Novum Digital Asset Alpha – Daily Analysis 23 July 2020 (7-Minute Read)

Welcome to Wednesday and I hope your midweek is finding you well! 

In brief (TL:DR)

  • U.S. stocks were up, with the S&P 500 (+0.57%), blue-chip Dow Jones Industrial Average (+0.62%) and tech-heavy Nasdaq Composite (+0.24%) all in the green, on the back of positive news on the hunt for a coronavirus vaccine that could help economic activity resume without a consequent rise in infections. 
  • Asian stocks were mostly down on fears over increased Sino-American tensions and the timing of another round of American stimulus. 
  • U.S. 10-year Treasuries surged, as yields slid to 0.595% from 0.605% a day earlier (yields typically fall when prices rise) as renewed concerns on the speed and strength of any economic recovery weighed on investors. 
  • Oil edged up slightly with WTI Crude Oil (Nymex) (+0.24%) up at US$42.00 from US$41.96 in the previous session, as investors turned bullish on a vaccine to back up consumption. 
  • The dollar slid as investors weighed the effect of another round of stimulus from Washington. 
  • Gold surged again yesterday with Gold (Comex) (+0.16%) at  US$1,868.00 from US$1,857.90 a day earlier, as investors mulled over the effect of a sliding dollar and increasingly never-ending rounds of stimulus packages.  
  • Bitcoin (+1.43%) had a stellar 24 hours as stimulus packages from Washington hammered the dollar, pushed up gold and saw stocks rise. Bitcoin was trading at US$9,500 at GMT 0430, with Bitcoin outflows from cryptocurrency exchanges edging below inflows for the first time in days, suggesting some measure of profit taking may be due (inflows typically suggest selling for profit). 

In today’s issue…

  1. Beware The Cheap Chinese Stock Rally 
  2. High on Hong Kong – How Chinese Tech Firms Could Power the Hang Seng Index
  3. Ethereum – Always a Bridesmaid, Never A Bride – May Be Having Its Moment

Market Overview

Turning into Thursday, the likelihood of a last-minute stimulus package out of Washington in an election year has produced a mixed bag. 
 
Stocks in the U.S. were up on both stimulus measures as well as positive results on the coronavirus vaccine front. 
 
But stocks in Asia were mixed in the morning trading session, with Tokyo’s Nikkei 225 (-0.58%) and Seoul’s KOSPI (-0.96%), down, while Sydney’s ASX 200 (+0.18%) and Hong Kong’s Hang Seng Index (+0.37%) counterbalanced the pessimism in North Asia. 
 
Being close allies to the U.S., South Korean and Japanese companies are seen as likely to take the brunt of simmering tensions between their two biggest trading partners, the U.S. and China. 
 
Washington instructing China to close its consulate in Houston has not helped already poor relations between the two superpowers while investors, though optimistic over a stimulus package coming out of the U.S., are still no doubt concerned that political gridlock will again factor into economics. 
 
Given that it’s an election year, lawmakers in Washington will no doubt want to make sure that any further economic shock is not on their hands, but at the same time, if politicians should revert back to their worst selves and use the opportunity of a stalled stimulus package for finger-pointing against their opponents, markets and investors will suffer as a result. 
 
Another round of stimulus will act as a rising tide that will likely (for now) lift all asset boats, regardless of what narrative one subscribes to. 
 
Non-yielding inflation hedges like Bitcoin and gold are likely to do well, as will stocks, as vaccine news and loose monetary policy feed an ever-inflating stock market bubble where fundamentals are a footnote to company valuations. 
 
In times like these, it may be prudent to take profit often and at regular intervals, regardless of the asset class.

1. Beware The Cheap Chinese Stock Rally

  • Chinese stock market rally still some ways from 2015 highs
  • Retail leverage to buy stocks remains an overlying concern and is potential risk to suddenly tank the market 
It’s been said that even before the Chinese invented gunpowder, they were betting on who would invent it first. 
 
So ingrained is the culture of gambling into the Chinese psyche that when China opened up its economy to capitalist reforms (with socialist values of course) and launched its first stock markets, Chinese punters of every stripe raced to place their bets on companies trading in the elements of earth, wind and fire. 
 
The ensuing boom and bust cycles did little to dampen the insatiable Chinese appetite to take risk. 
 
And while the Chinese may be savers by nature (no doubt decades of economic, social and political turmoil have had a hand in that), their propensity to save has always been tempered by their propensity to make it big. 
 
Nowhere is this tension between financial prudence and risk-taking more apparent than on the Chinese stock market. 
 
Talked up by propaganda mouthpieces, Chinese stocks have been on a tear of late. 
 
But so have other major stock markets, including America’s. 
 
Yet the crucial difference is in the quality of the recent rallies. 
 
Whereas the remarkable U.S. stock market rally from mid-March may have been born of fiscal and monetary policy, where the U.S. Treasury Department and the U.S. Federal Reserve jointly conspire to prop up markets, the Chinese stock market rally, has been built on the backs of individual credit and risk-takers. 
 
And unlike a central bank, Chinese retail investors can’t print more money to cover losses in the market. 
 
