Turkish Flu?


By Kevin Rodgers, Arion Non-Exec Director

Although it’s almost exactly ten years since the default of Lehman triggered the climax of the last financial crisis, the troubles in Turkey more closely mirror the previous great crisis– the Asian/Russian/LTCM debacle of 1998.   

This time, instead of Thailand being the first domino to fall, it’s Turkey.  What could it mean for the real economy and metals?  

It’s said that history doesn’t repeat, but that it rhymes.  The current crisis in Turkey has a lot of the same look and feel of 1997:  a currency losing 50% of its value in a few weeks; chaotic daily moves; political calls for domestic purchasing of the home currency as a ‘patriotic duty’. 

That said, the immediate causes of the problems in Turkey do not match the causes of the 1997 Asian crisis.  Then, a massively overleveraged domestic economy got to the point that foreign investors feared that they would not be repaid.  Since you can’t carefully dismantle a bubble, the result was sudden collapse and contagion.  

This time it is Trump’s tariffs (especially on metals) and growing investor nervousness about Turkey’s increasingly hardline political situation that have lit the fuse.  

What about the consequences?  In the 1990s crisis, the knock-on effects on the real economies of the ‘Asian tigers’ led to widespread demand destruction.   One consequence was a 1998 slide in the price of crude oil to inflation-adjusted price levels last seen in the early 1970s.   

This, in turn, put pressure on Russia’s balance of payments and thus to eventual default and a severe, if short-lived, emergency in the Western banking sector.   Throughout this period, base metals prices were under heavy pressure (e.g. Aluminium came off about 30%), although price moves were less severe than the collapse that followed the 2008 crisis. 

Could it happen again? 

We are already seeing some contagion into weaker emerging markets currencies (today the Rand is under pressure, the Mexican peso too) and base metals prices have been choppy recently after a strong rally from the lows in 2015.  There is certainly room to the downside. 

But this time there are some grounds for more optimism. 

For one thing, there seems little evidence of any contagion to Asia. This is crucial given Asia’s role in the metals markets. 

Also, given that the trigger this time is not so much a structural problem but rather a US policy decision, it is perfectly possible that the decision could be reversed. 

IF that occurs (and who would like to short unpredictability futures in this US administration?) then the whole ‘crisis’ could easily unwind as quickly as it started. 

Either way, probably not the best time to be short options.  

Bloomberg Commodity Index and selected commodities over August

 Arion’s take on Turkey’s Trade Tariffs

Commentary from Darius Tabatabai, Portfolio Manager

The crisis in Turkey and the evolution of the Trade War between the US and China really speak to us of a few overarching themes of which they are just the latest example:

1.       We are in an overarching tightening regime with a strong USD in the spotlight everywhere.

a.       This has obvious implications for Emerging Markets

b.       The right tail risk around inflation increasingly seems unlikely (emphasised by Tariff policies which are generally deflationary)

2.     The propensity of politicians to take previously ‘unthinkable’ positions on economic policy is vastly increased.

3.     The risks to downside shocks are ever increasing as full valuations in equities and credit make for a generally rocky environment

4.     QE was not just about rates – QE was a tool of Vol suppression - Vols are coming off a low base for the first time in a decade but the major risk warehouses (banks) have reduced their capabilities. Derivative markets are untested in extreme stress scenarios (see Feb in VIX, or April in Aluminium)

The latest tariff headlines and the crisis in Turkey for us are symptomatic of a broader change in world politics and economics. With increasingly partisan governments pushing agendas that challenge the previous orthodoxy we feel that the environment has changed. From a trading standpoint we see a number of themes as opportune.

1.     Skew is improved in value – with upside risks increasingly constrained and the vol of vol increased, owning downsides in Vega neutral structures in base and PGMs is a compelling trade.

2.     Vega – long term volatility is probably too low, with vols still near multi-year lows our propensity to hold outright long vol positions is also increased. Even with just a general re-pricing of risk premia volatilities should move higher.

For now, as Kevin said, it’s not a good time to be short volatility…

 Authors;              Kevin Rodgers, Non-Exec Director

                                   Darius Tabatabai, Portfolio Manager

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