Episode #450: Harris “Kuppy” Kupperman – Oil is the World’s Central Banker Now
Guest: Harris “Kuppy” Kupperman is the Founder and CIO of Praetorian Capital. He’s also the Chairman and CEO of Mongolia Growth Group (YAK: Canada and MNGGF: USA).
Date Recorded: 10/10/2022 | Run-Time: 1:12:57
Summary: In today’s episode, Kuppy shares why the macro set up today leads him go be as bullish on oil as it gets. He touches on the Fed, OPEC, ESG, and how he’s implementing this trade.
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Links from the Episode:
- 0:38 – Sponsor: Masterworks
- 2:08 – Intro
- 2:26 – Welcome to our guest, Kuppy
- 5:36 – Characterizing and defining his investing
- 8:13 – Kuppy’s Event Driven Monitor newsletter; Preview for free from The Idea Farm
- 10:16 – Free trial available at kedm.com
- 18:27 – What the world looks like to Kuppy today
- 23:43 – The Fed is Fuct; Episode #438: Rob Arnott & Campbell Harvey
- 24:34 – Oil is the world’s central banker, not the Fed
- 28:50 – How to put money to work in the energy sector given his macro thesis
- 37:10 – Episode #443: Kyle Bass on The Market, Energy Crisis
- 38:20 – A future where energy overtakes tech; Energy oscillation through the decades (link)
- 40:34 – How Federal Reserve policy will impact energy prices
- 43:20 – Kuppy’s take on ESG
- 45:48 – What the bear case for oil could be
- 47:27 – Investing in his fund; link
- 49:52 – Episode #343: Dr. Nathan Myhrvold, Intellectual Ventures
- 52:24 – The current state of uranium and the interest in it
- 1:01:10 – His thoughts on the wrecking ball that is the growing US dollar
- 1:04:49 – Kuppy’s most memorable trade or investment
- 1:08:03 – Learn more about Kuppy; Twitter @hkuppy; Adventures in Capitalism; kedm.com
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Meb: Welcome, my friends. We got another awesome show today. Our guest is Harris Kupperman. You may know him as Kuppy. He’s the founder and CIO of Praetorian Capital, a global hedge fund. In today’s episode, Kuppy shares why the macro setup today leads them to be as bullish on oil as it gets. You’ll have to listen to the show to see what his price target is. Hint, it’s high. He touches on the Fed, OPEC, ESG, and how he’s implementing this trade. One more thing before we get to today’s episode, think of one person who would be interested in this show and send them the episode. They’ll thank you later. Please enjoy this episode with my friend, Kuppy. Kuppy, welcome to the show.
Kuppy: Hey, thanks for having me on. It’s going to be fun.
Meb: For the listeners, where do we find you today?
Kuppy: I’m in Puerto Rico, beautiful Puerto Rico. We finally got the power back.
Meb: Listeners, the last time I saw Kuppy we were on his porch having a beer on the second house that I went to go try to find him at because the first house, I took a wrong turn and met some of his neighbors. But this on the west coast of Puerto Rico in a pretty famous surf town called Rincón. Tell us real quick what a Miami guy via Mongolia ended up doing in Puerto Rico. How long you been there?
Kuppy: I’ve been 17 years in Miami. I kind of wanted something a little different, and my wife and I went to Costa Rica. We absolutely loved it, living up in the mountains, going to the beach, and we just decided something different. And naturally there’s some tax advantages as well, but after 17 years I was just looking to do something different and didn’t expect I’d like it as much as I like it out here.
Meb: Yeah, Puerto Rico is great. I went there with my family. Even my mom tagged along, and I was joking…we stayed with our good buddy, Wes Gray on the east side of Puerto Rico, and you’re on the west side. You also just got a new office in Rincón, so if you’re getting a hedge fund hotel, peeps down in Puerto Rico, you can go look Kuppy up and squat in his new hedge fund WeWork office. Tell us a little bit about it. You got a surfboard in the office yet? You moved in?
Kuppy: No, there’s no break down there but we got a paddleboard. It actually is a hedge fund hotel. It actually was an Airbnb but we converted it to offices, so it truly is the hedge fund hotel. But no, it took almost a year to do the conversions because there are no windows available on the island for any amount of money. And then right when we were supposed to move in, the hurricane hit, and so that set us all back about a month, but we’re finally moving in. And I’m speaking from my house right now because they’re fixing our internet which got screwed up during the storm, so hopefully we’re ready to go next week.
Meb: Best sunset view, I think, in Puerto Rico, beautiful spot. What’s the local surf break for you then? It’s not right in town, where’s your go-to spot?
Kuppy: I usually go to parking lots, or I go up to River Mouth. A friend of mine has a place in River Mouth, so it’s kind of a gated community so you never really bump into anyone else there. So it’s just great because quite honestly I’m not very good at this and I get in the way mostly, and so it’s great to just have freedom to move around and not get in people’s way.
Meb: So I’ve graduated to what I call…I’m just a foam board surfer, so if you’re on these wave storms, they see you coming, they’ll get out of the way. At this point in life, I don’t need to be on some fancy short board trying to do tricks. I’ll just get out there and cruise around. Well, good, we need to have a good reason to come back down there. I had a total blast. We’re actually moving into a new office here in Manhattan Beach, so listeners, hopefully it will be done by year-end and you all can come have a coffee or beer there. Well, we should probably talk markets at some point. It’s actually a pretty interesting day.
We’re recording this Monday, October 10th. There was some news on the Nobel Committees this week, which I’m sure we’ll get to as well. But just as a little background, Kuppy, I’m trying to characterize you as your framework for investing. I’ve heard you describe yourself as an inflection investor before. How would you describe your style of investing, for those who don’t know you?
Kuppy: Well, I just look for opportunities and I’m really opportunistic. And what I’ve found is that the market’s roughly pricing most securities correctly, give or take 10%, 20%. And there are a lot of people that argue about what Google’s earnings will do next quarter, but that’s not my game. I’m looking for five baggers or better, and those sort of situations only come in inflections. And what I would call an inflection is two types, one is when a cyclical industry has been miserable for a very long period of time, it’s destroyed a lot of capital, people have given up on it, and the industry starts changing for the better for whatever reason. Usually it’s something commodity and it’s just cyclical, and people have given up on it.
And when the cycle turns, it turns with a vengeance, especially because at the bottom of the cycle everyone’s insolvent effectively and you’re bankrupt. And when the cycle turns, they make a whole lot of money, especially because a lot of the competition has disappeared, and there’s been a lot of mergers, and bankruptcies, and cost cuts. And so we’re seeing that same energy right now where these companies are gushing cash.
The other sort of inflection I do is usually tied to a corporate event, and I track a lot of event-driven strategies and corporate events tend to unlock value and create inflections. The most obvious one is when a business has suffered for a long period of time and they finally change the CEO. And the new CEO comes in, and he doesn’t have to be a rock star, he just has to fix the mistakes from the old guy. And oftentimes, when the new CEO comes in, you don’t know if it’s going to get better or worse but you know it’s going to change direction because the new guy has a plan. And oftentimes, the board of director is friends with the CEO and they let him stay way longer than he should’ve stayed. And by the time they fire him, the thing is such a mess that almost anyone with a new set of eyes can fix.
And we’ve seen a lot of inflections from CEO change but also cap structure changes, spinoffs, and post-bankruptcy merge, and it’s demutualization, privatization. All these things unlock value, and as a result, they set the business on a new trajectory and you get an inflection. You see a lot of these, and that’s why 20 years ago spinoff investors made so much money, until everyone realized what the game was, and now there’s less opportunity there. But these go in cycles and I’m sure there’ll be opportunity there at some point in my life again.
