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Goldman says cryptos aren’t “viable”, but Wall Street piles in, followed by a legendary quant fund

Wall Street wolfs down BTC

One of the biggest surprises around bitcoin’s critical halving event in May was that full-blown FOMO wasn’t limited to the crypto community. It swept up significant Wall Street players too. And if that wasn’t already enough of an eye opener, the scale of establishment interest ought to have been. It’s no secret that Wall Street remains sceptical overall. Yet as silos separating decentralised and centralised finance begin to disintegrate, more and more Street traders are becoming cognisant of opportunities, like the halving, that look too hot to miss.

Futures turnover across the crypto asset class rocketed 314% to $2 trillion versus 2019’s four-quarter average, according to TokenInsight’s Q1 2020 exchange report. Note that bitcoin futures accounted for 78% of Q1 contract turnover. CME Group’s open interest data confirmed that institutional moves made up the lion’s share of activity. Contract value bounded 43% to $407m, or 8,399 contracts, around a week before halving, compared to the same period in 2019.

What’s more, there’s also evidence that mainstream interest preceded bitcoin’s policy change. Late May brought news of Grayscale Investments’ continued no-holds-barred buying spree. Blockchain researchers calculated that the scale of its purchases, since the halving on 11^th May, amounted to all bitcoin mined since that date – and more. With 18,910 purchased by the last days of May, Grayscale buys outstripped the number of newly minted coins by 6,573. That means the asset manager was also probably hoovering up BTC on the open market.

Through an entity named Grayscale Bitcoin Trust, launched in 2013, Grayscale was the first listed financial group with an exclusive focus on BTC. And if Grayscale has accelerated BTC purchases of late, it’s doing so on behalf of clients: accredited investors only; some of whom may be ‘ordinary’ wealthy individuals, some that may be corporate. In other words, Grayscale’s investment campaign is one of the latest signs that bitcoin is becoming about as ‘mainstream’ as Wall Street can be.

Goldman vs. The Street

But the trend also lays bare a widening split in the financial establishment that mirrors divided global opinion, with newly enthusiastic crypto buyers on one side and die-hard sceptics on the other. Goldman Sachs, the quintessential ‘bulge-bracket’ bank, epitomises the risk-averse point of view right now. News site Decrypt reported that a Goldman presentation to investors decried bitcoin as “not an asset class”. The bank acknowledged that “hedge funds may find trading cryptocurrencies appealing because of their high volatility” but concluded that the “allure does not constitute a viable investment rationale”. That view pits Goldman against a rising tide of heavyweight Wall Street opinion to the contrary.

Enter the Renaissance man

Apart from Grayscale’s unabashed push, the buzz in the crypto sphere has also been cranked by signs that one of the most legendary quant funds in the market may be limbering up to go big on bitcoin. Renaissance Technologies was founded about 40 years ago and is still chaired by mathematician and former U.S. National Security Agency cryptologist Jim Simons. Commonly known as RenTech, the firm is arguably the most successful quantitative U.S. hedge fund ever. Its flagship Medallion vehicle has averaged annual gains of 39%, post-fees, since 1988, with a 66% pre-fee annual return that’s unmatched by any comparable institution. Medallion’s return for the year to mid-April was 24%, already trouncing the S&P 500’s negative 2020 performance.

Bitcoin trading “Permitted“

Consequently, a late-March filing by the group was widely seen as a potential game changer. The form essentially gave notice that RenTech is now “permitted”, to deploy some of its $166bn in assets under management on bitcoin cash-settled futures traded on the CME. Noting that the “relatively new and highly speculative asset” carried several risks, Renaissance did not state whether it had already taken positions in BTC contracts, or whether it would do so in future. The notoriously secretive firm—its main fund has no external investors—hasn’t elaborated since.

