Episode #171: Raoul Pal, “Buy Bonds. Buy Dollars. Wear Diamonds.”
Guest: Raoul Pal is the CEO and co-founder of RealVision and the author of the exclusive research newsletter, Global Macro Investor. Previously, he co-managed the GLG Global Macro Fund in London for GLG Partners, one of the largest hedge fund groups in the world. Prior to that he was with Goldman Sachs where he co-managed the hedge fund sales business in Equities and Equity Derivatives in Europe. Along the way he had stops at Natwest Markets and HSBC, and began his career by training traders in technical analysis.
Date Recorded: 8/6/19
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Summary: In episode 171, we welcome back our guest from episode 46, Raoul Pal. Raoul and Meb start with a chat about one of Raoul’s tweets, “Buy Bonds. Buy Dollars. Wear Diamonds.” Raoul explains that he sees global growth slowing after the longest recovery in history, as well as a number of countries in or nearing recession. That presents an opportunity in US Treasuries and Eurodollars.
The pair continue the conversation and get into how Raoul looks at the world. Raoul walks through his current view including his take on business cycle and yield curve indicators.
Meb then asks Raoul to explain “The Doom Loop.” Raoul lays out the idea that corporate debt has increased at an alarming rate since 2009 relative to household and government debt. He discusses what he’s seeing now, and the risk this poses to the global economy and asset prices.
As the conversation winds down, Raoul gets into some thoughts on gold and crypto.
All this and more in episode 171, including the greatest macro trade Raoul has ever seen.
Links from the Episode:
- 0:50 – Welcome back our guest, Raoul Pal
- :59 – The Meb Faber Show – Episode #46: “We’ve Got to Expect a Recession This Year or Next Year, or if We’re at the Wild Extremes, the Year After That”
- 2:25 – Raoul’s focus on buying bonds and dollars
- 8:01 – Why bonds are a good bet despite low yields
- 10:09 – Overview of Eurodollars
- 15:25 – The PMI and what it’s signaling
- 21:15 – Drivers of commodity prices and how that impacts the US
- 26:12 – Yield curves and recessions
- 26:16 – Cam Harvey – yield curve recession indicator
- 28:28 – The Doom Loop
- 36:31 – Risk in the system
- 36:40 – What if 8% is Really 0%? Pension Funds Investing with Fingers-Crossed and Eyes Closed (Faber)
- 39:42 – Thoughts on gold and crypto in the current environment
- 48:23 – Paradigm Shifts (Dalio)
- 48:45 – Why crypto should be a part of everyone’s portfolio
- 56:18 – greatest macro trade Raoul has ever seen
- 1:01:22 – The Meb Faber Show – Episode #165: Chris Mayer, “I Do Think The Biggest Challenge…Is Keeping It, Holding On To It”
- 1:02:05 – Latest with RealVision
- 1:05:39 – Realvision.com/free
- 1:07:41 – Connect with Raoul – @RaoulGMI on twitter
Transcript of Episode 171:
Welcome Message: Welcome to the Med Faber show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com
Meb: Hey podcast listeners, we got another great show for you today. We invited our guest back. He was with us on Episode 46, and with all the macro gyrations going on, I want to I talk to him and get his take on what’s happening, what to do. Former PM of GLG, Goldman Sachs before he retired from the headache of other people’s money, managing it. He now writes Global Macro Investor and CEO, co-founder of Real Vision. Welcome back to the show, Raoul Pal.
Raoul: Thanks man. Pleased to be here.
Meb: How the world look from you on the shores of the Caymans? Is it full on summertime there? How’s things down that part of the world?
Raoul: It’s hot and hell, gets a bit steamy. We get a bit of rain. But don’t forget, we’ve got a turquoise crystal-clear sea in front of us, so I can’t really complain.
Meb: You know, the last time I was down there hanging out with you, Zika was big in the news, and I’m not sure if it was a lot of hype or if it was something that just was mostly a tourist concern. Is that something that’s kind of blown over or is it still in the back of the tourism industry, take a hit? What’s the update on that?
Raoul: Actually, interestingly enough, we’ve just been certified as Zika free. So we’ve had a huge pickup in tourists because a lot of tourists were avoiding going to Zika countries. But the Cayman Islands is now free of it. So yeah, we’ve had that massive pickup. Really interesting. Before then I had friends of mine wouldn’t come down here, particularly, you know, if the wife was pregnant or, you know, they were looking to get pregnant or whatever. They definitely wouldn’t travel.
Meb: Last time I came down there my wife was pregnant, she was joking because my work trips for whatever reason she’s like, “Dude you’re doing a Zika world tour through like six countries that you should not be going to. We got to keep an eye on this.” Anyway, everything came out okay. So, we got a lot to talk about. The world finally, I feel like, is it starting to get pretty interesting with a lot of macro moves. You have a tweet that’s not evergreen, but every once in a while, it pops up in my feed that I love and would have loved to hear you talk about it. But you say, “Buy bonds. Buy dollars. Wear diamonds.” What are you talking about there?
Raoul: Well, to say…you know, when you said there’s a lot going on, the technical term we use in global macro trading is there is a shit ton going on right now. There is so much going on I can’t even get my head around it. The point being is…at a very top level, is global growth is slowing. We’re in the second, no, now the longest expansion in all recorded history in the United States and in several other countries. We are seeing Europe going into recession. We’re seeing countries like Australia going into recession. We’re seeing Asian countries in recession. We’re seeing China heading towards recession and the U.S. growth slowing, and forward-looking indicators of the business cycle suggesting the U.S. has a high probability of going into recession. It’s not there quite yet. So, as a macro guy, I’ve learned that the best thing you can do is not follow every single opportunity but distil it down into what is the most perfect opportunity that there is. And when you look at it, very few people understand this. Everybody wants to short equities and do all this kind of clever stuff or buy CDS or whatever it is. When actually one thing you know is central banks are kind of Pavlovian.
So as soon as this happens, they start cutting rates. Now, we also know that generally once the central bank cuts rate once, the Fed have never only cut rates once. So, it’s always been at least three times and that’s in a mid-cycle slow down. They’re considering this is the longest expansion in all recorded history, the chances of this being a mid-cycle expansion is close to zero. So, if it is a full rate cycle, i.e. we’re going into recession, then interest rates are going to zero and maybe negative. So what does that mean for equities? Well, we don’t actually know. You know, equities have been very buoyant considering usually it would mean equities fall. We don’t know if the prices have been distorted by central banks or not. I don’t really buy that argument. But for argument’s sake, we don’t know. I also know that trying to short an equity is a volatile and difficult task of which you usually end up losing your arse and not gaining any P&L in exchange.
Because what you basically get is you get something that goes from being a low volatile instrument. Equities, you know, have been around, let’s say 10, 12, volatility and before you know they’re at 40, 50 vol and your returns are less than the volatility, so you struggle to make any kind of high-quality returns. Now when you get to the short end of the fixed income market, which is the buy bonds part of the equation, that does extremely well indeed because the yield curve tends to steepen over time after it’s flattened and the front end of the curve just goes down as the Fed cut rates and the market starts pricing it in. As you’re seeing every day, it’s a relentless bid to euro dollar futures, which is the very front end of the market or even two year note futures. And that trend I’ve noticed in my kind of 30 years of my career is the single lowest volatility, highest return trend in the world when that happens.
