Economics of Good and Evil

Interesting presentation by Tomas Sedlacek at the 67th CFA Institute Annual Conference in Seattle, WA on the economics of good and evil.

Relearning Economics

The Post-Crash Economics Society at the University of Manchester recently released a manifesto for reforming university economic curriculum. Economic understanding and as a field of study is still very young relative to other sciences. It will be interesting to see the traditional framework around how we understand and teach about market interactions evolves in the coming years. Andrew Haldane, Executive Director for Financial Stability at the BoE, explains in the forward:

The agenda set out in this Report is exciting and compelling. While not exhaustive, it begins to break open some of the economics discipline’s self-imposed shackles. Some of this is discovery of the new – for example, in the area of evolutionary, neuro and behavioural economics. But a large part is rediscovery of the old – or, in some cases, dusting down of the neglected – for example, in the area of institutional economics, economic history and money and banking.


A Creepy World

A Creepy World

Great research was recently published by Didier Sornette and Peter Cauwels on a general framework to understanding financial markets and social systems. Sornette is Professor on the Chair of Entrepreneurial Risks at Swiss Federal Institute of Technology, Director of the Financial Crisis Observatory, and spoke about predicting financial crisis (video) at TED last June.

Before a critical threshold is reached, these parameters slowly drift, hardly changing the stress in the system, which has, at that point, a quasi-stable characteristic, only disturbed by noise. This gives us an illusion of control, we think that we understand the system and we assume that it will continue behaving as we expect it to for the indefinite future. We make naïve forecasts based on simple extrapolated trends without a real fundamental understanding of the underlying processes. Forecasters are happy and proud that they manage to find a trend and can fit a curve to it, without realizing that in fact they are blind. Examples are the credo that stocks always go up in the long run, the concept that inflation is contained because the velocity of money is low, the idea that governmental debt can always be refunded in the capital markets or that house prices always go up.

The real risks and opportunities in our modern, interconnected society can only be better understood if we get out of this fallacy. Only then will we be able to see and interpret the generic symptoms that occur when a system approaches criticality. (SSRN)


Mid-year Portfolio Review

Portolfio review introspection assets bonds investing stocks

With the second quarter ending last week and the Fourth of July holiday past, now is a great time to reassess your investment portfolio.

2013 started with a bang in equities.

  • The S&P 500 rose more than 14 percent into May, and then retraced 3 percent to current levels. Not a bad six months.
  • The NIKKEI took off like a rocket ship on “Abenomics” and has returned more than 31 percent, year to date.
  • Gold and commodities have faced a tough road, starting in April, on accelerated selling and concerns over slowing demand in China.
  • Treasury yields and mortgage rates have jumped over the past couple of months.

Needless to say, there has been a lot of volatility across the investment space.

Much of these price fluctuations have been driven by central bank commentary, monetary policy changes, and participant expectations—a constant tug of war. With interest rates trending sideways until recently and nowhere to go but up in the future, the 30-year bull bond market seemingly ended April, 29, 2013, according to PIMCO’s Bill Gross. (Note: bond yields are inversely related to the price, as yields rise the price falls or visa versa).

Rising rates will prove to upset traditional portfolio allocations and, negatively or positively, influence the pricing of many other risk assets.

No one has all of the answers, neither can they predict the future or create an impenetrable portfolio that always goes up. If someone tells you otherwise, you should run the other direction, and fast.

This reaffirms the value of basing portfolio decisions on a long-term thesis and adjusting with conditions. Whether you are working with professional adviser or individually managing your portfolio, it is important to reassess what has and hasn’t worked so far this year and formulate the best path moving forward.

Many participants attempt to time the market or make large moves in and out of assets, which has historically proven to be a loser’s game.

It is advisable to frame a macro thesis that guides your portfolio and dollar-cost average into various classes based on such. Adding incremental amounts of capital to your portfolio across a longer horizon ensures that you are buying more (or less) of an asset when it is relatively cheaper (or more expensive), but doesn’t impact the larger picture goals.

