global macro podcast series | featuring preston pysh · 2020. 7. 21. · your co-host, stig, run a...

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Global Macro Podcast Series | featuring Preston Pysh

I wouldn't say that the value investing is dead, by any shape of the imagination. I

think what you have happening is that because they're not supplying so much

liquidity into the system, you have a different incentive structure that now exists

than you used to have when it was just free and open markets and we would let

businesses actually fail which doesn't seem to be a thing anymore.

So, with that new structure you're now

getting all this incentive to allocate capital

into non-tangible assets (really strong,

powerful non-tangible assets, technology-

based assets). Think about, like, Google for

example. They don't have the CapEx that your

traditional brick and mortar type businesses

have - they're global. If there are inflationary

impacts they can just immediately adjust. It's

dynamically adjusting the bidding of the

prices for their ad revenue. All of those things;

the technology piece is just crazy in this. So,

there are a lot of things that are popping out

of this manipulation.

http://www.toptradersunplugged.com/start/

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Introduction

For me, the best part of my podcasting journey has been a chance to refine my own

investment framework through a series of conversations with extraordinary

investors in every corner of the world. In this series, I, along with my co-hosts Robert

Carver and Moritz Seibert, want to continue our education by digging deeper into

the minds of some of the thought leaders when it comes to how the world economy

and global markets really work to try and learn how they think.

We want to understand the experiences that

have shaped them, the processes they follow,

and the historical events that have influenced

them. We also want to ask questions outside our

normal rules-based playground. We’re not

looking for trade ideas or random guesses about

an unknown future but rather knowledge

accumulated over the course of decades in the

markets to try and make us better-informed

investors and we want to share those

conversations with you.

Our guest today is a super successful podcaster

and a diehard value investor who has also

embraced our side of the momentum-driven

investment space. So, you are really in for a treat

today. Please enjoy our conversation with

Preston Pysh.


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Niels: Preston, thanks so much for joining us, today, for a conversation as part of our

miniseries into the world of global macro where we relax our usual systematic, or rules-based

framework, to provide you with a broader context as to where we are in a global and historical

framework and, perhaps, discover some of the trends that may occur in the global markets of

the next few months or even years and, ultimately, how this will impact all of us as investors

and how we should best prepare our portfolios.

So, we are really super excited to dive into a few different topics in the next hour or so, not

least because you have a different background than most of our other guests. Since you and

your co-host, Stig, run a highly successful podcast, namely the Investors Podcast, and where

you, not only express your own opinions but, like us, also get to speak to some of the most

brilliant thinkers we can come across in this world when it comes to the economy and to the

markets which, of course, helps us become more informed investors.

But before I jump into the usual questions we have, I do have one specific one for you that I

wanted to just get into and that is that my understanding is that you started out as a "diehard

value investor" but you have since expanded on how you look at markets. So, without spoiling

the story, can you tell a little bit about this evolution and why you, perhaps, look at investing

differently than where you started.

Preston: I love the question because I don't even know that I have ever been asked that. I see

a lot of people on Twitter ask me, from time to time, in just short snip its. The evolution for

me came from a little bit of pain of the value investing strategy just underperforming over the

last five or six years, in general. I think some of it, too, came from just the 2008, 2009

experience. Coming out of that event I had the opinion that it was never remedied.

There was never a solution that was actually put in place. In fact, when I saw QE being used I

was thinking to myself, "OK, well how long are they going to do that?" I guess I operate off this

really fundamental thesis of manipulation: anytime somebody steps into a freely functioning

system, like nature, for example, when man steps into nature and they start manipulating

that, there is always a consequence of some sort that has to balance that manipulation out.

So, whenever I look at open markets I view them very much like the way nature operates.

When I saw, not just in the U.S. with central banking policy but globally, all the central bankers

having this coordinated effort to use quantitative easing in manipulating the bond market

which then falls out into all these other markets; when I was watching that happen (in 2010,

2011, 2012, 2013 and it just kept going), I was telling myself, "Alright, well, I better start

understanding macro because if I don't this is going to be a very, very painful event because

nothing has been fixed." It's just like you're putting a bigger and bigger bandaid on a wound of

the body that is just leaking more and more blood.