And this is where people like Stan Druckenmiller when he came on Real Vision, this is what he told us. He said, “Look…” The dirty secrets of him making his money, particularly in kind of bare market years is nothing to do with equities. It’s all trading euro dollar futures or 10-year bond futures. So, once you identify the cycle is going lower, you can identify the highest quality trade is the bond market. The dollar trade is somewhat different to that. That’s the fact that the world is short, 13 trillion U.S. dollars. Those are foreigners who’ve borrowed money according to the BIS and they borrowed dollars. That tends to be Chinese companies, South Korean companies, European banks, European corporates, and a bunch of other entities. That is a complicated situation, one of the reasons why everyone keeps saying, “Well, the Fed are going to cut rates and the dollar is going to fall.”
Suddenly the dollar doesn’t fall. In fact, it keeps going higher and it keeps exploding higher, and then trades back and goes higher again. And it’s because of all of these people are short dollars, and there’s a shortage of dollars in the system because of concerted tightening, which has now ended. Then there’s the tightening, about to start, which is due to the expansion of the debt ceiling and the replenishment of the Treasury General account, which is a slightly technical thing, but basically, it’s about $600 billion of withdrawal out of the money markets. And then there’s the regulatory changes that came with Dodd-Frank and Basel III. All of those have meant there’s no funding abroad, so the dollar keeps going higher. So, as the world economy gets worse and trade tariffs go up and world trade slows down, there’s even less dollars around. And so the dollar drives higher and higher and higher. So those two trends, when the dollar starts trending, it’s a very low volatile, very high reward trade. So again, in terms of the quality of trade it’s extremely high. So in this environment, “Buy dollars. Buy bonds. Wear diamonds.” And the reason wear diamonds, this is an old kind of 1980s markets expression. And it came from the fact that if you buy bonds, you’ll make enough money that you can wear diamonds. So there you have it.
Meb: The millennial version of that is the conflict free, lab grown, maybe, “Wear diamonds, cubic Zirconia.” Couple of interesting things about this because I think a lot of listeners may get stuck up on the fact they say, “Oh my god, why would you be buying bonds when they’re yielding such a low amount?” I think it’s hard for people to wrap their head around the fact that almost no one, back when bonds ten year was up bumping up against 2.5%, 3% you know, this prospect, most people thinking that they could go back down to lower amounts. We have an evergreen tweet I’d pull out every few years where I think it’s from like 2014 or ’12, it’s like, “Wake me up when the ten-year hits 50 bips.” You know, there’s this kind of just comment on what’s possible. So talk to us a little bit about that because a lot of our momentum sort of signals would say are had been allocating… I mean bonds are having a monster year, forget about 30 years or zeros. Could you see the potential of the U.S. joining the rest of the world, which every day seems to be more and more, not just sovereigns, but even some corporates in a potential negative yielding world. And talk about that from the framework of a macro guy who’s been around for a while because, you know, had we transported back 20 years, maybe would’ve said, “You know, that’s an odd place to be in the future when all these bonds have negative yields.” Any thoughts there?
Raoul: There’s a number of bits we need to unpack of that. So why bond markets are so interesting is yes, you get good price appreciation at the long end. And everyone goes, “Well, why don’t you buy at the short end?” Well, the fact is when you start trading two-year futures or particularly euro dollar futures, which are three-month rates and you can choose what expiry…. So, I can choose whatever I think the liable three-month rate is going to be for December 2020. So that’s very specific targeting of rates. I get enormous leverage. So each contract, you know, you’ve put down $2,500 margin and you get $250,000 of underlying exposure. So you get enormous leverage within these contracts. So, because they are low volatility, you can take large positions. And that means that you can make extraordinary sums of money. They also, even better than that, have options on them, and they’re incredibly liquid. In fact, the Eurodollar market is the most liquid market on earth.
Meb: And let’s interrupt there because we haven’t talked a whole lot about Eurodollars here for, so for those who aren’t familiar, give us just a brief overview of Eurodollars and why this is a market that’s of particular interest to you.
Raoul: Yeah. So, Eurodollars, it’s a weird term because we, everyone gets confused with the currency. It’s nothing to do with the currency. What it is the world is set up that there are dollars that are borrowed and issued within the U.S. banking system and there are dollars that are created outside the U.S. banking system that are borrowed and lent using an interest rate called LIBOR, which is, basically follows roughly what the Federal Reserve rate is, the Fed funds rate. But that rate is a free market rate apparently, everyone was done for manipulating it in the past. But it is supposedly a free market rate at which almost all money market instruments are set off against. So, that is LIBOR and the Eurodollar future is the future rates of LIBOR. It’s the price of money or the interest rate at which money is bought and sold or lent in the Global System outside of the U.S. basically. To make it more confusing, these things are traded in the U.S. so it’s the global price of money.
So, when you see a contract that’s priced at let’s say 98.5, what that means is you take 100 minus the price. So, 100 minus 98.5 is 1.5. It’s pricing that interest rates will be 1.5% by December 2020. So they’re very simple as that. Theoretically, this is the other part of your question, they could go to 100 which would be rated zero. But actually, we’ve now got to a world where that’s not even true any longer. They could go to 102, 104, 105. There is a realistic chance that U.S. rates go negative. Now, it seems that to me, and this is my big macro perspective, is that the predominant driver of interest rates is inflation. The predominant driver of inflation is demographics, and the demographics of Japan peaked first and rates collapsed and went to zero and then to negative. They were followed by the demographics of Europe, which was the next oldest set of countries and interest rates collapsed and then went negative.
And the final part of the equation is the U.S. And the U.S. looks like it’s got a slightly younger population, but as the average baby boomer starts heading into retirement, interest rates, inflation are going to collapse to zero and interest rates in the U.S. will tend to go negative. So, it seems that there is a catch up that will happen. That spread has been one of the reasons the dollar has been so strong. It’s not only the reason, but that spread of interest rates between countries. So, my view is that I would never have believed that interest rates could be negative, but now I’m seeing it at corporate bond level as well. I’m trying to get my head around it. And my job, or our jobs in financial markets is not to necessarily question, “Why, why, why?” It’s to understand, “Okay, what is this saying about the situation now? What do I have to do to invest around it?”
So that tells you that bonds could continue to rally. In fact, I think my target on the U.S. ten year for a long time has been half a percent. But I actually think they go negative. So that’s the U.S. ten-year yields could go negative. So that means there’s a huge potential rally to come. So that gives you a different look at your asset allocation. Sure. You might not get a high yield, but my god, you can get some capital returns out of it. And the same is true in Europe. Bunds have been terrible because, on paper they give you a negative yield at 60 basis points. The reality is, they’ve been in the enormous bull market where price gains completely dwarf the lack of interest or the opposite, the cost of buying these bonds because that’s what it’s come to now, you’re lending money to governments at a cost.
And why is that? At the macro perspective, it’s telling you there is something more broken within the system that the demand for money is not what people think it is. And I know many people think it’s a function of central banking. It’s probably not as much a function of central banking as a function of debts that were allowed to build up plus this demographic. But it’s interesting that people now perceive bonds to be so safe that they will pay money to be parked there. And somebody argued on Twitter the other day and I think interestingly so, is if you go to a bank and have a safety deposit box, you actually pay the bank for that. So why necessarily would you not do that with a bond? And I’m kind of like, yeah, I can see theoretically maybe we just had an anchoring bias based on what we knew, even though it’s…never in world history before have you seen negative bond yields. So it’s a really complicated world in macro and they’re trying to figure this out, but it’s very exciting.
