunity for the 12 countries that stand to benefit the most from financial inclusion.  

 

Note: China and Indonesia are not represented on the above Accenture chart but are massive opportunities as well:  21% unbanked in China and 64% in  Indonesia. 

The chart below shows the world's unbanked by region.  

Huge areas of the world remain unbanked with billions of dollars in revenues untapped for the players who seize this opportunity.

Mobile Is Eating The World

For the first time in history, technology, particularly mobile technology is making it possible to reach many of these places.  Mobile technology plus mobile banking with the use of blockchain technologies for financial inclusion can allow value transfers happen B2C, B2B, and P2P. Mobile is the preferred banking device for the developed world as the chart below shows.  Mobile + Blockchain allows the "Last Mile" for financial inclusion to become the "Last Meter".

Benedict Evans' presentation, "Mobile is Eating the World", provided a glimpse into how dramatically mobile has scaled and how it will continue to do so, ultimately becoming the device of choice for the entire world for most activities, including social and financial. 

Why Blockchains Make Sense for Financial Inclusion

According to Santander, their analysis suggests that distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022. 

This is important because banks are cutting back on costs and going branchless but want reach at the edge of wireless.  There is a massive customer base to connect to via mobile. Blockchains can cut operational costs yet allow for reach of the whole customer experience not just bank accounts. Bank accounts become the gateway to all types of asset transfers and allow for capturing the customer within an ecosystem.

International payments remain slow and expensive. Significant savings can be made by banks and end users by bypassing existing international payment networks.  Storing transactions in one automatically shared, tamper-proof database could eliminate the need for complicated procedures and clearinghouses now used to make sure banks have their records in sync, saving time and money and reducing the risk of error. Without middlemen, payments and settlement can happen rapidly allowing people access to their capital when they need it. Think of how this can impact villages and entrepeneurs in the developing world.  The allowance of frictionless savings and investment gives people more control over their financial destiny.  Settlement times and costs can be reduced dramatically and a distributed could support large amounts of small transactions (microtransactions) within a trusted network.

For banks, blockchains will allow for the most efficient uses of capital in history.  They can lower the amount of capital they are required to hold. Let's call it "Just In Time Cash". Right now banks have to hold a capital requirement as insurance for incoming and outgoing payments that are "in process" from other banks and existing infrastructure. This is driven by an inability to see in real time the liquidity position of an organization and its upcoming commitments, its inflows and outflows, especially from a risk scoring perspective. This inability results in need to hold more funds in reserve.  Blockchains provide an opportunity in providing greater transparency to enable regulators to be convinced that higher reserves are not required, and an institution that has this insight may be able to operate with lower reserves, especially if it can switch its portfolio rapidly.

Distributed ledgers support "smart transactions". These include smart contracts, transactions that include multiple assets, transactions that include multiple parties and 2 way transactions.  Think about this when thinking of financial inclusion. This will cause an explosion in tradeable assets globally and allow the unbanked not only bank accounts but access to global capital markets by allowing for all types of value transfers.  It also allows for better property records in emerging markets, where these are essentially non existent right now. Dispute settlement on all types of assets through contracts and legal services  increasingly tied to code can be linked by a blockchain.  Trade will go up exponentially locally and over distances because of unbreakable escrow or programmatically designed smart contracts. Local economies can become more dynamic and flourish.  

The Reasons For Not Having An Account

This section will discuss the hurdles that are faced today in trying to get a bank account and how blockchain + mobile tackles these problems.

Reasons for not having an account:

  1.    Identity: A mobile phone can provide this through an independent token or security element or biometric.  
  2.   Regulations: This is jurisdiction dependent, but flexible strategies are being used to help the cause of financial inclusion.  Tiered AML/KYC schemes that rely on digital. Changing some of the prerequisites for credit history and microtransfers for low income individuals.  
  3.  No Banks:  Mobile + Blockchains with an identity element allow for banks to reach where there are no branches.
  4. Cash instead of digital payments:  Governments and NGO's and the private sector are working to digitize money. The trend is heading in this direction.
  5. High costs and fees: Using a blockchain and getting rid of middlemen should mitigate these fees dramatically. Fintech companies are already slashing the cost of payments and remittances as well as the traditional players. This should leak into all assets as the technology is built out. 

Distributed Ledgers as part of the Infrastructure for Financial Inclusion

Distributed ledger technology as the underlying infrastructure in a mobile, digital world is compelling.  It also allows for customization depending on the region and their unique ways of transacting and settlement. It also becomes a two way street where efficiencies with the banks becomes wins for the end customer and vice versa.  Ultimately this allows banks to become technology companies where automated, paperless and super fast systems provide the backbone to getting customer reach, without all the traditional man power and departments/divisions needed for permissions.  

