George Soros "Retires" from Hedge Fund Business

In a surprising announcement this week, billionaire George Soros – equity manager of one of the largest hedge funds in the world – said he will be returning his investor’s money and changing his hedge fund to a private fund for himself and his family.

Soros’ decision is primarily due to new regulations which will make hedge funds more transparent and trade-restricted than they used to be.

Like most great investors and traders, Soros spends a lot of time contemplating human psychology and logical thinking (or lack thereof), and making big bets based on his analysis. Recently, Soros noticed that although the price of gold had been rising for weeks, silver had not experienced the same boom. Recognizing that at some point silver would have to jump as well, Soros bought large quantities; and, he was right. After a parabolic rise in the price of silver Soros sold out, partially causing the subsequent drop.

Soros is for some a shadowy and mysterious figure. He has one of the most extreme cases of clinical narcissism I’ve ever seen, and in fact he recognizes this. Though he doesn’t actually say “I have a narcissistic disorder,” he does describe himself as having “messianic tendencies” (i.e. the tendency to think he’s god). To his credit, he realizes that this is a belief he should try to suppress, even if he is an internationally famous billionaire.

Soros’ main contribution to the world of investing is a semi-philosophical concept called “reflexivity.” In a nutshell, reflexivity is the idea that while facts and circumstances generally create results, expectations and interpretations of facts can create results of their own. For example, even if a company is in good financial condition, if everyone believes the company is on the verge of bankruptcy they will sell off the stock and cause the price to plummet, thereby causing the financial instability they were worried about in the first place. According to Soros, understanding reflexivity is key to making superior investment decisions: I don't disagree.

These days, Soros gives a great deal of money to philanthropic organizations, mainly those that promote human rights, logical thinking and open-mindedness.

Soros’ logical demeanour and flexible way of thinking tends to drive doctrine-following and/or illogical people absolutely insane. Dorky talk-show host Glenn Beck, for instance, considers Soros a mortal enemy (Beck calls Soros “Spooky Dude,” mocking his Eastern-European accent in a Dracula-like fashion). The fact that Beck regards himself as Soros’ intellectual equal only adds to the hilarity.

Hopefully, retiring from public investing will give Soros more time to write and lecture. If so, I am looking forward to it.

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Lecture on Reflexivity (starts at 16:45 - prior is introduction).

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See also:

Glenn Beck "exposes" George Soros


Jon Stewart mocks Glenn Beck

The Death of Silver

Silver died an untimely death this week.

Retribution was swift and merciless. As soon as the Chicago Mercantile Exchange raised margin requirements (meaning you have to provide more of your own money to speculate), skittish traders headed for the hills. Silver lost a quarter of its value in just 3 trading days.

On of the big winners of the silver bonanza was billionaire George Soros. In weeks past, Soros noted that although gold prices kept rising higher and higher, the price of silver hardly moved. Realizing that at some point people would opt to buy the grey metal instead of gold, Soros loaded up. He was quickly proven correct as silver rose in a parabolic chart.

Soros reportedly sold heavily early this week: a beautiful trade - and the reason why he is a billionaire.

As for me...I'm not a big fan of jumping on any fast-moving investment train. I can't babysit my investments on a minute-to-minute basis, so I don't like investing in anything that I know will end in a major crash.

As Soros was busy making his latest millions, I received my first silver-related injury. While generously helping a client unload a large quantity of silver ingots, I somehow managed to hit myself in the face. Handling a 120-pound safety deposit box is not as easy as you might think.

Even as the blood streamed off my nose, I recognized that owning a horde of physical silver must be gratifying.

Will silver rise from the dead, and achieve its previous highs? Who knows. But, I sincerely hope that the volatility lasts for a few days more. I have been busy entering lowball orders for great mining companies, just in case the chaos continues. It would be nice if they all fill.

Silver is dead! Long live silver!

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"I feel like a virgin on prom night."

"Uncle Red," in the Stephen King movie, Silver Bullet.