Meb: Well, that’s what makes it interesting. I think you might be referring to Joe Wiesenthal who caught a lot of flak for that, you know, and that may be part of why it’s a structurally or behaviourally potential good trade where you listen to…probably the listeners to this podcast are saying, “Oh my god, the possibility of buying U.S. government bonds if they’re yielding 0.5% or 0.1%, I would never do that.” But then, you know, there’s two sides of the bond coin. It’s not just the yield of course, but the potential price gain or loss. You know, and I think that’s a struggle for a lot of people. You’re a long time PMI guy. If we had a hat for you, it’d be Mr PMI. No one loves the business cycle and kind of everything going on with ISM and everything else around the world. You had a couple of good tweets about that. Give us an overview of what the PMI is, for a refresher and then what does the world look like? Is that signalling anything good, bad or in between?
Raoul: Yeah. So, I look at the world in terms of the business cycle. What staggers me is most people don’t. So most people, most economists look at a linear extrapolation of the future, but you can bring a small child a chart of U.S. GDP or global GDP or any country. And bizarrely enough, it goes up and down, which tells you it’s cyclical. Yet economies never forecast recession and they never forecast a boom. They just forecast what they know. And it’s a kind of odd situation. So a long time ago, I started looking at this and trying to understand, “Okay, how can I understand the business cycle?” Firstly, to know where we are and then to forecast it. Because if I can forecast it, I know it trends. And I know that like a sine wave, it goes up and down. If you figure out when the sine wave has rolled over, you know when the next recession is coming within a parameter.
And that’s when I look at the probabilities. You know that the average expansion is a certain number of years, let’s call it seven to nine years. So you know that by about seven or eight years, you need to start looking for that rolling over of the business cycle and the potential extrapolation into recession, the future. And the reverse, once we’ve had a recession and it starts rolling up again, you’re started looking for that expansion and the opportunities that that will offer you. So what I use for that is something called the ISM. I’m actually moved to a bit away from the ISM and use something called ECRI, Economic Cycles Research Institute weekly data, which is free, you can find it on their website.
And ISM you can get pretty much everywhere. And the ISM is a survey of purchasing managers. So PMI stands for Purchasing Managers Index, there’s a whole bunch of these globally. It’s a survey every month that asks purchasing managers what their business conditions are like, you know, are they buying stuff, are they selling stuff, do they have much inventory, what’s their confidence levels like, all of those, what prices are doing. And that gives us some granularity. And oddly enough, it maps very, very well indeed to GDP. And what is really interesting is all the PMIs around the world map very well to their own GDPs. So they’re very useful. The ECRI is the one I use now, which is actually composed with a number of different economic data points. But that actually mirrors ISM. So let’s use the PMI or ISM going in this discussion. So the question is, what use is that? Well, when you look at these things, you’ve learned that if you put the year on year rate of change of the S&P 500, for example, it actually exactly mirrors the business cycle, the ISM or the PMI. And if you look at the year on year rate of change of bond yields or of copper or of oil or of most things, and most assets in fact just follow the business cycle.
So the business cycle is the largest driving factor of all asset prices. Now, embedded within a business cycle is everything from the credit cycles to demand for risk and a whole number of things. So it’s very consistent. So that’s pretty useful. So, I use that. And then I can then compare around the world what’s going on. We know for example that when a PMI crosses 50 that it’s telling us that the data is contracting and therefore, we’re getting closer to recession. Normally a recession is seen when the PMI gets to about 47, and then you can get to a really bad recession if you start to see a PMI get down to the high 30s. Now currently around the world, global PMI, which is an amalgamation of all of them, is at about 48, so we’re very, very, very close to a global recession. In China, we’re about 50 but the Chinese data is not very pure.
It’s been kind of manipulated, so we don’t really exactly know, but it’s around 50. So we’re going nowhere. It’s slightly contracting. Maybe it’s 47, 48. We are seeing Europe…Germany, we’re seeing its PMI in free fall. It is now down at 45 or so, and that’s telling us we’ve got quite significant recession underway in Germany and we’re seeing the PMIs across Europe also falling. We’re seeing the UK falling. We’re seeing Australia falling, we’re seeing Japan falling, we’re seeing South Korea falling, Singapore falling, we’re seeing India falling, we’re seeing Brazil…no, Brazil is rising. We’re seeing Argentina falling, we’re seeing the U.S. falling, Canada falling, Mexico falling. So what we have is a synchronized global slowdown and it’s being shown in real time in these PMIs. And that tells you, once you start looking at these, that the year on year rate of change of asset prices is going to start grinding to a halt and then very quickly becoming negative.
So we’re now at that very tipping point where if this data starts going a little bit worse, we’re going to start seeing negative returns from all of these equity markets, particularly in the U.S., which has been very close to its all-time highs. So there’s a lot to play for. It also tends to suggest that interest rates will go lower and lower and lower, and that commodity prices tend to collapse. And that links back into the dollar, which tends to be part of that as well.
Meb: I bet a lot of people who are listening are probably just listening to this podcast, taking a drive and saying, “You know, it feels weird because in the U.S. as I look around, it seems like inflation is low, it seems like the economy in many ways is booming. It seems like employment is super low.” And, you know, you hear a lot of people say why, you know, all of a sudden the Fed is cutting rates and part of this maybe because of what a lot of things you talked about where the rest of the world there tends to be a lot more dark clouds. Talk a little bit about, you mentioned commodities as one piece of the puzzle and we’ve seen some kind of big moves going on in the commodity space, in various sub sectors of commodities. You know, is this the deflationary impacts going on? Is it something to do with tariffs? You know, how is a lot of this global sort of recessionary concerns…what are the main drivers and what are the implications for commodities?
Raoul: What is going on globally is as the dollar goes higher, the denominator, the dollar is the denominator of prices of commodities. So i.e., for example, oil is priced in dollars per barrel. So, if the dollar goes up then the price of oil goes down against it. So that’s a common factor because it is the price denominator. So, as the dollar has been rising, commodity prices have been falling. So, everything from copper to agricultural commodities to oil have been falling in prices, as the dollar has risen. But something else goes on is, as the global economy slows down, as world trade slows due to tariffs, what you find is there’s a less demand for commodities. Remember the big commodity buyer was China and China is basically in recession right now. Japan is close to recession. Europe’s close to recession, so nobody is buying commodities. So that means that you tend to see price falls and the prices can fall pretty sharply indeed.
So when I look at that confluence of events between the deflationary factors of the dollar and the globalized demand, it makes me think the oil may fall to firstly, somewhere maybe in the mid-40s and I think eventually into the $20 a barrel range, which is an extraordinary…sounds outrageous and that I’m going for sensationalist headlines, but it’s basically an extrapolation of the chart. I use a lot of charts and understanding the potential movements of the dollar and what’s going on in the global economy. That would be consistent with a global recession, which looks like it’s happening. So, that plays back into the U.S. So the U.S. is a weird fish because it’s very consumption driven. And so what you’ll hear at this point in the cycle is three things, you’ll hear, “Well, the ISM, which is a manufacturing survey, that doesn’t matter anymore. The U.S. is an 80% or 75% services-led country, so manufacturing doesn’t matter.”
