ALTERNATIVE MARKETS UPDATE AUGUST 2020 - FED WANTS OPTIONALITY - AND THAT IS BULLISH FOR VOL

​Alternative Markets Update August 2020
Covid-19 has caused a tremendous impact on central banks and leading to steep sovereign debt increases in the whole world. Figure 1 shows the global sovereign debt to GDP. It is currently at the second highest level it has ever been only behind WW2. As the level of 89.5% shown in the graph is just as of Q1 2020, it is likely that the level will surpass its previous high during WW2, as the most severe impact has been during Q2 2020. Furthermore, central banks had to use huge fiscal support, as shown in Figure 2. The means necessary outclass every economic crisis by far, except for wars. The differences are especially shocking when comparing it with the Great Depression starting in 1929 and the Global Financial Crisis starting in 2007.

Global Sovereign Debt/GDP Levels from 1851 to Q1 2020, Source: BofA Global Research, IIF, IMF and Maddisson Database, August 2020

Fiscal Support of the FED from 1901 until now, Source: BofA Research Investment Committee, Global Financial Data, White House Budget, August 2020

Fed Wants Optionality - and that Is Bullish for Vol! by Aquila Markets
*Fed creates optionality around Yield Curve Control and its “now in doubt” September review – which by definition creates volatility
*We are watching with interest to see if USD higher / risk lower persists, but we do not think the “highs” are in
*We believe the market is yet to begin considering a potential sweep by the Dems – this is a core theme on the radar for the Autumn
Despite having been quite sanguine about the Fed, the golden rule of the Fed “creates” volatility worked once again. There is clearly pushback within the FOMC itself to Yield Curve Control, recognising the upside of entering into a policy that the market is defacto already following is limited. Instead, the Fed has created optionality for itself. Additionally, the market started to question whether the results of the Fed’s policy review would indeed be presented in September, where average inflation targeting – ie letting inflation run Hot – would be a core part.
The timing of such a big announcement is creating an issue for the Fed, given the election, the recovery and the situation with the virus. September we believe will be entering a period of max uncertainty on the those three issues, which makes commitment to long term plans hard to justify, and it may be the Fed it trying to – again – create optionality for itself by delaying until, let's say, December.
​But given the correlations we have been highlighting between rates, equities, commodities (Gold is correlating strongly with TLT, for instance) and realised volatility, any sense that rates COULD go higher caused the spill lower in stocks, especially given the horrendous breadth in US equity leadership, weakness in Asian stocks and a stalling in European markets.

