The Whiskey Revolution

Thursday, 11th September 2014

Melbourne, Australia

By Greg Canavan

  • The whiskey revolution
  • Aussie dollar breaking lower
  • Bungy jumping on the trading floor

The birthplace of capitalism — and Adam Smith in particular — Scotland, is the latest region to give global equity and currency markets the wobbles.

On September 18, Scotland goes to the polls for an independence vote. Early polling suggests the Scots just might decide to ditch the UK. They joined the ‘Kingdom’ back in 1707.

Is this a big deal or not? Should you be worried about it?

I don’t know to be honest. If the Scots stick with the UK (and there’s a decent fear campaign going on to ensure that happens) then it will be business as usual.

But if Scotland decides to walk away, then things will get very interesting. It could well be a ‘fat tail’ event.


Well, in a globalised world, everything is connected. Especially the banking system. And this is where problems could emerge.

Let me explain…

The UK has a huge current account deficit. You can see the deterioration since the ‘recovery’ from the 2008 recession in the chart below. In the year to March 31 (the latest data available) the UK ran a current account deficit of £74.6 billion. That’s around 4.5% of GDP…which is pretty high.

In other words, the UK relies heavily on foreign capital to sustain its standard of living.

The Scottish vote for independence threatens to blow the current account out further, which is why the British pound took a beating this week as some polls showed a ‘yes’ for independence vote.

If the Scots walk, they’ll take North Sea oil and gas with them (or a big chunk of it anyway). Along with a whiskey export market worth £4.6 billion in 2012, Scotland would most likely run a trade surplus as an independent nation.

That would have a whole bunch of ramifications for the pound and the UK’s credit rating. It would result in a global shift of capital that would have many unintended consequences.

That’s why markets are on edge. And it’s why you’re seeing a scare campaign run by the vested interests in England. Check out this from the Telegraph:

Scotland could be forced to raise billions of pounds to maintain financial stability as an independent country, the Governor of the Bank of England implied on Wednesday.

Mark Carney told MPs that the estimated £15bn Scotland would inherit in sterling reserves in the event of secession would fall well short of the levels used by other countries that have adopted foreign currencies.

He added that Scotland would need to run a fiscal surplus for several years in order to build up the reserves, a task which he conceded could require imposing extra taxes or spending cuts on its population. "These are real fiscal costs," he said.

England manages to get by just fine running massive deficits. Global capital would have no problem supporting a financially conservative Scotland (they’re Scots, of course they would be financially conservative!) especially if they run a whiskey and oil based trade surplus.

But the big banks and pension funds, reliant on the Bank of England as a lender of last resort, have said they will relocate if there is a ‘yes’ vote.

I hope I’m wrong. I hope the Scots go it alone. It would be good for future generations to leave the UK and their basket case economic model. The UK’s main export now is London property. That’s a slight exaggeration, but the fact is they’re pawning off their assets to live beyond their means.

But it’s likely the elites and the banks will win again. Fear campaigns work well when uncertainty is in the air. Better the devil you know and all that.

But it’s one to keep an eye on. In a week’s time we’ll know the outcome.

Speaking of a basket case economy and pawning houses to maintain a lifestyle, what’s happening in Australia?

For the past week, it’s been wall to wall iron ore. The price of our most valuable commodity is in freefall. But it’s all too much…even for this iron ore bear. We’re due for a rally.

But when Nev Power from Fortescue comes out and declares prices are heading back over US$100/tonne, you’ll know to sell that rally.

What the iron ore miners really need is a weaker Aussie dollar. And not just by a few cents…I’m talking much weaker, as it was in the 70s.

Maybe it’s on its way. The Aussie just crashed through the 200-day moving average vis-vis the US dollar. My guess is that it’s heading back down to the early 2014 lows.

Aussie dollar breaking lower

I asked Jason McIntosh, a veteran trader and technical analyst, for his take on the recent price action and where the Aussie is likely to go from here.

(Jason, an old mate of mine, is Port Phillip’s latest recruit. He’s developing an algorithmic trading system, the details of which we hope to unveil soon. In the meantime, read on below for another instalment of Jason’s former life on the trading floor).

Here’s what Jason had to say about the Aussie’s price action:

This week may well prove a turning point in the Aussie dollar. The past two days have seen the dollar fall to its lowest level since March. In doing so, it breaks five months of narrow trading between 92 and 95 cents.
The Aussie should now find overhead resistance around 92.00 to 92.50 cents. This is an area where sellers are likely to be waiting. 
A move below 90 cents looks probable over shorter term.   
However, it is too early to declare a longer term bearish phase is underway.
The moving averages are still positive… and this will remain the case until the 50 day moving average crosses below the 200 day average. 

Moving averages are a trend indicator. I find longer term averages are an excellent way of determining if the "tide" is coming or going.
You improve you odds of a success by trading with the trend… just as it’s easier to swimming with the tide.
We will get a clearer picture of the Aussie’s longer term trend over the next few weeks.  

But don’t expect a weaker Aussie dollar to be a panacea for Australia’s economy. It won’t be. A sharply weaker dollar usually indicates global economic troubles. And if the (former) Aussie battler falls too far too fast, then Australia will suffer inflationary pressures via imported inflation.

That means Glenn Stevens won’t be able to cut interest rates in an environment of slowing global and domestic economic growth.