Secondly, they’ll tell you that consumption is everything and U.S. consumption is high, “Just look at the recent consumption numbers.” Then they’ll say employments. They’ll say, “Look at employment, we’ve got record low unemployment, everything is perfect.” And in theory that looks great. The problem is all of those data points are pointing to the things that happened 18 months ago. You see those things will lag versus things like the ISM. So if you put consumption or employment against the ISM, it lags between 18 and 21 months. So it’s telling you back then when the Fed were hiking rates, they were right to do so because employment was very strong. Problem is, is now the forward-looking indicator tells you that employment and consumption are not going to be good going forward, and the interest rates were wholly inappropriate for what the economy could bear.
So, though…that data is going to weaken over time, so everybody’s looking at the wrong thing. The other thing that’s really important here is the…also the manufacturing index. Sorry, the services index lags the manufacturing index. So that too is you’re looking at a data point in the past, but what we’ve got is this risk that oil rolls over. Now, oil is important because the U.S. is now the world’s biggest exporter of oil and the world’s largest producer of oil. So, that drives the manufacturing cycle and a lot of the job cycle and a lot of the cash cycle and expenditure cycle of the U.S. is driven by the oil patch. Now, if the oil price falls, then you start to have problems because oil production is still an expensive business even with the technological advantage. And before you know it, very quickly, great profits out of that sector go into big losses.
And the problem is that sector has a lot of debt. So that suddenly starts to tip, if you’re not careful, the employment situation. And it starts tipping the consumption and it starts tipping forward into other areas. And if that happens, then suddenly people buy even less cars. Cars are already pricey in a recession and they start buying less clothing, and clothing’s already pricey in a recession, and they start going out to restaurants less. And restaurants are already in recession. So, that whole situation is not looking good. And all the forward-looking indicators are suggesting that U.S. GDP growth going in the next quarter or two, will be at close to zero. It’s not yet suggesting recession but I’m extrapolating the trend and assuming that it’s going to follow the rest of the world.
Meb: Yeah. I mean, if you look at another indicator which Cam Harvey wrote about this in 1986, you know, about the yield curve, people can argue about it till the cows come home as to why it may be different this time but no matter what, you can’t really say the ochre is a good sign or signal and it has a pretty phenomenal track record of predicting recessions, particularly in the U.S.
Raoul: I remember very clearly the last two yield curve inversions because I was very active in financial markets, very active in macro. One, I was running my own fund at the time, the GLG and then the second one in 2008, I was writing for Global Macro Investor. And 2008 was incredible, because there was the housing issues going on. Everybody said, “The yield curve inversion is just to do with mortgage hedging. It is different this time.” And this time around, we have the same discussion about, “It’s the central banks. It’s different this time.” It’s not different this time. The bond market is much bigger, much more powerful, and is the best single predictor of economic conditions. Bonds are always right. Well, almost always right. The only time I’ve ever seen the bond market wrong was 1994. It can be wrong by a little bit, there could be corrections, but nothing where it’s really wrong, not like equities that suddenly can show over a 6-month period, a 30%, 40% loss because pricing was unrealistic versus underlying conditions. Bonds tend not to do that, and the bond market’s screaming at us that there’s a recession coming.
Meb: Yeah, and you’re starting to see it in some other countries that haven’t seen one in a really long time as well. I think Japan may have tipped over at this point too.
Raoul: Yeah, that’s true. I saw that yesterday. It’s like, that’s incredible that Japan, who has not had an inverted yield curve since 1990, has now gone inverted. What’s also extraordinary is its yield curve, along with that of Germany, Denmark, and a whole bunch of other countries, is at all points negative and inverted, and this is just extraordinary.
Meb: I’d love to go back and read the finance textbooks, try to tell them that, put that a chapter in from 10, 20 years ago about the negative yielding, inverted yield curves as a chapter. I think every professor on the planet would say you’re crazy. So, a couple of other things you’ve talked about that I think are pretty interesting. There’s one where you’ve talked about the doom loop. People listening are probably say, “Is he talking about, is this the Elon Musk? You know, is he negative on the hyperloop? Is this a reference to a Beastie Boys old song?” I remember the old “Flute Loop”, what a great song. Anyway, what’s the doom loop? What’s it referencing?
Raoul: In every recession you need the bad boy. What is the thing? The one thing, the one thing was in 2008 was housing and financial debt was part of that. So the financial markets blew up, the households blew up and the banking system blew up. It was all related. In 2000s, the recession was all to do with the equity market and the excessive borrowings and kind of speculation and hubris that came with an equity market that had gone to all-time record highs in terms of valuation. So what is it this time? Because you need to pin it on something. And it could be about central banks and it could be about negative yield curves, but it’s always about debt somewhere. So what is the debt in the equation? The one that didn’t blow up is the corporate debt pile. The corporate debt pile doubled from 2009, unlike any of the others.
Government debt didn’t increase significantly and nor did…I mean, it increased but interest rates change was not that big. And we had a…household debts actually were reduced. Yes, we had credit card debts that increased. We had a few debts. Student loans exploded. But the real monster was the corporate debt market. So what’s interesting about the corporate debt market is, as more and more companies issued bonds, credit quality went downhill. So AAA is the highest quality and many years ago these were a lot of companies with AAA rated debt. There’s virtually none now. But as they’ve issued more and more debt as the corporate sector in the U.S., which is something like 93% in debt, oh sorry, it’s about 75% in debt in the U.S. alone, as a percentage of GDP, they have lowered debt quality down to BBB and there’s 4 trillion BBB bonds in America, which is enormous.
What is that all about? So where does this corporate debt come from? Corporate debt comes from buy backs. So because interest rates were so low and there’s this stupid tax ruling, corporations can basically issue stock options to their management and then issue debt and buy back all those shares. They all get rich. The shares go up just because there’s less of them. So their market cap doesn’t move, and what they’re doing is actively destroying shareholder value over time for the sake of showing some taxable profits. So that goes on and they start massively changing the balance sheets of these firms and the firms start getting downgraded. But, “Who cares? The equity market’s going up, everything’s fine. We’re in the right part of the business cycle.”
But the other part of this is who are these bonds sold to? Well, the bonds have been sold to the pension system, because the pension system has been in a big mess, a sort of big black hole as it’s not managed to generate the returns that it promised its underlying pension holders. So those pension holders are not going to get the money they expect back. So in a bit of a panic, the pension sector has taken enormous risks, and that’s a holding too much equities versus bonds. And when they hold bonds, they want as much of this corporate bond BBB and junk bond stuff as they can get their hands on. Okay. That’s all well and good. The other problem is, is who is the biggest buyer of BBB? Well, it’s the state pension systems like Illinois, you know the firemen and teachers and all of that kind of stuff. And all of those states which were bankrupt and had the big black holes, they started taxing their population in order to fill the pension black holes.
So, took it directly from the voters and put it back into the pension system. Okay, that’s fine. That inflow went directly into corporate bonds, they bought the corporate bonds, the companies sold them, bought back their own equity. Problem is, the corporate profit cycle and cashflow that generates the buybacks is almost 90% correlated with the business cycle. So if the business goes any lower, the buybacks stop and that’s…the biggest buyer, in fact, the only buyer of equities in the world, in the U.S., leaves the building. It’s the corporate buyback. All other sectors are net sellers of equities as the baby boomers go into retirement. The other side of the equation is tax receipts are 90% correlated to the business cycle. So the moment the business cycle goes down, the biggest buyer of bonds, in terms of corporate bonds, leaves the building too.
