The New World of Risk - GameStop and Cryptos

Kerr Neilson,

Kerr, with the help of Andrew Clifford, founded Platinum in 1994 with a view to making money for investors. The emphasis was on continuing the successful investment approach.. More

01 Feb 2021

The slant of the early reporting by the popular media on the crowd-driven squeeze on heavily shorted shares like GameStop is worthy of commentary. The angle is one of the little investor outwitting the so-called professionals, with the former walking away with huge gains. It is indeed a spectacular occurrence and reflects the democratisation of access to information and to markets, facilitated by the internet.

The vagueness of the links among the participants has allowed this crowd-sourced spectacle to scrape by the protections afforded market participants against stock price manipulation. The clever aspect is the understanding by its leaders of the effects of attacking crowded short positions. They would have understood the technical aspects that such disruption would unleash. Namely, in the first instance, the reversal of a price trend would activate trading rules where a fund is obliged, because of its internal guidelines, to cover a short position once a share price moves up by a pre-set percentage. This closing of short positions, involving buying back shorted shares, amplifies the new upward trend. At this point the option traders chime in to cover exposed contracts that they have written in those shares, again adding to the squeeze and lastly, financial intermediaries offering exchange-traded funds (ETFs) or index-based products suddenly find themselves grossly underweight what were hitherto insignificant constituents of their universe. They too need to buy to redress their implicit short position. This creates a veritable ascending daisy chain. Importantly, this same mechanism can unwind as put options are bought and existing holders feel vertigo. The root problem, however, is very old-fashioned; total consensus is dangerous, something a contrarian fund manager is highly alert to.

The response of politicians might be as expected, fulminating about the failures of the US Securities and Exchange Commission (SEC). There is also the intervention by the courts as the financial fallout threatened the survival of the likes of trading platform Robinhood, who was forced to change its trading policies and quickly adjust margin requirements to meet calls from the clearing house. Reading these accounts may fill some with a degree of satisfaction regarding the come-uppance of the established order and the emergence of a fairer world but sadly this event highlights the dangerous experiment of central bank balance sheet bloating. It also highlights the new world of instant mass communication.

It further reflects the growing sense of injustice in the workings of established systems and the imperfections of the response by governments to these problems, with short-term fixes, that are likely to lead to this phenomenon recurring even as the ‘authorities’ try to flatten this waterbed of discombobulation with changes to trading rules and margins.

The maturing of the internet and its increasingly advanced functions, including becoming a venue for the exchange of value, is in parallel fuelling frantic activity in crypto currencies. The skyrocketing price of Bitcoin has acted as a giant flywheel to gear up innovations among third-generation crypto applications where participants are rewarded with coinage for their support as originators, coders, network enhancers and so on. With a market value of over US$600 billion, Bitcoin is head and shoulders larger in market capitalisation than the next tier like Ethereum and Ripple, which weigh in respectively at around US$150 billion and US$20 billion, while some really interesting plays are capitalised at a measly US$1 billion or so.[1] This is despite the fact that, so far, Bitcoin cannot be tendered to pay taxes, the ultimate guarantee of value for money. What any of them is worth is still a wild guess but one should be extremely cautious and open-minded before disregarding these coinage-funded markets. Money, after all, is an accounting entity and a way to measure, in the first instance, the price of labour!

The link of these two phenomena within the financial markets lies in the ‘democratising’ power of the internet. The hope and belief by some that there can be a parallel universe is an emphatic statement about social division. This social divide lies between the capital-owning class and the rest, as well as between the old and the young. The former has been the winner so far in the game of central bank intervention. However, the effect of cheap money and government handouts is now shifting the willingness of the ordinary punter to have a go. These are interesting (and dangerous) times when risk is regarded as a game.

[1] Source: as at 1 February 2021.

DISCLAIMER: This article has been prepared by Platinum Investment Management Limited ABN 25 063 565 006, AFSL 221935, trading as Platinum Asset Management (“Platinum”). This information is general in nature and does not take into account your specific needs or circumstances. You should consider your own financial position, objectives and requirements and seek professional financial advice before making any financial decisions. The commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. No representations or warranties are made by Platinum as to their accuracy or reliability. To the extent permitted by law, no liability is accepted by Platinum for any loss or damage as a result of any reliance on this information.

Most popular