Birkoa Newsletter 10 (end-September continued...)

Dear LPs:

I had forgotten to include the section on cryptocurrencies in last night's newsletter, so I will go over the status of that aspect of our portfolio here.

Crypto and Crypto ETF - 

Owing to the recent liquidity-driven selloff cryptocurrencies have pulled back from their highs, when Ether had reached $2k and Bitcoin $25k back in mid-August, now hovering around $1.3k and $20k, respectively. Time and again I have seen steady 20-25% moves up, only to give it all back. It is just incredibly annoying seeing this repeat, but it's important to note the reason why this is happening. When liquidity is low and the market gets spooked by increased acceleration of rate hikes, then correlations completely break down and everything falls together. So while in mid-July crypto was getting more uncorrelated with U.S. tech stocks, that correlation has returned (for now) given this moment of synchronized selling across all asset categories. I believe this to be temporary, with traders being mostly worried about what the Fed would do so they're moving all their positions into cash. The flip side of this is the increased cash buildup which will only move back into risk assets once there's more certainty about the Fed's terminal rate.

Due to the turmoil within crypto markets, the crypto ETF has also given back all its gains, which had upped 45% at one time, to effectively flatline now. As you can imagine, it's once again, very annoying, but important to ride through this moment in time.

I am going to remain put in our crypto positions because of the longer-term nature of those positions. Once the concern over rate hikes gets alleviated, they will resume their recovery.

The following section is FYI - 

I wanted to provide a supplement to try and assuage some of your prospective questions about the recent selloff and why I'm not too worried about our long-term prospects, although I am very careful and vigilant with every position within our portfolio at all times, and remain ready to step in should any forced liquidation situation occur. This is why I've been at it around the clock ever since September 11th, when our portfolio took a leg down owing to some hotter than expected inflation numbers from August, made worse by the Fed's hawkish tone in its subsequent meeting. 

Feel free to ask any other questions you might have individually to me. Also, happy to hop on a zoom call anytime.

Question 1 - Why is the selloff happening?

 - Due to traders pricing in higher terminal rate by the Fed as it battles inflation.

Question 2 - Is the selloff warranted?

 - A little yes, but not to the extent it has. Generally in moments of panic, the markets tend to overdo it because of forced selling across major pension and hedge funds.

Question 3 - Why is it affecting our portfolio, even though it has minimal exposure to U.S. markets?

 - Since the world is seemingly undergoing a synchronized slowdown, everyone is piling onto Dollars as a safe haven of last resort. Therefore, all the rest of the world's assets are largely crumbling.

Question 4 - Why does Birkoa not account for this?

 - Since this is a limited-time, short-term, liquidity-driven event. There is no way to anticipate these kinds of market plumbing issues for positions like ours which are in time horizons of 6 months to 3 years.

Question 5 - Any risks to our portfolio?

 - As mentioned yesterday, some technical risks like maintaining a maintenance margin on our margin account. Presently, that margin is healthy and while on-paper losses are certainly not welcome, they're meaningless unless we actually take those losses. 

Question 6 - What if maintenance margins decrease?

 - In the unlikely event of that occurring, I have several ways to post cash to extend the margins; notably liquidating near-profitable or profitable positions like Palladium. Therefore, I'm always mindful of this. This is why even though I don't trade in and out of positions everyday, I've been working around the clock the past 3 weeks to remain vigilant of unlikely scenarios like this. Our maintenance margin as of this writing has been going up the past couple of days after having remained constant last week, which is welcome news. And that was before the good news coming out of OPEC+ and Russian metals ban.

Question 7 - How long will this situation take?

 - From what I can tell, markets overreacted to central banks' tightening, especially the Fed's tightening the past 3 weeks. Furthermore, we're beginning to see a shift to the Fed's tone and in accepting inflation might be coming down and the intensity of hiking might be toned down in the future. This is part of the reason why the markets seem to be rallying broadly today (October 3rd-4th) to begin the month of October. U.S. manufacturing data also seems to have underwhelmed today, which suggests that peak inflation might have been achieved and that inflation might be cooling. 