So you end up in a situation where there’s no buyer of equity and no buyer of bonds. So, and you’ve got a business cycle that is not good. So, that is going to start to create an enormous problem because as that happens, there’s likely to be a downgrade. Somebody is going to get downgraded from BBB to junk bonds. Okay, why does that matter? It matters because BBB holders are these pensioners, pension companies or pensioners in the end and junk bonds are different owners. And the junk bond market is only a trillion dollars and these BBB’s are 4 trillion. So if you lose, if you downgrade 20% of the BBB market, which easily could happen, you’re totally screwed. There’s not enough buyers of junk bonds. So the entire junk bond market goes into paralysis. And that would mean a complete seizing up of the entire corporate bond market in one go.
And I think that is pretty high chance. So if that happens, then what happens is the business cycle goes lower. That means there’s no buyers of equity at all. So the equity prices fall. So as the equity prices continue to fall, who were the big issues here with BBBs? Well, there’s 5 firms. It’s Dell, it’s GM, it’s Ford, it’s General Electric and it’s AT&T. So five companies, if their share prices start falling and let’s use GE as an example of a terrible firm whose share price keeps falling. If that continues to fall, they’ll get downgraded. So then you increase the cycle. And what happens is as the business cycle gets lower, these corporations stop spending, the business cycle gets worse and the doom loop starts seeing spreads widen. And then you’ve got no buyers of bonds and everybody is a seller of corporate bonds, both at BBB level and into the junk bond level.
And there’s nobody at all who’s in a position to take the other side of that. So what you end up with is a larger and larger black hole within the pension system of which eventually once you get in this downward spiral of equities versus bonds versus bonds versus equities, as you keep going round and round around in the doom loop, you end up with the central bank having to step in and underwrite the pension system, because if not, you’ve lost all of your voters, which is the baby boomers, all in one go are going to go bust. So you’ve gotten some big losses to come out of the pension system. The government’s going to have to underwrite it and it’ll have to be the central bank that does it and then somehow, we don’t know how they’re going to finance that whole situation. But it means that the likelihood of quantitative easing and a large increase of the Fed balance sheet goes up dramatically.
So that’s the doom loop. It’s something I’m really worried about because I’m very worried. I think we’ve talked before in the past about the demographics and the issues with the baby boomer retirement. With the average baby boomer being 65-years old, you’re about to wipe out their savings if you’re not careful. And it all happens around a recession. Now, it’s fine if you’re 30-years old and you lose 50% of your pension because you just continue to add to it over time and you compound your wealth and it’ll all work out okay. But this time around, the largest population in all recorded history with the largest amount of money in all recorded history, all retire at the same time and don’t have a job. So in which case, how the hell do they buy the debt? They can’t. So, it’s a really, really dangerous setup and something that I’m just hyper focused on.
Meb: So, we’ve talked a lot in the past about the pension fund system and, you know, I just continually shake my head. We wrote an old piece called something like “pension fund investing with eyes closed and fingers crossed.” They come up with this magical 8% return figure, which, you know, in a world of four or 5% inflation makes a lot more sense than a world of zero or two inflation and targeting arbitrary nominal returns is such a strange concept in my mind versus they’re saying, you know, that real target should probably be, I don’t know, inflation or short term bonds plus 4% for a spread on equities or whatever they invest in, which, you know, knocks it in half. And of course they don’t want to do that because they have to put a lot more money into the funds because they’re underfunded. You mentioned Illinois’, Illinois’ is certainly going to be probably a problem child. And so what do they all do? They all have found private equity as a saviour in this cycle, which seems like it could be one of the driving factors. All this discussion makes me want to go launch a tail risk BBB bond, inverse fund, ETF, maybe we’ll look into that.
Raoul: It’s a huge problem. And these pension funds have taken too much risk. So now what they’ve done is gone from triple B and junk because they drove yields down so low. They then drove down hedge fund returns by the same process because they crammed into the largest hedge funds and said, “We don’t want your volatility of returns, lower your volatility, we’ll give you more assets.” So they crammed down the returns of the entire hedge fund industry to now be a 5 vol, 8% return product to look like high yield bonds. So they destroyed that business and then they went in massive amounts into private equity. Now the problem is, is the hedge fund industry and the private equity industry is totally illiquid. So come a need to pay back these pensioners, they’re going to have to liquidate everything else. They own a lot of equity and they’re in a hell of a lot of corporate bonds.
So the more corporate bonds fall, the more they’ll have to sell, because they don’t have anything else where they can access liquidity. So I think that’s a huge problem. So an easy way for people listening to this podcast, saying, “Well, how the hell do I hedge myself? How do I trade this?” So, my answer to everybody in everything, every instance is the best trade in the world is Eurodollar futures because the Fed are going to have to come to zero and through it. If you don’t really understand those two-year bond futures, they’re fine. If you don’t understand that TLT, ETFs, even that’s easy. And if you’re feeling a little bit racy and you don’t mind a bit more speculation then just buy some punts on the HYG because the HYG is basically high yield, and high yield is going to get obliterated if that BBB thing works. But you’re right, the opportunity here is somebody needs to set up a tail-risk fund for this and then go back to these pension funds and sell them back the tails.
Meb: Say, “Here. You’re going to hedge your garbage.” I love that idea.
Raoul: They’ve sold the tails and they need to buy them back again. And so a hedge fund manager could basically create a good income stream by buying…is by creating the tails back for all of the pension industry.
Meb: That’s funny. So there has been a couple bright and shiny places in the markets this summer and one of them is to see the gold bugs start to come out of hiding where gold is starting to creep up a little bit. Any thoughts on the precious metal, and as an extension, feel free to answer that question with the newer form of potential money and the millennial’s love of crypto. So any thoughts on either both of those spaces? What’s going on?
Raoul: Yeah, a lot actually. Gold to me is just a currency and trades the inverse of the dollar, because it’s priced in dollars, but it is a currency. It trades like a currency. And it did nothing for, I don’t know, six years, seven years as it digested the huge move that it had had. And then it started breaking out versus various currencies. So, it was becoming a strong currency. As interest rates went negative around the world, gold with a very slight negative carry i.e. it costs you a bit to store stuff, was relatively attractive as a place to store your money. So okay, that makes sense. And then suddenly the markets realized that, “Okay, if we’re going into global recession or we’ve got a probability of a global recession, we have to price in the probability of, ‘What are the central banks are going to do?'” And ordinarily, I don’t really care about that.
Why I don’t care is, that’s the reason gold fell in the last recession. The dollar went up, gold fell because we weren’t near the end game, where the central banks did something that made gold the only asset you could own or one of the only assets you could own. But this time around it’s getting interesting and it’s getting interesting because of Japan. Japan already owns about 70% of its government bond market. It owns most of its ETF market. So if Japan, which it is, goes into recession, BOJ are going to have to do something. What on earth are they going to do? Are they going to put interest rates negative 5%? Sure. They could give that a go, but the most likely outcome is they’re going to have to buy all their bonds in quantitative easing. So if they buy all of their bonds, then they’re going to write them off and that’s called a debt jubilee.
