More Earnings & the first Fed Meeting of the year. The anatomy of a squeeze - analyzing GameStop and the FTX DeFi index
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The Bitcoin Economic Calendar:
Week of Monday January 25th to Sunday January 31st.
Market Commentary:
Bitcoin: It was the second straight week of losses for Bitcoin amid very high volatility in the crypto markets. Bitcoin finished the week at $32,288 down -9.86%. Throughout the week we also saw the GBTC premium get compressed to 2.7%, its lowest levels historically. The importance of this cannot be understated, we will dive into what this means in more detail later in the episode.
Over the course of the week we also saw Michael Saylor buying the bitcoin dip, announcing that his company Microstrategy had purchased an additional $10 M in Bitcoin at an average price of $31,808/BTC. While small in comparison to their existing position, Saylor also sees potential benefit in signalling to the market that there is still institutional appetite in the low $30ks.
Last, but certainly not least, Blackrock, the largest asset manager in the world, is said to start allowing 2 of its funds to get exposure to Bitcoin through the futures markets. The move allegedly comes as a response to increased investor demand. As the headline by The Times reads, Blackrock giving Bitcoin its "seal of approval" is likely to be considered a massive signal in the institutional investor community.
We continue to see mixed signals in the crypto markets - and a very resilient ball of hot money that does not seem to go away. The price action that we are seeing in DeFi vs. Bitcoin continues to illustrate that there is very likely still a large presence of retail and short-term speculative participation at play in the markets. This may be caused by short term speculators becoming frustrated because Bitcoin "is not going up fast enough" and "is too expensive" and get drawn into "faster moving" coins with promises to be "the next bitcoin", or "the next Ethereum". We have seen this market dynamic before - DeFi could very well become this Bitcoin's rally's "ICOs". In the past, we have seen these types of trends wane away as regulation eventually catches up and the sheer volume of new projects causes investor fatigue and the hype slowly wanes until it reaches a tipping point.
We'll discuss what the options markets are showing for Bitcoin's January 29th expiration along with the futures markets in our Whats Ahead for the Week section below.
S&P 500: New president and new all time high last week for the S&P 500. The index blasted higher to close at 3,841, up 1.94% for the week. As we had written about last week, the banks kicked off earnings season and they did so with a bang - with JP Morgan and Goldman Sachs both posting blowout numbers.
While Bank of America also posted impressive numbers, what became evident from the reports is that the revenues and profits did not come from the retail banking divisions, but from their trading arms.
This exemplifies that the areas of growth and revenue over the course of 2020 for banks were not their lending portfolios or their day-to-day banking activities, it was their trading as investors frantically shuffle between financial instruments to try to position themselves for growth and hedge their risk. With analysts predicting one of the best years of trading in the U.S. since the great recession, and a slew of IPOs on the pipeline, investment banks look to have a phenomenal year ahead. With all the stimulus activity and incentives, retail banks are also likely to benefit in that environment.
The coming week is packed with earnings and very importantly, the Federal Reserve's first official meeting of the year, and the first ever under president Joe Biden. The market will be looking closely to what the Fed has to say. The yields on the U.S. 10-year treasury have moved over 1% - which is important, not so much because of the number, but because it has clearly broken its downtrend and investors are starting to demand higher interest to make up for inflation expectations. There may be some pressure within voices of the Fed and it will be interesting to see how Powell navigates through it. The market will be watching very closely and so will we. We'll discuss what type of sector rotation is typical in these parts of the market cycle in our What's Ahead section today.
Gold: It was a positive week for gold last week with it closing at $1,854/oz, up 1.49% for the week. Looking at the price action in equities and the bond markets, Gold is potentially catching a bid because of the increased signs of inflation in the markets.
DeFi: The biggest catalyst for the sector was likely the freezing of the proposed FinCEN legislation around KYC and self-hosted wallets by the Biden administration - which, as contemplated, would have signified a very significant blow to all of DeFi. This led to a _lot_ of volatility in the DeFi index and a sharp rise with the index closing the week up 13.93%. The last three weeks have all followed a long-squeeze, short-squeeze into all-time high patterns which has led to the index almost doubling in the same 3-week period. We can potentially see this happening week after week until retail money runs out - or goes away. As we will be discussing below, high volatility is very common when markets start getting crowded with short positions and extreme leveraged positions - particularly when the underlying assets are thinly traded. Given the recent price action and the index defying gravity into a new all-time high, the potential for more volatility remains high.
Anatomy of a Squeeze: Analyzing a Long-Squeeze (DeFi) and a Short-Squeeze (Gamestop)
What is a squeeze? You can think of a squeeze as a situation in which an investor borrowed an asset to carry out a financial transaction - and is forced to close his or her position to return the borrowed assets. The most common reasons that investors borrow assets in a market are to go long or to go short .
When going long, investors typically use the assets they already have in their portfolio to secure a borrow for more cash to purchase more assets for the portfolio. In this case, the investor believes that the cost of borrowing will be lower than the price appreciation of the assets purchased. If and when the value of the assets in the portfolio approach the value of the borrowed cash, the lender of the cash must sell the investor's assets to recuperate the cash it lent. The more cash you borrow, the higher the risk and potential payout.
When going short, investors typically put up cash as collateral to borrow an underlying asset that they believe is overvalued. They will then sell the borrowed asset, with the expectation that they can repurchase it at a lower price in the future. In this case the investor believes that the profits from selling the asset and buying back for cheaper will be higher than the cost of borrowing the asset. There is an added risk to a short position - which is that the price of a stock can theoretically rise into infinity - which means there is technically no limit on how much an investor can lose if a stock they borrowed to sell increases in price.
The best way to understand these market phenomenons is to look at how they play out in the wild and analyze the reasons why.
