Best stock investments – Jim Rickards, Saudi Arabia, and the “Great Currency Shock of 2016″



Best stock investments

I’m absolutely sure that Jim Rickards knows a lot more about the global political economy and currency fluctuation than I do, so I’ll give you that point right up front.

That doesn’t necessarily mean he’s going to be able to make you a lot of money, or that the promises he uses to sell his trading service will come true.

Richards’ Currency Wars Alert and IMPACT System have been very, very heavily promoted in the past year or so by his publisher (Agora), and I haven’t written about him… so I guess it’s time to get around to it.

Why now? Well, partly because he’s had some time to be both right and wrong in his trade recommendations, so our readers who have tried the service out may be able to provide some feedback (is that you? Use the comment box at the bottom, please!) … and partly because his latest big sales push with a “live video event” earlier in the week promoted one specific “secret” trade, so there’s at least one teased idea of his that I can explain for you.


Generally, Rickards is predicting a US recession — caused by the Federal Reserve tightening during a time of weakness… but while that means he says he wouldn’t own US stocks right now, he says he does see opportunities to make money by buying options to leverage his insight into global currency trends.

The basic spiel for this next “currency shock” that he thinks you can profit from is about Saudi Arabia — he says that there have been two big “Currency Shocks” recently from overnight currency revaluations, the first one being the Swiss Franc’s decoupling from the Euro about a year ago (the second was the bump down in the Chinese Yuan, though that’s still underway and it wasn’t just a one-time thing like the Franc)…. and that the next one will be the Saudis removing their currency’s peg to the US Dollar, all of which are little salvos in the “currency war” that he says has been going on around the world since 2010.

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This would cause a drop in the value of Saudi businesses, at least in US Dollar terms, so should bring down the value of the Saudi stock market… but, unfortunately, Rickards says there isn’t an easy and liquid way for individual investors to bet against the Saudi currency or stock market, so he has found what he thinks is a very good proxy: Turkey.

His argument, based on his analysis of the past and his expectations about how the dynamics will work in the region, is that a Saudi de-peg will cause the other governments in the region to also bring down the value of their currencies, and that Turkey — with lots of pressures on it from all sides — will be the largest and most liquid market to suffer as a result.

So he’s recommending a bet against Turkey’s market, and since he only recommends buying options in his newsletter/trading service, that means he’s buying puts on a Turkish ETF.

There’s really only one of those, particularly if you want options and liquidity, and that’s the iShares Turkey index ETF, ticker TUR.

Turkey’s market is cheap by most standard valuation metrics (PE of 8, for example), but has also fallen by more than 40% over the past year and is obviously a risky market for geopolitical reasons — if you shoot down a Russian jet and have ISIS and independence-seeking Kurds on your doorstep, let alone a flood of refugees and a perilous connection to the Euro, risks are high and unpredictable. So it makes sense that it’s cheap. Turkey is going to have a slowing economy for quite a while thanks partly to war and refugees cutting into tourism and, like many emerging markets, is beaten down.

Whether the Turkish market will fall further if the Saudi’s depeg their currency from the US Dollar, I have no idea.

The one Saudi Arabian ETF has fallen more or less in line with most other emerging markets ETFs (including TUR), but it has only existed for a couple months (and has no options trading, in case you’re wondering). I also checked with a couple of my brokers, and there are no shares of the Saudi ETF available to sell short… so, surprise surprise, lots of other folks have figured out that the Saudi economy is going to pay a price for their intentional flooding of the global oil market and the crash in oil prices. (That doesn’t necessarily mean a lot of people are shorting the ETF, it has very low liquidity and very few shares outstanding so it might just be too small to have many shares available to short — but I would assume that there’s far more demand to short that ETF now than there is to go long the ETF, it has fallen 20% this year and a bit more than that since it was launched last Fall.)