How’s that possible? Well, it’s just an accounting trick and it’s doable. What does it mean? It means that probably their currency collapses because there has to be some mechanism to reprice risk. And if they’re saying, “Government bonds were all worth nothing, we’ve bought them all back and therefore we can default on the stuff.” You generally will see some other macro variable move significantly, probably the currency, which will be great because it will generate a bit of inflation for Japan, it’ll change the outcomes, it means they’re much cheaper as an export nation as they pivot towards a robot nation because they don’t have any population, they’re shrinking. So okay, that’d be a great game changer for Japan, but it means everybody else would have to look at doing something similar because the Europeans are pushing on a string too. They’re right at the end of their tether.
How much further can they go because they own already most of the government bond market of Europe as well? So that’s a huge issue. So gold really, in this, is the option on the end game. If the central banks hit the end game in this cycle, then gold goes up exponentially for a period of time as the world struggles with whatever the outcome is going to be. What does the future system look like? Maybe they find a resolution of that and then gold goes back down again. Fine. I don’t really care about that yet. There’s no point in trying to yet think about what the final solution will be. Maybe the world can carry on with more debt and write it all off and nothing happens. Who knows? I mean, maybe the M&T crowd are right. And again, I’m not here to pass judgment on any of those.
I’m just here to look at probabilities. That’s why gold is going up while the dollar is going up. I don’t think it’ll necessarily keep doing that all the time, but over time it’ll definitely go up while the dollar goes up, a lot. And that leads me into, okay, if you’re going to do that, if you’re going to take that leap, that intellectual leap of, there is an end game potentially approaching and that gold is an option, well, then what is Bitcoin? Bitcoin is also an option. It has some of the properties of gold, in which case it will, it can protect you in a situation like this against an issue with money. Problem is, is really, Bitcoin is far too volatile to be a store of wealth right now. So what is it? It’s a lot of things, and it’s not one thing. We all try and anchor ourselves on what we think it is. But what Bitcoin is along with digitization, Blockchain, cryptocurrencies and all of the things we’re seeing, including the new Facebook one, stable coins, ICOs, the whole lot, is this is a whole entire new financial system from soup to nuts being built in front of us.
And I know people don’t want to believe it and they can’t see it, but I’m so convinced now that this is where we’re going. And I’m not saying for a second that Bitcoin is the currency the world’s going to use. I think what Facebook did with their Libra was something much closer, which is a basket of global currencies, including the dollar, which means there was no denominator. The denominator there, it has to be probably inflation driven by money supply. It’s a very simple format. It’s like a closed world. It’s like a monetary stream. But that would be a global currency and it’s being issued by private company, which is an extraordinary turn of events. Now, could it be issued by the RNF? Yeah, but who’s going to stop? I mean, what can stop Facebook or Amazon or Alibaba or anybody issuing a globalized currency of that sort?
Now, what’s interesting about that one is it still includes the underlying currency. So it doesn’t get rid of that because many people said about cryptocurrencies, “Well, the government’s never going to agree to this because you can’t pay your taxes in a cryptocurrency.” Well, this whole Facebook idea allows exactly that. It allows the underlying currency to be there, but it allows everybody, including all world trade to take place on a stable pricing platform. So, and Bitcoin is all part of that equation. It is one of the cleverest single things I’ve ever seen because it solves enormous amounts of problems for the financial world that we have, including things like ownership and trust. It is really an extraordinary development of which I don’t think we even have the slightest idea of the number of applications that are already being built and where this thing is going.
The world of digital value is something we are going to have to get our heads around as we understand that digital assets have real value in the world, as much as a piece of art has value, much as gold has value. If we ascribe it a value, and it can be recorded forever on a Blockchain than it is a permanent asset. If it’s a permanent asset, it has value. So, that’s what I think we’re doing. And I think Bitcoin is pricing in its stock flow model, which is a fantastic guy on Twitter called “Plan B.” His handle is @100trusd, 100trnusd. And he’s built a stock flow model of very complicated mathematics, which is extraordinary and compares all assets. It’s like gold, silver, copper, platinum, palladium, diamonds and Bitcoin. And they all exhibit certain stock flow models. So, gold and Bitcoin are almost identical in how they look.
Gold currently has a higher valuation than Bitcoin because of where we are in the stock flow, i.e. a lot of the new coins haven’t been developed yet and as we start drawing down on the overall supply of 21 million, the price goes up over time. On the other side, it shows how silver has a stock flow model of half an industrial commodity like copper and half precious, which is exactly right, same with palladium and platinum. So he’s built this incredible flow. Diamonds, high priced diamonds look like Bitcoin and like gold, as we also kind of intuitively know. So that’s telling us that this whole Bitcoin thing, if he’s right and he’s been very right so far and there’s some deep maths and some great regression analysis suggests that it’s just going to keep going up until it gets to $100 trillion market cap, which is basically, interestingly enough, about the same size as the entire global capital markets. Not the capital markets, the entire global money supply. So there is a lot going on in this space and it is all about the optionality of this, of a separate system being built in front of our eyes. So that was a long answer to a short question.
Meb: That was great. I mean, it’s interesting food for thought. There’s a couple of things, you know, I mean, as we look at gold, you’ve started to see a lot of the big dudes come out in support of it at this point in the cycle. You know, Ray Dalio was talking about it with his new piece. Paul Tudor Jones is talking about it. And historically, you know, we’ve done studies. A lot of people have talked about this. When you either have negative real interest rates or flat or negative yield curve tends to be a great time for gold for a lot of reasons historically. You know the thing about crypto is once everyone can kind of solve the plumbing and pipes and custody widespread where it’s, you know, accepted by the major banks or fidelity, I know they’re working on it and you can get some ways to easily invest in a basket at a lower cost, to me that’s something I think you’ll see the wide adoption, I don’t know. Certainly it will be fun to watch as all this plays out in real time.
Raoul: And also, Meb, sorry, just a thought about this. So look, we do have a dichotomy between different peoples’ investment opportunities sets. So, you and I are Gen Xs, baby boomers now they have to make that switch out of equity, out of the excess real estate, out of all of their investments into an ability to draw down income over time. So that tends to be a fixed income is the way you have to do. So their propensity is towards that. Our propensity is a bit screwed up because we’ve got really expensive equity markets and the bond market that is not the opportunity it once was, apart from the trading point of view that we talked about. And its difficult sets of things, but we still have a career. You know, we have the ability to generate income, to run businesses and do that kind of stuff.
And that’s where we tend to be focused on that. The entrepreneurial journey seems to be our investment. And then on the other side, you’re a millennial, you’ve come out into this world and you want to start saving, but do you pile your money into equities at all-time highs with an expected negative 10-year rate of return? No. Do you want to accumulate bonds for the next 30 years until retirement? Clearly not. Do you want to buy property? Well, property prices are very expensive and basically you can’t afford it. So until we fractionalize it using Bitcoin or something else, you know, cryptocurrencies and fractionalized, you know, ownerships of stuff, there’s no way. Now once you fractalize you can turn things into incredibly more expensive valuations. But right now, they have no opportunity set available to them. So let’s say you’ve got Bitcoin. Now, maybe you’re a cynic and you say, “Okay fine, I’ll put 10% of my portfolio in.” If we’re right and it goes to, you know, 100X, well, it becomes one of the greatest investment opportunities.