First, lets look at a long squeeze as experienced in the FTX DeFi index on Jan 21st (last week):
As we can see from the chart above, the DeFi index went down by 23% in a 24-hour period during January 21st. Notice on the chart how that day had the highest daily volume in the DeFi index's history. Additionally, the funding rates for the perpetual swaps of Aave and Eth are both down dramatically relative to their last 30-days moving average. This is a sign that the levels of leverage have been "washed out".
Why does this happen? Typically - these market events happen when investors have borrowed way too much cash to purchase the assets they are participating in. Investors that are looking for a quick return, typically like fast-moving assets, and additionally layer a lot of leverage on top, you know - to get there quicker. When investors borrow a lot of cash, it means that very small price moves will cause their portfolios to crumble and force them to sell their assets. When sophisticated market participants see this, they can effectively issue sell orders to systematically try to drive the market lower, thereby causing forced liquidation sales, which themselves trigger more sales, and once the levels are low enough, the sophisticated market participants happily start taking the other end of the forced sales and rebuild their positions.
If there are enough new investors around, the long squeeze can get bought back up - as it happened in the case of DeFi.
GameStop - the short squeeze of a lifetime:
Last week also provided a unique opportunity to look at one of the most dramatic short squeezes in modern history play out in the shares of video game retailer GameStop.
GameStop is a physical video game retailer with most of their stores located in malls. With malls taking huge hits and sales going digital, the stock had been taking a beating throughout 2020, starting the year at $6.81 and seeing levels of a low as $2.81 in April and closing the year at $6. The stock had amassed a short interest equivalent of 138% the shares available for trading. Last week, the company announced that activist investor Ryan Cohen, founder of chewy.com, would be joining its board of directors - causing shares in the company to spike as some hedge funds and investors started covering their short positions. Investors caught notice - particularly in the widely popular Wall Street Bets subreddit, and started piling into the stock, knowing that there was still a large number of investors that would have to do the same. On Friday things reached a fever pitch when short seller Citron Research, a vocal investor who is short the stock called the recent buyers "suckers" - which trigged a massive rally in the stock, closing the day 51.8% higher, at $65.01. The stock is up 245% in 2021.
While extreme, the Gamestop example is a great reminder that investors that understand the pain-points that market dynamics create, can organize and go after other market participants. This is true in both examples - and it's why it is always important to understand market dynamics as an investor.
Summary:
As we can see, any type of investment position that requires a borrow, creates a market dynamic whereby the loan has to be repaid. Sophisticated market participants have ways of estimating the "borrow" levels in the market, and when the borrows become large enough, they present a very attractive market opportunity. This is why we follow perpetual swaps funding rates and short interest levels so closely. The higher these indicators are, the more likely that market volatility will be present.
Difficulty Commentary
We had a new difficulty adjustment kick in on Saturday noon which brought us to a new difficulty all-time high of 20.83 TH, up 1.05%. Block times are back at an average of 10 minutes and the mempool has come down quite a bit. While still at December levels, transaction costs and speeds should be much closer to normal this week. The next adjustment is showing a slight increase to 21.03 TH and it is likely that we will see hashrate keep rising to catch up with the recent run up in price.
What's ahead for the week:
The Federal Reserve, which has been a reassuring voice for investors since COVID started, is scheduled to have its first FOMC meeting of the year and the first one under president Joe Biden. Analysts expect the Fed to continue providing an encouraging backdrop to investors and businesses - and the Fed's policy decision, to be delivered on Wednesday at 2 PM, will very likely impact markets.
Additionally, we have a GDP reading out of the U.S. on Thursday - where analysts are expecting a +4% annualized reading for the last 3-months of 2020. While it is impressive - let's keep in mind that Q3's GDP growth was of 33%. Still, this does mean that the economy is heading in the right direction and can be perceived as a "good job, keep going" nod to the Fed's recent policy decisions.
Elsewhere in the Macro world, we are starting to see commodities picking up bids. Additionally, analysts at Goldman Sachs were quoted last week as saying that Biden's recent actions are supportive to oil prices. With the potential for inflation in the U.S. and more activity on "main street" vis-a-vis financial instruments, typically has investors shift their views to industrial growth. With commodities having experienced suppressed demand and price action for a prolonged period, investors may potentially start looking at the sector for growth opportunities. The relationship between FANG stocks and commodities is something to keep an eye on.
Outside the Macro readings - we do have 13 our of the 30 the Dow Jones Industrial index companies reporting this week - which could lead to a week of very high volumes and decisive moves in the major equity indexes in the U.S.
On the Bitcoin front, we are seeing interesting market dynamics at play. The compression of the GBTC premium to historical lows is likely the most impactful dynamic at play. The arbitraging of these types of market opportunities are signs that professional investors and institutional activity is coming to the market to make it efficient. While it makes competing for these opportunities more difficult - the tradeoff is that it provides significant liquidity and legitimacy to these markets. On the options front, we are seeing a large open interest in the $52k strike for January 29th on Deribit.
As we explained in our Short vs. Long squeeze analysis above, these types of market dynamics are setups that lend themselves for high volatility. While the perpetual swap funding rates have seem to gotten "back in check" after last week's long squeeze, signs abound that retail is very much still around and picking up steam.
As always, we'll keep you posted on any relevant news throughout the new year right here and from our Twitter account @hodlwithLedn
Canadian Central Banking Updates:
Current Target Interest Rate: 0.00 - 0.25%
Current Overnight Money Market Rate: 0.23%
Source: https://www.bankofcanada.ca/rates/
U.S. Central Banking Updates:
Current Fed Interest Target Rate: 0.00 - 0.25%
Current Effective Federal Funds Rate: 0.09%
Source: https://apps.newyorkfed.org/markets/autorates/fed%20funds