All told, there were few concrete takeaways from the disclosure. On the other hand, a firm like Renaissance is unlikely to grant itself the freedom to trade a particular asset and then simply park that facility on a shelf. The group has accumulated a raft of quantitative data-driven strategies over decades of research. It deploys algorithmic systems, AI and machine learning, in a multilateral, multi-asset universe. For an attempted graphical depiction of RenTech’s key strategic pillars, see Figure 1. Note: I have no illusions about the high probability that my take is flawed in multiple ways. Still, I hope it at least serves as an adequate introduction for the uninitiated.

Figure 1. – Simplified graphical depiction of Medallion Fund strategy

Sources: Little Harbor Advisors LLC; Institutional Investor; Wilmott, P., Orrell, D.: ‘The Money Formula: Dodgy Finance, Pseudo Science, and How Mathematicians Took Over the Markets’, Wiley, 2017

Measured iron ore exposure and modest valuation are key

Anglo American, the £26bn mining group, continues to outpace FTSE 100 rivals after a volatile year for basic resource suppliers. Note that Anglo was also among only a handful of large-cap shares with a high-positive score in our recent technical analysis screen, that aimed to discover UK shares with the most, and least, promising medium-term outlooks. Broadly improved appetite for risk over the last couple of months or so has provided firmer ground for the sector, though not before a trade deal began to unravel in May, coinciding with a deepening downturn in China, the world’s biggest consumer of base metals. Now, Anglo trades 17% higher in 2019. That compares with an 8% year-to-date advance by the FTSE 350 mining index, but both price returns have been ravaged by 2019 challenges. Anglo pulled almost 30% higher for the year in mid-June. The FTSE 350 mining index saw its best levels around a couple of months earlier, rising about 23%.

After the slump, most UK-listed base metal shares have drifted higher, though it’s been a grind. For most, the main hope is that getting a ‘phase one’ deal over the line—eventually—will help put a floor under demand for copper, iron ore, aluminium and other heavy minerals. There’s little certainty in the demand outlook though. For Anglo, the fundamental horizon is just as ambivalent. The group pivoted back to metallurgical and coking coal as its main revenue generator in 2018, but has had to change track this year as production economics shifted again.

Anglo American Plc. minerals by revenue – FY 2018

The rise of precious metal prices this year, in the wake of gold, which also underpinned diamond prices, helped Anglo’s stock outperform shares of iron ore-focused giants like Rio and BHP. Ironically, Anglo has more recently been ramping iron ore production, with an exponential 94.9% year-on-year surge in 2019’s first half. Production stood at 21.6% of revenues by July vs. 11.7% a year before. And it is iron ore demand that looks best supported in coming months. Drivers include port inventories from China that began to turn lower at the beginning of Q4, according to Bloomberg data, together with a pick-up in infrastructure investment. Bloomberg also cites a 20 million metric ton deficit in 2019. However, an expected supply-side normalisation in China may weigh from Q2 2020. If seen, Anglo’s measured iron ore exposure would remain an advantage.

Readings aren’t so bright for Anglo’s current chief revenue generator met coal, with uncertainty over shipments to China into 2020 after quotas prevailed throughout October. South Africa, Anglo’s main coal producing country, saw flat volumes at the end of Q3. Diamond production fell 15.7% on the year, the fifth straight monthly fall. Platinum output also weakened.

A picture emerges of a better-diversified and nimbler miner than its FTSE 100 rivals, helping explain the stock’s outperformance. A huge gap in total return versus peers—37.4% over the last year against the FTSE All-Share Mining Index’s 11.3%—is another factor, though bear in mind it partly reflects an outsize $1bn buyback announced in July. At the same time, Anglo trades below counterparts on a number of valuation models. For example its 4.6x ratio of market value over underlying earnings (EV/EBITDA) trails the peer group average by 37%. Still, after the battering the industry received over the past year, most stocks trade below historical averages. Furthermore, after sharp stock price declines rivals’ higher multiples can deceive. Combined with a better optimised output focus, Anglo’s modest ratings should do no harm to the shares in the months ahead.

