Why Perry Capital Shut Down: The Full Letter

That 2016 would be disastrous for hundreds of hedge funds - confirmed by the unprecedented number of HF shutdowns even as the S&P is supported by central banks just shy of all time highs - was presaged by the closing of Nevsky Capital at the very start of the year, whose famous farewell letter.

As a reminder, instead of swimming against the central bank current, one which has swept away so many prominent, iconic hedge funds, Nevsky did the noble thing when it admitted that:

"it is more difficult than ever before for us to accurately forecast macroeconomic and corporate variables. This pushes up our cost of capital and substantially increases the risk of us suffering substantial capital loss on individual positions either because of a forecast error or simply because we could be caught up in an erroneous market trend, which could then persist for far longer than we could take the pain. This has made what we enjoy most – the thrill of analysing economic data releases and company accounts – no longer enjoyable. It is therefore time to accept that what we have done has worked brilliantly for twenty years but does not work anymore and move on. We are confident our process will eventually work again – for the laws of economics will never be repealed – but for now they are suspended and may be for some time; an indefinite period involving indeterminate levels of risk during which we think it would be wrong for us to be the stewards of your money."

Then earlier this week, another hedge fund legend, Richard Perry of Perry Capital likewise folded his flagship Perry Partners fund, although unlike Nevsky's eloquent farewell, Perry had a far simpler justification for the closing: "the industry and market headwinds against us have been strong, and the timing for success in our positions too unpredictable."

Short, simple and to the point. And yes, we get it, because we have said it all along for the past 7 years: central planning will inevitably crush everyone in nationalized "markets", before central banks themselves throw in the towel once they own all assets, ending the "wealth effect" transmission channel, having made the 0.01% richer than their wildest dreams in fiat terms. To all those who are still stuck in the business unable to retire and trying to make their P bigger than their L every day, our condolences. 

Full Perry Partners letter below:

Dear Investors

 

Over 28 years ago, Paul Leff and I started a money management firm. Our catalyst oriented value approach combined financial analysis and active engagement with management teams to create attractive opportunities with asymmetric risk/reward. During this time, we provided capital to many companies and countries facing stress and distress. Our style worked well for many years and we had the pleasure of hiring, training, and working alongside some of the best people in this business who have significantly contributed to the success of Perry Capital. Although I continue to believe very strongly in our investments, process and team, the industry and market headwinds against us have been strong, and the timing for success in our positions too unpredictable.

 

As a result, we have decided to wind down Perry Partners LP. We will manage the Fund's wind down in the most effective way possible. We have been raising cash and plan to return a substantial amount of the fund's capital in the beginning of October. The rest of the portfolio will be monetized in an orderly fashion and will be categorized by expected liquidation horizon: short term (2-3 months), medium term (6-12 months) and longer term (greater than I year).

 

We will prudently manage the remaining investments down over time. The short and medium term investments will be sold opportunistically but efficiently so as not to move markets or harm investment value. The longer term investments, for example the GSEs and some of the RMBS putback securities, will take time and energy to successfully realize an appropriate result. Our core team remains in place so that no effort or diligence will be compromised. We are committed to these investments and to you, our partners.

 

Going forward, we intend to return your capital quarterly. I am completely dedicated to making sure this process goes as smoothly as possible and have no other plans. Our interests are aligned — the Perry funds represent almost all of my liquid capital.

 

Over the next few weeks, I hope to speak with many of you. I want to personally tell you how much I have valued your support and trust. Thank you for your partnership over the years.

 

All my best,

 

Richard Perry

Nifty

Sell Nifty 

Stop-loss 8840

Don’t bet on Russia capping oil output

In spite of the sharp fall in the price of oil since 2014, the Russian oil industry is healthy and production, confounding many predictions to the contrary, is growing steadily.

Indeed, boosted by the launch of several greenfields this month, Russian oil output has gained around 200,000 barrel per day in September alone to a post-Soviet record of 11.18m barrels per day.

Although this booming rate of output gains cannot be sustained; slow, steady production increases from these levels will remain the norm at least until 2020. So how is this dichotomy of rising production and sharply lower oil prices possible?