Question 8 - But how did everything in your portfolio become correlated like this?

 - The strong Dollar, an artificial and temporary phenomenon, seems to be the reason. China still being in lockdown hasn't helped either and everything remains depressed there, although there is now light at the end of the tunnel.

Question 9 - Ultimately, will it matter for our long-term goals?

 - No; I think that it's impossible to time a market or to predict the exact bottom. But to be somewhere in the vicinity of the bottom, as I think we are in China for example, is super-useful as well since eventually there is an upswing. Hong Kong just reached its lowest level in 11 years, and if that's not close to the bottom, I don't know what is. Hence, patience is key.

Question 10 - Could it possibly go down further still?

 - Of course it could, but eventually there will be a rebound. We're also seeing more and more central banks doing an about face in their hiking cycles. Britain did it last week, and Australia did it sometime ago today, surprising the markets with a smaller hike than anticipated. The general expectation now is that the Fed will have to pivot.

Question 11 - Will the Fed pivot?

 - Yes, I think it just has to. They have overdone it. And they are disrupting the global functioning of the markets via liquidity concerns plus harming emerging nations in the process. I just cannot pinpoint when exactly, but I think even if there's a leg lower from here, the correlations among assets will slowly begin to break.

Question 12 - Was this a highly unusual situation?

 - Yes; something like this (synchronized Dollar-led liquidity crunch) is extremely rare and impossible to anticipate. Birkoa is not a trading firm so sometimes when things like these occur, it's important to not panic and sell prematurely. Eventually the fever always breaks. 

Question 13 - Why didn't you dump your positions when you saw this coming in the past month?

 - On September 11, we were within 7% of breaking even overall (despite the depressed crypto prices). On September 13th, all of a sudden the August inflation numbers came in hotter than expected, thereby leading the markets into a tailspin because they priced in a more hawkish Federal Reserve. Since then the selling in every market had been relentless leading right until the last week of September. I didn't dump positions since I knew this was a liquidity event, and my focus in the meantime shifted to ensuring that the maintenance margins are maintained. And then in the last week of September, I was a bit heartened that at the very least there was an impressive maintenance of the margin from the week prior although the markets kept falling. 

Another reason I didn't sell is because of simple probability - the more you trade in and out of positions, the greater your chances of being correct diminish exponentially.

Question 14 - Should Birkoa have just taken profits and moved all into cash once it became clear that the selling was going to be relentless following September 13th? 

 - Could have, but that's not what I do, as it'd have led to a windfall tax on you as individual LPs due to capital gains on some of the profitable positions had I just moved to cash. Moreover, as mentioned earlier, trading is truly not my forte. Arriving at an analysis and constantly re-evaluating that analysis until a price target is hit is.

Question 15 - Anything I could have done to prevent this?

 - Absolutely, take less leverage (in which case losses would've been contained to within half of what they are now). But, I think buying opportunities like these don't come often, and it's not like I have used way too much leverage either (leverage ratio < 1), which is why the relatively comfortable buffer and less chances of forced liquidations. 

I hope these answers provide you with more clarity into my thinking and relieve you of any worries. I am working around the clock monitoring everything in the world's financial markets, and will provide more information as things progress. But without jinxing anything, am a little heartened by the macro events coming true at least (China easing lockdowns in Hong Kong, OPEC+ supporting crude oil prices, metals ban in Russia thereby helping Palladium, some glimmer of hope about bad economic data leading traders to breathe a sigh of relief from an overzealous Fed, Central banks the world over forced to make a U-turn in their tightening, etc.). 

Also, as the Dollar loses its temporary strength, it'll only be bullish for our crypto positions since they're ultimately meant to be Dollar hedges.

Regards,

Pranjit Kalita 
CIO

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Birkoa Newsletter 10 (end-September)