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So, that's where I was approaching it from, I always was very skeptical as to what was taking

place since 2008, 2009; that we weren't dealing with free and open markets. So then it was

just like, "Well, who can I read? Who's the smartest person in the world on this subject?" Well,

Ray Dalio kind of emerged as one of those people. Then, from his readings popped out other

books and other people that I started studying. For me, it became kind of... I actually started

really enjoying it a lot because it was very complex to try to understand.

I wouldn't say that the value investing is dead by any shape of the imagination. I think what

you have happening is that because they're not supplying so much liquidity into the system,

you have a different incentive structure that now exists than you used to have when it was

just free and open markets and we would let businesses actually fail which doesn't seem to be

a thing anymore.

So, with that new structure you're now getting all this incentive to allocate capital into non-

tangible assets (really strong, powerful non-tangible assets, technology-based assets). Think

about, like, Google for example. They don't have the CapEx that your traditional brick and

mortar type businesses have - they're global. If there are inflationary impacts they can just

immediately adjust. It's dynamically adjusting the bidding of the prices for their ad revenue.

All of those things; the technology piece is just crazy in this. So, there are a lot of things that

are popping out of this manipulation.

If I was going to explain it for a person who might not understand financial markets real well,

the way I would explain it is, if you went in and you put a nuclear reactor into this natural

environment and it's popping out this biowaste, that environment is going to naturally adapt

to it in some way. It's going to try to cleanse itself of that and I think that's probably the best

way I can describe what's happening with central banking policy right now. They're doing

aggressive quantitative easing. Some of them are starting to do UBI and you're getting all

these weird effects that are happening in the market right now.

Niels: Yeah, and we'll definitely get into all of that, but what I also think is interesting about

that journey (where you could say, "OK, I start with value, but actually, right now, maybe I

believe that momentum will be the better place to be,") is that we come from the momentum

side. Trend following certainly could be described as momentum.

What I find really interesting is that I think there's a great compliment in the two. If you think

about the lifetime of a trade (and in this case let's just take a long trade), value investors will

be having most of the benefits early on in the trade because you're going to be looking for

that deep, deep value; which with trend followers, we're definitely going to be short at that

time. So, we won't enjoy anything until the markets have changed, etc. etc.

But then, on the other side (without being an expert in value), at some point it gets too

expensive. Value investors will get out. But then, the trend followers are stupid enough to just


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stay with the trend for as long as it goes. As we know, sometimes markets can go to extremes.

So, the combination of the two, and the fact that you have embraced both, I think is just

fantastic.

Let me jump back to what we tend to start out with, in this series, in terms of questioning and

that is just to get your picture of the world right now. What do you see? A lot of people

compare this to what has happened in the past (of course, you mentioned Ray Dalio - he's one

of them), but there are other crises that we go back and compare to. Just from a clean sheet

of paper [perspective] where do you see the world right now?.

Preston: In chaos.

When I'm thinking about how this is going to continue to play out, central bankers have to

print. This is all becoming a story of the dollar, in my humble opinion. I think, globally, this is all

coming down to the dollar, and I think it is all coming down to the failure of the dollar. How

long that's going to take place? I really don't know. I do think that we're not getting into an

aggressive competition of monetary policy.

So, we just saw the United States step in, do aggressive printing (I think it was three or four

trillion). So, when they print that much, now all the other countries and all the other

currencies are feeling the effects of that. They have to counter it with more printing on their

side. So, now that's what we're seeing over in Europe and all over the world. When they

counter that with more aggressive printing what does that do to the dollar? Well, relatively

speaking it makes the dollar stronger. So now, what does the U.S. have to do? They have to

step in and they have to print again.

So, you're getting into this phase where that wasn't nearly as strong as what we're seeing

today. I think, now that you have COVID you have all these protestors on the streets, which is,

no doubt, causing implications to businesses and their ability to capture revenues. Whenever

you've got protestors on the streets, just in the major cities themselves, you've got changes in

major buying habits.

I think that that trend where the COVID isn't gone, it keeps coming back, is going to wreak

havoc come the third quarter, the fourth quarter of 2020 for these businesses. So, it just is

going to cause more printing. It's going to cause more universal basic income checks, which

causes more devaluation of the dollar, which then goes back into the international front, then

they have to reprint.