Meb: Yeah. You graciously let us share your “Event-Driven Monitor,” which, listeners, is his newsletter that is detailed and lengthy. There’s a lot of data in there, and I say that as a compliment. But we’ll add a link in the show notes, but we sent one to The Idea Farm, which is now free, listeners, reminder, in September. Tell us real quick what you guys attempt to do in this letter.
Kuppy: I asked one of my analysts to start producing it and the data was super useful, and I sent it to a couple of my friends and said, “Where are the bugs,” because they follow these strategies, too. “We know we have bad data. Help us find the bad data so we can make the data scans better.” And so we didn’t know what to call it each week when we sent it out, so we just called it “Kuppy’s Event-Driven Monitor.” I didn’t know what else to call it. And pretty soon we had 200 people subscribed. People I’d never heard of just started emailing me, “Hey, Kuppy, I need this. I need this, this is amazing.” And so we said, “Let’s turn it into a business,” because I was spending quite a decent amount of money on analysts. We now have four people full-time producing this and it’s great that someone else is paying for it instead of me.
It’s basically hedge fund research built by a hedge fund, my fund, and we’re tracking about 25 event-driven strategies. We’re just giving you data runs. We’re then giving you some cliff notes on the ones that we think are most interesting. We’re color coding the ones that are timely or new, and we’re basically trying to make this super useful. I realize it’s over 100 pages each week, but you’re not supposed to read all 100 pages. You’re supposed to cue in on the couple strategies you’re fascinated by, read the cliff notes, and then go on with your weekend. And mostly we’re going to flag 5 or 10 interesting things for you each week and that’s your homework for the rest of the week to go dig in and figure out if you care. And then we toss in some macro at the beginning just because right now macro is just trumping event driven. And this goes in cycles, too, but right now if the market’s going to melt, it doesn’t really matter what the event driven is, it’s going to trade with the market.
So we do a lot of macro commentary as well and I write that. And anyway, it’s a year and three months old, and people really seem to like it. And I’m really proud of what my team has been able to produce, and I really recommend everyone take a free trial. Go to kedm.com and take it for a whirl, and I don’t think you’ll be able to go back afterwards. It’s changed my trading.
Meb: It’s in the category, for me, of, there’s a lot of tools that I know a lot of investment shops, and friends, and hedge funds, and we used to do a few here internally where we built some software programs and we would just share them. I’m just going to read a couple examples because, for me, this is always in the giant hard pile. I remember reading when I was a young investor some of these distressed situations, whether it was Marvel or others, the Carl Icahn early days, and just thinking to myself, “My God, these people earn their alpha because this is the most complicated, you now, Elliott style. Some of the things on Kuppy’s, your all’s website, it goes, “Demutualisations, bankruptcy exits, right offerings, spinoffs, 13D filings, insider buys, tender offers. I mean, that just, like, lordy, how do you keep track of all that?
So to me, but that’s where value add. It’s not, “Hey, what’s your opinion on Tesla,” like, the 10,000th analyst that’s looking at Tesla, but you really have some rando security that’s doing a rights offering that, to me, it seems like a lot more opportunity. Does that seem fair?
Kuppy: Yeah. Like I said, everyone has a view on Google and Apple. They grow, kind of, every year, and so you just figure out what the growth rate is. You just count it back and you’re within 20% of the fair value. And I don’t have any edge there, but if a company is doing a rights offering to raise capital to either de-lever their balance sheets, or invest in some growth initiative or something, I guarantee you that it’s going to totally change the dynamics of the business, and that’s where the opportunity is.
Meb: So before we get to the macro, which we’ll probably spend a long time with, are there any particularly memorable weirdo situations? And, you know, for you, a normal category weirdo situations is already pretty weird, but then you’re the next level, I feel like. Listeners, Kuppy lived in Mongolia for, what is it, a decade, over a decade?
Meb: So anyway, in running these screens, is there any that come to mind as you’ve looked at over the last couple of years, you’re like, “Huh,” then you dig deeper and you’re like, “Wow, this is really interesting situation?” Are there any of the thousands you’ve looked at that kind of bubble to the top?
Kuppy: Oh, absolutely. Let’s talk about Thungela because that’s the best one. Thungela is a low-quality, high-cost South African thermal coal producer that was owned by Anglo American, which is a UK diversified mining company. And Anglo American decided to improve their ESG score by dumping Thungela. Anglo American is mostly owned by pension funds in the UK. It’s owned by ETFs. When you think of a spinoff, a pension fund by their nature has to sell it because it’s coal and they’re not allowed to own it. And an ETF, it’s not going to be part of the ETF basket, it’s too small. They have to sell it.
And who’s the logical buyer? You have UK investors. This thing trades in Johannesburg. Who’s the logical buyer of this toxic piece of debris? They also had huge environmental liabilities. It was just a messy security, and so it spun off and it starts trading at 110 pence, and I’m looking at my spreadsheet and I’m redoing the spreadsheet in real time and I’m saying, I must’ve missed a number somewhere. This is wrong. It has almost 100 pence a share of cash, net cash. You get this thing that’s producing cash flow, even at depressed coal prices it’s going to produce 200 pence a year of cash flow, so it’s half of one times cash flow, but on an EV basis, it’s, like, 1/20th of 1 times cash flow. I mean, we already know what the first dividend is going to be and it trades at 100% dividend yield.
I’m saying I’m converting U.S. dollars, to pounds, to rand, and I’m thinking, “I must’ve screwed something up.” I do the model five times over two hours and I’m like, “No, I didn’t screw it up.” And we ended up buying a good chunk of it, a really good chunk of shares at about 110, 120 pence. I’m just trying to pull up where it is now, but I think it was, like, a 25 bagger or something, which it’s not supposed to happen in finance.
Meb: What was the market cap? Was this thing, like, 20 million? Was it 200? Was it 2 billion?
Kuppy: No, it was, like, 200 million. It’s not terribly small. Yeah, it was a 19 bagger at the peak, and that’s after they paid you multiple large dividends. The dividends are in rand so it’s kind of hard to backwards engineer it, but I think it worked out to almost a 25 bagger with dividends in one year. And obviously the price of coal going up helped and some other things helped. It wasn’t supposed to be a 25 bagger, but I looked at it and said, “What’s the right multiple for a South African, high-cost thermal coal producer, three times earnings?” I kind of looked at it and said, “I thought this was a five bagger.” And I sold mine for about a four bagger because I always leave a little on the table. You just want to recycle your capital fast.
In my wildest dreams I didn’t think it would go further but a bunch of my readers held it. They still hold it, it’s a 20 bagger. They get paid for five lifetime subscriptions to KEDM. And when you think of it, when I tell you the situation a year later you say, “Yeah, that’s obvious.” A bunch of sellers had to sell, they really had no choice. No one was on the other side of the trade for the first week because who’s looking for a South African coal mine? There is no institutional buyer for that. Even in South African no one really wants it, so you understand the setup. But the question is, could you have flagged it?
And for about two months, every week in KEDM we said, “This thing is going to trade weird. It’s going to trade down. There’s going to be forced sellers.” If you haven’t built a model, what are you doing? Get going and spend it now, or we know there’s going to be distressed sellers. I mean, we didn’t know it would go that crazy but we flagged it multiples times, it was so obvious. And without KEDM saying to me, “Hey, Kuppy, this thing is coming,” I would’ve totally missed it. I made a couple million bucks on it. That’s like I said, you know, multiple lifetime subscriptions.
Meb: Well, it comes in to this category where it’s a little…warty is the wrong word, but it’s a little hairy because it’s like, it doesn’t fit into the normal structure or Lego of a portfolio, right? So many of these stocks, they fall into a basket where it’s like a classification system, right? And some of them there’s just a natural…it’s like pouring water or sand into some rocks. There’s a little crack that just no one falls under that umbrella, and so a lot of times you find the opportunity there where it’s not going to be picked up by a traditional index ETF. It might be six months, or a year, or two years later and there is, you’re kind of like often natural buyer, but that’s fun finding these gems. How often do you guys kick stuff out where it’s like, truly kind of smacked yourself in the face opportunity? Is this sort of thing where you start to, you screen, and then you do due diligence and 1 out of 10 are really interesting? Or is it like 1 out of 100?
