A tale of exponential interest

Imagine you have a savings account and you deposit an amount. The bank transfers the interest to your account and the next time you get interest on your principal plus all the interest transferred to you until that time.

This is known as compounding interest. In my more technical blog I derived the interest paid to that account, see it here. It is a differential equation whose solution is the exponential function
$$e^{kt}$$
Where k is the interest given by the bank.

Could everybody be infinitely rich? Of course not. For these interests to be payable either there is debasement of the currency or the market should be flooded with products manufactured at the expense of this planet's billion-year energy reserves (be more aware of what surrounds you, you can download for free the excellent manuscript by D. MacKay). Until today we have used the second option. If we run out of energy, the first option will come suddenly.

Also read the interesting post at Do the Math displaying the views of an economist and a physicist about the topic. Some excerpt for your delight:

Physicist: Before we tackle that, we’re too close to an astounding point for me to leave it unspoken. At that 2.3% growth rate, we would be using energy at a rate corresponding to the total solar input striking Earth in a little over 400 years. We would consume something comparable to the entire sun in 1400 years from now. By 2500 years, we would use energy at the rate of the entire Milky Way galaxy—100 billion stars! I think you can see the absurdity of continued energy growth. 2500 years is not that long, from a historical perspective. We know what we were doing 2500 years ago. I think I know what we’re not going to be doing 2500 years hence.

On sociopaths, sheep and truth seekers

I recently came across this article and was especially moved since I have been working with a problematic yet charming individual who has managed to deceive a lot of people. I agree there is no objectivity in this text, but the intuition it contains feels very realistic:

Within the realm of human society and human governance, the population is divided into three general brain types: Sociopaths, Sheep, and Truth Seekers.

Sociopaths Within the human population there exist a small subset of individuals whose brains are essentially defective in one important regard: They do not experience emotion as the rest of the population does. They are driven only by the temporary happiness (or exhilaration) obtained through the gain of power or money.
Once this temporary rush wears off, they exist only to seek their next fix. Although they do not experience normal emotions, they understand well how to emulate them and how to manipulate them to their advantage.
Sociopaths tend to feel little remorse and do not have a conscience in the normal sense. They do not seek to simply live their lives, and as a result, have tremendous amounts of time to devote to their solitary purpose of obtaining more power and more money. They are naturally suited for climbing social power structures. The highest levels of banking, finance and politics contain far larger concentrations of sociopaths than the population at large.

Sheep The great bulk of the population exists neither to control others or to discover truth. They simply want to live their lives. They attempt to do this through the path of least resistance. The process of seeking truth involves tremendous amounts of mental work that gets in the way of living their lives. They prefer not to do the heavy lifting required to arrive at a set of beliefs, but rather, to adopt a predefined set. They find great comfort in seeking the approval of others as it reassures them the belief systems that they have adopted (or have been taught) are correct. Once reassured, they are relieved of the arduous mental work required to discover the truth. The Sheep tend to follow the voices of the sociopaths, who in turn seek to herd them; to shear them; and in some cases – to slaughter them.

Truth Seekers At this this end of the distribution lay the diametrical opposite of the sociopaths. These are the individuals whose desire for truth and the ability to live free, is so strong that they will accept a more difficult life in order to accomplish those goals. Unlike the sociopaths, they have no desire to wield power over others. In fact, they view the control of others as a great burden – a tremendous drain on precious time – time that should be spent discovering the true nature of the world around them. These people are strong individualists and tend to be scientists, artists, and thinkers. Because of their inherent nature, they tend to avoid any involvement in politics, the bureaucracy, and institutions of management. It is only in times of great political strain, and threat to their own freedom, that they are forced to become part of the politic. They rise up during times of revolution, as necessary, only to fade away once the overthrow of the sociopaths has been accomplished. Power is then gradually yielded back to the sociopaths as the lessons of the past are slowly forgotten by subsequent generations of Sheep.

Now, the individual I have been working with gained my total trust and friendship, only to discover he is a narcissistic sociopath, in the need of people praising him around. No financial harm came from him, but he meant a setback in my career and, more importantly, I was psychologically impacted during the time I continued working with him since the day I discovered his true personality.
 