First, Russian oil production is highly profitable on a pre-tax basis, much more so than is generally understood. Second, both the Russian oil tax regime and the rouble are highly geared to oil prices, cushioning wellhead margins and keeping overall well economics for producing companies surprisingly stable in almost any oil price environment.

The precipitous fall in oil prices since mid-2014, from over $100 per barrel to just below $50 a barrel today, has resulted in a rapid reduction in investment in the global oil industry, which has naturally resulted in a significant reduction in field-level activity.

Most visibly, the number of working US oil rigs has collapsed by about 75 per cent from the 2014 peak. Canada (-79 per cent), Latin America (-54 per cent), and the Asia-Pacific region (-32 per cent) also all saw significant drops in rig activity. Even in the Middle East, where Saudi Arabia is in the process of taking market share, the number of rigs in operation has fallen 12 per cent from 2014 peak levels.

Russia, however, is clearly bucking this trend. Although upstream capital expenditure in the country has fallen in dollar terms, that has been entirely due to the sharp fall in the rouble. Drilling activity itself has actually risen by 25 per cent since 2014, driving a steady rise in Russian oil output even as the rest of the non-OPEC world sees various degrees of declines.

This increase in oil production despite sharply lower oil prices has caught many observers by surprise. In December of 2014 Opec forecasted a small, 10,000 bpd production loss for Russia in 2015, while theInternational Energy Agency predicted a more significant 90,000 bpd fall. In reality Russian output went up by about 140,000 bpd.

In December of 2015 Opec again predicted a decline in Russian output for 2016, this time of around 70,000 bpd, while the IEA anticipated “largely flat” output. In the event, Russian production broke through the 11m bpd level in early September, and with the launch of several new greenfield projects hit 11.18m bpd by September 20, the highest level since 1989 when Russia was still part of the Soviet Union. Looking forward, we expect Russian oil production to continue to climb, if less dramatically, for the medium term until hitting about 11.5m bpd in 2020.

So how has Russian oil production been able to outperform the forecasts of knowledgeable observers, increasing production in spite of low oil prices?

We see two general reasons: First, contrary to common misconception, Russia’s oil production is not a high-cost venture. Instead, the typical Russian barrel of oil resides far down the cost curve, generating economic value even at oil prices below $20 per barrel, although the bulk of that economic value goes to the Russian government via taxes, rather than to producers in the form of profit.

Second, both Russia’s oil tax regime (explicitly) and the free-floating rouble (in effect) are tied to the price of oil. The combination of an automatically-adjusting tax burden and rouble work to act as a very effective cushioning mechanism for wellhead operating margins.

The Big Read

Russia: Siberian spring

New drilling in Soviet-era brownfields makes it unlikely Russia will help ease global glut

The union of only modestly lower, and generally stable, wellhead margins and sharply lower upfront well costs has served to keep new well economics for producers surprisingly stable in almost any oil price environment for Russia’s oil companies. Indeed, we estimate that the returns a standard vertical well in West Siberia today is the same or even higher than what would have been earned on that same well in June of 2014 when oil was around $112 a barrel.

This somewhat counter-intuitive result — that field-level returns could be stable in spite of sharply lower oil prices — is probably what has caused otherwise knowledgeable observers to serially underestimate Russia’s production potential the last few years.

So what does this imply for Russian oil production going forward?

In short, with a stable return environment and substantial geological resources left to tap, we see Russian oil production continuing its slow climb for at least the next five years. While the increase in any given year is unlikely to be large enough to move the needle on global oil markets, neither can other global producers look to Russia for help in reining in output to boost the price of oil.

Ronald Smith is Citigroup’s senior Russian oil and gas analyst

a

Hedge funds pull business from Deutsche Bank

Hedge funds have started to pull some of their business from Deutsche Bank, setting up a potential showdown with German authorities over the future of the country’s largest lender.

As its shares fell sharply in New York trading, Deutsche recirculated a statement emphasising its strong financial position.