Kuppy: We probably flagged 20 things a week. We’re like, “Hey, go look at it. It’s interesting.” I’d say about once or twice a quarter there’s something where I really, really dig in because, hey, something is really interesting. And oftentimes you have a situation where you don’t know what the price is going to be, you just know there’s a weird situation coming up and that’s likely to lead to a mis-pricing. But you spend a day building your model and then sometimes it just doesn’t work like you expect it to. And sometimes, like in the case of Thungela, I actually would’ve bought more. If that started trading at, like, 300 pence and it was an easy double, I would’ve bought a lot more because it traded so cheaply I literally didn’t trust my own numbers because it just seemed so bizarre.
But no, I’d say once or twice a quarter we find something really interesting to do. One thing about KEDM, and I want to make it very clear, we don’t give out stock recommendations. We’re not a recommendation service, we’re a data service. We tell you what we think is coming that’s interesting, and then it’s up to you to figure out what it’s worth. But flagging it’s 90% of the battle, because if no one would’ve told me about Thungela I would never have seen it.
Meb: Well, if you guys want to get weird, sign up for a free trial and start to look at some of these ideas. So let’s skip over to where you’ve spent a lot of time in the last few months thinking and writing on your blog. The nice thing about a podcast like this, listeners, and this was the original intent, man, five plus years ago. I have to look it up when this thing started. You, and I, and your buddy shared a few beers on the roof in Puerto Rico talking ideas, and telling stories in markets, and certainly a lot of what we talked about then has transpired in the ensuing months. And this would’ve been when, February, January? So give us a little overview. What’s the world look like to you today here in October? What are you thinking about on the macro situation? Mr. Bernanke just got a Nobel this morning, so what’s the starting point? What are you thinking about today?
Kuppy: Well, in terms of the Nobel, it’s amazing to see that the guy who built the entire Kiwi money printing system that’s now been floating was given a Nobel right before the match is lit and it really detonates. I think it’s really about to go boom. It just seems funny to give it to him now when the facade is already, sort of, crumbling. But I mean, the history of Nobel is that they give it to war criminals and other evil people, and now they give it to bankers, I guess.
Meb: On that jumping off point, what’s the world look like today? You said something was going to go boom. What’s getting ready to go boom?
Kuppy: Well, the history of the Federal Reserve since I got into this industry over 20 years ago is that they over stimulate, because when times are good everyone likes them, and so they just keep giving more of the happy juice. And then eventually they panic about inflation and they raise rates, and they keep going until they break something. And then after they break something they panic with the happy juice again, and they overdo it as they always do, and you get another huge boom, then another huge bust. And the Federal Reserve will keep going this cycle, once again, until they break something. They always break something. They never stop without breaking something, and so I think they’re trying to break something, except this cycle might be different in that because of the inflation that’s impossible to rein in, and they’ll never catch inflation, they’re going to succeed in breaking the central banks.
Last cycle, in ’08, they broke investment banks. Some of the large U.S. mortgage banks, they blew up. But it was systemic, I guess, but it’s very different than if you go out there and blow up the Swiss National Bank, and BOE. I mean, the SNB just reported $100 billion loss in Q2, so just think of the magnitude of these losses. It might’ve been Q3, but in any case, look at the Federal Reserve. They’re sitting there with 50 billion of equity and they have an 8 trillion balance sheet, and the mark to market on all the MBS that they bought at the top of the cycle, they must have a trillion and change mark to market loss. Of course, they don’t have to mark to market their own book to hold to maturity, but then that result is that, if you look at their funding cost, they’re bleeding a few billion dollars a day right now funding all these MBS. That’s their net cash that goes out every day, and that’s not sustainable.
And then they’ve committed to QT, which means they’re going to sell these MBFs, which means they realize the loss, which means that that 50 billion of balance sheet equity is vaporising. They sent over 100 billion to the treasury last year, and this year the treasury is going to have to send them something like 500 billion or something. And as you raise rates, naturally the U.S. hasn’t termed out its interest rates much because the treasury has been mismanaged horribly like everything else in the government. And so if you raise interest rates to 4.6, which is where they’re telling you they’re going to take rates, and you hold it there for a couple of years, one, two, three years, you’re going to take the interest expense from 300 billion up past a trillion.
And I mean, a trillion, that’s bigger than the military. It ends up being 4% or 5% of GDP. You’re going to literally squeeze the economy to death at these interest rates, yet they’ll never catch inflation because oil is about to scream out of control. And that’s what I really want to talk about. But we’re in the first phase, where they’re in their heads saying, “If we raise interest rates enough, we’ll be able to catch inflation.” And there’s good inflation, there’s bad inflation, there’s owner equivalent rent, and when that goes up, everyone says, “Oh, good, BlackRock is making some more money, and everyone is happy. And yeah, it’s terrible if you’re a middle-class guy that has to pay for rent, but no one ever cares about them. They care about their friends in private equity.”
Wage is going up. Oh, that’s great. That offsets the owner equivalent. That’s good, we got to give the middle class a little bit of a raise. Let’s give them 2% each year. That’s nice. And so they kind of ignore that as food and energy because food and energy trickles down into everything else, whether it’s services, whether it’s hard goods. Even food is basically just energy because it’s transport costs, growing costs, it’s all the components. And so it really just dials back into energy costs because energy drives everything.
And what you’re seeing in Europe right now with nat gas, I think it’s about to hit the U.S. when it comes to all petroleum products. And I like to talk about oil just because it’s the one that everyone talks about the price per barrel, but I think it’s every energy sub index is about to scream out of control, and that’s going to bring inflation out of control. And the Federal Reserve is going to have too much of the bad inflation, and that’s what they’ve been chasing for the last six months. They’ve been chasing bad inflation. But at some point they’re going to break stuff trying to chase it, and I don’t think they can catch it anyway. And they’re totally in a box and I think they don’t realize it yet.
Meb: Okay, so there was a lot in there that we can unpack. And listeners, again, we’ll put some show note links to Kuppy’s writings, including, “The Fed is Fuct,” part one and two, maybe part three. I don’t know how many you have now at this point.
Kuppy: I’ve got four now but they just keep coming.
Meb: Yeah. It’s CPI week. We’re recording this, and I do my polls, as I love to do. And the expectation is that inflation is coming down pretty quickly, at least from the respondents. We did a podcast, you mentioned owner’s equivalent rent, with Rob Arnott and Cam Harvey, which I thought was really thoughtful, where they said, back in August, they said, “Look, this is probably going to be elevated just by the way the math works throughout the rest of the year.” They even had a comment that I think was really anti-consensus. They said, “You may not have seen the high inflation print for this cycle,” which I feel like would be extreme anti-consensus view.
So where do you want to hop off? Do you want to start talking about inflation? Do you want to start talking about this energy thesis? You had a really great quote where you said, “OPEC controls the price of oil, and oil is the world’s central banker, not the Fed,” which I thought was a pretty interesting comment. I’ll hand you the mic. Where do you want to go?
Kuppy: Well, let’s go talk about oil because that’s what’s driving everything here. From a big picture standpoint, oil is a cyclical commodity. At the bottom of the cycle, everyone kind of goes bankrupt. At the top of the cycle, all the oil companies start drilling some more, and then they go bankrupt again. Supply and demand is what sets the price, and there’s been multiple cycles since they discovered oil in 1860. What’s happened this cycle that’s very different is that when the price starts going up, we haven’t seen any supply response. There’s been under investment since 2014, and there’s been no supply response.