People with such problems fill the upper ranks in the organizations. Psycopaths and sociopaths present themselves as charming and efficient, and they thrive in times of risk-taking.

Do not forget that your best friend is not the one who tells you what you want to hear, but the one who tells you what you need to hear.

BFA-Bankia update: converging to fair value

Bad news for Spanish retirees, especially for my retired policeman contact there.

All the way down from EUR 3.75. The Spanish government has bailed out the bank, taking EUR 7bn in convertible bonds. A default would trigger the bonds, officially making the State a shareholder of the bank.

Now, the history of this bank is one of getting liquidity from where there is some to bail out banks with no liquidity at all. The source of liquidity was Caja Madrid, a public regional bank with plenty of current and savings accounts. The liquidity hole were CAM and the like, deeply immersed in real estate, especially vacationing houses. To support the plan, the company went public with an initial price of EUR 3.75. The main public were retirees, who have financed the whole operation so far.

Savers have withdrawn about EUR 1bn from the bank and is in the verge of a full-blown bank run.

Debunking Jim Rogers on farming

Jim Rogers has been speaking a lot about farming being the profession of the future. Now, I love his insights and I regard him as one of the best and most honest investors, as I have already said, but reading that a farmer will become as rich as a banker is something ridiculous. Nobody in the history of the world has become rich harvesting. Ever. Per Zerohedge:

His advice, and perhaps Maria should look into it given their ratings recently, is to become a farmer; own farmland; and speculate on agriculture. On the dismal 'ethical' state of our leaders and management, the thoughtful Rogers opines, "You can read world history for decades. There are always people doing things wrong. We have not changed our human nature and we will continue to have scandals and problems" and in a follow-up to CNBC's standard 'money-on-the-sidelines' argument he crushes the money-honey's dreams: "Finance had a great 30 years. That's finished. Now to advance, we have too many people, too many MBAs, too much leverage and too many governments that don't like us". A must-see rebuttal to the 'normal' CNBC hopium with more on China's slowdown, a US recession, Europe and a Greek exit, QE3, and 'tractors'.

Let's analyze this. If the world is to become more rural, then about three in four of the population are expendable. Maybe that is supported by the statement in red. In the absence of banks, credit and monetary base expansion, life as we know it has no meaning anymore. Let's assume that you follow his advice and you survive the holocaust that a reduced banking sector means for the world. Becoming a farmer implies spending your time caring about your farmland. This means that you are open to intruders and armies. What happened at the end of the Roman Empire? People gathered around some strong authority: the count. He, and other nobles and rich men, bankers among them, were large landowners, never farmers themselves. This is what always happens. There will always be legions of poorer people than you that are willing to take a farming job for little money, just go to any farm. If you become a farm owner and get some hold of the laws governing your area, then you will fill the role of count. Otherwise, the one who has a better hold of the sword will take your farm and impose his law.

BTFD

Gold forming short term bottom. Spreadone goes for STRONG BUY and reports Citi prop trading buying 310 @ 1557 and Barclays 190 @ 1662. Also, Goldman Sachs bought EURUSD 290 million @ 1.2833.

Gold and correlated markets including EURUSD forming very short-term bottom and could see a nice rebound, ahead of the ECOFIN meeting.

Bear in mind that short-term measures and rebounds will not endure the deflationary environment and that only straight QE3 will push markets up. On the downside, remember that Greece is already discounted.

Listen to people who have something to say

Watch The FRONTLINE Interview: Cathy O'Neil on PBS. See more from FRONTLI

And her very, very interesting blog at http://mathbabe.org/

In life, follow your heart. In trading and investing, don't

Markets play with investors' (but more so with speculators') psychology. They can only exist because of this psychology. The brain is a machine that learns patterns. However, most of the patterns presented in life are contextual and regular. This is, a situation has some conditions that can be described with a model such as "my boss started yelling at us and the atmosphere became tense so I employed carefully chosen words and adopted a cautious attitude". The regularity is identified in the brain as a tense situation, and the contextuality is presented as it comes, the boss started yelling and the situation became more tense. As the situation becomes less tense, we react differently, with more ease.

