The Alchemy of Finance: Reading the Mind of the Market

Honestly this book was hard to follow and I'm still not sure how Soros does it. He is an excellent thinker but I think this book was over the top for me.

Soros explains here his key analytical principle of reflexivity - essentially a positive feedback loop - in the context of boom-bust cycles in financial markets and economies, and its applications in his extraordinarily successful "global macro" trading system during the 1970s, 80s, and early 90s. He gives unique contrarian insights into our understanding of supposedly cut-and-dried economic and financial ideas, such as his trenchant denial of the efficient markets hypothesis and financial markets equilibria. He draws surprising links between economic phenomena which hitherto were supposed to be independent of each other, the best example being his emphasis on the propensity for bank lending to reflexively influence the collateral values of the financial assets which it finances in such a way as to lead to a boom-bust cycle. That mainstream economists would quibble with Soros's ideas are to be expected, for economists are known for being unreasonably disputatious and uncommonly sensitive to outsiders' criticisms of their theoretical sacred cows. But in the analysis of market trends and dislocations, and trading opportunities, I know where I would put my money, given a choice between academic economists and Soros. Success speaks for itself. Soros applied his theories so successfully that he became the most successful hedge fund manager ever, his flagship Quantum Fund generating an average annual return of 30%+ between 1969 and 1995. One cannot but admire his tremendous courage, for example, in taking on the Bank of England and breaking its back, as it were, in his famous 10 billion dollar Sterling short trade in 1992 which netted him a cool billion, and made him a legend among traders and feared by central bankers worldwide. His honesty in admitting his missteps, and coolness with which he analysed his failures, is equally impressive, and sets an example for all professional investors. George Soros is a not just a legend, but a genius with one of the finest analytical minds of his time. He elevated trading to a fine art, an alchemy of which he was an inimitable wizard.

The Alchemy of Finance proposes Reflexivity as a general theory of investment valuation. It suggests the valuation process arises through an interaction of fundamental conditions and investors' efforts to understand and act on their understanding of fundamental condtions. Grasping Refexivity is aided by keeping in mind three main ideas: (1) Reflexivity is best observed under special conditions where investor bias grows and spreads throughout the investment arena. Examples of factors that may give rise to this bias include (a) equity leveraging or (b) the trend following habits of speculators. (2) Reflexivity appears intermittently since it is most likely to be revealed under certain conditions; i.e., the equilibrium process's character is best considered in terms of probabilities. (3) Investors' observation of and participation in the capital markets may at times influence valuations AND fundamental conditions or outcomes. Soros' secret rests in the name of his Golden Goose: The Quantum Fund. If you're a novice investor this book is probably too densely packed for you to decipher. Nonetheless: It belongs on your bookshelf as a motivator.

In all of investment literature, there's nothing quite like the peek inside Soros's mind in his "real-time experiment." The only thing that comes close is Lefevre's _Reminiscences of a Stock Operator_. Even when Soros is wrong (like when he sees the 1987 crash as marking Japan's rise to world dominance, or in predicting a worldwide credit collapse in the late 80's), he is fascinating. The guy really is smarter than sin, and the writing gives you a sense of the kind of relentless energy as well as intellect he brought to his work. His discussion of "Reagan's Imperial Circle," in which Reagan's aggressive military posturing coaxed inflows of foreign investment into US dollar-denominated currencies, thereby masking the massive inflation his military spending created, explains as well as anything the US's prosperity in the 1980s. It also provides a road map, written twenty years ago, to what might happen now that those inflows, as well as the internally generated credit from Fed rate cuts have stopped. Inflation? Falling dollar? Is massive government spending really the Holy Grail politicians think today? Why did it not work for Johnson or Nixon, and work for Reagan? Will it work for Bush? Reading Soros greatly improves your understanding of the landscape that these questions come from. I'm a dyed-in-the-wool value investor, and this is one of my three favorite investing books. Probably not for beginners, though.