European regulators and government officials have kept a low profile in public over Deutsche’s deepening woes. However, in private they have struck a sanguine tone, stressing that in extremis there is scope under European regulation to inject state funds to support the bank, provided it is done in line with market conditions.

Marcel Fratzscher, head of DIW Berlin, a think-tank, said: “If push comes to shove, the German government would contribute because Deutsche Bank is the only global bank that Germany has.”

A person briefed on the situation at Deutsche said some of the bank’s hedge fund clients had imposed risk limits on the business they do with it in response to the negative headlines swirling around the lenderand the recent rise in its credit default swap prices, a key indicator of credit risk.

The reining in of risk had affected the sales and trading operations of its global markets division, this person said, but it had not seen similar moves by clients in its transaction banking or corporate finance divisions.

Deutsche has become the focal point of growing anxiety about the health of Europe’s banking system after the US Department of Justice told the bank it was seeking $14bn for mis-selling mortgage-backed securities.

Shares in the bank, which hit a 33-year-low this week, were down almost 7 per cent in New York in afternoon trading, after closing up 1 per cent in Frankfurt. Concerns about Deutsche rippled through the wider US market, sending US banking stocks down as much as 1.6 per cent, and the S&P 500 index off more than 1 per cent at one point.

After Bloomberg reported that about 10 hedge funds, including Millennium Partners, Capula Investment Management and Rokos Capital Management, had cut their exposure to Deutsche, the bank recirculated a statement, saying: “Our trading clients are among the world’s most sophisticated investors. We are confident that the vast majority of them have a full understanding of our stable financial position, the current macroeconomic environment, the litigation process in the US and the progress we are making with our strategy.”

Barry Bausano, chairman of Deutsche’s hedge fund business, told CNBC it had seen outflows, but added that it had also seen inflows, characterising the moves over the past week as typical of the ebbs and flows of the prime brokerage business, which he said remained very profitable.

Most of the bank’s 200 derivatives-clearing clients made no changes. A London-based analyst noted that the €33bn of hedge fund money held by Deutsche was dwarfed by its €223bn liquidity reserves at the end of June, including cash and sovereign bonds. “They can last at least two months, more like three months, if no one deals with them,” he said.

Jeffrey Gundlach, the prominent investor and founder of DoubleLine Capital, told Reuters on Thursday that investors should “stay away” from Deutsche shares for now, calling them “unanalysable”. He said: “The market is going to push down Deutsche Bank until there is some recognition of support. They will get assistance, if need be.”

The woes of German banks were further underlined on Thursday as Commerzbank, the country’s second-biggest lender, unveiled plans to cut 9,600 jobs and scrap its dividend “for the time being” to boost its flagging profitability.

The move came as the profitability of the sector as a whole is under pressure from a suffocating combination of excess capacity and record-low interest rates.

Official concern about the state of European banks was highlighted on Thursday by the EU’s bank regulation chief who warned that Brussels was prepared to reject international plans to toughen bank capital regulations if they piled excessive pressure on the sector.

Valdis Dombrovskis, a vice-president of the European Commission, said the EU would not accept reforms that “lead to a significant increase in the overall capital requirements shouldered by Europe’s banking sector”. The US and Switzerland are among nations pushing for stricter rules in the Basel Committee on Banking Supervision as part of efforts to prevent another financial crisis.

This week, the German government was forced to deny reports that it was working on a rescue package for Deutsche as the lender’s share price tumbled.

As part of Commerzbank’s new strategy, drawn up by new chief executive Martin Zielke, the lender will replace its current four divisions with two: one serving corporate clients, the other serving retail and small business customers. The plan must still be approved by the supervisory board,

Its Mittelstandsbank, which caters to the small and medium-sized companies that make up the backbone of the German economy, will combine with its investment banking division to focus on corporate clients. Its trading activities will be scaled back in an attempt to reduce earnings volatility and the bank will push to digitalise many of its processes.

The reorganisation will prompt writedowns of about €700m, pushing the bank to a loss in the third quarter. Commerzbank still expects to make a “small net profit” for the full year, despite rising provisions from its exposure to the shipping industry, which is in the grip of a prolonged downturn.