Markets do not offer the same patterns that life has presented to us in one million years of evolution. Continuous moves lead to sharp reverals and volatility clusters in an unmanageable way. Thus, we identify regularity in clustered directional moves and contextuality when these have already happened. And that is when the reversal comes.

It is not surprising that relatively few people can master this. As the experimental physicist can master something so far away from basic evolution as the manipulation of particles beyond the atom, prominent investors identify patterns different from what life provides.

I read an interview to Rick Rule (yes, despite appearing a lot in KWN) sums up the previous ideas. The summary is taken from Zerohedge (link):

What's important is that good markets are for selling and bad markets are for buying; it's counterintuitive. Your perception of how events will play out in the future is determined mostly by your experience in the immediate past; and if the last three investment decisions that you've made have rewarded you – if you feel good about your precepts – you begin to do something natural, which is confuse a bull market with brains, and you begin to become very aggressive. If your last three decisions – irrespective of whether they were well thought out – haven't played out so well, you become cautious. What you need to do is teach your brain to overwhelm or overrule your heart and understand that cheaper is better and more expensive is less good. It's difficult, but it must be done. Many things that are rewarding are difficult.

This is the idea underlying my decision to open a long position in EURUSD. There initially was a bounce and I saw no strength (I hoped it closed the gap 1.3050 - 1.31, which it did not), but I made the mistake of marrying that position and then it became a losing one. Since this position is extraordinarily small under 10K EUR long, I can afford the luxury of retaining it and use a spike to close it. It will count as a fail and the marriage mistake and consequent overview of the lack of strength is noted.

 "The time to buy is when there's blood in the streets"

Baron Rothschild in the 1800's

The turning point and the next leg in Gold

We have been warned about further near-term weakness in gold and pretty much else by prominent investors such as Jim Rogers (link here)

That is not to say that gold is bulletproof. In fact, Rogers says a gold price correction could happen sooner rather than later, and the downside is USD1200 - USD1300 a troy ounce.

and Marc Faber (link here)

Gold may not perform very well in the near future. The gold market has performed so well, we could have some setback.

Which is part of a broader market weakness stressed again by Marc Faber (link here)

The market is vulnerable. Many stocks sell off on news that is not really bad, but not just as good as expected. So I am of the view that maybe we have something more serious here.

Bear in mind that no asset will inflate more without additional monetary stimulus. The inability to generate profits at the same pace than overall interest payments due to sustained high energy prices is burning the money that solvent businesses have. A credit implosion burns money and removes liquidity, creating a monetary deflation whose effects are similar to the Great Depression. This is what Bernanke knows, but I don't know whether he has factored in the true importance of oil in the equation.

In any case, without monetary easing, equities will crash, draining liquidity out of the system and making several institutions insolvent, which will spur fear into the already weakened markets and will drive them further down. That is the signal Bernanke is waiting. I've been hearing talk about further QE since April 2011, but Bernanke is an elegant guy and will not let politicians, economists and the broad public criticize him over QE. They will have them begging him for more QE. And that moment will come once equities crash.

This scenario is a market-wide collapse in which only one asset would survive: oil in case of a conflict with Iran, an option that has become increasingly likely. Short everything, long oil.

Concerning gold and silver, bloggers Dan D. from The Fundamental View, Mr. Hui from Humble Student of the Markets, and of course the previously mentioned investors Jim Rogers and Marc Faber, and myself, are expecting further short-term weakness that will make the metal plunge (for the last time in my opinion) until reaching the max pain point of many investors, only to recover after institutional investors (not the small investor) counts on immediate easing. Look for a massive drop in both the price and open interest in the COT (Commitment of Traders). I am no chartist (and I could use one), but I believe that USD18 to USD20 could be a bottom for silver in the worst-case scenario, that would revert all gains from QE2. That would put gold in USD1260 to USD1400 using a crashed-BDI ratio of 70. I chose this ratio because it would coincide with low industrial demand for silver, and would correlate very well with another plunge in the Baltic Dry Index.

I believe the 1260 number is appealing to technical chartists, since it is the bottom gold made back in 2010. This figure is also in the range Jim Rogers is saying in the media.

So, wait for those beautiful Chinese 2012 silver pandas to fall into your hand at incredibly cheap prices. Be patient, buying silver will again be profitable and a very good investment because it will react with the same strength as it did in 2011.