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The FDIC - Combating Stupidity Since 2011

Those who understand behavioral finance know that sometimes you have to protect people from orchestrating their own financial doom: in The Intelligent Investor’s Mind, I devote a section of every chapter to it. Financial quants and investment professionals (who should know better) are no exception. In fact, great genius is required to create a truly phenomenal financial disaster.

On March 29th, the Federal Deposit Insurance Corporation approved new rules for mortgages – essentially “anti-greed, anti-laziness” rules - that align the interests of homeowners, bankers and investors.

Under the new rules, banks will not be able to repackage and sell a mortgage (ex. Mortgage bonds, CDOs), unless the borrower puts down a 20% or greater down payment. If the borrower puts down less than 20%, the bank will be forced to keep some of the risk on its own books - known in the industry as “keeping skin in the game.”

Effectively, these new rules force banks to care about the quality of the loans they receive from mortgage brokers, and care how those loans perform. Prior to this, a mortgage broker could underwrite a loan from someone they knew couldn’t pay, sell it to a banker who didn’t care if the owner couldn’t pay, and in turn sell it to an investor who didn’t bother (or didn’t have the skill) to check to see if the owner couldn’t pay.

The National Association of Mortgage Brokers will undoubtedly hate the new rules. They are already fuming about the Federal Reserve’s new “Truth in Lending” regulations in general. Despite pushback, however, the matter will be put to vote this week and is expected to pass.

The days of dreamers with bad credit and no cash, walking into a mortgage broker's office, getting approved, then sitting on their new sofas & waiting for riches through equity appreciation are truly over - even if the market comes back.

People will always find new and ingenious ways to ruin themselves financially. Even so, it’s nice to see the old gaps being closed.

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"If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring."

George Soros
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Is the US Recovery in Danger?

This week saw low sales numbers in housing, lowered (but still rising) durable goods orders, and a generally pessimistic attitude all across the board.

In fact, “pessimistic” may be an understatement. One website effectively summarized the prevailing mood: “Things will never get better. We are all doomed.”

One of many problems with doom and gloom reporting is the resulting dialectical materialism (George Soros calls it “reflexivity”). When people believe something it can become a reality, even if it wasn’t a reality at the time people began to believe it. For example, if people believe there is an increasing chance they will lose their jobs or homes due to recession, they will curtail their spending, thereby causing the recession that they feared. Despite the reflexivity effect, however, I do not believe that this recovery is endangered.

Consumer “entrenchment mentality” is already in full force, and has been for some time. As noted earlier in The Frost Report (The Spending Zone), Americans have been paying off their debts and increasing their savings for seven months straight, and are almost at the point where their free cash flow will increase substantially. As a result of these debt repayments and savings, consumer credit scores are already the highest they have been since 1998.

The corporate world largely reflects the personal one: businesses have vast amounts of emergency cash, have paid down and/or refinanced debts, and have streamlined staff and operations. Corporate America is mean and hungry. With solid balance sheets and low stock prices, M&A activity should rise soon and remain high for months.

The combination of high cash flow, lower debts, higher savings, and excellent credit ratings simply does not match the “we are all doomed” mentality. Similar to cult members who wait for the mother ship, at some point people will realize that the economic apocalypse they are preparing for is simply not going to occur.

Based on the numbers, I suspect that this revelation will strike the US consumer within the next 3 quarters. Regular (if not exceptional) spending will resume shortly thereafter, and corporate America will follow suit with mergers, expansions and hiring.

Though the international picture is deteriorating, it will not be enough to derail the US turnaround.
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“Hysteria has now disappeared from Wall Street.”

The Times of London, November 2, 1929
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Reflexivity and the Decline in Home Sales

Recent headlines confidently announced that the 33% reduction in U.S. new home sales for May 2010 was due to the expiration of the new-home buyer’s tax credit at the end of April.

