In mid-August, when the market was enjoying its low-volatility grind higher, we observed that one of the biggest bears in the hedge fund industry, Crispin Odey, was having a bad year, with his hedge fund sinking some 30% through the end of July. Since then, conditions have only gotten more precarious for the billionaire hedge fund manager, and as the FT writes, for Odey, who is betting it all "on a violent unwind of a QE bubble", the endgame may have arrived.
As Miles Johnson writes, "many financial commentators have warned that current monetary policy has inflated a bubble that will one day violently pop. Few of them have risked money betting on the precise manner in which a chaotic unwinding of quantitative easing will play out through financial markets. This makes the portfolio of Crispin Odey, a London-based hedge fund manager, an interesting outlier. Mr Odey is one of only a handful of investors who has backed up his dire prognosis for the global economy with a series of large, leveraged trades designed to pay off in the event of a crash."
To be sure, as we noted two months ago, Odey's bets are predicated on a collapse of Japanese bond prices, a surge in the price of gold and immolation of equities. Or as the FT puts, it, "If it works he may make hundreds of millions of dollars for his clients. If wrong his fund may not survive."
However, while for Odey the endgame of fighting the Fed (and other central banks) may have arrived, he may have a problem cashing out, even if correct. As FT observes, a closer examination of Mr Odey’s individual positions reveal the ways in which he has translated his views into a set of assumptions about how markets will move in the event of a crisis. The biggest risk he now faces is even if the denouement he predicts finally arrives, his trades may well not react in the way he intended.
Odey’s first big assumption appears to be that market turmoil will cause the value of the US dollar to rise against other major currencies. His flagship hedge fund holds 104 per cent of its active currency exposure in the dollar, according to his most recent letter to investors. This presumably is based on the idea that severe market stress will see investors rush into the safety of the largest global reserve currency.
However, "this assumption needs to be questioned. In the event of a market catastrophe the only major central bank that has the ability to cut interest rates is the US Federal Reserve. If the Fed is forced to take action this could see the euro and the yen rise against the dollar, rather than fall. Added to this both the eurozone and Japan have comparatively strong current account positions. The dollar may indeed surge in a crisis, but it would be unwise to bet your house on it."
Mr Odey’s second big trade is that Japanese government bond yields will explode higher as financial markets realise that the “all in” Bank of Japan has run out of ammunition. Some macro hedge funds have over the years attempted to short JGBs based on the idea that the country’s indebtedness and poor growth was incompatible with its low yields. JGB yields have continued to drop, leading to the trade being nicknamed the “widow maker”.
Here too, there is a gamble even assuming central banks lose control: "the premise that JGB yields will rise during market turmoil is no certainty. The Japanese are the world’s largest single owners of financial assets, which in the event of a crash would presumably be sold and funds repatriated into yen. Over the last two decades a strong yen has tended to coincide with a fall in Japanese government bond yields. Betting against JGBs in anticipation of a crisis may have painfully opposite consequences when a crisis arrives."
But all of the above pales in comparison to Odey's gold bet:
Mr Odey’s single biggest bet is that the value of gold will surge. This gold position represents an eye-watering 100 per cent of his fund’s net asset value, meaning a large rally or fall in its value may dictate the fate of his entire portfolio. His intellectual justification for the position is well rehearsed. He recently observed how “central banks have printed $80tn of money, backed by only $1.27tn of gold”. The real value of this “printed” money has therefore been debased and logically should fall when priced in gold.
Even here a "cashing out" problem emerges, because shoudl China implode, gold may end up being sold not bought: "Odey’s long gold position interacts with his overarching premise — that a crisis starting in China explodes through global markets. Large amounts of global gold demand come from Asia."
In other words, while massively levered to an unprecedented, global failure of QE, Odey may not be able to profit even in that case, or as Johnson concludes "for those of us watching from the sidelines the lesson should be clear: predicting a crash is far easier than ensuring you profit from it." What he ignores, also, is that in a worst case scenario where faith in not only central banking is lost, but fiat currencies lose value as a result while banks keel over left and right, just who will honor their contractual agreements to cash your shorts, or novate your CDS?
For Odey, the answers better come soon, because the only thing worse for his hedge fund and LPs than the end of the world coming in short notice, would be if central banks once again manage to keep the artificial market calm, cool and collected and levitating ever higher.