And if you plan to trade these markets, trade safe and good luck.

DISCLAIMER: I have no position in commodities at this time, nor I plan to open any position in the near future.

Long EURUSD (small) position opened

Last sunday I bought some EUR at 1.2980 betting on a quick recovery from the French/Greek elections "shock" and French banks taking advantage of a weaker Euro to repatriate more capital. I believe further weakness is highly likely and this position is very small (thousand EUR). Although it has recovered the 1.30 barrier (1.3035) and has proved to be stronger than gold and oil (but weaker than equities), I am not comfortable with this position and will use any spike to close it.

My opinion is that, absent monetary easing, being long is risky even though equities are somehow being levitated, making this a time when being at the long side is very risky. Further bad news out of Europe may send this pair lower. It is easier to open a short position at a comfortably-enough high price (in any high beta asset) and wait for a plunge (such as the ones we have been observing), since volatility to the downside will be higher.

The college bubble

Ten years ago I though that university degrees would be increasingly worthless with time, given the number of colleges that admitted an ever-increasing number of students, along with the number of new colleges opening each year. In other words, it was apparent that college degrees were in an inflationary cliff.

On the top of that, college aggregated costs (including undergraduate tuition, room, and board at public institutions) rose 37 percent between 1999–2000 and 2009–10. Prices at private institutions rose 25 percent. The new normal in the US has been to take student loans (which are on the verge of default in a sub-prime implosion, as Zerohedge have commented on numerous occasions). All prices are adjusted for inflation. In Euroland, friends in Spain report that one academic year is now EUR 2000, up a 66 percent from the previous year.

As a desert, we have been introduced to "degrees" unrelated to arts or the sciences, or to nothing in particular for that matter, such as gender studies, studies for gender equality, social carer (now with college degree inside!) and so on. Weak degrees such as education have become a nest where mediocrity is now synonym to achievement.

These three facts (rising number of students, of degrees and prices) are clear symptoms of an education bubble. My opinion is that one must put space between himself and this bubble. In this case, one must learn to face life without the imposed need for a degree. Stay away from degrees which are inherently professional and promise the job of a lifetime. Stay away from degrees swept by dumb people bent on parties and giving shit about culture, knowledge and hard work.

If you want knowledge, a very cheap way to get it is to buy the books by Dover Publishers and solved exercises by Schaum. With prices ranging from USD5 to USD30 on Amazon, you will be given everything you need to acquire knowledge. Math forums exists all over the Internet, so specific questions can be addressed and discussed by anonymous posters. Also, don't forget about materials published in platforms such as OpenCourseWare from MIT and Stanford.

When taking a job, one would start from the bottom but with technical ability and knowledge there would be no obstacle to reach the top if the company is honest and with a foot in the real world. Remember, the old paradigm is dying.

Of course you could go to Germany or any other country that still subsidizes its education. For now.

Think about it, it is hard, but the other option is placing yourself in the world of underwater student loans.

PD: Just as I was about to hit "publish", I stumbled upon the last quote by Marc Faber, in this very line of thought, that I quote here:

My advice to young people is that the degree is not important. If you have parents that can pay for your degree, then I would take one. If I had to borrow a lot of money, I’m not sure I would take one. I would try to work for someone who is successful and acquire knowledge from them.

Whatever you do, you should do with a lot of passion and heart and like what you do. If you like what you do, you will do a better job than if you are indifferent to what you do at your job. I think there are plenty of opportunities in every field.

Short EURUSD position closed

I closed a short EURUSD position that was lagging in my account from sometime ago (from 1.34) and that was very small (I know, it is bold to have a position opened but life at work has not been easy and one has his priorities). Closed at 1.3130, I pocketed $400. If EUR remains weak for the day I might consider going long. It went down a lot for the day and the reasons for a strong EUR reported by Zerohedge are still in place, namely: USD-priced asset repatriation by French banks. This might only be a speculative movement against Manufacturing PMI figures, and might correct itself during the day or week, given that the European markets opened higher.

In any case, a tail move of 100 pips such as this one provided an excellent opportunity to get rid of this "legacy" position.