Why is there no supply response? Well, in the West you have this ESG thing, and what you have is all the banks are scared to lend because they don’t want to be called anti-ESG, so the banks really aren’t lending. There’s no equity capital available to drill and explore. A lot of the super majors are taking the cash flow and building windmills instead of exploring or even maintaining existing projects. A lot of them actually are divesting their projects. Pension funds are selling, endowments are selling, so there’s just no capital in the industry. The industry is starved of capital. From the regulatory standpoint, Biden is going around and cancelling pipelines, cancelling drilling permits, not issuing any permits.
In Europe, they’re suing various energy companies in court and saying that they’re not doing enough about carbon emissions. So if you’re an energy company and Biden is telling you, “Look, we’re looking at excess profits taxes. We’re looking at stopping exports. We’re looking at price ceilings, maybe we’ll nationalise it, who knows,” would you drill any wells? Of course you wouldn’t. You would take your cash flow from the wells, you’d pay yourself some big dividends, you’d go to the beach. Because why would you take the risk when you don’t know what the hell they’re going to do? And that’s happening in Europe, too. That’s happening around the globe, and the net result is there’s really been no supply response.
And as energy prices go ups, what we’ve also seen is that the demand keeps growing. I say this all the time but it’s worth saying again. There’s 7 billion people on this Earth that want the same standard of living that you and I have in terms of per capita energy consumption, and many of these people consume almost no energy. They don’t have refrigeration. They don’t have microwaves. They don’t have light bulbs even. A lot of them are still burning wood, and they’ll eventually save up money. They work a lot harder than us Americans do. They’ll eventually save up money and they’ll buy all the toys that we have, and they’ll use a lot more energy.
And as those people start using more energy, energy consumption globally is going to accelerate because we’re in this S curve. If you look energy consumption of, oh, about 3,500 of per capita income, your energy consumption really expands. And a lot of these places, whether it’s India, or its Southeast Asia, or it’s Africa, they’re right at that 3,500 where their energy consumption expands. And so that’s why we’ve seen energy consumption in the non OECD just exploding, literally exploding. And then in the OECD they keep giving everyone stimulus because no one should go without.
Just today, France announced that they’re going to be giving stimulus to everyone, the UK last month. Don’t worry about energy bills, we’ll just cap your bill here. What is it, California gave everyone $1,000 because inflation was too high. What do you think that does to inflation? So if you don’t penalize guys for using more energy, well, then energy demand, that doesn’t stop. If you made guys in the UK pay for their energy they’d go around turning off light bulbs and turning the thermostat down. But if you don’t incentivize them to do that through the price function, no one does it.
And so the net result is that the supply response has been totally destroyed, and the demand response has been thrown out the window, and a couple thousand years of economics has just been turned on its head. And we all know where this is going to go, but it’s really quite obvious, but the politicians are all searching around for short-term solutions so they get re-elected, and all this is going to make the crisis a whole lot worse. So we can maybe stop there and drill down on this, then we’ll talk about what happens next.
Meb: It’s been a weird year, right? So you and I were talking back in, I think, it was Jan or Feb. Oil was in an up trend, but let’s call it somewhere 80s, and then it went just absolutely parabolic north, spent a majority of the summer, spring in, sort of, that 100, 120 range. There’s been an odd situation in the U.S. where we’ve started depleting the petroleum reserve, which to me, seems like a really odd time to be doing it, but I’m not a politician. And then oil has kind of come back down, sliding back to where…where are we now, somewhere, 90-ish? I don’t know. How do you think this plays out? And is the way in your mind, is the thesis owning the actual commodities? Is it owning equities? Is it some sort of spread trades? How should we start thinking about putting money to work in this thesis?
Kuppy: Sure. I think the way this plays out is that this year has made, what was the thesis last year when I was talking to you? It was right before the Russian war. I had a thesis that oil would go higher. What has changed with the Russian war has taken both thesis and made it kind of supernova. And I think it’s really important just to look at rough number. If you look at today, right now, the global economy is sort of in balance, give or take a couple hundred thousand barrels of supply and demand. The reason why it’s in balance is that you have the OECD countries basically selling a million and a half barrels a day from their strategic petroleum reserves. And I think this makes no logical sense. Oil is not particularly expensive by historical standards anyway.
Back in 2012 to 2014 it was around 100 and no one was in panic. But you have this 1.5 million, then you have this weird situation where the Chinese can’t decide what they’re doing about Covid so they’re just going around locking down cities sort of arbitrarily. One guy tests wrong and they lockdown 30 million people, and so that’s basically taken 2 million barrels of demand off the market. And I don’t think that’s sustainable because you can’t run an economy when you keep locking down all the time. And so I think after the Party Congress, they’re going to be done with all this nonsense, so that’s 2 million barrels that comes back online.
Russian oil exports are going to decline over a million barrels in 2023. All the Western firms just left the country. The Russians don’t have the capacity to reinvest. They don’t have the equipment, they don’t have the technological know how, and they can’t even keep their existing wells running. They just can’t get pumps and parts, and so that’s going to be a million barrels, and that might be 2 million barrels even that the production declines. Let’s just call that a million. And then global demand grows, let’s call it a million and two every year. That’s just what it does because of those 7 billion people.
And so you add it all up and you have about, let’s call it 6 million barrels, okay, of swing, offset by maybe the world grows on the production side by a million barrels, shale kind of recovers a little. Some of the offshore stuff starts kicking in, so let’s just call this a 5 million swing, from roughly balanced today to deficit. A 5 million deficit would be the biggest deficit we’ve ever faced. That’s 5% basically of global demand. That’s, like, catastrophic. You’re going to draw down inventories at an insane rate and the whole refining system will break. I think this sends oil to some insanity price, and it’s interesting that it all coalesces around November, December, where the SPR releases, the Chinese Party Congress, it all ends, and I just think oil is going to do a supernova.
I think what’s really interesting is that there’s been a lot of guys shorting oil because in 2008 you had an economic crisis and the price of oil dropped, but everyone is just remembering 2008. Generals always fight the last war. But there’s been a lot of situations we have had economic crisis and the price of oil has gone up. Think of the ’70s. And so I think people are short and they shouldn’t be short, so that adds a little fuel to the fire. But what really, I think, has happened is that OPEC really changed the dynamic last week. They looked at what was happening and they said, basically, “You have a 5 million deficit,” okay? I think everyone knows the same numbers, and maybe they haven’t done the math, but they should know the numbers.
So when you look at the Federal Reserve, and they’re raising rates, what the Federal Reserve is really saying is that, “America is a rich country. We can print dollars. We’ll always have enough oil, but we need to make sure that 5 million barrels of demand disappears, so let’s go to India. We’re going to give you guys a currency crisis. We’ll take a million or two here. We’ll go to Pakistan, you guys are screwed. We’re going to take some here. We’ll go to Turkey. You guys have no energy independence. We’re going to take a little back here,” and just kind of going around the world playing whack-a-mole with poor countries, and trying to set off currency crises, and banking crises, and trying to force these guys to consume less. But it’s hard to force 5 million barrels of reduced consumption globally because even in the GFC it only dropped three, and that’s the true GFC. You need a bigger crisis than that by almost half again.
And so that’s what basically Powell has been saying. He’s been saying, “We’re going to rein in inflation,” which we talked about before was oil. “We’re going to take the price of oil down, and we’re going to do this by destroying 5 million barrels of demand.” What OPEC said last week, it said, “Hey, you guys can’t just go and bankrupt all our customers. How is that good for the world? We’re going to stop you from doing that. If you want to destroy 5 million barrels of demand, well, we’re going to pull 2 million barrels off the market and make you have to destroy 7 million. You target 7 million, we’re going to make you destroy 10 million. We’re united and we have the ability. You’ll never actually destroy enough barrels without destroying the galaxy, and so why even fight this battle? You can’t win it.” And that’s effectively what they told Powell. “You guys can’t ever catch the price of oil. Stop trying to target oil.” And I don’t think people took that lesson and understood what OPEC really was saying.
