Market Update
Portfolio Change: Sell Coinbase (COIN)
We launched Cabot SX Crypto Advisor during a time of extreme global uncertainty. However, I did not accurately predict that one of our current recommendations – LUNA – would decline in price to the extent that it has over the past several days.
I personally apologize to anyone who purchased LUNA at the highs when we began covering this cryptocurrency.
LUNA is a project that I have been following and scrutinizing for many years. The founder, Do Kwon, and I speak occasionally on LinkedIn, and I believe the intentions behind a decentralized, algorithmic stablecoin are good.
The longevity of the project is dependent on UST returning to the peg of $1, with new and improved safeguards and collateral.
What happened?
LUNA suffered a short attack.
When Terra (LUNA) decided to purchase billions of dollars in Bitcoin (BTC) as a reserve asset in exchange for LUNA and UST, this removed liquidity from their system and opened the door for the attack. The reasoning for Terra to purchase BTC was to have collateral to utilize in the event of ongoing market volatility to help shore up the peg of their stablecoin UST.
A large trader borrowed billions of dollars of BTC and sold it to Terra while also shorting BTC. In addition, they built a $350 million dollar position in UST while Terra’s own reserves were low. They sold their UST, temporarily knocking UST from its peg of $1 down to around $0.97. This led to speculation that Terra would begin selling BTC, causing prices across the board to decline. This has led to the downward spiral which we are currently in.
One important point – Terra (LUNA) did not liquidate their BTC holdings as many have suggested. They built up BTC reserves to lend to centralized exchanges.
Despite all of this – LUNA still has value. LUNA’s price cannot stabilize until Terra can prove it can return their stablecoin UST to its peg of $1, which will likely involve a fresh round of support financing and building new safeguards to ensure this does not happen again.
Terra runs on its own Layer One blockchain, and the builders of this community are rallying around the ecosystem.
I am continuing to monitor the situation and over the coming days I will do my best to provide the most accurate, up-to-date information as it comes available.
If you do initiate a new position in LUNA, trade with a tight stop-loss. Upside is favorable in this case if you do so.
Portfolio Construction
Our Equity Portfolio is 95% in cash – we have been in cash since launching the issue, correctly staying out of the downdraft. Coinbase (COIN), our only equity position, remains extremely undervalued. However, earnings for the quarter left much to be desired as the company generated negative operating income and therefore does not meet our standard for generating positive cash flow. Positive cash flow is a must-have attribute for share price to appreciate in this market. We are no longer recommending a position in COIN. SELL
We do, however, remain bullish on the ProShares Bitcoin Strategy ETF (BITO) – believing this is the best way to gain exposure to Bitcoin (BTC). With Fidelity opting to hold BTC in 401k savings plans, other brokerages will follow. We are at the earliest stages of BTC adoption. Charts suggest more risk to the downside – please trade with a tight stop-loss if you are looking to initiate a new position. Over a long-term hold period, BTC at this level offers highly favorable risk-reward as many large holders began buying at the 30k level, including Block and Tesla.
Our Crypto Pure Play portfolio is 65% in cash and to date owns Terra (LUNA) and Ethereum (ETH). Since we already covered the rapidly ongoing problem with LUNA above let’s turn to ETH. I do not believe that ETH will suffer the same extremely rapid price decline as we are experiencing with LUNA. However, the LUNA and UST situation has ramifications for the entire crypto ecosystem and its effects are not entirely known at this time. As a result, we recommend that you preserve capital (as we have tried to do to date, as shown by our large cash position) because the markets simply are not in a good place. With limited upside, we are defensive and must anticipate potential moves to the downside.
These price declines in both cryptocurrency and U.S. stocks mean that the expected future returns are going to be much larger.
I remain positive on quality U.S. companies growing their operating income from businesses that deliver real value to users and customers. I also remain highly positive on the benefits of cryptocurrency.
Today, there are some positive takeaways for the market as the pace of inflation begins to slow.
Upcoming Trade
Nvidia (NVDA) reports earnings in two weeks. We are waiting for the release of the quarterly report before initiating a new position in NVDA. The stock has traded downward, making the expected return much higher for this high-quality company.