So, assuming you believe Rickards is right that the Saudi currency is going to be depegged from the dollar “any day now,” what would the investment be? He continually says that it could happen tomorrow, which is why you need to get in on this trade immediately (you won’t be able to after the depeg has alraady happened), but also allows as to how there’s no real certainty, he says it might take them two months or six months to get to that point. So I’m going to assume that he would want to have as much flexibility as possible, which means buying options out more than just a month or two… which probably means he would want to recommend buying puts on the TUR with an August 19 expiration, giving his prediction eight months to come true (there’s also a May 20 expiration, which he might be using as well — February seems way too early, that gives only four weeks to be “right”).

If you’re convinced, as Rickards is, that this will happen, then you would buy puts on the TUR — that means you’re entering into a contract that gives you the option (but not the obligation, that’s why they’re called options — buying them gives you an option, selling them gives you an obligation) to sell TUR at a certain price before the expiration date.

If you haven’t traded options before, it’s not all that complicated — buying a put option means you want the right to sell a stock at a set price in the future, you would buy that option because you think the stock (or ETF, in this case) will be below that price by the time the contract expires. Buying call options is just the reverse, you want the right to buy at a set price in the future, because you think the stock will be above that price. Strike prices that are ‘in the money’ are contracts that would be worth something today — ie, since TUR is at $34 now, the February put option with a $40 strike price is “in the money” and worth at least $6, since you could buy that option now and exercise it to sell TUR at $40. It’s actually trading at about $7, which means someone’s willing to pay an additional dollar over the $6 as a bet that it will fall a bit more over the next month… and the month before February expirations represents not just possible upside, it’s also possible downside — if TUR rises to $36 over the next few weeks, maybe that option is only worth $3 or $4, or if it does rise to $40 the option is essentially worthless (if anyone can sell TUR for $40 because that’s the current market price, no one will want to pay extra for the privilege of doing so).

And you don’t have to own TUR shares to “sell” it at the expiration date, the option to force someone else to effectively buy TUR from you at a set price has value without you actually owning the underlying equity to begin with, you would probably just sell the option back to close the contract when it hits your profitability level (assuming you’re right about which direction the price goes), you don’t actually have to buy TUR and then sell it to someone. Most options are not actually exercised, they’re just bought and sold to open and close the contracts.

So which combination of expiration date and strike price might Rickards be recommending? Well, as I look at them I don’t see many that are particularly compelling in terms of their trading volume (the number of contracts that have been traded today) or open interest (the number of contracts that currently exist), but there are a few possibilities…

May expiration:
May $35 puts (TUR160520P00035000) — open interest over 4,500 contracts, current price about $5
May $39 puts (TUR160520P00039000) — open interest over 4,000 contracts, current price about $7

August expiration:
August $32 puts (TUR160819P00032000) — open interest over 5,000 contracts, current price about $5

I don’t know what the trading volume might have been on those contracts on the day Rickards made his recommendation — not sure what day that was, frankly, but his big live video presentation that I watched which touted this pick, and which drove a lot of questions our way, was on Monday night this week (and he was apparently presenting from his house near the French King Rock here in Western MA, which is just a few miles a way from me — maybe I should go knock on his door). Today the trading volume so far on the August $32 puts is over 500 contracts, and that’s more than 5X the volume of any other contract in the options chain for TUR, so I’ll guess that this is the current recommendation from Rickards.

[Correction: check the comments at the end, I failed to look at a second source for available contracts, and the pick was almost certainly actually the August $30 puts that weren’t quoted in the first place I checked, not the $32s — TUR160819P00030000 has open interest around 7,000 contracts, huge volume of 4,000, priced around $4 currently… and obviously requires the underlying ETF to fall two dollars further, but costs a buck less than the $32s]

How would such a trade work out? Well, you pay the $5 per share up front to open the contract and buy your option — each contract represents 100 shares, so for one options contract you’d pay about $500 plus commissions (a little higher than stock trading commissions from most brokers, but shouldn’t be a lot higher). That would give you the right to sell 100 shares of TUR at $32 a share anytime between now and August 20, when the option expires. If those options were expiring today they’d be worthless (since the underlying ETF is at $34), so you’re buying just “time value” and hoping that the price moves down.