Meb: So with the commodities, again, so all right, we have the election coming up. We have CPI print this week, and you’ve had a successful hedge fund for a number of years now. How do you think about making this trade, and is this something that most individuals can replicate?
Kuppy: Well, I think there’s a lot of ways to win. I mean, almost everything tied to energy will go up. What you’re trying to do is find that middle balance between taking risk, and getting the timing right, and also exponential upside. I’ve been playing this mostly with long dated futures options.
Meb: And when you say long dated, you’re a lot more long dated than what people mean when they think long dated. I feel like half the investors today, long dated, they mean, like, end of year. You’re like…
Kuppy: I’m 2025 mostly. I have some ’23s and some ’25s. I mean, I bought these things a year ago and they’ve done well. I’m up a couple times already on my investment, but I think it’s a great way to play this. I don’t think this is a quick and done. I think we have a long-term energy crisis that’ll just keep going, and I want long dated options to play it out. Long energy is effectively long inflation. I own some of the offshore services companies. I own Valaris and Tidewater. Valaris is the largest offshore drilling company. Tidewater is the largest offshore services company.
My view is that over the rest of this decade you’re going to see a lot of growth in energy services offshore just because the countries where you’re seeing a lot of discoveries are countries where they really need the dollars, and they’re not as fixated on ESG, and carbon, and other things. They just want the dollars to grow their countries, and so you’re seeing places like … and Suriname, and Namibia, and Brazil where they’ve just welcomed this exploration. And with exploration comes discovery, and with discovery comes more exploration because people are making money. And so I think the demand for this equipment is going to appreciate a lot, and a lot of this equipment trades at fractions of replacement costs.
And that’s really the two ways I’m playing it. I also own just some BNO, which is the Brent Oil ETF. It’s picking up a little better than a 2% monthly roll yield just because the shape of the futures curve. Basically the front month is at a premium to the second month, and so that 2% to 3% monthly yield is 30% to 40% a year that I make in a pretty risk-free way. And so that’s pretty attractive, plus I get the appreciation of the price of oil, and plus, I like the fact that Brent is a global commodity. You can’t have any one country just price cap it, and so that’s a nice thing to round out the portfolio. It might not have the same amount of torque but I think it’s going to do very well, and anyone could buy that if you have an equities account.
Meb: We had Kyle Bass on the podcast, and one of his phrases when he was talking about the energy companies, and you referenced this earlier with the politicians. He says, “We need to stop fat shaming these energy companies.” It’s so hard to watch politicians, who I think at this point, I think the majority know better and they do it anyway, which is so frustrating, where they’re talking about all the price gouging from the gas stations, which have the lowest margin business on the planet, and they talk about all these things, which if I was an energy company CEO, I’d be like, “Bro, F you. Where were you guys for the decade?”
Or go back a few years ago when energy companies were in just a world of pain, and now that you’re trying to incentivize increasing supply and you’re hating on us, come on, man. Anyway, the interesting part is a lot of our cash flow and value-based screening metric strategies are finding obviously a lot of opportunity in energy because many of these companies and stocks are quite cheap and cash gushing at these levels.
Kuppy: Yeah, they are quite cheap, and it’s interesting that your screening methodologies are coming to the same thing that I’m using this for.
Meb: Yeah, sometimes they do and sometimes they don’t, right? And we’re agnostic and it’s always curious to see what’s going on in the world, and then sometimes between the U.S., and foreign, etc., one of the…as sort of a lot of the very expensive stocks have imploded over the past couple years and seemingly continue to, where certain sectors that have gone in and out of favor over the decades, full cycle, tech being one that just my career has been the darling, the hated, the darling, seemingly the hated again, I don’t know. But trying to become somewhat agnostic about where these companies are located and what they do, I think, is hard for investors, but energy even now is, what, 4% of the S&P, 5% now, down from almost 1/3 at its peak?
Kuppy: At the end of this cycle it will be larger than technology. Energy, it gets really large and it shrinks down to nothing, and it gets really large again, and that’s the cycle. And that’s why a guy like me, I love these sort of cyclical businesses because there’s just a lot of amplitude to the inflection. But no, I think that energy will take a lot of market share from investor capital over time and it’s going to be a painful, slow grind higher because no one wants to invest in it, but the cash flows don’t lie.
Meb: We got a great chart on this Colby will add to the show note links, listeners, on the tech and energy oscillations through the decades, great visualization of the popularity waxing and waning over time, and what’s hot for sector ideas.
Kuppy: It’s funny that you have the cyclicality. You have 100 years of history, and yet, investors can’t seem to make money out of it. It’s just odd that money flows in at the extremes and valuation, and then they all sell at the trough evaluation, and they’re doing the exact opposite what they should be doing. And it never makes any sense to me because you can see this visually.
Meb: Story as old as time, Kuppy. That’s not something that’s…that’s par for the course, right?
Kuppy: Right. Well, you and I are both harvesting that alpha premium in different ways, but it’s just interesting that there are not more people doing this.
Meb: What else is on your mind around the energy complex, while we’re still on this topic of Fed, inflation, energy? Are there any points, thoughts that we didn’t cover here that you think are important not to miss?
Kuppy: Yeah, let’s cover one more, and this is kind of a thought piece. You should think outside the box about everything you thought you knew about Federal Reserve policy. Let’s say Iran and Saudi got into a war tomorrow and all that oil came offline. Well, the price of oil would go to 500 and the Federal Reserve would be forced to lower interest rates to save the economy. You can’t have oil at 500, you have to save the economy. Even though the economy is experiencing massive inflation, they have to cut rates to save the economy. It’s an existential almost. It’s like a tail event that no one expected.
Well, what if oil goes to 500 because Biden’s running around cancelling pipelines and not allowing anyone to drill? Would the Fed have the same follow-through mechanism? I don’t know, but I kind of think oil is going there, and so you might see the Fed actually, at a certain price level, have to panic to save the rest of the economy just because there’s so much leverage in the economy. And at some point they’re going to give up on chasing inflation because they can’t ever catch it. Inflation already lapped them if you think about it. You got a racetrack and you’ve been chasing it, and then inflation already just zipped past them. And so I don’t think they’re going to catch inflation, and at some point they’re going to say, “Look, 7% mortgage is up, that’s not good for homeowners. And look what we’ve done to our friends in private equity. We can’t let them have a down year. Look at what’s happening to this sector, this sector.”
Well, stop, we’re not going to catch oil. The Federal Reserve is here to provide price stability and to create jobs, or to ensure jobs, I forget the exact language. The Federal Reserve has nothing in their mandate about energy policy. And so if other parts of the government, our government and other governments, are set on having an energy crisis because they’re fat shaming the energy companies, like you said, then maybe the Federal Reserve says, “Look, let’s say we’re going to do price stability, X energy, and we’re going to focus on the job side because that’s really more important to America than the price of energy. And everyone is just going to suffer a bit on energy.”
I think that you’re going to have a situation pretty soon where energy gets to a price level where most other companies buckle under the strength of energy. And I like to joke that it’s going to murder all the CUSIPs, because pretty much everything else in your portfolio that’s not energy is probably going to drop a lot, like, a lot. And the Fed will have to ride to the rescue to save the economy, and that’s probably what sends energy into that parabolic, blow-off, insanity phase. We’re still really early in this process.
Meb: So as we think about this, you’ve got some thoughts on ESG, and its role, and what’s going on here. What’s Kuppy’s take?