The bank added that its core tier one capital ratio — a closely watched measure of financial strength which stood at 11.5 per cent at the end of June — had strengthened during the quarter, and would be “nearly 12 per cent” by the end of the year. Shares in the bank closed down 3 per cent at €5.81.

Alongside the 9,600 job cuts, Commerzbank also intends to create about 2,300 positions, meaning it will achieve a reduction of about 7,300 — or about a seventh — in its 50,000-strong workforce.

The job cuts will help Commerzbank trim its cost base from €7bn to €6.5bn by the end of 2020. “I am pleased that they made cost-cutting a key part of the plan, but it is a shame they didn’t go a bit further, and cut the cost base to €6bn,” said Neil Smith, an analyst at Bankhaus Lampe in Düsseldorf. “I would also have liked to see them exit their shipping portfolio sooner, and fund it by selling their stake in Comdirect.”

The restructuring will cost “in the region of” €1.1bn, Commerzbank said. To cover this, the bank will suspend its dividend for the time being — having only reinstated it last year after a seven-year hiatus in the wake of the financial crisis.

Commerzbank hopes to boost its return on tangible equity to “at least 6 per cent” by 2020. If the interest rate environment improves, the bank thinks a return of at least 8 per cent “will be achievable”. It is aiming for a core tier one capital ratio of 13 per cent by 2020.

Additional reporting by Robin Wigglesworth and Joe Rennison in New York and Stefan Wagstyl and Patrick Jenkins in Berlin

This article has been amended to clarify that Deutsche’s statement had been issued before Thursday

Nifty

Buy 8750-8740

Stoploss 8700

(High risk trade)

Oil Spikes After OPEC Announces It Has "Reached A Deal To Limit Oil Production"; Execution to take place in November.

As was leaked earlier today by Reuters, which reported that OPEC could announce an output-freeze deal on Wednesday in Algeria, although full details are unlikely to be firmed up before a formal meeting of the Organization of the Petroleum Exporting Countries in November, moments ago Reuters blasted that this is precisely what OPEC has decided at its Algiers meeting, when it announced that a deal to limit oil production has been reached, however the execution won't take place for another two months.

• OPEC REACHES DEAL TO LIMIT OIL PRODUCTION, EXECUTION IN NOV - OPEC SOURCE

Oil, as expected on this latest attempt to spark a headline driven buying frenzy, has surged on the news, and was up 4% at last check, some $1.75 higher, trading at $46.40 even though it remains unclear just how - if at all - a "supply freeze" takes place when practically all members who are not producing at capacity such as Iran and Nigeria will be granted an exemption.

 

Incidentally, the "deal" which is really a deal to meet again in November as nothing will be "executed" until then,comes at a time when Russia, the world’s largest energy exporter, just reported it is on course to pump a post-Soviet record amount of oil in September, adding as much as 400,000 barrels a day to the country’s production. The output surge comes as OPEC nations meet in Algeria, with discussions to curb a global surplus at the top of their agenda.

Russian crude and condensate production is set to average 11.1 million barrels a day this month, compared with 10.7 million barrels a day in August, according to preliminary Energy Ministry data compiled by Bloomberg. That would surpass the 10.9 million barrels a day January production level, which officials considered as a potential cap during failed talks among producer nations in April.

This means that as OPEC is padding itself on the back for pushing the price of oil higher, what is really happening is that both OPEC and non-OPEC producers are on pace to "freeze" production at all time high levels, and meanwhile shale production is also set to ramp up now that the price of oil may once again trend higher.

As to Russian production, it has every opportunity to continue growing, potentially adding another 2-3 percent over the next 12 months if the government doesn’t raise taxes on the industry, according to Artem Konchin, an oil analyst at Otkritie Capital in Moscow. Rosneft and Lukoil, the nation’s two largest producers, have shifted their guidance on output to positive territory as they start new fields and increase spending on core production in Siberia, he said in an e-mail.

“If the freeze happens at current levels, then the bar is obviously higher,” Konchin said. “Technically, I’m not sure how that whole thing will be implemented -- no one is sure.”