If TUR is at $32 or above all the way from here into August, and never drops meaningfully below that to give you a profit that you could jump on along the way, you’d lose your money. All of it. The option would be worthless.

If TUR drops by, say, 50% between now and August and is trading at $17, you start to see some real profit — your options contract means can sell 100 shares for $3,200 but those shares would only cost you $1,700 in the open market, so the profit is $1,500. Since you put up $500, you’ve made a 200% return and tripled your investment.

If things are much more cataclysmic and TUR falls to, say, $10 from the current $34, you’ll be cackling with delight as you cash in your $2,200, a $1,700 profit on top of the $500 you invested (a return of 340%). I assume that a minimum of a 50-60% drop in the value of the Turkish stock market is what Rickards is looking for, since that’s what would give the potential for a 300% gain on that options position. (TUR is already down about 50% over the past year, just FYI — the new Saudi ETF KSA has moved generally in the same trend as TUR but is down much more in its young life, it’s down 21% over the last four months while TUR is down 7%.)

That’s the kind of returns Rickards is looking for — big, several hundred percent gains over less than a year as currencies make big moves (and the equities or ETFs that are levered to those currencies make even bigger moves). I don’t know how frequently he picks right with these trades, but he says he sends out a new alert every two weeks and that he has booked big gains of 100% or more on a few of them over the past year, including some big gains recently. Not once in the ad presentation did I hear them say “100% losses”, though they did admit to not being right every time — and if you’re not right when you’re speculating on options, you’re likely to see quite a few 100% losses from options that expire worthless, or that crash in value if a bunch of newsletter subscribers are all trying to sell at once.

Here are some other notes that I jotted down as I was listening to his presentation:

He says that there are always ways to make money, including selling options or shorting stocks, but that he likes to buy options because he’s betting that things are extreme and will get more extreme (selling options, on the other hand, is betting against volatility — betting that things will stay normal). And he says he’s only recommending buying options when there’s a strong possibility of large gains (200%+).

He also noted that they have current open positions with 60, 80, 100% gains, and that they have recently booked big gains of 100% on puts on Goldman Sachs and an emerging markets ETF.

His assumption is that there will be more big opportunities coming because of the flaws in the Black-Scholes model that’s used on Wall Street for calculating the value of options. He thinks Black-Scholes underestimates “black swan” or “avalanche” shocks, assumes they don’t happen, and it assumes that the price adjusts gradually as events hit the underlying security — but that’s not the case, the world is more volatile and you want to buy to benefit from those big jumps if you can predict them.

Rickards says that this “break” of the Saudi Riyal with the US dollar would happen tomorrow, or in two months or in six months. You can see it coming analytically, but you can’t be sure of the timing so you have to be positioned in advance.

And, of course, he says that he likes buying put options because it gives you a lot of upside but very limited downside.

My thoughts?

If you do this kind of trading, keep in mind that “limited downside” just means your loss on any trade is capped at 100% of whatever you put in… which means you have to be mindful of the amount of money you’re putting at risk. The outsize gains come at risk of outsize losses — there will be some 100%-500% gains if they pick the direction and timing right, but there will also probably be a substantial number of trades that result in 100% losses (or close to that). You can’t lose more than 100% if you’re only buying options, so that’s good (your downside is theoretically unlimited if you short a stock or ETF instead of just buying a put option, if it goes soaring you could be on the hook for 10X what you thought you were risking), but the 100% losses can come with some regularity — partly because we’re talking about short time periods of often less than six months, and partly because these are to a large extent “all or nothing” trades made largely based on the analysis of a single person (a person who has, in the past, been wrong about short-term movements in currencies and markets, just like any other person will be).