Kuppy: Well, I think ESG is just horribly misguided. There’s no one-size-fits-all for different public companies. Every company needs to be a good corporate citizen. They need to treat their employees fairly and treat their shareholders fairly, obviously that’s the piece I care about. But you can’t just set broad guidelines and say, “This is now ESG. You have to do it,” and I think that’s where the mistake started. And then ESG, which in theory makes a lot of sense, I think, got co-opted by guys who say, “Oh, we don’t like carbon dioxide, or we don’t like this thing you do. We don’t like this thing you do. We don’t like this thing you do.” And the companies can’t possibly comply.
And then you had all these investors say, “We’re ESG because it’s good for marketing.” And then they all dumped a bunch of energy stocks at the low, which seems kind of crazy. And it just made the problems a lot worse, and I don’t think ESG funds have served their investors very well. They took the bottom of an eight-year bear market and they sold other energy stocks right into a bull market. How can you possibly be doing something useful for your clients? They meanwhile repositioned all the capital into these green energy things that don’t work. I mean, they lost on both sides of the trade.
I think ESG is this really misguided thing. We’re probably at peak ESG now, much like we’re probably at peak carbon, and everything else. I tend to think that when energy prices are low it’s great to talk about windmills, and solar panels, and carbon fighting, and everything else, but when it starts impacting your pocketbook and you can’t afford to heat your home, you go cut down some old growth to burn it, and that’s what we’re seeing all over Europe. They’re cutting down these old growth forests and they’re paying other countries to do it, too. They’re burning more coal than they have in the last decade. Where did ESG go? It’s all been bastardised.
And I think if you were a German politician and you said, “Let’s go build some more windmills and solar,” no one wants it anymore. They just want their nuclear power plants turned back on. That’s clean energy, and for whatever reason the German got in their heads to shut down all their clean energy and become a vassal state of Russia. They did it to themselves and they deserve to all freeze now, and they deserve to all be speaking Russian, too. I can’t imagine what terrible economic policy they did over a decade, where no one stopped them really. It’s insane.
Meb: So as a macro you’re kind of a consummate trader. One of the most important things to do as an investor, as a PM, is to say, “Okay, what’s the bear case? How does this trade end up going south?” One of the protections obviously you have is by buying options so your downside is limited. But what brings oil back down to 50 or 60, or what causes this trade to not happen? You may have to get pretty creative here, but what is the potentials?
Kuppy: It’s hard to overcome 5 million barrels. You can’t do it on the supply side. You just can’t ramp up that fast. These are multi-year projects outside of shale, and shale is kind of doing what it can do. Maybe shale adds a million barrels, but they don’t have the drilling crews, they don’t have the equipment, they don’t have the pipe. It’s unlikely to ramp up fast. No, it has to be on the demand side. You need some global catastrophe, whether it’s lockdowns, whether it’s a true economic crash, you need something that stops the demand side. And even if you stop the demand side, well, then no one invested in production and you just defer the problem a year.
I don’t really see a bear thesis, I see more of a timing problem where you might get the timing wrong on the price of oil. That’s the risk of using options versus just owning a producer, or owning equipment, or something else, but I don’t really see a really downward thesis outside of them destroying the economy or locking us all down again. I guess the other risk is Putin lobs a nuke and you have a billion less people. That would do it.
Meb: Okay, well, that was creative. We asked for creative and we got to it. Yeah. What else is on your macro mind, so your portfolio, are you guys still open to investors? Can we even mention it? You guys got a private fund.
Kuppy: Yeah, we’re still open to investors. We got three slots left in the U.S. The government gives us only 99. You can go to https://www.praetorianvc.com/praetoriancapital/ where we have information about the fund, and we also have our performance numbers, which have been very good. We’ve been up this year. I guess the other thing on my mind that’s worth talking about that we didn’t mention is that the solution to all these problems is nuclear. If you were to announce tomorrow that we invented this new technology that doesn’t produce any carbon, that produces amazingly reliable, very cheap, base-load power that can be used in conjunction with green energy, because it’s not always sunny, it’s not always windy. And you can basically phase out all the coal plants, all the nat gas plants, and you just build these things, I think everyone would be super excited about it.
But instead you come with 70 years of baggage, and there’s been some accidents, there’s been some mistakes, not going to deny that. And as a result, everyone is terrified of this technology. And you see some countries that have accepted the inevitability, like China and India, that are racing ahead to build these things. You see some places like Germany that have three left and they’re trying to shut them down as fast as possible, and I think somewhere in the middle is the right solution. I tend to think that you’re going to see a real resurgence of nuclear, especially as the technology gets better and becomes even more reliable and lower cost. I think it takes some time to build nuclear power plants so it’s not going to impact my oil thesis, but if you’re going to have EVs driving around, where does that electricity come from? It’s not an EV if you burn coal.
Meb: Someone had a great Tweet the other day, they were like, “First of all, your Tesla runs on electricity.” It depends where you live. So if you live, and I’m going to totally massacre these locations and what they do, but they’re like, “If you live in Norway your Tesla runs on hydroelectric energy. If you live in XYZ, your Tesla literally runs on coal. If you live in XYZ, it runs on nuclear.” So it just depends what your energy source for your electric grid is. I heard a great phrase that I think is…we spend a lot of time with this one any time the politicians start talking about buybacks, which just makes everyone’s IQ go down 50 points, but it needs a little better branding. I heard someone mention, they said, “We need to rebrand it elemental energy, or something like that.” It just gives it a better sounding…
We had Nathan Myhrvold on the podcast and he was involved in this new 2.0 nuclear design company, but they had just got approval. I think it was Wyoming, to start to try to build some test modules. But I always wondered, I was like, “If I’m a state governor, and particularly in a state that may be not marginalized, but one that just the economy is struggling or energy prices are high,” I’d be like, “Yo, let’s try it. We’re going to put it in this corner over here. Let’s give them a shot.” But it’s crazy to me, I don’t know.
Kuppy: I think the crazier thing is that they’re actually shutting down plants. It’s already built. It’s already there. Why shut it down before its useful life? That’s the mistake Europe made. That’s why they’re having this energy crisis right now. They had perfectly good nuclear plants and they shut them, and I mean, they deserve to be cold for making the wrong decision. But I think eventually people will come to the conclusion that no power source is ideal. They all have flaws. Wind power is killing all the birds. I mean, it’s super sad, plus they’re ugly, plus you got to replace the turbines every couple of years, and they have these giant graveyards of turbines, which are made out of petrochemicals, mind you. It’s not even clear based on how you do the math if it’s actually stopping any carbon emissions or if it’s just changing how they’re being done.
And so I think nuclear is going to be the thing they settle on just because they tried everything else, it doesn’t work. I’m very bullish nuclear and I own a lot of physical uranium. There’s an entity called Sprott Physical Uranium Trust. It just owns uranium. At some point I think the price has to go up high enough that it incentivize people to produce more uranium because we’re in a deficit situation right now. Russia is no longer doing enrichment for the West. They’re no longer exporting enriched material to the West. That deficit is going to get worse, and as a bunch of nuclear power plants get turned on in China, and India, and some other places on this earth, the demand is going to grow, and the supply isn’t growing.
It’s kind of like a recurring message with me, but supply and demand, it’s super simple stuff. And I just have done it for 25 years and been very successful at it. Find something that’s in a deficit and find a reason why the price is about to go up because sometimes deficits last for a long time. And in the case of uranium, I think people are going to finally come to the conclusion that it’s the least bad option, and I think you’re going to see a lot more plants that were supposed to shut down staying online, and as a result, the demand for uranium should keep expanding just from existing plants, not even new plants, and there’s a lot of new plants. So I guess that’s my other stock pick for you guys is Sprott Physical Uranium Trust.
Meb: What’s uranium been up to? It’s just kind of been chopping back and forth, is that the main takeaway this year?