So, I think you're in this do-loop of printing (competitive printing). What does that mean for

the market capitalization of equities? I think what you're going to see are these violent rips in

both directions.


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So, we saw at the start of 2020 the market was just peaking out. We went through a massive

reevaluation of supply and demand and what business implications that was going to have.

The Fed responded in force, bid the market caps of these companies (or at least the top few

that actually drive the indexes) back up. Now I think you might be starting to see the next rip

down, right now. It's yet to be seen but I suspect that you're going to see another drop, a

significant drop, a violent drop only to see central bankers step in and double down on their

printing; whatever they did last time they're just going to do double that. Then you're going to

go through that whole cycle over again.

So, in nominal terms, I think you're going to see the market go sideways. I wouldn't even be

surprised if you see the market go up, which I think very few people are saying in nominal

terms. But in real terms, if you're going to measure it in gold, you're going to measure it in

bitcoin, you're going to measure it something that has a fixed supply to it. You're going to see

it go down. You're already seeing that in 2020. The market is down if you are measuring it in

gold or bitcoin, it's down by, like, 15% to 20% it's down.

If I was going to say the one thing that I think most investors are missing today, I think it's that.

I think they're doing their measuring with nominal fiat dollars and their not measuring it in

real terms off of a fixed commodity or whatever people want to call bitcoin and gold.

Niels: What's on your mind, Rob?

Rob: Yeah, it's really interesting because I remember standing in front of a seminar in about

2011 and saying, "What's going to happen from here is going to be a competitive race to the

bottom in terms of interest rates because devaluing your currency is a cheap and easy fix to

your problems." It doesn't really help everybody. It's a kind of classic prisoner's dilemma, you

all end up in the same boat. So, it's really fascinating that everyone did that and then, of

course, printed money and it's hard to see an end game for that.

So, you talked a bit about equities and you talked a bit about gold and bitcoin. I'm sure we'll

get onto those later as well. But what about the market that is directly affected by this

government intervention; so, the fixed income market and the bond market? Obviously, we've

got U.S. Ten Years are sub seventy basis points, which (I'm pretty sure) is an historic low. I

remember, back at this seminar, people were saying that U.S. Ten Years could never go below

3%. So, that was a poor forecast.

Preston: We crushed those numbers.


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Rob: We certainly did, yeah. I just said, "Well, look at Japan. There we go." So, how do you

see the yield curves evolving, both in terms of the steepness but also relative across countries

and just your thoughts on the fixed income market, generally really?

Preston: So, you hear or you read in the news, and they say, "Well, we're going to do this

yield curve control." Anybody who works in finance knows exactly what that means, but for

the rest of the public, which is more than 95% of people out there, they hear, "Oh, they're

going to do yield curve control and everything is going to be perfectly fine."

But what they're really saying is, "We're going to look at the notes, the bonds; we're going to

look at the whole yield curve, from short duration clear out to the Thirty Year and we might

even start adding some Fifty to One Hundred Years into the mix. If anybody steps in and tries

to sell it we're going to step in and we're going to buy it with freshly printed cash and hold the

yield at an exact number." That's all it is, but they'll call it all these fancy things that confuse

the public so that they don't understand the farce that we're living in. That's what it is, it's a

total farce.

I think what they're going to do is that they have to keep the yield curve (in the U.S.

specifically), they have got to keep the yield curve in a positive slope because you, of all

people Rob, know what that damage does if the yield curve starts to invert for managing the

liquidity on a bank's balance sheet. It just doesn't work.

You go back in history and you look at anytime the bond yield curve is inverted, well, we get in

these liquidity events real quickly. So, I think, from the central banker, if I'm Powell at the Fed,

he's drawn out just a really mildly sloping but positively sloping yield curve. The Thirty Year

might be 1% and then he's taking it clear down to zero for the overnight rates. They're

absolutely trying to control that by anybody who is stepping in and selling beyond that yield,

they're going to step in a buy it so that they can keep it pegged at the yield.