The details don't matter: for now the algos are buying because other algos are buying. :)

Nifty

No Figures for nifty today being an event day..

China’s Ambitious Plan to Make the Yuan the World’s Go-To Currency

China’s long-held desire to provide an alternative to the U.S. dollar will get a boost on October 1, when the yuan enters the International Monetary Fund’s basket of reserve currencies, placing it alongside the pound, euro, yen and dollar. The yuan’s ascent is a validation of the importance of the world’s second-biggest economy and the work policy makers have done to allow freer access to the nation’s markets.

China’s currency hasn’t kept up with its global ambitions

Still, there’s a long way to go. While China’s the biggest trading nation, the yuan is barely used in world markets. Even in U.S.-China trade, just 2.4 percent of all payments by value were conducted in yuan.

Comparison of international trade and currency use

Total exports and imports

Share of global payments

$4.0T

41.9%

$3.7T

$1.3T

$1.1T

8.4%

3.2%

1.8%

USD

China

Japan

GBP

U.S.

U.K.

CNY

JPY

Sources: IMF and SWIFT

The yuan’s elevation could bring billions in investments

The yuan’s inclusion in the Special Drawing Rights (SDR) basket will prompt central banks and fund managers to buy more Chinese assets, with estimates of as much as $1 trillion of inflows in a five-year period. China needs the cash, with its economy growing at the slowest pace in more than two decades.

Among the main beneficiaries will be the onshore bond market, which foreign investors have been flocking to since the government accelerated the lowering of barriers in February 2016. Global funds boosted their holdings of Chinese government debt by the most in two years in June, while the benchmark yield touched a record low in August.

Global sovereign bond market projections

40%

share

U.S.

30

Japan

20

China

10

U.K.

0

Sources: BIS, Oxford Economics, Credit Suisse estimates

Then there’s the issue of interest rates: with SDR entry, Chinese sovereign bond yields will decline further, lowering the government’s borrowing costs. The yield on 10-year Treasuries is now less than 1.7 percent, compared with more than 2.7 percent for Chinese sovereign debt.

Ten-year bond yields

5%

China

yield

4

United States

3

2

2009

2010

2011

2012

2013

2014

2015

2016

Sources: ChinaBond, Bloomberg

The world will only play along if China leaves the yuan alone

One of the basic definitions of a reserve currency is that it must be freely traded. And the yuan is not quite there yet. The People’s Bank of China is often suspected of intervening in the market to nudge its exchange rate one way or the other. The central bank also limits onshore daily moves to 2 percent on either side of a fixing that it sets. Then there are capital controls, which restrict the ability to move money out of the country.

Despite this, people have found ways to move money out to escape yuan depreciation pressures and a volatile stock market. An estimated $1 trillion has flowed out of China since September 2015.

Estimated China capital flows

$150B

100

50

0

-50

-100

-150

-200

2009

2011

2012

2014

2015

2010

2013

2016

Source: Bloomberg

The Federal Reserve Bank of Dallas suggested in July that the yuan failed a safe-haven test, finding that China’s currency underperforms as market volatility increases.

SDR inclusion is likely to prompt the Chinese government to push ahead with reforms to its exchange-rate policy, as part of its efforts to bolster international usage of the currency. But challenging the dollar’s hegemony will take more than a while, with the memory of the shock August 2015 devaluation relatively fresh in investor minds. The greenback has maintained itsdominance since the mid-20th century, fighting off competition from the yen and the euro.

After the IMF in 2010 rejected China’s request to include the yuan in the SDR basket, the nation took several steps to support its claim. It made the yuan’s fixing more market-based, allowed greater access to its bond market and closed the gap between the currency’s rates at home and abroad. In November last year, the IMF deemed that the yuan was freely tradable enough to become a global reserve currency.

In the long run, a stronger yuan could be a much-needed fix for the global economy as it would increase the purchasing power of China, the biggest consumer of commodities in the world.

Nifty

Sell Nifty @ 8660-8700

Stoploss 8750