Even if you bought in at the previous peak of equities on October 9, 2007, and held the position until recently, you would have returned about 16.5 percent. Emotional driven investors exited on the way down or near the bottom and re-entered closer to the recent peak earlier this year, missing an enormous return possibility, as displayed in the charts below.

Portfolio Outlook Investing 3q 2013 JPM insights

Some of the many threats that exist to investors going into the second half of the year, and beyond, include:

  • Global demographic shifts and monetization of sovereign debt
  • Federal Reserve taper: effect on equity, debt, commodity, alternative, and housing markets
  • U.S. fiscal policies, Obamacare, and regulatory risks: effect on employment, sales growth, capital investments, etc.
  • Japanese volatility and the yet-to-be-seen impact of “Abenomics”
  • Euro crisis: high levels of debt, social unrest, unemployment and a slow recovery
  • China: growing pains in both social and economic policies necessary to evolve with the current demand (somewhat similar to U.S. growing pains through the 20th Century)
  • Unrest and corruption in developing markets
  • Shale gas impact on energy markets and various supply chains
  • Technology, resource scarcity, and sustainable design effect on employment, housing, transportation, food, communication, politics, etc.
  • Changing asset correlations

As a whole, the S&P 500’s forward price to earnings ratio (13.9x) remains below its long-term average (14.9x) and corporate earnings are at all-time highs. Investors should position themselves to capture economic recovery through specific industries’ or countries’ growth potential, while defending as best they can against rising rates and the underlying systemic risks, based on their long-term goals and risk profiles.

It is a constant battle to not let emotions or intraday noise drive portfolio decisions, but investing is an ongoing process and self-reflection is a necessary component of growth. Plus, the recent evolution of financial instruments (ETF, ETN, MLPs, etc.) has created many opportunities previously unavailable to retail investors.

If nothing else is gained from this introspection, you will at least be more prepared for evaluating the rapidly evolving market landscape.


This article was originally featured in the Bellingham Business Journal.

[Photo: fs999/Flickr; Graph: JP Morgan Insights, 3Q Market Review]

Mineral Royalty Stream Financing

Resource streaming, also known as volumetric production payments (VPP) or metal purchase agreements, provides commodity exploration and production companies the necessary financing to bring projects into production. This has become an attractive financing option due to the fact that VPP’s are cheaper than equity (no shareholder dilution) and safer than debt, making this a “win-win” for both the mine operator and financing company. Streaming agreements allow the mining company to capitalize on proven reserves before the operation becomes productive.

These diverse agreements are crafted to emphasize each party’s strengths and protect against the others weaknesses. The underwriting financier enjoys the resource upside while avoiding the downside risk associated from operations. Stream financing allows the mine operator to leverage proven reserves to fund production or expansion, while avoiding many negative side effects associated with traditional financing methods. Full Report

[Photo: Buckdog]

Mineral Royalty Stream Financing

(Photo: Sandstorm Gold)

Checkout the updated Outsider Trading research page which now includes reports covering Mineral Royalty Stream Financing and The Hybrid Solution to Portfolio Management. The latest paper analyzes a lesser known, but quickly evolving, type of financing in the mining industry (abstract below).

Resource streaming, also known as volumetric production payments (VPP) or metal purchase agreements, provides commodity exploration and production companies the necessary financing to bring projects into production. This has become an attractive financing option due to the fact that VPP’s are cheaper than equity (no shareholder dilution) and safer than debt, making this a “win-win” for both the mine operator and financing company. Streaming agreements allow the mining company to capitalize on proven reserves before the operation becomes productive.

These diverse agreements are crafted to emphasize each party’s strengths and protect against the others weaknesses. The underwriting financier enjoys the resource upside while avoiding the downside risk associated from operations. Stream financing allows the mine operator to leverage proven reserves to fund production or expansion, while avoiding many negative side effects associated with traditional financing methods.

We have some great research projects and articles in the pipeline, stay tuned for more!