Chart points

An almost sparkling clean rising trend line since September 2016 continues to support the overall technical buying case. Since marking the high for the year at 2293.8p on 1st July though, AAL has struggled to extend the upside. Additional resistance was created at 2124.8p at the end of that month with a short-lived attempt to break the correction that ensued between July and August. Since then, with assistance from the long-term trend mentioned above, AAL has mapped out a rectangular channel, though the prospective bounds haven’t been tagged since October as the shares marked and recently broke below a shorter-term flag between September and early-November, corroborating 2124.8p resistance. A base has been evident since 11th November around 1994p and would be a precursor of an additional test of a shorter, more limited rising channel in place since the autumn. Below that, the main long-term rising line, would be in play. The overarching bull case would begin to face questions below these structures, with 1759p, 3rd October’s kickback support, a possible decider.

Anglo American Plc. CFD – Daily

As European investors show the most buying interest in UK shares for years, here are the stocks with the best—and worst—chances of strong gains, according to technical indicators

Context

The skies may be brightening for UK shares. Or at least investors are beginning to think so. A Bank of America Merrill Lynch survey of fund managers from earlier this month showed a net 9% of EU investors intended to overweight British equities, the highest in 5 years. Likewise, Morgan Stanley called British stocks “potentially the best global equity opportunity for 2020”, based on a view that hard-Brexit risks are fading fast, though only after battering relative UK stock market valuations to 30-year lows. Reduced bearish sentiment on chronically unloved UK shares also reflects better prospects that Britain could unsnarl its convoluted Brexit process. Improved  global risk appetite on hopes for trade de-escalation helps as well.

Risks are hidden in plain sight, of course. See the recent stock market swings as prospects of a ‘phase one’ deal have waxed and waned. For the FTSE 100, a slide in dividend growth to a fraction of the global average in Q3 may not bode well for sustained net inflows either. Still, we assume investors will tend to seek the best opportunities, even in a limited window of improved sentiment. So we decided to create a ‘screen’ of technical chart indicators with the aim of sifting out stocks with the most and least  favourable near-term outlooks.

Methodology

• Universe: FTSE-All Share Index which includes FTSE 100, FTSE 250 and FTSE Small Cap stocks, totalling 628
• 18 technical studies applied in weekly intervals between 18^th October and 18^th November
• A selection of the studies: Bollinger Bands, Directional Movement Index, MACD, Relative Strength Index, stochastics, short/long-term moving averages, Average True Range, William’s %R, Exponential Moving Average
• Bullish signals scored 1, bearish signals -1. Scores were totalled and stocks ranked according to score
• Scope was managed by selecting the top-40 and bottom-40 ranked equities
• For sector classification, we adopted a combination of the Industry Classification Benchmark and Bloomberg’s BICS (link opens a PDF). Using both allowed a good balance between a system that was sufficiently descriptive but with broad enough categories to spot trends

Things to remember when looking at these results

• Technical analysis is backward looking. Strictly speaking, it tells us nothing about future price action
• We assume that as a snapshot of current conditions, technical indicators can offer clues about what might happen in the near future
• Technical analysis is mostly a tool for interpreting current and recent price action
• Technical indications may turn out to be misleading in practice. Note our methodology hasn’t been back tested

Key points from the results: Sectors

• The general impression conveyed by the results was that so-called ‘value equity sectors’ (as opposed to ‘growth equity sectors’) were favoured. In other words, within the UK stock market, higher-yielding though relatively stable stocks are being favoured by investors over faster-growing less stable shares
• The most frequent equities to emerge, even in our pared back selection were Investment Funds and similar vehicles. There are almost 190 such entities in the FTSE All-Share. The majority received a positive score in our screen. This gels with BofA Merrill’s finding of rising demand for exposure to UK stocks. But funds appeared among both positive and negative ranks. This denotes active selection within the UK market. Because of time constraints and limited space, we won’t go into further detail about funds. In any case, trends are easier to spot from single-stock sets than funds. On that basis, listed funds were removed from our finalised list, but distinct companies that operate funds were kept