Which doesn’t mean I’m saying Jim Rickards isn’t smart, or that he doesn’t have intelligent insights into global trends, or that he doesn’t have good, quantitative systems that help him make forecasts. I’ve read some of his stuff, and it’s interesting, and he’s probably often right about currency trends. I just don’t know if he’s got a particular gift for consistently winning long-term 4-8 month options trades — I’m skeptical that anyone can turn broad market insight and analysis of global currencies into consistent wins on leveraged trades.

So keep that leverage in mind when doing position sizing — if you’re only willing to lose 25% of some chunk of money, for example, then only use 25% of that money to buy speculative call or put options and leave the rest in cash or something similarly “safe.” If you’ve got $100,000 but only willing to permanently lose $10,000 of it, then only bet $10,000 on buying put or call options. Stop losses don’t work very well on options, particularly if they’re volatile picks and are “out of the money” — in some cases you can hedge these kinds of options trades, either by placing a simultaneous call option to reduce your downside if you’re wrong, or selling a further-down strike price contract to reduce your cost, but those are also expensive and cap at least some of the potential for windfall gains…. and my expectation is that a successful options speculation portfolio relies on occasional windfall gains to offset lots of substantial losses.

Which is a long way of saying that position sizing is a big deal, and it’s why you should never compare the returns of options trading with the returns on a non-leveraged equity investment — mostly because you’d be crazy to put the same amount of money at risk.

If you make five of the trades recommended by a service like this in the course of a year, at, say, $2,000 a pop, then there is a nontrivial chance that you could lose all $10,000 if Rickards (or some other service) is wrong about the timing or the size of the movement in the underlying stock or ETF. And yes, even if the logic is sound and the quantitative analysis is correct and the position is well-argued, any service is going to be wrong with some regularity if they’re buying options and shooting for 200%+ gains with every trade.

If you have just a couple trades out of those five that give you a 100% loss in expiring worthless, as I would expect happens several times a year for any such trading service, then remember those pesky rules of math: a 50% loss can only be recovered by a 100% gain. Imagine that you have five $2,000 speculations — two of them expire worthless, so that’s a $4,000 loss. The other three, that $6,000, have to show gains of 60% on average just to break even. To get an overall gain of 100% from your $10,000 initial investment, the pressure is on — those remaining three trades would have to average well over 200% gains.

I don’t know what Rickards’ batting average is, or what the record of the service might be (there’s been quite a lot of discussion of the service among our readers here, but I’ve never seen the actual numbers of his historical trading recommendations over the past couple years), so I’m only guessing that a 40% failure rate is not out of line with what some of his readers might see. I could be way off.

So there you have it — Rickards this week has been recommending puts on the Turkish ETF TUR, I think he’s probably recommending August $32 TUR puts in the $5 neighborhood, and, well, that’s all I’ve got. Now I’ll open it up to the rest of you: Any experience with Rickards and his Currency Wars Alert? Any other thoughts on this kind of options buying strategy? Let us know with a comment below.

P.S. On the broader Saudi Arabia/Turkish front, those are certainly hotly debated topics — Barron’s has done a pretty good job of summing up the issues for Turkey’s economy, and there are plenty of people who argue that the Saudi’s will hold firm to their currency peg and remain tied to the US dollar for both strategic and economic reasons. Rickards noted as much in his presentation, saying that the same folks thought the Bank of England would hold firm to the Pound’s value under assault from George Soros et al 25 years ago, too, but they eventually had to cave before they spent all their reserves propping up the currency… and the Saudis will do the same. I don’t know if the comparison will hold true, but there are certainly folks arguing on both sides — though the contrarian bet is probably to go long Saudi Arabia or Turkey right now, so note that it’s what they call a “crowded trade”… which doesn’t mean it won’t work, but might mean that it’s somewhat expensive since few folks are inclined to bet against you.

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