In the first two weeks of this month, the Shanghai SE Composite (+0.37%), an index representing a broad swathe of Chinese companies, but skewed more heavily towards financial firms, rose 14%. 
 
For good measure, Shenzhen’s CSI 300 (+0.50%), the Chinese equivalent of the S&P 500, rose some 20%. 
 
Part of the problem is the widespread availability of “shadow margin.” 
 
Because a US$1 bet can make US$10, plucky Chinese investors, fueled by propaganda are throttling up bets on a market they believe can never go down. 
 
Although current levels of margin are about half their peak in 2015, stocks are also 20% from those peaks. 
 
And then there’s the opacity with which margin levels are at currently. 
 
According to data from China Securities Financial Corporation, which refinances margin trading and has liquidity support from the People’s Bank of China, the central bank, margin financing loans were a third higher in June than in May. 
 
And in the first week of this month, the margin balance outstanding in China surged by almost a tenth to US$185.5 billion, according to a report from the South China Morning Post. 
 
According to state-owned media Caixin Global, some platforms offer illegal margin trading to retail investors borrowing as much as US$143 for US$14.30 deposited – a leverage of 10 times. 
 
Hopefully, investors are more savvy this time around. 
 
Chinese state media started warning investors earlier this month, in what can only be seen as a tremendous irony coming from a communist country, to “respect the market” and to manage risks accordingly. 
 
With economic growth in China slowing to its lowest level since its economy was opened up and domestic demand not keeping up sufficiently to make up for the shortfall in the global demand deficit, Chinese stocks are wading into dangerous territory again. 
 
The danger though is that while retail investors can get leverage to buy stocks relatively easily, they also get spooked just as easily. 

2. High on Hong Kong – How Chinese Tech Firms Could Power the Hang Seng Index 

  • Increasing Sino-American tensions threaten to restrict Chinese tech firm access to American capital markets
  • Chinese tech firms looking to list in Hong Kong may help to buoy the Hang Seng Index which is trading at deep discounts relative to other global indices
Tear gas, pandemic and national security laws have done little to satiate investor appetite for one of Hong Kong’s stock market darlings – the very operator of the exchange itself. 
 
As one of only a handful of listed firms on its own stock exchange, the Hong Kong Exchanges & Clearing (+2.10%) boasts a market cap of US$59 billion and is only second to Chicago’s CME Group (+1.24%). 
 
Trading at some 40 times price-to-earnings ratio, Hong Kong Exchanges & Clearing boasts a 60% premium to its peers and it stock closed at a record this week, up over 40% in 2020. 
 
By comparison, the Hang Seng Index, the city’s 50-year-old benchmark, is down 11% for the year, on the back of Hong Kong’s long list of troubles. 
 
But that divergence between the exchange operator and the Hong Kong stock market may not be as unusual as it seems. 
 
The same way that the tech-heavy Nasdaq Composite has galloped ahead of the blue-chip Dow Jones Industrial Average, Hong Kong Exchanges & Clearing stands to gain from a flood of new listing from Chinese tech firms, prospects for a jump in derivatives trading and an inflow of cash from mainland-based investors as stocks in China get overheated. 
 
While Hong Kong companies are battered by the social and political winds buffeting the semi-autonomous territory, Chinese tech giants like NetEase (-2.48%), JD.com (-1.40%) and Alibaba’s (-2.40%) Ant Group have either listed, or plan to list on the Hong Kong stock exchange, at a time when tensions are higher than ever between Beijing and Washington.
 
Hong Kong, whose status as an international financial center has come under pressure ever since Beijing enacted harsh national security laws in the territory, has since become the unlikely beneficiary of heightened tensions between China and the U.S. 
 
As tensions escalate between Washington and Beijing, the U.S. has threatened to curtail Chinese companies’ access to the U.S. capital markets, which has triggered many firms to look to Hong Kong instead. 
 
And that has buoyed the fortunes of Chinese stocks listed on the Hong Kong exchange, including Tencent Holdings (+1.48%), which owns the ubiquitous WeChat app that can do anything from payments to social media and is up some 44% this year, as well as food delivery service Meituan Dianping (+0.99%), which is up some 89% this year. 
 
As more Chinese tech firms pour into the Hong Kong market, the complexion of the Hang Seng Index will change. 
 
Already, the compiler of the Hang Seng Index is scrapping a weighting limit for dual-class shares on some of its gauges, a move seen by many as eventually paving the way for more (Chinese) tech stocks to join the benchmark and this week it launched a new tech-focused index. 
 
And that makes the Hang Seng Index look somewhat attractive to add to a portfolio.
 
On a price-to-earnings basis, the Hang Seng Index is close to its cheapest on record relative to the MSCI’s index of global shares. 
 
And in a year when most indices, including the S&P 500 are up on little more than policy measures, the Hang Seng Index may be good value, especially if more Chinese tech firms start looking to list there and start skewing the index more heavily in favor of one that tracks Chinese tech stocks. 