Kuppy: Yeah, it’s about 48 a pound right now. The peak is around 60 and the low is around 40, so it’s kind of right in the middle of that range. I bought mine a year ago when Sprott was 31, so it’s been an okay investment, especially in a very tough year when the market’s down a bunch. But what I like about it also is that uranium, it doesn’t respond to what happens with Apple, or the S&P, or interest rates. In the end, the world uses 185 million pounds and it only produces 150 million pounds. The 35 million has to come from somewhere, and eventually you drain the warehouse and then the price goes up. That’s the history of commodities. Then the price goes up, and then they start producing more. And so at some point on the way to the price going up, but before they start producing more, you sell it. And so I just do that over and over again, and I think uranium is right at the point where you start to see the price, which has been kind of grinding higher, actually start to accelerate.
Meb: So as you think about your strategies and putting it together in a portfolio, how do you, as you talk to people as potential investors, how do you describe where it fits in? Most investors today are in a world of pain. I think we surveyed our listeners and it’s probably around 90% of people are probably down this year because stocks and bonds are both down, and that, for most investors, is the portfolio. Are you kind of like the sriracha? Are you the alts bucket? How do people think about when they think about a macro fund like yours that’s by definition going to be different? What do they think about as far as position sizing and how to blend it into the mix?
Kuppy: I think if someone wants to invest in the fund they should make a small piece of their portfolio probably a lot smaller because it’s going to be more volatile. I tell my LPs that about every two years I expect to be down 35% from peak to trough, and I don’t think there’s a lot of funds that will say that publicly. A lot of funds will do everything possible to avoid that happening.
Meb: Charlie Munger will, he says it. Charlie, some of the Berkshire guys, he’s the best, but he’s like, “If you can’t handle a 50% loss,” which has happened multiple times at Berkshire, he’s like, “You shouldn’t be here. And this is just what most people see as a safe investment.”
Kuppy: I mean, safe investments come from buying assets at very low valuations and then not being levered because the price can trade anywhere. So you want to make sure you’re not the one getting the margin call at the bottom. I’m not saying I don’t use any leverage. I use some but I try to keep it pretty subdued. And if you buy really cheap things that are earning cash flow every day, every day the company is more valuable just because they’ve retained earnings. Just on a time and valuation scale, you can’t go too many orders without the cash flow that keeps building up forcing the share price higher if you buy something at two times earnings or three times earnings.
We do the inflection investing, which is great, but we try to focus on semi-monopoly sort of situations. Obviously offshore drilling isn’t a monopoly business, there’s a lot of companies doing it. But if you buy the largest guy they’re the lowest cost guy just from economies of scale, whereas some other situations we’re truly investing in monopoly businesses, or semi-monopoly businesses. If you buy them at two and three times cash flow with good balance sheets, time is on your side because the cash just keeps building up, and it usually comes back to you in dividends and buybacks, or they acquire stuff and it just keeps growing.
And so buying really cheap stuff, buying stuff with strong macro tailwinds…every time I ever lose money it’s because the tailwind isn’t there. I expected a tailwind, the tailwind turned, and I was stubborn. I said, “This thing’s too cheap. I’m not going to sell it,” and that’s usually when I get hurt. When you look at that volatility that we’re going to have a down 30, 35 every two years, that’s usually because the stock starts at 10, it goes to 30, and then it just pulls back to 20. And you could say, “Kuppy, you just lost 1/3 of the money,” and I’d say, “No, we doubled our money and it’s just a matter of perspective because we’re both right.”
And we just saw this in oil. Oil, I got long oil at around 40, it went all the way to 120. It bottomed two weeks ago in the 70s and here we are at 90. It’s that exact same, makes a big move, pulls back a bunch, makes the next move higher. And if you can’t stomach that pullback, you’re the sort of guy that’s going to sell at the low, whereas I’m the sort of guy that adds on the pullback. You have to be willing to accept a lot of volatility, and I tell that to all my potential investors and scare some of them away, but it’s part of the nature of it. You don’t want people calling you up and saying, “What happened? I saw my statement last month and I can’t believe how much we’re down.” And I say, “So?” And you just have to accept that and it’s just part of the game.
And so I think that’s very different. Most funds, they spend a lot of money on hedges, they buy options, they do a lot of things which reduces the volatility so it makes it more marketable. But the downside is that, if you’re looking at this as a long-term investor in the fund, why do I care about the volatility? I just want to make the most money possible in a tax advantaged way. Why do I want to give away 50 BPS every month to buy volatility hedges? I want that 600 BPS in my pocket. And so I just have a different mentality about it all, and I think that on a rolling, three-year basis, it seems to be working.
Meb: We talk to a lot of investors over the years, and much like you, what you just described, I think it’s really important to educate them on the strategy, the implications, expectations. But we had many investors, this is going on 10 years now with ETFs, but they’d talk to them, call them up, and say, “Well, I bought this fund three months ago, six months ago and it’s down. But I like you so I’m going to hold it for a little longer.” And I said, “Well, you think that’s bad, it can get way worse.” And they say, “Well, what do you mean?”
I say, “Well,” like, they’re talking about a long-only stock fund. I’m like, “Well, if the market goes down 50, I would expect this fund to be down 50. If the market goes down 70,” but also, as an active strategy it could go probably years underperforming and looking different. And so there was a great Ken French quote where he’s, like, “If people are trying to draw inferences from performance on these short-term time horizons it’s crazy because there’s a fair amount of randomness in the world, and this short-term performance chasing is what gets you into so much trouble.”
Kuppy: Right. I think there was a study done on Peter Lynch, who’s one of the greatest investors of all time, and he had his Fidelity fund for many, many years, and they looked at the inflows and the outflows. And they determined that over the entire time, and I forgot what he did, like, 25%, 30% a year, some amazing number. Over the entire time on a dollar basis there was no money created at all. People added at the peaks. The money comes in, he has to spend it, so he buys more shares, and then on the pullbacks, everyone redeemed and he has to sell it all at the lows. So if you held it the whole time you made a lot of money, but most people didn’t hold it the whole time. They basically bought the peaks and sold the lows, and there was no dollars created during a 20-year period where some of the best performance ever created was created. It just shows you the wrong mentality of investors. You might have better data on this than me.
Meb: I mean, dude, I gave 50 examples of this. My favorite example I used to always give, and it’s in many cases for these public mutual funds, it’s not the portfolio manager’s fault, right? They’re just doing their normal day to day, but the investors buy what they wish they had bought, and so a Ken Headon or CGM fund. That thing for a long time was printing 25% a year.
Kuppy: He just closed down this week.
Meb: Oh, no, did he really? I didn’t see that. He’s an older guy.
Kuppy: He’s an older guy. I think his exact quote was, “Why am I bothering?” He’s down to a couple hundred million that was basically his money. He’s like, “I’m investing in volatile sectors and it’s just too hard. The money comes in when I don’t really want it. It comes out when I really want it. I should’ve closed down 10 years ago.”
Meb: He’s actually having a great year, it looks like. He had, it was, like, up 70% year or something. I think 2000, 2010 was a great period for him. Anyway, same thing, like, the average dollar invested in his funds was negative. It wasn’t whether it was 20% or 22%, it was 0 or negative. But assuming you’ve seen it with the ARK funds more recently, that thing moonshot up and rocket ship crashing down, too. But the flows, it’s like, it’s sad and it’s frustrating but it sort of is what it is, going back to what we said earlier. It’s sort of like the story as old as time.
Kuppy: Yeah, this is the business we’ve chosen for ourselves.
Meb: Yeah. Man, we’ve done a whirlwind tour. Anything else on your mind? The U.S. dollar has been a bit of a wrecking ball for, I feel like, this macro. What does that play into your thesis? I feel like a lot of people, the assumption is commodities are really going to only do well in a dollar weakness, but that hasn’t really been the case this cycle with the dollar romping up and mini-commodities doing the same. What’s your thesis there? Do you have any perspective on the dollar?