Here is a breakdown of sectors/industries that were highlighted most frequently

Source:  Bloomberg

• As hinted at earlier, careful attention needs to be paid to sector classifications. Some classifications may mask more specific trends. For instance, Barratt Developments obtusely is classified under Home & Office products under BICS, though is more usefully categorised as a property share.Similarly, online takeaway firm Just Eat manages to be classified as a media firm
• Generally though, 5 separate Property shares point to a clearly defined appetite for the sector. Incidentally, property shares, which are thought to be amongst the most sensitive to Brexit fallout, have often reacted sharply to news linked to Britain’s EU departure. However, it’s worth stressing that residential property shares have continued their long-term outperformance since Britain voted to leave the European Union in 2016
• The Oil & Gas sector is a stand out with negative pointers. Three exploration & production firms –  Petrofac, Shell and Tullow – and one oilfield services company– Hunting scored minus points
• Retail/Discretionary is another prominent segment with unfavourable indications, including Marks & Spencer and Dixons Carphone
• Asset Management was indicated for both upside and downside simultaneously. Again, this suggests purposeful selection, underscoring revived interest in UK equities
• So-called ‘Gaming, Lodging & Restaurants’ shares appeared 3 times. On closer examination, the stocks comprise one online gambling operator – 888 Holdings Plc – and two pub/restaurant groups – Wetherspoon and Restaurant Group
• The main takeaway from sectors appearing with high frequency is that almost by definition, only a handful of stocks were pinpointed. For that reason we are inclined to see the positive indications as being stock-specific, or at least due to narrowly applicable reasons. Overall, we’re more confident to spotlight a preference for the investment style (‘value’) rather than preferences for specific sectors

Key points from the results: Individual shares

• With consensus upside and downside provided in the complete tables below, it’s possible to spot some shares with positive technical indications that have been rank underperformers in the year to date, and vice versa
• From a mean-reversion perspective, recent positive signals following underperformance may provide a basis for strong recovery. One example is specialist insurer, Just Group (formerly known as Just Retirement).  It has fallen 33% in 2019 but its consensus target price points to 61% upside. Note that consensus target prices do not always agree with the direction suggested by the technical screen
• The obverse of the above may also apply: recent negative signals following outperformance may provide a basis for marked declines
• Large-cap vs. small cap shares: only a minority of large-cap names were highlighted on the bullish or bearish side. Among the former, Anglo American, AstraZeneca, BAE and RBS were the highest-valued firms to receive positive scores. Big stocks with negative scores included, Shell, BHP and Unilever. At £8.5bn, Burberry is the smallest stock by market value that could be considered a ‘large cap’. Still, it’s among the highest-rated stocks in our screen, so warrants a close look. The luxury retailer beat expectations with a solid first-half, despite disruption in its key Hong Kong market
• Generally, we have treated the precise score/rank accorded to any given stock as not very significant on an aggregate basis
• However, the score is likely to be of interest on an individual stock basis
• Perhaps, when more than one stock was highlighted in the same sector, the stock with the highest score, should be favoured most, and vice versa for negatively-scored shares
• We intend to examine individual stocks with strong positive and negative scores in separate articles in coming days and weeks

Shares with positive scores (ranked) – 18^th October 2019 to 18^th November 2019

Source:  Bloomberg

Shares with negative scores (ranked) – 18^th October 2019 to 18^th November 2019

Source:  Bloomberg

Key takeaways/re-cap

• The most compelling takeaway in our view, is that technical indicators strongly point to a ‘value investing’ style as more favoured than ‘growth’, ‘momentum’ or other investing styles
• Investment funds and similar vehicles were the equities investors opted for the most to express both positive and negative views on the stock market outlook
• Oil stocks, and specialised commercial services groups came out worst in the technical screen; a small cohort of retailers also received the thumbs down
• Property was the sector with the most frequent bullish indications in our study
• Mid-cap shares were highlighted more than stocks with the largest market value, though among the latter, Anglo America, Burberry and RBS were ranked highest