Building an ecosystem does not happen overnight but looking at what architecture banks and startups can use to reach end customers and bring them into the financial system and access global capital markets, leads one to believe this is a use case.  The internet of money is truly on its way. 

For a presentation I did for the Wall Street Blockchain Alliance (WSBA), please click here.






Bitcoin Price Analysis 10/16/15: Sitting in Key Support Zone

The big price run up has been followed by a big decline into a key support area. In order to remain in bullish position price needs to remain above the $300-$315 area.  The daily chart below shows that the price is consolidating within a zone right above this key support level.  Something else to consider as well is all the overhead supply which has been created from the blow-off top and subsequent spiral down.  Some key resistance areas have been Identified but most of these are relatively minor with the really big one being the $400 area as the price ran up to $500 and promptly sold off leaving those 2 consecutive long wicks full of supply.  If price consolidates here, getting above $370 would make a retest of $400 likely.

The indicators have corrected extreme overbought conditions caused by that exhaustion move.  After sliding here they appear to be basing before the next move higher.  The price is sitting and has bounced off of the 50 day exponential moving average which is at $306 and remains firm support. 

The weekly chart provides a more bullish picture. The price was able to close above the $300 level on a weekly basis for the first time since December of 2014. This is bullish. All of the indicators remain at bullish levels on weekly basis and the price remains above its weekly EMA's. If the 50 week EMA can cross over the 100 week EMA that would further improve the bullish picture.

The price formed a blow off top after a parabolic surge and promptly corrected this condition all the way down to the key support level it sits at now. Consolidating in this zone and not falling below is what is necessary for the picture to remain bullish.  The first area of resistance now is $331, followed by some minor resistance until $370.  After the recent waterfall in price, and being able to hold above $300-$315 support zone on weekly basis remain cautiously bullish.

Is the Great Bond Market Bull Over? Not So Fast.....

What a difference a day makes! Well maybe not a day, but not too long ago (mid-September) after the Fed meeting consensus thought there was little chance that rates would rise this year as "global concerns" heightened and global stock markets were sinking on fears of a Chinese economic crash.

Well November is now here and consensus has decided that there is high probability of rate hike in December. The mob is a fickle brother, just ask Maximus.  In fact, the US Treasury futures markets have an implied probability of a 70% chance  of a rate increase in December.

Meanwhile, Barclay's has it at an absurd 90% probability:

This has caused a huge breakout in the US Dollar which looks like it will be above 100 soon.  Can you say Euro parity?

This has caused further pressure on commodities as the below charts of Gold show. Gold is below all of its weekly exponential moving averages and falling. This chart goes back to 1981 and shows some critical support areas particularly the 1000 area, which if falls could pave the way for massive support at 700. There is also support at 900.

This gold chart goes back to 1971 and shows a bit more clearly why that 700 area is huge.  It is not up to date as it ends in April. Gold has dropped significantly since then. The ROC right now is -7.03, so still not seeing anything extreme that would indicate a sign of reversal.

Commodities are at a critical area that must hold if a bottom is to be formed. Below is a chart of CRB which is compilation of all major commodities and it is showing we are entering a must hold area.  

 

As for the bond markets, the short end of the curve has reacted and essentially priced in a rate rise coming as they have all had massive moves. Below are charts of the 1-year, 2-year and 5- year treasury yields.


This has put the short term yield structure in an overbought position. 

The 10-year, 20-year and 30-year treasury yields have also reacted positively to this and have surged in recent weeks. In the last few few days they have sold off a bit but are still in bullish positions and poised to go higher based on any news of rate rises or economic upside surprises.


Before getting excited there is clear overhead resistance in all these charts, from June/July 2014 that needs to get cleared to put them in a truly bullish position.

 

The Forest Through The Trees

If one looks at the weekly charts of the 10-year, 20-year and 30-year there is a clear bull trend in bonds still going on and there are some key areas that need to be cleared before the bull market is written off.

For the 10-year clearing resistance at 26 would be constructive:

For the 20- year, getting above resistance at 3.25 would be constructive:

For the 30-year, getting above resistance at 35 would be constructive:

Before the great bond bull market is written off, let their actually be a first rate rise and some talk from the Fed on how they intend to normalize the interest rate cycle (if they can even do it).  Right now, the charts in shorter time frames are bullish but there are some hurdles to climb before writing off the bond bull market.