In other words, we are supposed to believe that home sales were robust due to an $8000 tax credit, and now that this credit is over the housing market is bust. Nonsense.

In fact, the reversal in new home sales was primarily caused by an equally large decline in psychological wealth that occurred at the beginning of May - which had nothing to do with tax credits.

Rapid declines in consumer spending are caused by rapid declines in asset values, such as stocks or real estate. While there is much talk about how a drop in stock prices can “predict” an economic downturn, there is little notice that a drop in stock prices, rather than predicting a downturn, may actually be the cause of one.

When people see their net worth decline, they compensate by saving. That is, they decrease their spending and increase their margin of safety, further exacerbating the symptoms of the decline.



The “flash crash” of May 6th 2010 punched the confidence out of retail investors, psychologically forcing them to transfer billions of dollars out of equity investments. So, while April saw inflows to equity mutual funds of $13.89 billion, May saw outflows of $29.94 billion (www.ici.org). Negative headlines caused retail investors to run for the hills - and they haven’t stopped running. These days, the market fluctuates wildly from the trades of hedge funds and volume traders, while those working with retail clients (such as Financial Planners and Brokers) sit at their desks, bored.

Stocks are reasonably priced, with little room for a disastrous collapse like the one from the peak. Home prices are low. Interest rates are low. Despite problems in Europe and Asia, the U.S. economy has all the logical conditions which make it ready to rise from the ashes. However, retail investors and consumers are anything but logical.

Until the chat-room anger and gloom subsides, both stock and housing markets will linger - and the buying opportunities for rational long-term investors will be sublime.
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“…the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.”
The Federal Reserve, Press Release, June 23 2010

“Housing cannot lift the United States from its new state of Marxist depression, you bunch of morons. The American Dream is just that. Rest in Peace, USA.”
Anonymous comment on a financial news website, June 24 2010
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See also: Reverse Attribution

Cognitive Dissonance

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"Cognitive dissonance" is the name for anxiety caused by disconcerting thought processes. That is, when people are faced with facts that make them uncomfortable, they tend to ignore these facts, literally to the point of self-denial.

Cognitive dissonance is the reason why a mother won’t accept that her son is dead, even when the police are standing in the doorway telling her. Cognitive dissonance is the reason why a husband with an unfaithful wife will always be the last to know. It is why those in debt do not open their mail. It is why Al Capone thought he was a good person because he donated to charity. And, it is why Americans who wished to buy a home in 2006 (or already had one) insisted that there was no housing bubble, despite all evidence to the contrary.

It is a natural thing for people to seek confirmation of their existing beliefs. Finding facts to prove you are right is both satisfying and comfortable. This is why conservative Republicans watch Fox News, anti-globalization protesters read Noam Chomsky, and why environmental activists seldom read the Oil and Gas Journal. But in order to be a truly effective thinker, one must embrace cognitive dissonance by intentionally seeking disconfirming evidence. For many great thinkers, including investors Charlie Munger and George Soros, the best technique for embracing cognitive dissonance is a simple one known as “Inversion.”

Inversion states that in order to prove that something is true, you should try to prove it false; that is, for any strong belief that you have, regularly search for evidence you might be wrong. If you wish to buy a stock, for example, you would include a search for reasons not to buy it. You would read not just the glowing press releases about the company, but also seek out all negative facts about the company, and judge these facts without emotion. Only after finding no significant reasons not to buy the stock would you actually buy it.

Cognitive dissonance is not easy to overcome. You will be fighting natural human emotion every step of the way. Despite a lifetime of working on it, I have fallen prey at least twice, and will no doubt do so again. But by making a habit of questioning your own judgements and attempting to prove your own beliefs false, you will become a stronger and more reliable investor (and possibly a better person). Soon, you will find that your mental discomfort becomes a source of pride and pleasure, not to mention lucrative.
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“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.”
John Kenneth Galbraith

“Reverse Attribution” – What the News Doesn’t Know

On Jan 21st 2010, President Barack Obama announced that he would limit the amount of “gambling” (i.e. high-risk leveraged trading) that banks would be allowed to do using client money. Traders worried that as a result of this announcement, future bank earnings may not be as high as they’d anticipated, and so stocks dropped. Pretty straightforward, isn’t it? Not really. Investors should be aware that the market is understood via “reverse attribution” (also known as “post hoc ergo propter hoc”). That is, after a market event has occurred, analysts try to determine why it happened and report it as news. In reality, there are limitless reasons for market moves: some simple, some complex, and others masterfully planned.

