Saturday, October 23, 2010

Forensic "Accounting": Is This High-profile Betting Exchange Minding the Store?

Betfair Group PLC had a high profile IPO on Friday (yesterday, October 22nd 2010) in London with shares doing well in aftermarket trading. Betfair (and its closest competitor, Betdaq) are a different breed of online bookmakers: they are the so-called "betting exchanges" where anyone can be the bettor or the bookie, and the odds are determined by supply and demand. Further, one can place a bet at the prevailing market, or can place a limit order of sorts at higher (or lower) odds in the hope of getting it filled if the market moves. One can trade in and out of positions as many times as he wants to, and can act as a market-maker, quoting bid/ask at any time. Unfortunately, Betfair does not accept US participants for regulatory reasons, but one can still poke around the site.

For any game, Betfair gives not only the odds but also the liquidity offered at each level, as well as the total matched (traded) and unmatched (bid/offer) volume so one can find the more liquid games where the spreads between the back and lay are tight. To back is to bet on a certain outcome; to lay is to bet against that outcome=what the bookie does. Betfair collects a % from the winnings for the service of matching counterparties, and, unlike a traditional bookmaker, does not act as a counterparty in any transactions.
It should be noted that most of the volume is in Western Europe soccer, and since soccer is a low scoring game, the typical bet is a straight-outcome bet (moneyline) and not a spread bet. There are three outcomes, home win, draw or visitor win (denoted as 1x2; and the home team is listed first, unlike the US standard). The odds are quotes as coefficients, that is the multiple of your bet you can expect to have back. For example, a 1.25 means you get $1.25 total back for a $1 bet (25% ROI). This is the equivalent of a -400 moneyline (you get 500 total back for your 400, 25% ROI).

I decided to check where the liquidity is on Friday night. One can search either by unmatched bets (bid/offer volume) or matched bets (traded volume). A decent % of the bets listed are longer-term bets (i.e. England Premiership winner this season), with some of the upcoming games mixed in (i.e. England Premiership weekend games). So imagine my surprise when I looked at the following ranking for matched bets liquidity:

Most liquid games as of Fri 11 pm EST:
Chelsea v Wolves $1,032k matched /$4,053k unmatched
Spartak Niltchak-Tom $527k matched/$101k unmatched

Tottenham-Everton $501k matched/$1,360k unmatched
Real Madrid- Santander $428k matched/$3,430k unmatched
Stoke- Manchester United $286 matched/514k unmatched
Birmingham-Blackpool $265k matched/$190k unmatched

There are a few REALLY odd things about #2. It is from the Russian Championship. Neither team is one of the premier teams in the league by far. There is a 5-to-1 ratio of matched-to-unmatched volume, versus 1-to-8 for the Real M game or 1-to-4 for the Chelsea game. A bit odd, right? Even the Birmingham game ratio is 1.4-to-1. So the data is showing lots of volume traded, but shallow depth, unlike most other games that show depth much greater than traded volume.

So this peaked my curiosity: since when has the Russian championship become so popular? I went to see the volumes traded in all the other games and I was in for a surprise. There was one game (Spartak Moscow, a high profile team) with $217k matched, but the other were $1.6k, $1.1k, $0.85k, $11k, $12k, $2.2k for the Alania, Saturn, Amkar, CSKA, Anzhi and Rostov home games respectively. The odd game has 50 times the average volume traded for all other games but one! Now this is getting really interesting.

Betfair also shows how the coefficients (the odds, basically) have changed over time. Based on my observations, the odds are fairly stable over the few days leading to the game, barring any major unexpected changes with one of the teams. So imagine my surprise when I saw that the coefficient for the home win (where most of the volume is traded, 521k of 526k total) has been DROPPING like a rock, from 1.60 to 1.25! So, in other words, you're seeing the strange "price" dropping on unusual volume over a few days, while bids/offers are uncharacteristically sparse at any level.

By now I was suspicious. I decided to check on WSN to see what is going on with the regular bookmakers and the Betdaq. Here are the odds quoted for a home town win: 1.57, 1.50, 1.53, 1.55, 1.57, 1.50, 1.53, 1.30, 1.23, 1.22, 1.53, 1.55, 1.53, 1.55, 1.53, 1.24, 1.24 from bet365, Wm Hill, bodog, unibet, expekt, sportingbet, Ladbrokes, PaddyPower, 188Bet, VCBet, BlueSquare, interwetten, totesport, bet-at-home, betsson, betfair, betdaq respectively. This is a HIGHLY unusual dispersion in quoted coefficients. It looks like some of the bookies had caught on the falling price, while other had not. The coefficient falls if there is large volume coming for the particular outcome (the equivalent of moving the line on a football game).

So what is happening here? To me it looks like there may have been some trading back and forth to move up the liquidity rankings, and once "dumb" money started coming in, there was heavy buying of "home win", moving the coefficient down. Again, usually the coefficient does not move much while here it looks like there was a big disbalance: someone was hogging all "home win" bids. The small number of unmatched bids is showing that there wasn't really a functioning market but rather an absorption of whatever "dumb" money came in to take the other side of the "home win" bet.