NY Fed: Maiden Lane III “AIG bailout” generates $6.6B

The fed recently sold its remainder share (ML III) related to the bailout assistance given to AIG during the recession, which resulted in a $6.6 billion profit.

“The completion of the sale of the Maiden Lane III portfolio marks the end of an important chapter—our assistance to AIG—that was undertaken to stabilize the financial system in the midst of the financial crisis. I am pleased that we were able to achieve our principal goal, which was to protect the U.S. economy from the potentially devastating effects of AIG’s failure, while demonstrating sound stewardship of taxpayer interests. I am proud of and commend all of the people at the New York Fed who worked tirelessly and diligently to get us here.”

Global power shifting to US?

Ambrose Evans-Pritchard, in a recent Telegraph article, outlines somewhat of an unheard topic in recessionary journalism: global economic power shifting back to America.

“The switch in advantage to the US is relative. It does not imply a healthy US recovery. The global depression will grind on as much of the Western world tightens fiscal policy and slowly purges debt, and as China deflates its credit bubble.

Yet America retains a pack of trump cards, and not just in sixteen of the world’s top twenty universities.

It is almost the only economic power with a fertility rate above 2.0 – and therefore the ability to outgrow debt – in sharp contrast to the demographic decay awaiting Japan, China, Korea, Germany, Italy, and Russia.”

Neither a borrower nor a lender be

In Shakespeare’s Hamlet, Polonius shared with his son Laertes critical advice that has withstood the test of time. The saying “Neither a borrower nor a lender be” is still used today and holds various meanings to its users. The full discussion between Polonius and Laertes revolves around the trip that Laertes is about to embark upon. Although the attitudes and preconceived notions towards finance and borrowing during Shakespeare’s time are greatly different, we see that the advice created still holds value in today’s modern financially intertwined societies.

The literal conversation that took place in Hamlet between Polonius and Laertes is just, to the unknowing reader, fatherly advice to his son who is about to travel and mingle in the dangerous land of Paris. The conversation goes, “Neither a borrower nor a lender be; For a loan oft loses both itself and friend, And borrowing dulls the edge of husbandry” (Shakespeare). Polonius is saying that lending and borrowing money is a dangerous sport. It can greatly influence relationships and add an extra level of complexity to ones life. In today’s society, borrowing and lending money is much more regulated then during Shakespeare’s time.

The underlying principal of owing or lending an asset of great value to a person who might not make good on the arrangement still resides. Modern markets are much more efficient in connecting lenders and borrowers, mostly through financial institutions such as banks. These institutions add a level of security because of their size and backing. This backing comes in the form of legal action, insurance and collateral. If the borrowers in Shakespeare’s time where to neglect their obligations, the lender would be left holding the bag plus the added complexity of the damage to their relationship. Today, banks act as impartial lenders who minimize the risk through various resources, ultimately relieving as much of the possible dangers related to financing.

During the era of Hamlet, it is interesting to note the level of borrowing that was occurring. It is said “in the days when Hamlet was first staged, borrowing was epidemic among the gentry, who sometimes neglected husbandry to the point where they were selling off their estates piece by piece to maintain an ostentatious lifestyle in London” (eNotes). The attitudes of the upper class towards lending and borrowing money were generally negative. It was thought, during this time, that a proper gentleman should be able to carry his estate forward and provide for his family on with his own merits. The act of borrowing brought forth a perceived weakening of the persons’ social status and ability.

A more modern example of this age-old prophecy is the current European crisis. Weaker economies who are relying on a Euro-zone bailout, such as Greece and Spain, are living through the trials and tribulations of there past decisions. The Euro-zone as a whole is expected to relieve the financial burdens created by these weaker countries through financial support. Stronger countries, such as Germany and France, are faced with the decision to help their “friends” to the south ride out the turmoil.

