Welcome to the free version of the Art of the Bubble! This is a free educational service from 1.2 Labs. Our paid plans make use of the same base algorithm that our crypto hedge fund, 1.2 Capital Management,does. We have two primary data offerings for stocks: (1) a risk parity “Bubble Portfolio” and (2) a “Leveraged Index Portfolio”. They are pictured below relative to their benchmark: the QQQ, which is an ETF of the Nasdaq100. (Data updated quarterly). Click for Paid Options

Hello Bubble Riders!

“Be fearful when others are greedy, and greedy when others are fearful.”

-Warren Buffett​

I am still kicking myself for not picking up a CryptoPunk at just over $2k last cycle. At the time of writing, the floor price (the cheapest NFTs in the collection) are valued at 47 ETH = $76,563, which implies better than a 38x return.

Determined to learn from my mistakes, I’ve been watching the 90%+ decline in NFT volumes, a literal decimation, and the numerous lawsuits leveled against top projects waged in the hopes of recovering settlement fees. Unless the US economy falls off a cliff, things in the NFT world are about as bad as they can be before the next cycle.

But what strategy should you use to identify a few turn-around bets right now?

Let me introduce you to Real World Arbitrage–it’s the other RWA (which is typically an acronym for Real World Asset).

Because the NFT market is hated by outsiders and filled with despair by the remaining insider participants, it is materially discounted relative to art in the “real world.” If an artist exists in both worlds–i.e., is established in the traditional art world and makes NFT collections–then there is likely to be a discrepancy in pricing in their art collections.

The idea is to buy the discounted side of the pair, i.e., the NFTs, and bet that its price will close the gap to parity (or near parity) with the other side. (As a technical aside, this is nearly a statistical arbitrage trade but for the art world).

I think Takashi Murakami’s pieces are perfectly positioned for this trend (the linked article is worth reading, if you plan on trying your hand at this).

Murakami’s flowers launched just before the FTX implosion and the cheapest (floor price) were valued at $28,665. Now that floor price sits at $1428 (using CoinGecko data). Their value has been more than decimated along with the rest of the NFT market.

But Murakami is also a world-renowned artist in the traditional sense–selling physical paintings and sculptures. He’s innovated by assuming Andy Worhal’s mantle and taking aim at Japanese trends, especially those as they are exported to the “West” through anime and video games.

He’s collaborated with Drake, West, and Billie Eilish, been featured in Museum of Modern Art (NYC) and Gagosian, and his prints have appeared on Supreme shirts, Vans skateboards and Louis Vuitton handbags. He is the real deal.

Here’s the Real World Arbitrage trade. The physical replicas of his NFTs are selling for $70k – and the originals, the NFTs themselves, are selling for $2200 (as reported here).

That’s a 31x discrepancy.

Assuming that this irrational gap closes, and that Murakami’s NFTs–the originals–are valued at the price of their derivative physical art, you stand to make that 31x return.

That projected gain, moreover, makes no assumptions about the value of his art increasing over time–that the physical copies gain wider renown, for example.

At its core, this is a bet that the same works within a single artist’s collection should have about the same value.

Some due diligence points come to mind.

Maybe there will be some sort of permanent discount relative to the physical world (I doubt it), but even so, you’ll still be looking at a nice return. At a 33% discount, you’re still looking at better than a 20x trade.

The above uses 3rd party reporting on sales prices and those should be verified. I’d also like to know more about the volume of sales (highly illiquid markets can exhibit irrational price discrepancies that prove difficult to close).

The entire trade supposes that Murakami as an artist continues to be at least relatively successful. The arbitrage is between the digital and conventional worlds, so some further due diligence around his standing and trajectory in conventional terms is warranted.

These due diligence points notwithstanding, I find the situation interesting.

-Sebastian Purcell, PhD

The Macro Situation

Home is where I want to be
Pick me up and turn me round
I feel numb, burn with a weak heart
I guess I must be having fun

The less we say about it the better
Make it up as we go along
Feet on the ground
Head in the sky
It's ok I know nothing's wrong . . . nothing

— “This Must Be the Place”, Talking Heads

The house (US economy) may be getting in order, but the outside (global) environment has a different look. There may very well be a two-front storm brewing.

• Storm 1: Just when inflation in the US looked like it might be turning a corner, OPEC+ and Russia announced cuts in oil production until the end of the year.
• Storm 2: The Chinese economy has yet to emerge from its slump due to reduced consumer spending and a terrible property market. Even though an Oxford economic model suggested a shrinking Chinese economy would only affect US GDP by 0.1%, the main worry is US market volatility, where money runs back and forth between stocks and an already suspect bond market.

The current Fed temperature check indicates a rate pause is still on for this month (92%). But looking further ahead, the polling has changed with more economists (43.6%) predicting an increase in November.

Crude oil topped $87 this week. According to a report from Skandinaviska Enskilda Banken AB, crude looks to remain steady at around $85 per barrel well into 2024.

Gold is facing some downward pressure as it seeks some stability until more is known about the upcoming Fed meeting. The USD Index is at 105.06, its highest since March 2023.

- Todd Mei, PhD and Sebastian Purcell, PhD

AI Sentiment Report

The following sentiment scores use ChatGPT as part of the AI tech stack to sectors through leading indicators. (Lesson 4 of The Art of The Bubble covers the selection of lead indicators for bubble trades). The scores are most indicative for the next day of trading (a Monday), but they appear to set the general tone for the next week.

The methodology employed is based on this peer-reviewed academic article, which produced 550%+ results in back tests over a 2-year time frame. We consider 4 and 5 scores to be positive, but please bear in mind that the AI model is still in its validation phase.

Happy Trading!!

-The Research Team

Dom Viera, Samantha Russell, Nicole Zinuhova, Aiza Malik

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