Kuppy: I don’t have any super strong view on the dollar because I don’t really understand when the Federal Reserve pivots. They’re going to pivot, because like I said, they won’t catch inflation, and eventually they’re going to admit defeat and save the rest of the economy. And I don’t know the timing on that, only Powell knows that. It’s probably going to be one of his golfing buddies crying about their quarterly performance. But like you said, the commodities normally don’t do well during the dollars strengths, and the fact that they’re doing well during dollar strength, I think, is really telling you a story because the dollar is not always going to be strong. And when the dollar does pull back, I think the commodities really just scream out of control.
The fact that they’ve been so strong during a period of dollar strength, I think it tells you how strong a sector is. I like to believe that sectors and stocks that do well during periods with bad news, and I’d say a very strong dollar is bad news, those are stocks that you want to own because when the news gets better, the stocks are going to really slingshot. And I think that’s what’s about to happen to commodities, and all of the commodities, the supply-demand deficits in oil, you could say the same thing with copper, you could say the same thing with zinc.
Basically all the commodities have had minimal investment and then there’s massive amounts of demand, just because, if you look at, we had a huge move in commodities in the 2000s because China was booming, and this decade is India’s decade. And then you layer on top the fact that they’re going to keep building these green things, and all this green technology needs huge amounts of all sorts of base metals. And so you have India and the green economy at the same time, and I think you’re just going to see a demand for commodities stay super elevated and likely accelerate at any time that interest rates decline or the dollar declines.
Meb: How much of a role does shorting play in your portfolio? Is that something that you spend much time with? Is it, sort of, market dependent?
Kuppy: I hardly ever short. I’m just not very good at it. After 25 years, I know what I’m good at. I’m good at getting inflections right at the moment where things start getting really better after they’ve been miserable for a decade or two, and you get to make 5, 10, sometimes 20 times your money doing that. Why would I short? You know how many times I’ve been short of fraud and it just doubles? I don’t feel like I have any edge and so I just stopped doing that. Folks know what I’m good at. I’ve been surprised how many of my friends over the past two years have literally destroyed their numbers over shorting, whether it was shorting frauds, meme stocks. I’m just amazed how much upside volatility there is in individual names.
The rules have changed with all the Robinhood guys, and it just amazes me that people keep shorting when you know that you have no edge. And even the best short sellers have suffered, and it just seems like a terrible strategy versus just buying good companies, and like I said, the value goes up every day that you hold it. It’s just a better strategy and so I don’t short. I feel sorry for anyone who does.
Meb: Before we let you go, you got to let us know, you’ve probably had, I don’t know, thousands of trades and investments all over the world over the years, good, bad, in between. Most memorable, what has seared in Kuppy’s brain as one that just, like, when I ask that question, is the one that sticks out?
Kuppy: Let’s talk about Tesla. I would short that in 2018. I would short that in 2019. I thankfully covered right when he started really fudging the numbers, and thankfully I covered. I have a bunch of friends who got taken out in body bags. I covered at 200 a share, I think, two splits ago. That was a 10 or 20 bagger since where I covered, and if you have a 2% position that’s a 10 bagger, that’s going to cost you 1,800 BPS. If it’s a 5% position at 10 baggers, you’re out of the business. The most important thing in this game is just not going broke and not getting taken out of the game.
I have a lot of friends that got taken out of the game because they refused to cover and they even added to the short because they were so short that the valuation made no sense. It just made less sense as time went on but didn’t stop the price from going up. I lost a couple hundred basis points and many of my friends lost their careers. So I just think it’s really, like, a memorable thing because every step of the way where it seemed crazier, Elon Musk would just turn the volume up to 11 and do it over and over again, and here we are. He’s in a battle with the Ukrainians, the Russians, Twitter, his own company, and it’s just the circus goes on.
Meb: How do you think about those? You say you don’t do as much shorting anymore, but even on some of the long ideas, is there a stop-loss, or is it simply, has the story changed? Has the thesis changed? How do you think about the, “All right, I’m wrong, I’m moving on,” part of the trade?
Kuppy: Well, it all comes down to the thesis. When you look at anything I own, you’re going to have a best case, worst case, mid case. The range of outcomes is so wide that it doesn’t even make sense really even to model it very much. I’m in an inflection situation, plug the price of energy in, and you end up with such differences in cash flow, what’s the point of doing it, the exercises? It’s much more important just to get the thesis right. And if the thesis is wrong it doesn’t matter how cheap it is. There are a lot of cheap stocks that go nowhere. They’ve gone nowhere for decades. I’m here to compound my money very rapidly and recycle my capital when it’s not working for me. And so if it’s cheap but there’s no tailwind, I’m out, and I take my loss, and I move on. If it’s working, I stay in it. I don’t usually sell so much on valuation. I sell when the thesis starts losing some strength.
A lot of these things, it’s like a Cat 4 hurricane. It’s just going and going and then it dials back to a 3 and a 2, and you kind of feel that, and the share price might keep going, it might not. But as the thesis loses some strength you just have to get out of it, and that’s usually what drives it for me. That’s my exit, not price.
Meb: There’s probably no better lesson, listeners, from the older crowd who’s got enough of the scars than learning to take losses as not something that is a bad thing but a good thing, and move on, and always live to trade another day and not get taken out in the body bag. Kuppy, if people want to learn more, what are the best spots to get in touch with you, places to learn more about your newsletter, your fund, watch you pick fights on Twitter? What are the best spots?
Kuppy: If you want to watch me pick fights on Twitter it’s @hkuppy, H-K-U-P-P-Y. Apologies in advance, I’m probably going to offend you eventually. If you want to go follow my blog, it’s “Adventures in Capitalism.” I write there every week or two whenever I have something to say, and go to kedm.com. Take a free trial. I really don’t think you’ll be able to trade without it. I know I can’t go back. So that’s how you find me.
Meb: I don’t know if you saw this, this is Meb’s humor. So as someone who’s been involved in markets long enough, and now there’s social media, it used to be blog comments, letters to the editor where we would get all the hate. Now it’s obviously Twitter and elsewhere, and you got to have a thick skin, you and I. But get to the point where, and it used to be book reviews. Those used to be rough. But we started collecting over the years, we call it Meb Hatorade, where we think at this point it’s just pretty funny. Usually they don’t get too evil and personal, but listeners, Kuppy had a good Tweet where he was talking about hanging out in Puerto Rico and some probably anon account came in and said, he was talking about me, “Who is this guy, Meh Faber?”
And so I get my name mispronounced, misspelt all the time, Starbucks, etc., but I thought that was the absolute funniest thing I ever heard, “Meh Faber.” I was like, “I need to put that on t-shirts.” I’m like, “My wife is going to love this.” And so of course, as childish as I am, I like…we need freezing cold takes for a Twitter account for investing, but I certainly waited for the rest of the year to go by. And I was like, “Meh Faber sounds pretty good this year, doesn’t it?” And restarted the thread of this poor person eight months ago. So anyway, you got to have a good sense of humor with the trolls and the haters, otherwise you get…it gets too personal, but I thought you’d find that funny. So I’m going to get some “Meh Faber” shirts made at some point. Kuppy, it was a blast. Look forward to seeing you in the real world, and Puerto Rico, the new office. You got to buy two extra surfboards so when we come visit we can all…
Kuppy: Yeah, come on down. I got a foamy and I got an epoxy now so you can choose whichever one you want.
Meb: Thanks so much for joining us today.
Kuppy: Hey, thanks for having me on. Glad we did this.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
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Source: (2022, September 13). Wall St suffers worst sell-off since June 2020 after inflation data. Financial Times
Source: (2022, September 19). Fund managers pitch ‘alts’ to retail investors as institutions max out. Financial Times
Source: (2022, September 30). Inflation punches Wall Street again, ending knock-down quarter. Reuters
Source: (2022, June 24). State of the Art Market: An Analysis of Global Auction Sales in the First Five Months of 2022. Artnet News.