In 1929, millionaire trader Jesse Livermore sensed a change in the public. After weeks and months of positive news, he sensed that people were getting bored with the “prosperity” story. Livermore knew that a well-known economist, Roger Babson, was going to give a speech the following day, saying that markets were overpriced and due for a crash. Livermore knew that this would be the speech because it was the same speech that Babson had given the previous two years! Recognizing the opportunity, Livermore sold short vast quantities of stock (meaning that he would make a profit if the market declined), and then had his staff of secretaries call every major new agency in the U.S. and alert them to an “important speech” that was about to take place. When the press conference took place, it took place to a packed crowd of eager reporters. The following day, Babson’s dire predictions made front-page headlines, and the market took a frightening dive. This was the beginning of the end for investor confidence in 1929. The infamous” great crash” occurred less than two months later, with many blaming Livermore’s orchestrated press conference as the catalyst that started it.

The market decline that began on Jan 21st 2010 may have been caused by Barack Obama’s pronouncement, as explained in the opening paragraph. Or, it may have been caused by opportunistic traders. For weeks prior, traders had been saying that the market had gone too high and was due for a correction. These traders, upon hearing Obama’s speech -- and seizing the opportunity -- started short-selling bank stocks like mad. The short-selling led to anxiety on the trading floor, causing stocks to drop further. George Soros calls this “reflexivity”: that cause and effect make things that were not previously a reality, a reality. Or, I could be completely wrong, and it could be that a wealthy Arab, for no particular reason whatsoever, decided to sell his bank stocks that day.

A few years ago, a mutual fund manager told me the story of when his mutual fund decided to sell a certain company’s stock. The day they started selling just happened to coincide with an announcement by the same company, saying that they were changing some of their board members. The next days’ headline: “X company stock drops after appointment of new board members: investors not pleased with changes.”

In the book Wall Street Meat, Andy Kessler tells the story of a German banker who decided to have some fun at the bank’s annual Christmas party. The inebriated banker called in a buy order for a massive number of shares in pharmaceutical company Eli Lilly. As the whole party watched the computer monitor in anticipation, the share price ticked higher and higher and higher due to the onslaught from the huge order. When the Dow Jones newswire reported “heavy buying” by a foreign investor, the partygoers screamed with delight. Finally, the New York Stock Exchange halted the buying on rumors that this was a takeover attempt. Disappointed that the fun was over, the partygoers went back to their steins and punchbowls to continue their Christmas celebration. The following morning the large purchase was quietly sold off.

When news agencies simply have no idea why markets are moving, they employ common expressions, most notably “profit taking” (to describe a drop) and “bargain hunting” (to describe a gain). For instance, “the markets went up today on bargain hunting,” is a convenient way to describe an increase in the market on a day with no substantial news. “Profit taking” and “bargain hunting” are your clues that in fact no one has a clue.

On any given day, no one knows exactly why stocks move. Sometimes guesses are (probably) accurate. Sometimes they are dead wrong. Sometimes they cite a single reason when in fact there are several. It’s up to you to dig further than people watching from their sofas. It’s up to you to know that sometimes people manipulate the market for fun or for personal gain, even if it kills grandmother’s retirement plans.

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“Heavy selling out of the Middle East was an old standby. Since no one ever had any clue what the Arabs were doing with their money or why, no story involving Arabs could ever be disputed.” Michael Lewis, Liar’s Poker.