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RESEARCH PERSPECTIVE VOL. 138 August 2020 Alternative Markets Update August 2020 Covid-19 has caused a tremendous impact on central banks and leading to steep sovereign debt increases in the whole world. Figure 1 shows the global sovereign debt to GDP. It is currently at the second highest level it has ever been only behind WW2. As the level of 89.5% shown in the graph is just as of Q1 2020, it is likely that the level will surpass its previous high during WW2, as the most severe impact has been during Q2 2020. Furthermore, central banks had to use huge fiscal support, as shown in Figure 2. The means necessary outclass every economic crisis by far, except for wars. The differences are especially shocking when comparing it with the Great Depression starting in 1929 and the Global Financial Crisis starting in 2007. Figure 1: Global Sovereign Debt/GDP Levels from 1851 to Q1 2020, Source: BofA Global Research, IIF, IMF and Maddisson Database, August 2020 Figure 2: Fiscal Support of the FED from 1901 until now, Source: BofA Research Investment Committee, Global Financial Data, White House Budget, August 2020 The unprecedented interventions of the central banks have caused inflation fears, which increases the value of real assets, especially gold. Gold has risen steeply in 2020 as a consequence of these interventions. A reason why gold might be worth more than before, even if it should crash, is that the mining cost of gold has steeply risen over the last two decades. Figure 3 shows the mining cost of an ounce gold from 1985 to 2020. Silver recently started a bull run as well, during which it had the second-best month ever. Currently, it is now trading between $26 and $29 during the past two weeks. Silver sees a similar development as gold. In comparison to gold, silver is not necessarily getting more expensive to mine, but its mining sees a slowdown, as shown in Figure 4. Overall, the supply in silver mines has declined, while at the same time, there are not many new mining projects in the pipeline. Another important factor is the decarbonization in the US, which will likely cause an increased demand in silver. Due to the expected rising demand and declining supply, silver is expected to rise even further. Figure 3: Costs of Mining One Ounce of Gold, Source: Refinitiv & Andrews Gwynne, August 2020 Figure 4: Silver Mine Supply from 2004 until 2020 (Estimated), Source: Silver Institute, BofA Global Research & Andrews Gwynne, August 2020 BTC (Bitcoin) remained relatively stable during the last two weeks around the $12k mark. Most other cryptocurrencies have experienced more volatility during that time but also remaining close to their level two weeks ago. For ETH (Ethereum), it becomes more and more interesting to see whether the growth achieved in 2020 is sustainable and whether the boom in DeFi (decentralized finance) sufficiently explains the growth of ETH. Similar to DeFi, fintech and tech companies have seen a huge surge throughout the pandemic with valuations of both public and private companies skyrocketing. Figure 5 shows the highest valued fintech startup in every country. Several countries, such as the US, the UK, Sweden, Brazil, China and India, have fintech startups with values above $1bn. Most Western countries have at least one fintech startup with a valuation of more than $250m. Generally, in the tech industry, there is a substantial increase in climate concerns, as there are more and more new technologies in development, launched respectively, as Figure 6 shows. The tech industry has benefited enormously from the crisis, as tech stocks have broken record highs after record highs. Tesla, for example, just reached $2,000 and Apple reached a company value of more than $2tn. Figure 7 shows the historical development of the Apple stock. Apple has reached a high of $1.4tn prior to the crisis on 29th January 2020. During the start of the pandemic, the stock crashed as well, but rebounded relatively quickly and set a new record of $1.5tn on 16th June 2020. Then, within two months, the market capitalization rose to the $2tn mark. Figure 5: Most Valuable Fintech Startup in Every Country, Source: Fintech Collective, August 2020 Figure 6: Climate Tech Hype Cycle, Source: Shayle Kann, Energy Impact Partners LLC, August 2020 Figure 7: Apple’s Market Capitalization, Source: Andrews Gwynne, August 2020 Hedge funds have experienced strong gains in July 2020, as the average strategy is up 3.29% for the month, while the Barclay CTA Index is up 1.63%. Equity strategies had a very impressive months, as our SMC Equity Strategy Index is up 6.19% with the Market Neutral Equity US Algo gaining more than 16%, resulting in a YTD of 50.66%. Other very well performing strategies for the year are Long/Short US Equities Disruptive Technologies and Long/Short US Equity Consumer, TMT, Healthcare with 33.60%, 34.84% respectively. Tactical Trading strategies performed even better than equity strategies in July 2020. Our Discretionary Global Macro strategy is the most successful this year so far with an exceptional YTD of 61.82% and is up 16.30%. Similarly, the Bitcoin Altcoin Actively Managed strategy is up 28.13% in July and 57.52% for the year. 20th August 2020: Journal: Fed Wants Optionality - and that Is Bullish for Vol! by Aquila Markets *Fed creates optionality around Yield Curve Control and its “now in doubt” September review – which by definition creates volatility *We are watching with interest to see if USD higher / risk lower persists, but we do not think the “highs” are in *We believe the market is yet to begin considering a potential sweep by the Dems – this is a core theme on the radar for the Autumn Despite having been quite sanguine about the Fed, the golden rule of the Fed “creates” volatility worked once again. There is clearly pushback within the FOMC itself to Yield Curve Control, recognising the upside of entering into a policy that the market is defacto already following is limited. Instead, the Fed has created optionality for itself. Additionally, the market started to question whether the results of the Fed’s policy review would indeed be presented in September, where average inflation targeting – ie letting inflation run Hot – would be a core part. The timing of such a big announcement is creating an issue for the Fed, given the election, the recovery and the situation with the virus. September we believe will be entering a period of max uncertainty on the those three issues, which makes commitment to long term plans hard to justify, and it may be the Fed it trying to – again – create optionality for itself by delaying until, let's say, December. But given the correlations we have been highlighting between rates, equities, commodities (Gold is correlating strongly with TLT, for instance) and realised volatility, any sense that rates COULD go higher caused the spill lower in stocks, especially given the horrendous breadth in US equity leadership, weakness in Asian stocks and a stalling in European markets. Radar Additions: USDCNH support zone at 6.85-6.90 is on the radar – and has held first time. Given the stretched nature of markets we renewed our 1mth VIX call spreads as the previous ones rolled off – we like to keep paying for what we think are great risk reward bets to keep in the book. We note that TLT VIX (20+yr bond ETF) picked up from the 12/15 support zone on the radarscreen, and we added 04Sep AUDUSD put spreads to the trade opportunities sheet, risking 0.1% of capital. We do NOT think the highs are in, but we recognise that markets that have been anaesthetised by not just liquidity, but the expectation of supportive conditions FOREVER. Anything that shakes this sense creates an uptick in volatility which, by definition, causes position sizes to be reduced, not increased. Re the election – the market has yet to really focus on the potential of a Biden victory. The effect of both share buybacks and Us tax cuts have created a perfect environment for equities to rally in the US, yet the leadership remains so so narrow. More than this, what happens if the Dems sweep all three houses? This would change – materially – the support for equity investors in the US. A core theme we do not think the market is fully appreciating. Figure 8: Performance Overview of Major Indices and Currency Pairs, Source: Aquila Market, August 2020 Figure 9: Performance Overview of Specific Indices and Equity Industries, Source: Aquila Market, August 2020 Figure 10: Overview of Open Opportunities, Watchlist and Closed Trades, Source: Aquila Markets, August 2020 Figure 11: Technical Analysis of Ishares 20+ Year Treasury Bond ETF, Source: Aquila Markets & TradingView, August 2020 Figure 12: Comparison of Ishares 20+ Year Treasury Bond ETF and XAUUSD (Gold-USD), Source: Aquila Markets & TradingView, August 2020 The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, Stone Mountain Capital LTD. Readers should refer to the Disclaimer. Chris Eagle Aquila Markets E : [email protected] M : +447712885718 Chris is an experienced executive who runs his own consultancy service which focuses on business development, market structure, financial market analysis and training. He worked on the sell-side for twenty years. He left Jefferies in 2015, where he worked in the Global Foreign Exchange and was Head of FX product distribution. This perspective is neither an offer to sell nor a solicitation of an offer to buy an interest in any investment or advisory service by Stone Mountain Capital LTD. For queries or for further information around our research and advisory services please contact email: [email protected] under Tel.: +442037228175. 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