Was there an informed insider making the bets? Quite possibly, E European championships are (allegedly) rife with rigged games, reflecting the high levels of corruption in general. Traditional bookmakers will not take high volume bets on odd games, BUT the exchange gets paid on volume. So things like these can happen much to the detriment of the small bettor. If you think HFT and stock exchanges, you are not far off. You are not far off either if you think manipulation, "tape painting", etc.

Oh, yeah, and the final result: 2-1 for the home team. Color me surprised. Be careful because you don't know what the other side knows about the trade, and the deal facilitators will not look out for you.

Wednesday, October 6, 2010

Heretical Thoughts on Gold Miners

This story was linked to by WSJ columnist and investment book writer James Altucher.

Over the last few days, I went through over 90 precious metal miner presentations from a recent forum. The companies presenting ranged from the major majors to minor juniors (pre-production, spending your cash on drilling holes across the globe).
Here is what I found out:
-Every miner is undervalued compared to its peers
-Every miner is a steal at its 2012-2015 projected production level
-Every miner has multiple high-potential opportunities in the world's most prolific mining region
-Every miner has an experienced management team that has a history of delivering results
-Every miner operates in politically stable, mining-friendly jurisdictions
-Every miner has wonderful community relations
-Every miner is a low-cost operator and is also sure that their costs will continue to go down
-Every miner is drastically increasing both reserves and production, but overall reserves and production are expected to decline
-Every miner expects gold and silver prices to go up due to multiple, undeniable fundamental factors
-Every miner is unhedged (well, almost, there were 2-3 that were removing hedges)
-Many miners have brand-name investors that they are proud of

So, satire aside, can all be right? The answer is an obvious 'no' for some of the points, and a subtler 'no' for some of the others. Here is what I was able to surmise about the industry and its underlying dynamics.
-Demand for both gold and silver comes from two general sources: actual use (industrial apps, jewelry) or "investment." As investment demand has increased, so has the commodity price. It appears to me that investment demand for gold is about 3x the level it was at in 2006-2007. You don't have to be a market maven to know what happens to price when supply is relatively inelastic.
-Miners are generally levered to the underlying commodity price level, so the miners' shares have been going up as well. This also attracts attention, and additional investment demand for the sector. Again, you do not have to be a market maven to figure out the price dynamic in a relatively fixed supply environment.
-There has been phenomenal growth in the AUMs of ETFs such as GLD, SLV, IAU, PHYS, CEF as well as miner ETFs like GDX, GDXJ, SIL, and broader "material" ETFs
-ETFs are just like many other asset management businesses, they do very well for their sponsors if AUMs grow; AUMs grow very well if the sector is doing well, so sponsors issue more shares and buy more of the underlying assets
-This is a positive feedback loop, and I am not sure that I like this dynamic longer-term, particularly for non-productive assets
-Imagine having a fund that accumulates residential lots in California, starting in 2002. The fund issues shares, and starts buying lots, moving the price up. Other market participants see that and start buying lots, too. The fund is doing very well because the underlying assets are appreciating. So they issue more shares and go back to the market for lots. The fund also thinks that every investor should have residential lots in their portfolios because they don't make land any more, while demand for housing is projected to increase for the next 50 years, real estate is a privileged asset class, expanding home ownership is a national priority, most millionaires come from real estate, etc.etc.etc. You get the picture and you know how the story ends. It is not a perfect parallel but there are some striking similarities.
-So increased investment demand moves up the underlying PM prices, charging the miners higher. With miners being higher, now there is a 2nd level of investment demand, that of the miners' ETFs + everyone else who wants in. Does it mean that the feedback loop is accelerating? Possibly.

More importantly, does it mean "sell now"? Absolutely not. I do not have a price target for gold (and, hence, miners) because I cannot estimate for how long central banks and governments around the world will continue with their inflationary policies. I would think that most of the appreciation in PMs/PMMs between now and "the peak" will be due to psychological factors, and, by this stage, there are no milestones for them.

Full disclosure: both BCIF and I personally are long miners of various sizes and precious metals, and short the Bernanke- Greenspan- Obama- Pelosi- Geithner- G.W.- Rumsfeld complex and everything it stands for.

Monday, October 4, 2010

How Not to Woo Customers: Craig-Hallum Edition

So, imagine this: several of your micro-cap holdings and research targets are presenting together in a conference in your city. You register for said micro-cap stock conference put together by a small bank called Craig-Hallum. There are no restrictions of any kind on the registration process: a straight-forward registration form with standard questions. 

The day before the conference you get a call, asking you who you are. You explain your story, your plans, and specifically why you registered to attend. Then you get the question "so how can we benefit from your presence there?" You are a straight-forward guy and you explain that at this stage, there is no benefit to the organizer. Of course, there is a direct benefit to the corporate (so-called) clients as they get to present to a wider audience, and there might be benefits down the road to said bank. 

But, as is the case with non-apex creatures, such foresight is deficient. The caller just tells you point-blank that you're not welcome. 

So, dear Craig-Hallum, thank you for allowing me to register just to call me the day before your event to tell me that I am not welcome: you win my eternal adoration (and some fame on the internet).