Wellness Check

Will Casey |

“That millions of people share the same forms of mental pathology does not make these people sane.”- Erich Fromm


Sam Bankman-Fried, or as he prefers, SBF. Where to start? Perhaps at the end. The fluffy, t-shirt sporting, tousle haired “genius” was the darling of the cryptocurrency space—until he wasn’t. I assume by now that you have heard enough about the colossal failure of both of his companies, Alameda and FTX, and maybe you paid attention long enough to hear about the collateral damage to other related entities—BlockFi, Solara, Liquid Global (hilariously misnamed), and many others. In fact, according to the firm’s new CEO, restructuring expert John J. Ray III, there were roughly 130 companies that had been operating under FTX Group. Most of these will, of course, vanish and somewhere between 100,000 and 1 million other creditors will be left staring vacantly at their account statements wondering how it all went so horribly wrong.

How did SBF get away with what appears to be either incomprehensible incompetence or massive fraud for as long as he did? By creating—as Ben Hunt, publisher of Epsilon Theory calls it—the Magical Money Machine.

Commodity trading in general and crypto trading in particular have much more lax regulatory environments than do traditional securities. SBF exploited this fact to advertise something that would never have been allowed in a traditional security solicitation. Alameda promised a 15% annual return on borrowed money (you could not invest in the equity of Alameda, only lend to it) while simultaneously pledging this from Alameda’s 2018 pitchbook: “These returns have no downside – we guarantee full payment (sic) the principal and interest enforceable under US law and established by all parties’ legal counsel.” Given the lack of minimal editing and the outlandish claim for well above market returns with no risk you have to wonder how any sophisticated investor (lender)—and there were plenty—fell victim to this sham.

Leaving nothing to chance, SBF greased the palms of legislators on both sides of the aisle (to the tune of over $40 million), promised millions to high profile charities, launched a multimillion dollar ad campaign during the 2022 Super Bowl starring Larry David and Tom Brady (the beginning to a year Tom would undoubtedly like to forget), cozied up to key US regulators—the Commodities Futures Trading Commission and the Securities and Exchange Commission—and volunteered to help them craft new regulations for crypto trading (what could possibly go wrong), and finally, acquired naming rights for the Miami Heat stadium for a cool $135 million.

What isn’t surprising are the lengths to which SBF went in order to camouflage the inevitable disaster. What is surprising is that once again so many investors fell victim to the allure of the Magical Money Machine.

How does Las Vegas still exist when we all know the house always wins? How does the Powerball lottery routinely attract hundreds of millions of dollars with hundred-million-to-one odds? Through the promise of outsized return for minimal effort.

The collapse of Alameda and FTX is just the most recent signal that we are in the beginning of the end of this most recent period of speculative mania. It is however, not the only signal. Here are a few other examples.

Cryptocurrencies. Bitcoin’s price peaked at over $65,000 per coin on November 8th 2021. As of this writing, its current “value” is $16,677—a 74% decline. The other powerhouse in the crypto world, Ethereum, hit its high on the same day as Bitcoin at $4,626. Today it is “worth” $1,251—a 73% drop. Many other lesser-known coins have fared much worse, and are for all intents and purposes worthless. My original thoughts on crypto haven’t changed much and can be found in the July 2021 newsletter, Planet of the Apes, found on the Access website.

Meme stocks. A meme is defined by the American Heritage Dictionary as “a unit of cultural information, such as a cultural practice or idea, that is transmitted verbally or by repeated action from one mind to another.” The idea was identifying companies that had fallen on hard times and whose price could be manipulated, the transmission was the communication of this plan on the social media site Reddit, and the repeated action was executing buy orders for the stock in question. The result was to drive these meme stocks to prices that were unrealistic and unsustainable. Two companies were front and center in that action. AMC (yes, the movie theater company) stock was taken over by “apes” (a derogatory term for a group of investors that banned together on Reddit and pushed market prices around by their collective actions). And take over they did. AMC’s stock hit $59.26 on June 14th 2021 before falling to the current price of $4.08 (↓ 93%). The poster child for meme mania was is Gamestop (yes, the futureless video game purveyor) which rang in the New Year in 2021 at $81.25 before falling to the current price of $17.33   (↓ 79%). You’ve got to hand it to the true believers in that one. Hope springs eternal.

Tesla. It is interesting to watch how one of the most respected men in the country (world?) has turned so quickly into a pariah to many. Leaving Elon’s personal challenges aside, my concern is, and has been, the valuation placed on his company. As I wrote about in the January 2021 newsletter, Anti-Gravity, it was is difficult to see how the valuation that investors placed on the stock has been at any point justified by the underlying profitability (or for a long time, lack thereof) of the company. Being first to a market is important, but not so important as being able to defend your position in that market when others enter. Tesla stock peaked at $381.59 on November 1st 2021. The current price is $113.64 (↓ 70%). At the time of my original writing on Tesla, I came up with a $49 price if you valued it as Elon described it, as a technology company. This was calculated at the time using price/earnings multiples that were much higher than they are now. I also calculated a value if Tesla were merely a car company. That number was around $10 per share. However you slice it, the current valuation still looks rich.

ARKK. Cathie Wood was, for a time, considered the smartest person in technology investing. Her tech focused Exchange Traded Fund clocked consistent, outsized gains against the broader stock market, even though many of the companies in her portfolio hadn’t made any money. Her fund hit its high price on November 7th 2021. Since then the fund has lost 80% of its value. At least in Vegas you’re offered a cocktail.

What’s the common link here? The examples above illustrate speculative behavior that peaked in 2021. What’s to blame for all of this risky conduct? Covid policy (free money), Federal Reserve intervention (cheap money), climate concerns (incentive money), financial nihilism (skeptical money). Money. When trillions of dollars can be created through nothing more than a few key strokes it inevitably lands in someone’s hands. If no more goods,  services, or productive enterprises are created by this money, prices for each inevitably rise.

The US stock and bond markets have not been immune to the rapid unwinding of risk. As measured by the S&P 500, the US stock market is down 19% from its summit in 2021 and the bond market is down 18% from its high water mark in 2020. The equity markets of developed Europe and Asia logged similar results with the EAFE Index falling 19% from its high. China fared much worse. The Hang Seng Index is off 36% from its peak. The pain experienced is universal.

As is normally the case, Central Banks around the world have been late to recognize the forces that they have unleashed all over the globe. As is always the case, politicians will continue to push Central Banks down the path of easy money to protect themselves from torches and pitchforks. Our Fed will pivot. The only question is when. Will it reverse its current course on interest rates too soon adding fuel to the inflationary, speculative fire? Or will it continue on the path of high interest rates pushing our economy into a full-on recession (one that everyone can finally agree is happening).

We continue to be vigilant for any policy changes. For the moment we remain committed to our focus on hard assets such as commodities, precious metals, primary energy, and industrials while looking ahead for additional opportunities  as they present themselves.  

In the meantime, someone should run by Jay Powell’s house to see if he’s OK.