The European Central Bank (ECB) and International Monetary Fund (IMF) have all reigned in on the issue.  It is said that, “Germany is under pressure from the US, France and some other countries to go further than just expanding the EFSF (European Financial Stability Facility) to 40 billion Euros”… possible solutions include, “letting it borrow funds from the European Central Bank or private investors in order to buy euro-zone government bonds” (WSJ). It is becoming clearer that Greece and other struggling countries problems are not limited to the euro-zone, Europe, and just there markets. The social unrest and economic burdens stemming from these crises will damage the global economy for many years. The age-old saying from Polonius to his son seems to be holding true.


Shakespeare, William. “SCENE III. A Room in Polonius’ House.” The Complete Works of William Shakespeare. MIT. Web. 28 Sept. 2011. <;.

ENotes. “Neither a Borrower nor a Lender Be – Shakespeare Quotes.” ENotes    Literature Study Guides, Lesson Plans, and More. ENotes. Web. 28 Sept. 2011. <;.

Forelle, Charles, and David Crawford. “Euro-Zone Bailout Plan Progresses” Business News & Financial News – The Wall Street Journal Wall Street Journal, 28 Sept. 2011. Web. 28 Sept. 2011.            <;.

“What’s wrong with America’s economy?”

The Economist has recently summarized, in great macro fashion, what it believes to be the greatest problems facing growth and economic stability in the United States. The speedometer to most economic problems relates back to Americans happiness and the future outlook, which is at recent all time lows. Throughout history, when the grimmest times are upon, the US always seems to recover and spur growth. Some instances in the past include “the inflation ridden late 1970s or the fear of competition from Japan that marked the jobless recovery of the early 1990s”. Both these periods in history rebounded with abundant growth. When 3 out of 4 Americans do not have faith in our political system (Congress) it is time for our leaders to take a step back and reevaluate the plan.

Recent statistics exhibit increasing market stability and decreasing unemployment, which are all great signs of economic recovery, but many Americans have yet to get the same impression. Although all of our problems are not due to cyclical and short-term worries portions of this angst can be attributed to rising gas and stagnant housing prices. The major concern is founded in the long-term negative outlook “about stagnating living standards and a dark future in an economy slow to create jobs, saddled with big government deficits and under threat from China”. Americans need to focus more energy on recovering from the recession than looking at what is coming up from behind. The global economy is so intertwined that when one of our major allies is growing we will also reap the benefits. The Economist also notes that many of these emerging threats do not have “a Silicon Valley… or Ivy League”, substantial proof of US economic vantage.

The outcome of long-term growth and happiness lies in how we react and alter some of the lagging areas of our current economic/political system today. Problematic areas of concern include the corporate tax structure, the national budget deficit, and job growth. All of these directly affect the economy but tie back to our political structure. To increase corporate growth and the amount of federal revenue generated their needs to be some incentive to bring American companies operations back home. This will not only benefit all through taxes collections but help job recovery and growth, potentially spurring the upswing needed to put the country back on track.

The level of federal debt is at a staggering 90% of GDP. Globalization provides larger open economies, such as the US, a cushion from initially feeling the repercussions associated with this issue. But, at the current rate we are heading it wont be long before the cushion wears off and substantial changes to American lifestyle will be inevitable. As US tax paying citizens, we are all in this together and need to create a plan to limit spending, increase amount of revenue generated, and budget our countries future more carefully. The greatest power we have to affect these changes is our vote.

The most substantial consideration affecting happiness relates to job recovery and growth. In recent years, the recession has claimed millions of careers and left many Americans structurally unemployed. Structural unemployment has been prevalent through the Euro Bloc for years but seems to becoming the norm in the US, having the “smallest fraction of prime-age men in work and in the labor force than any other G7 economy”. Our legal system/prisons, drug policies, and education are the largest contributors leading to increased structural unemployment. This abnormal decrease in the work force will certainly affect future growth and economic benefit for many years to come, unless changes occur now.

Print Edition, Leaders. “Angst in the United States: What’s Wrong with America’s Economy? | The Economist.” The Economist – World News, Politics, Economics, Business & Finance. Economist, 28 Apr. 2011. Web. 03 May 2011. <>.