And it’s basically like being given equities for the baby boomers in 1982 with the PE events or being given a bond market in 1982 to the baby boomers, what they got, and they got a PE, they got their bond yields of 17%. They had a gift of wealth generation. They kind of screwed it up because they borrowed too much money. We as Gen Xs, we’re in the middle of all of that trend. We never got any of that skillset. But in the end, we realized that, and we had enough youth left in us to go to make up our income sources elsewhere. But the millennial, I think, why would you not choose Bitcoin? Why would you not choose that option? Because if it goes to 0 and it’s only 10% of your savings, it’s irrelevant in the longer-term scheme of things and your equity bond and other valuations will probably have some return that’s okay. And so it’s that. But if it goes up 100X, it makes a huge difference. Or maybe it goes up 1000X or whatever the number is. Because it, you know, it’s a kind of exponential return function right now. So I just think, I don’t see any reason why it would not get adopted.
Meb: Yeah. My only comment on that is that 100 times out of 100, this is me personally, I would rather invest in a basket of 100 start up early stage companies and some of those could be companies building out the whole crypto space, you know. And eventually if crypto gets big enough, all those companies will eventually be a part of, I don’t know if it will be a part of the traditional equity market, but a part of some global market cap, you know, of all the investable assets. But the challenge for me is the sizing on that. You know, I used to joke with…back when the peak of sort of crypto was going on, I guess it was January 2018, we were getting a lot more inquiries from friends and they would say, “Meb, you know, I’m interested in crypto, what’s your opinion?” I’d say, “You know, I’m supportive, I’m a cheerleader but I’m largely agnostic as to actual investing or not.”
And they’d say, “Well, look, I want to do it. How much should I put as a part of my portfolio?” And I said, “You know, why don’t you do as a percentage of the global market cap which at that time was probably 1%, maybe it’s now 0.1% or 0.1%, I don’t know.” But I said, that way, along the lines of what you just, your thesis was, if it grows, you don’t really have to rebalance the market cap. If it becomes 5%, 10%, 20% fine, you know, you’ve participated in that exponential upside and if it goes from 1% to 0% then well, it’s no big deal. So it’s interesting. It’ll be fun to watch.
Raoul: That makes total sense. And I too like you think that the VC space…okay, we’re probably at the peak of cycle in VC right now, but, you know, I think the opportunity set with technology and the rate of change of almost everything around us is so high that VC remains an incredibly attractive proposition over time. So, you know, of course it’s cyclical. I think with VC you probably need a bit more skillset, experience wise, because you need to understand businesses and business models and that kind of stuff, which again generationally tends to suit somebody who’s had a bit more experience than somebody who is 28 years old.
Meb: Yeah. What we talk a lot about on here is to say, “Look, if you’re going to do angel investing or private investing, and there’s a lot of wonderful platforms like angel lists, etc, now you can do it for $1,000 probably per company. So you’ve really got to diversify across probably 30, 50, 100 companies and do it with a 10-year allocation period. Meaning if you’re going to put in 100 grand, you’re going to do it 100 grand every year or 10 grand every year, whatever it may be for the next 10 years and commit to that now. Otherwise, what’s going to happen? Well, if and when we go into the next recession, payer market, most people would just stop allocating. And that’s often when a lot of the best opportunities come up. You know, the multiples will come down, you know, you get a nice washout and then you just keep allocating.
So that having been said, I live in Los Angeles, so we see the flip side of a lot of the potential good flow, which is restaurants and movies that people, everyone wants to invest in. They can be good investments. But a lot of the crowd funding sites too, it seems to all be craft beer companies. And I love craft beer more than anything on the planet as a consumer. But it seems like, and there’s been some big exits, but it seems like every, almost everyone is some sort of a craft beer company. I don’t know. The nice thing nowadays is that like the Angel List, we’ve had Jason Calacanis on to talk about this where you have some great screening. And for me the helpful part is to get to a company that has actual product market fit with like a half a million or a million in revenue because the biggest attrition seems to be when you just have an idea.
And that’s not to say that half of them are going to fail anyway. It just means that there’s something there maybe, who knows? Raoul, we’re going to start winding down. You know, last time you were on…we ask first time guests a question, which was, you know, what’s your most memorable investment? And you talked about that. So this time I want to flip the mic around because you asked me this when we were in the Caymans a couple of years ago and the question is, what’s your best idea right now? I said at the time, this was end of 2016, I said, “emerging markets.” Last time you were on, you definitely talked about Greece as one idea I remember, which has had maybe the number one equity market so far this year, but certainly has had some strong returns over the past couple but has been an interesting one. I think we know the answer, but let’s put it to you. What do you think is your best idea right now?
Raoul: Buy bonds, wear diamonds.
Meb: That great. And before we let you go, I have to ask you one more question because it might be my favourite thread of the summer. You kind of really dangled it on us where I think you were stuck on the tarmac leaving or heading to the Caymans, I can’t remember which. And you send out a tweet with something like the lines of, “I’m waiting on a flight. So I want to give you the story of the greatest macro trade I’ve ever seen.” And then just dot, dot, dot, dot, dot, dot. I think maybe the plane took off where you got stuck, lost internet. But, can you tell us that story? Because I think it’s a really fun one.
Raoul: Yeah. That story is exactly pertinent to what’s happening now, which is why it’s such a phenomenally good story. And it explains the power of the Eurodollar market and it explains the power of capturing that trend when the economy starts slowing and understanding what is the true trade, the one trade. The one trade that beats them all and filtering all the noise. That’s what made it so phenomenally good. And it taught me a big, big lesson. I was at the time, this was going back to 2000. I’d left Goldman Sachs where I was running the hedge fund sales business in equities and equity derivatives. And I’d gone over to a hedge fund. And I was learning my way about running a book. And I was typical as a salesman going into a hedge fund overtrading and everything, because it was like being given…a kid in a candy store. And I hadn’t really understood what makes the great trade.
And then I hear from a friend of mine about a guy at one of the biggest hedge fund firms in the world. He was in London, in their London office. Well, it was outside London, and the Fed cut rates just like they’ve just done. And it was on January the third 2001. Most people weren’t in the office. But this guy drove into his office, saw what was going on, had just been given his new risk limits for the year and he went extraordinarily limit long of Eurodollar futures expiring at the end of that year. So this is kind of what we’ve just seeing now. We’ve just seen the first cut. So what happens? Exactly like now, Eurodollar futures explode even though they’d been…probably seen the cut, they start saying, “Huh, they don’t cut once, they cut lots of times.” And Europe were in a business cycle. So, rates and everything get slashed. So this guy who shall remain nameless, got on a plane and went to his house in Majorca in Spain. And he didn’t come back.
He just did one trade. And he stayed, never coming back to the office until he was up about 250 basis points. So that was an enormous move in interest rates he had made, had his biggest year ever. He was the biggest profit generator for the giant hedge fund he was working at, and suddenly rates backed up 75 basis points in a huge bloodbath. So he gets the phone call from his boss, who’s one of the most famous hedge fund managers, if not the most famous hedge fund manager of all time. Calls him up, says, “I’m coming to the London office, can you fly back? I want to meet you.” So tail between his legs, he heads back off to the London office from Spain and his boss says to him, looks him in the eye and goes, right, “You’re up the most of any person in this firm. You’re the largest driver of profits. You’ve just given a ton of money back, but you’re still up huge. What do you want to do?”
