Saturday, March 1, 2014

Review of Traders, Guns and Money by Satyajit Das

"Derivatives have always been about knowledge: people who knew, people who didn't."

Satyajit Das is a former derivatives trader and marketer who is jaded and cynical and is pretty honest about the ways that the banks jam the derivatives customers they trade with. In Traders, Guns and Money, he quotes an early career mentor about getting clients - for these types of derivatives trades, industrial companies hedging interest rates or commodities prices - to do more business: "Give the guy a win first up - he'll be hooked. Then, you reel him, real slow."

Most of the book is about a consulting job on behalf of an Indonesian company that got totally jammed by a bank with a crazy derivative transaction. Satyajit was involved in many Asian derivatives deals, and he has an amazing anecdote in the prologue about Asia bubbles. This is supposedly delivered by an anonymous financier in Hong Kong:

"There are distinct phases in investment madness in emerging markets. Phase one is growth. You get a lot of foreign investment. It is mainly relocation of production facilities. Cheap brown people do dirty jobs for nothing [...] In phase two, living standards improve for the fortunate. For the bulk of people, nothing changes, of course. A middle class develops chasing McDonald's and Wal-Mart consumer heaven. Property prices and shares go crazy. Local banks lend recklessly. Foreign banks lend recklessly to local banks. The foreign banks think the local banks won't fail because of government support. Investors dive in. They talk about "growth" and "portfolio diversification". [...] Phase three. Costs rise to levels that make the economies uncompetitive. They are not cheap any more. Alas, the capitalist caravan must move on. [... Local] politicians talk bravely about the 'need to move up the value chain'. They launch ambitious initiatives - the world's tallest building, the world's longest building, a new port in a country which has no sea access, bridges over rivers between two cities that do not exist, entire new cities! [...] Foreigners develop a peculiar hubris. They are bulletproof. Fundamentals of value are irrelevant in this world. [...] Then, of course, kaput, it collapses. This was in 1995."
This is exactly what has happened in China. Describes it to a T. And things are in the stage right before collapse.

Think of a Venn diagram of types of investors. There is a very large circle, representing a lot of capital, interested in owning things that are doing well or "going up" - the momentum investors. There is a much smaller circle that represents people interested in grim situations - the vultures or distressed investors. Satyajit describes what happens when the tide goes out,
"Investors belatedly reviewed the value of investments. Glamorous companies, touted as 'best-of-breed' world beaters, turned out to have no earnings, no cash flows, and no value. Most seemed to be vehicles for property speculation."
 Then a sharper breed comes in and picks through the rubble.

This quote really resonated:
"in one investment bank, an analyst focused exclusively on equity research coverage of a single global resource company. The research was excruciatingly detailed and of doubtful relevance. The analyst seemed confused as to whether they were analyzing or running the company." 
As often happens, Ben Graham already wrote about it,
"A thing I would like to warn you against is spending a lot of time on over-detailed analyses... because you get yourself into the feeling that, since you have studied this thing so long and gathered together so many figures, your estimates are bound to be highly accurate. But they won't be."
Another funny observation is that in the late 90's, the "central banks sold off their gold reserves, forcing the gold price lower. This triggered increasingly aggressive forward gold sales by gold miners trying to protect themselves from falling prices". Now, one of the clues that it was time to buy gold at the bottom at $285 was that the miners themselves were so pessimistic. They were closing mines and they had also sold years of their production forward - meaning it was already spoken for.

This was almost a 5/5 book. It's definitely underrated by the dorks in the Amazon reviews who want an ibank desk job ripping off derivatives customers  and who thought they were buying an instruction manual.

Derivatives dealing isn't that hard. I mean, you have to be good at math. But it isn't any more difficult than being a surgeon but the traders make 10x or 100x as much. Some good writers like Falkenstein have pointed out (and Satyajit confirms) that the trading vigs are really coming from the firm and not trader talent. That leads to a theory of these big profits being a result of an oligoploly of financial institutions.



Stagflationary Mark said...

Another funny observation is that in the late 90's, the "central banks sold off their gold reserves, forcing the gold price lower.

As a person who owned gold from 2004 to 2006, I find this topic quite interesting.

I have been asked (in the past) why I no longer want to own gold especially now that central banks around the world are buying gold.

My answer is always the same. If the best time to buy gold was when central banks were selling (which is definitely true using hindsight), then it stands to reason that the best time to sell gold is when the central banks are buying.

It is not rational to use central bank buying and selling arguments any other way in my opinion.

Put another way, if someone claims that we should be buying gold because central banks are buying, then in order to be consistent that same person must claim that we should have been selling gold when central banks were selling.

Since we know for a fact that we should not have been selling gold when Gordon Brown was selling gold in the late 1990s, the whole argument falls apart.

Nothing ruins an investment idea more for me than arguments that don't make logical sense. I can see valid arguments for owning gold but central bank buying is definitely not one of them.

In any event, I no longer wish to own gold. I told myself that when I bought in 2004 I'd only be selling once. I sold for a 50% profit in 2006. In hindsight, it was a reltively low risk "low lying fruit" trade (although it did not feel like a low risk trade at the time). I'm done. In order to want to buy it again, I'd need to see it come down in price substantially (compared to toilet paper and aluminum, two items relatively speculator free).

All rising gold prices can do for me now is inspire me to hoard more basic necessities (ones that do not require a greater fool to make them useful to me). These relatively lower gold prices of late don't even get me to do that these days (at least not like I was). I'm leaning disinflationary/deflationary. ZIRP is looking more and more like a long-term situation (with little to no hope of escape). Sigh.

CP said...

Yep, exactly.