So yes, a dollar in the 70s might be good news for iron ore miners but not so much if it means weak demand pushes the iron ore price into the US$60/tonne region, which is a real possibility as China struggles to contain its unfolding property bust.

But that’s a worry for a later time. Right now, iron ore is due for a rally. Don’t get too carried away by it though.


Bungy Jumping on the Trading Floor
By Jason McIntosh

GET ME CALLS…GET ME CALLS!’ was the war cry from the spot Aussie dealer.

It was September 1993. Australia’s trade numbers had just come out, and they were ugly. Export prices were on the slide and the Aussie dollar was in freefall.

The scene on the Bankers Trust foreign exchange desk was chaotic. Waves of selling were coming from around the globe. Sell orders for hundreds of millions of dollars were relentlessly hitting the desk.

‘Get me calls!’ is what a foreign exchange trader yells when he needs to buy or sell a lot of currency quickly. He wants everyone on the phones to other banks for prices…and he wants those prices NOW!

The typical dealing parcel in the 1990s was $10 million. So if you asked a dealer for Aussie in 10, he would give you his buying and selling price for $10 million.

You didn’t get long to think it over. The price was only live for a couple of seconds!

Foreign exchange dealing is like a high stakes game of pass the parcel. No one wants to be stuck holding a pile of falling currency. Dealers are frantically calling other dealers to pass on the tumbling dollar.

This is a high stress job. You can win or lose hundreds of thousands of dollars in the blink of an eye.

The great thing about working at BT was that your star could rise quickly. There wasn’t a hierarchical structure to climb. Promotion was on merit alone.

I was moving up the ladder fast. Within just two years I was a forward foreign exchange dealer… a big leap from my entry position on the bond desk.

Forwards are what we call a ‘derivative’. They are complex financial products involving plenty of maths.

The forward price is a currency’s value at a set time in the future. Whereas the spot price is its value today.

Pricing forwards was my introduction to writing algorithms. This would become a stepping-stone to system trading…but more on that later.

We usually did our own thing on the forwards desk. However, today was different. The dollar was plummeting and the sell orders were overwhelming the spot traders.

The Aussie dealer was screaming at everyone to get him calls.

I had four banks on my go to list — ANZ and Citibank in Singapore, Bank of America in Hong Kong, and Mitsubishi Bank in Tokyo. This was my first big call out… and the pressure was on to get it right!

With a phone to either ear, I got calling. ‘Aussie in 10,’ I said firmly and quickly.

The prices fired back down the line at me. I shouted them over to the Aussie trader… his response was a decisive, ‘SELL, SELL!’

I sold $40 million in less than 60 seconds. It was a huge adrenalin rush.

I’ve done a few extreme sports in my time — skydiving, bungy jumping, and climbing. But none was as intense as this.

I remember the feeling to this day…it was like nothing else.

Spot foreign exchange was one of the most exciting jobs on the planet. It was also mind-blowingly stressful.

The senior dealers at BT had an interesting quality. Every one of them was in their late twenties and early thirties. The same was true for another high-octane group – the futures floor traders.

You would find a high proportion of the dealing room’s ‘supernovas’ in these roles. These were explosions of brightness that would quickly fade from view. This was a young mans’ game.

This youthful age pattern was not typical of all dealing desks. Many of the strategic position takers were older.

It took time to develop the skills to consistently make a lot of money.

My boss on the forwards desk was in his forties. Carlos was a wise trader who had made the bank piles of money over the years.   

He had a cool head and could hold a winning trade for weeks. This was in stark contrast to the loud and brash spot traders at the other end of the dealing desk, where trades might only last seconds.

It didn’t take me long to realise I’d landed on the right side of the fence as a forwards dealer.

Sure, spot foreign exchange was exciting. But I knew forwards was where I was going to develop the skills to become an algorithmic trader.

The spot dealers would laugh at how long it took to price a forward. They would joke it took less time for them to eat their lunch then it took us to make a price. 

But there was a good reason why it took us a bit longer.

You see, pricing forwards requires lots of calculations. This meant I got very good at working with mathematical formulas and spreadsheets…two essential requirements for system trading.

It also made me think logically in a series of steps. Much like a pilot going through a pre-flight check.   

I was developing key skills as a forward foreign exchange dealer. Skills that would later be pivotal in my transition to an algorithmic trader.

Carlos was big on using maths to detect inefficiencies in the forwards market. He noticed there was often a lag in correctly re-pricing forwards after large moves in the markets.

Financial markets are meant to be efficient — at least that’s what I was told at university. However, I was now seeing for myself that this was not the case.

The re-pricing lag was an exploitable inefficiency…and Carlos took full advantage of it. Our team of five forwards traders milked this anomaly for millions of dollars.

The practice became less profitable over time as other banks caught on. But I now had a valuable insight into how markets work.    

Markets are actually slow to adjust to new information.

Sure, there’s an immediate knee-jerk reaction. But then it often takes time for the market to fully appreciate the whole story. Not such an efficient market after all!

This is one of the reasons we get price trends.

Carlos’s forwards pricing algorithms were invaluable. Through them, I had seen first-hand that markets really are slow to react. The holder of this knowledge has a real advantage.

This was an eye-opening concept…one that would shape my understanding of markets.