And the guy looked at him and said, “I want to double up.” And the famous hedge fund manager said, “Do it.” He beautifully recognized when somebody was absolutely on his game, the guy doubled up his position. So now he’s twice the amount of risk he’d ever taken in his life. He had the largest single position in the firm by a huge amount. He gets back on a plane and pisses off back to Majorca and does nothing again. In November, after the Fed had been cutting and cutting and cutting rates, the equity market had collapsed 50%, he gets back on a plane, flies back into the office, closes his positions, makes I think $200 million for himself and retires. And that was it. And the beauty of that trade was him knowing that it was the knock-on effect of understanding, the Fed have cut, the Fed are going to cut a long way. They need to. The equity market’s going to make them cut even more because there’s a huge bubble there and the Fed are going to have to try and offset that. So, don’t even bother trying to short equities which are volatile. Don’t bother trying to do anything else, don’t bother trading any single instrument, just buy the front of the curve. You know what’s going to happen, and when there is the inevitable over positioning panic to maybe something’s changed, that’s when he had to take the one other brave decision, which was to double up. And that was just the best trade I’ve ever seen in the world.
Meb: And now he owns the entire island. Well, you know, I think there’s some really instructive parts about that. You know, lining up your trade time horizon with actually how long… I mean, how many of us would’ve sold that every piece of the way once you’ve made some money? And then we’ve had some guests on the podcast, I mean, Chris Mayer was talking about 100 baggers where, you know, these big massive stock wins over the years, but you actually had to hold them in many cases, 5, 10, you know,15 years.
Raoul: So, oh man. I mean, I tried with Bitcoin. I had it from 200 to 2000 I thought I was a god until it went to 20,000 and I felt like a complete chimp, and it’s really hard to do. One of the great pieces of advice I’ve got in my career was from Paul Tudor Jones, who said to me, “Raoul…” The best traders he’s ever seen match that trade time horizon with our idea horizon, which is what you just mentioned. And this guy had a clear understanding of where he thought rates would be at the end of the year and that’s what he traded, and everything else he filtered out. That was genius.
Meb: You’ve been a money manager also a writer for a long time, but also probably the hardest I imagine of all the careers, an entrepreneur. Catch us up with what’s going on with Real Vision. One of my favourite properties were a long-time consumer, have loved watching the business evolve over the years. What’s happening and you guys every time I hear you, you started hiring more people and get better and better guests. So what’s going on in the world?
Raoul: Yeah. We haven’t you back for a while. We need to get you back on.
Meb: I’m a quant. I just spit out the same stuff every so often. But yeah, tell me about the biz.
Raoul: But people don’t understand quants and I think it’s a really misunderstood part of the market. And I think the more you could do for that, the better. Because you know, there’s so many people who just write it off and say, “Well, it’s the machines. They’re going to screw up.” That people have now understanding of what quant really means nowadays. So I think it’s important you come back on. That’s a side-track. The entrepreneur’s journey is the hardest bloody thing I’ve ever done. But it’s also the most rewarding, as you know. And Real Vision has been, it’s almost five-years old. It will be on September 3rd, I think it is. September the 5th. Real Vision’s journey has gone from four co-founders in our houses scattered around the world to a small office, to a small office in the Cayman Islands where we’re based, to now a global entity with people in most continents and 50 people in our New York office.
It’s been an extraordinary journey where we’ve had the vision to democratize the very best financial information, use video as the medium and basically create the Netflix of finance. From that vision to us having, I don’t know, 45,000 subscribers and enormous growth and seeing how completely passionate everybody is about us. You can see on Twitter every day how much people absolutely love Real Vision. Because we’ve given them access to people like you just us having the conversation to say, “Hey, this Meb, can you come in and explain to people how quants work?” That is just not accessible for anybody. But we can do that with Real Vision, and they can get to understand things from the very best people in the world at what they do. It’s just an extraordinary thing where we have Stan Druckenmiller telling us how he makes money, how he thinks about trades, what setups he looks for, everything he thinks and he’s learned about money management, all of that from the greatest ever trader investor in our entire lifetimes.
Well, that’s priceless alone. And it’s only $180 a year. But, you know, we’ve been growing as well into a number of different areas. We’ve been hosting live events. We have kind of this elite membership business where, you know, we’re hosting events around the world. We’ve got one in the Cayman Islands coming up. We’ve had, you know, events in New York. We also have had kind of workshops where we help train people and educate them in things that they need to know by using, you know, really good traders to help them with that process. One of our big ventures now is we’ve launched, say, free sites as well, so it’s called Real Vision Free. And you can find it at realvision.com/free and there is about 20% to 30% of our entire content is not behind the pay wall because we don’t want to limit it to people who can just pay.
We want to let everybody get access to the very best financial information. And so. that’s a big drive for us to push forward, to get our name out there, to grow our audience, to make sure that people are engaging in finance at this very important juncture where it’s possible that we go into recession and people need to be aware, and need to be understanding of the risks that they’re taking. So yeah, that’s where we are with Real Vision. It’s all very exciting. So, if anybody’s listening and they don’t really know Real Vision, just pop over to realvision.com/free and there’s the free version. Or if not realvision.com, sign up for a free trial and have a look around at what is an incredible resource.
Meb: This concept, you know, something that’s been eating at me for many years, podcasts listeners are probably sick to death of hearing about it. Where our educational system in the U.S. doesn’t require or teach any form of not just investing but personal finance and wonders why, you know, we have politicians wonder why we have such problems with student debt and people struggling with just very basic personal finances. You know, a lot of it, it’s just never taught and so many have been blessed with either the interest to go do it or the family to kind of craft that. But, you know, we’ve long talked about this, you have a much better phrasing with the “Netflix of finance”. Because I used to say, “the Rosetta Stone of investing” where you have these topics, you know, and the thing that, you know, could really catapult you guys is if you, on the free side, you kind of categorized it, it almost into like coursework.
“This is a 101 level. You want to come, here’s the videos you watch in order and then once you graduate from that program, you want to go learn about security analysis here, you want to learn about commodities here.” And then that way it gets like a daisy chain of consumption of all the ideas. Because I know a lot of people that I love all the content on there. It’s one of the benefits of Real Vision. Kind of like, what do you watch next? Where’s the next best thing? So, I’m excited. I’ve loved watching you on this journey, so listeners check it out. It’s a lot of fun.
Raoul: You’re right. And sorry, just to go back quickly about that point about content organization. I think there’s a journey of discovery for people and the knowledge, that we’re just in the middle of starting to build some sort of, you know, basic AI, content recommendation engines so people can put in the kind of level they are, what kind of topics they are interested in. So, people get a unique experience because we’ve now got one and a half thousand videos in our back catalogue and we produce three new videos a day. So it’s a fire hose of information, so we’re just trying to make it easier for people to digest as much as they need or want.
Meb: Raoul, this has been a blast. You mentioned it, what’s the best place to track you?
Raoul: Yeah, best place to find me is on Twitter. I’m very active there and I’m very happy to engage with people. So it’s @Raoul, R-A-O-U-L-G-M-I, Global Macro Investor, which is my research business. So find me on Twitter, hunt me down. I’m more than happy to chat, engage. If you’ve got any feedback on the podcast, I’d love to hear from you.
Meb: Listeners, remember, “Buy bonds. Buy dollars. Wear diamonds.” Raoul Pal, thanks for joining us today.
Raoul: Thanks Meb.
Meb: We’re going to add all these show notes at mebfaber.com/podcast. Do subscribe to the show. If you guys got any feedback on this or any episode, firstname.lastname@example.org, leave us a review. We love to read them. Subscribe to the show on iTunes, Radio Public, Breaker, anywhere good podcasts are sold. Thanks for listening, friends, and good investing.