Today we’re thinking about the meaning of the words “fungible” and “arbitrage”. Fungible means “mutually interchangeable”: that this thing is the same as this other, so the prices of two fungible things – two dollar bills, for example – should be the same. If they're not, if the prices diverge, then we can buy at the low price, sell at the high one and collect free money. A proper arbitrage does mean free money.
The price of this fungible is currently this and will be that – that's time arbitrage by definition because we've just introduced time into it. The other name for this is speculation and it's really not quite the same thing as true arbitrage.
An example illustrating the meaning of arbitrage is something fungible like BP shares which are traded in two different markets: London (BP.) and New York (BP). Each New York share is 6 London shares. So, the New York price should be 6x London. There's the pound sterling to US dollar (GBP/USD) rate to consider as well. That price in each place is determined by how many are buying and selling in that marketplace. The two prices might move out of line with each other if the breakdown of buyers and sellers is different – at which point it's possible to buy in one market, sell in the other, at the same time, and make a profit. Free money.
What is your sentiment on BP?
The meaning of arbitrage in fungible goods: Here's one price for BP shares (BP.)
And here's another (BP)
Now, with BP this is unlikely to be more than a fraction of a cent either way – because many people trade BP and would act on a price difference. These days it would probably be an algorithm as well. 50 years ago it was a starting job for many a trainee stock broker. Call New York, check the prices of stocks traded in both places, shuffle a few and make a few cents or pennies. As the markets have become more efficient, the effect of arbitrage in fungibles is to keep prices aligned very efficiently.
But hold on to the essence of arbitrage: that the same thing – or something that is mutually interchangeable, or fungible – can have different prices at the same time in different markets. I'm going to use an example that recently existed but does not now – to illustrate, not to suggest a trade.
Polymetal is a gold miner operating in Russia and Kazakhstan. The shares have slumped recently for obvious reasons – but the company isn't directly affected by any of the sanctions. It continues to operate, mine, sell gold and so on. The point here is not to talk about the company so much as the fact that there used to be 5 different share quotes for Polymetal, all of which were fungible. You could buy one and, with a bit of paperwork perhaps, deliver to another. This means the prices should track each other for if they don't then folk will buy the one, sell the other. That arbitrage of fungible shares, by definition, being would make the prices parallel each other again.
The main quote is London (POLY) which is, as I write, spot on £2. It's also quoted in Almaty (AIX: POLY) at $2.43, which with the FX rate is about right. But there's a Moscow quote as well (MCX: POLY), which is 450 roubles. This is for the same share – these are, in normal times, fungible so there is (or was) an arbitrage opportunity that made sense. You can, or could at least, buy on one exchange and sell on another, same piece of paper close enough. 450 roubles is £6.77, so buy in London and sell in Moscow, right? Even given some paperwork that's £4.50 free money per share moved so let's get to it!
Except the shares are not, in fact, fungible now. One problem is that as a foreigner you can't sell shares in Moscow – that's banned. Another is that if you buy in London then the ownership is registered with Euroclear, but to sell in Russia you need to have ownership agreed by the National Settlement Depositary and the two systems no longer talk to each other – those sanctions again. So, even if you were Russian and bought in London you couldn't do it. All of which doesn't sound very exciting. Tim, why are you telling us about things we cannot do?
But there were five quotes, not just three. Simple London stocks aren't supposed to be sold or marketed to Americans, so there are varied programs agreed with the SEC about how this might be done. Sometimes it is simply brokers who make London stock available. Sometimes a company organises an ADR program directly. Both of these existed for Polymetal. The broker organised quote (OTCPK: POYYF) and the company ADR (OTCPK: AUCOY). And here's the thing – those prices did diverge. At one point AUCOY was $5.69 and POYYF was $3.02. There are some minor differences, POYYF cost more to trade (perhaps a $25 fee per lot charge) but, roughly enough, we could sell one AUCOY and buy two POYYF. And they're the same thing, each represent one POLY share in London.
The definition of arbitrage in fungibles: risk-free profit. If you can find it
There's arbitrage value there, two different prices for the same fungible thing. It's possible to buy one, sell the other and gain free money.
Now, I've deliberately chosen this one as the price gap doesn't exist any more. In fact, neither AUCOY nor POYYF trade at present at all. Which means that I'm not recommending a trade, but I am able to point out that arbitrage opportunities do, sometimes, exist. Sometimes there is free money out there.
There is though, as this story shows, a trick to this. We've still got that difference between the Moscow and London price but that can't be traded. OK, the price difference exists but it's not a viable arbitrage. The POYYF to AUCOY price difference did exist – it lasted a couple of weeks in fact. It was possible to trade it – as I know from a certain direct experience. The lesson being that a mere price difference isn't enough, we need to know that it can be traded across.
Arbitrage, by its definition, is risk free, taking advantage of prices differences in fungibles across markets. It requires that we can deliver the one from one market as settlement to the other. Significant prices differences are rare – 2 for 1 offers don't arrive all that often. Often, even mostly, there are settlement reasons – ie, they're not in fact fungible – like the Moscow and London quotes in Polymetal. Sometimes though, just sometimes, they're real, like that POYYF and AUCOY price difference (for completists, those prices above were true on March 6th this year, 2022).
The correct initial response to spotting such an arbitrage in genuine fungible things is to ask for an explanation: “Why's this bugger offering me free money?” That requires a certain amount of checking of course – but sometimes it really is true. And when it is then it's fill yer boots time. The difficulty, sadly, is spotting when it really is true that there are risk free $100 bills lying around.