3. Ethereum – Always a Bridesmaid, Never A Bride – May Be Having Its Moment

  • Tethe’s transaction volume (outside of cryptocurrency exchanges) surges past Bitcoin for the first time 
  • Increased used of dollar-backed stablecoins could lead to greater participation in crypto assets as an investment tool among stablecoin holders 
The coronavirus pandemic, which saw many organized sporting events cancelled, provided an unexpected boost for million of punters looking to find new arenas to scratch their gambling itches and many of them poured into the cryptocurrency markets. 
 
As sports betting came to an almost standstill, punters started to bet on Bitcoin and other cryptocurrencies. 
 
But Bitcoin’s relative price stability over the past months has brought about a collective yawn from gamblers more accustomed to an “all-or-nothing” gaming venue and relatively tight trading bands and flat volumes has caused many to grow bored. 
 
In contrast, Ethereum trading volumes and volatility have increased dramatically, powered in large part by the recent surge in interest in decentralized finance, or DeFi tokens. 
 
Several DeFi projects have seen the dollar-value of their digital tokens surge some 250% in the past month alone, at a time when other asset markets were volatile at best. 
 
And that has led to a surge in interest in Ethereum, the platform underlying these DeFi tokens, and has led to the Ethereum blockchain overtaking the Bitcoin blockchain in terms of network value settled in dollar terms. 
 
With the large increase in economic activity on the Ethereum blockchain, the market cap of the world’s second largest cryptocurrency, at US$50 billion, has been gaining ground on Bitcoin’s US$170 billion. 
 
And the trend shows no sign of abating. 
 
Price stability for Bitcoin, against a backdrop of rapid development for Ethereum and increased demand for stablecoins (which run on the Ethereum blockchain) and DeFi tokens have helped to narrow the gap between Bitcoin and Ethereum. 
 
But while stablecoin and DeFi sector growth continue to drive Ethereum blockchain transaction volume and settlement value, one of the biggest challenges facing the Ethereum blockchain is congestion and scalability. 
 
Already 70% of Ethereum’s total daily transaction volume is taken up by stablecoins, compressing the remaining capacity for DeFi and other new token projects. 
 
And while Ethereum’s core developers are actively working to improve the scale of the blobkchain, its choice as the preferred blockchain for stablecoins, thanks to lower fees and faster transaction times, could come under increasing pressure as stablecoins explode in popularity. 
 
For now at least, those who were bullish on Ethereum’s prospects are seeing those bets pay off, and that activity has led to other punters betting alongside them.

Trading Bitcoin Today

Bitcoin surged higher over the last 24 hours, breaking out strongly over the resistance at US$9,400 and testing the new resistance at US$9,500 before retracing to currently trade at US$9,480 (GMT 0330). 
 
Part of the surge for Bitcoin can be explained with a similar surge in the price of gold, as well as expectations that Washington’s US$2 trillion stimulus package will continue to put inflation expectations back on the table. 
 
Yesterday’s long trade for Bitcoin, to consider entry at US$9,350, and take profit when Bitcoin once again tested US$9,420, with a stop loss at US$9,330 – was profitable.  
 
Naturally, with the surge in Bitcoin, yesterday’s short for Bitcoin, to consider waiting till it made a move towards US$9,420 again and short to US$9,300 with a short cover at US$9,450, was stopped out with a small loss. 
 
Lining up the long for Bitcoin today, there is some support at US$9,460, so consider setting up an entry closer to US$9,470 and taking profit on another test of US$9,520, with a stop loss at US$9,460. 
 
The bullish trend for Bitcoin is likely to persist, any sustained push over US$9,500 will see Bitcoin test US$9,700 again. 
 
Shorts for Bitcoin can wait till Bitcoin tests US$9,540 and short to US$9,460 with a short cover at US$9,550. 

Trading Ethereum Today

Ethereum continued its relentless advance, buoyed by positive sentiment from increased usage and bullishness from stablecoin transaction volume. Overnight, Bitcoin surged like a rocket ship heading towards US$270 before paring back gains and now trades around US$263. 
 
Yesterday’s long for Ethereum, was to consider an entry at US$244 and taking profit at US$246 with a stop loss at US$243 – a trade that was profitable and when Ethereum broke out of US$246 it never looked back. 
 
The short for Ethereum yesterday was to wait till it rocked US$246 and then short to US$242, with a short cover at US$247 – this trade was stopped out with minimal loss. 
 
Breaking out of US$246 was a significant move for Ethereum and it is likely to trade within a higher band. 
 
Longs for Ethereum can consider an entry at US$263 and taking profit more aggressively at US$270, with a stop loss at US$262. 
 
Whereas shorst for Ethereum can wait till it clears US$269 and short all the way down to US$262 with a short cover at US$271. 

Novum Digital Asset Alpha is a digital asset quantitative trading firm.

Exclusive access to Novum Digital Asset Alpha’s Daily Analysis is made in conjunction with Bitcoin Malaysia.

The information and thoughts laid out in this analysis are strictly for information purposes only and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws.

It does not constitute a recommendation or take into account the particular allocation objectives, financial conditions, or needs of specific individuals.

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