So, now the question becomes, how long can they sustain that before everyone starts saying,

"There is some funky stuff going on here," and they don't buy it anymore.

One of the most common questions I get asked from people is, "How does the bond market

break? How does it explode? How long can they do this?" I really think that it's going to come

down to when people start to realize that they can take these massive trillion-dollar tranches

of bonds and invest it somewhere else and get a better return, like a lot better return, you're

going to start seeing... It will start off as a trickle that starts coming out of that market, but

then it's going to be the biggest explosion.

You could, potentially, see something like that with bitcoin, which I think is really controversial

for most people in finance to hear that. If bitcoin starts (I'm just going to use this as an


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example), let's say bitcoin starts to run and all your trend followers are going to pick this up

real quick, right? They're going to see the price go through ten thousand, eleven thousand,

then it's going to be off to the races at that point because it's going to break a technical

barrier.

If that starts to happen and people are looking at the amount of printing that is happening

around the world because we're in this competitive printing phase and people are saying,

"Well, that's, supposedly, sound money. I don't know how it operates. I don't understand this

whole protocol stuff, but it's been around for over ten years, and for some reason, they can't

kill it and now its price is running."

Just think that if even a slither, like .01 percent of the bond markets starts funneling money

into something like that. I just can't imagine how they're going to be able to contain it. So,

that's one of my concerns for the bond market moving forward is they're going to be trying to

do this yield control. They're going to have a buyer trying to control the yield curve (in the

Fed), they're the buyer of last resort - they're going to buy everything. So, if I know I have a

buyer at that price, no matter what, I don't have a nominal risk, but I definitely have real risk if

I continue to stay in there.

Come on, you've got Paul Tudor Jones buying bitcoin now. So, what does he know that no one

else knows? So, who's the next Paul Tudor Jones, who's the next major financier that's going

to step in and say, "You know, well, let me buy some chump insurance and just have this .01

exposure to bitcoin now that it is running past the previous all-time high of twenty thousand."

Then it's just going to get really interesting. I think that if I was going to describe how the bond

market blows up, I think there's one example of, maybe, many where you could say, "I could

see a lot of people leaving the bond market for something like that." Then it gets aggressive

and it just compounds on itself from there.

Rob: Yeah, so it's appropriate now to introduce a major financial figure who has been buying

bitcoin, and we were talking about it before the podcast, Moritz, over to you.

Moritz: Yeah, Preston, very cool to have you on the show and I'm pretty keen to speak about

bitcoin in a bit because I'm not sure about Rob and Niels, but certainly I'm in your bullish

camp.

Before I do that this yield curve control, I know it has come up quite a few times. I'm struggling

a bit with what are they actually going to control because the yield curve is pretty flat already?

I'm just saying, personally, if say we're at 1%, whatever, if the impact is that they're reducing

that by twenty-five BPS or it goes up by twenty-five BPS or something like that, it doesn't

matter to me in the slightest. It's not impacting any of my purchasing decisions. It's not


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impacting any of my financials. It's just too little too late. Whereas, if they had a yield curve of,

say, at 18% (go back to the Volcker times) and they did yield curve control, then, and go, "Oh

yeah, we're doing something in the 5% range and we're really shifting this down." Then yeah,

5%, that moves the needle. But we're kind of at zero. What are you actually controlling?

But I do agree with you that at some point there may be a shift in sentiment that gets all those

pension funds and everybody that's structurally long bonds looking at not the nominal yield

that they are getting (which is some cases is negative anyway, as you know), but at the real

yield that they're getting. So, it's interest-free risk. That's essentially what it is.

Then you go, "Well, how about I replace a little bit of that with gold because gold doesn't pay

me a coupon. It doesn't pay me interest. Yeah, it may have some risk but maybe the risk is to

the upside as opposed to the downside in that environment. And how about I put a little bit of

that thing in bitcoin or how about I buy stocks?"

At that point, it's very difficult to control the bond market because, as you say, the Fed would

then have to come in and just guzzle everything up. Then they own the bond market. I guess

that could be one of the end games where it's like, "You own all the bonds, we don't want any

of your bonds. It doesn't matter where you priced them. We're just going into physical assets,

be that equities, or gold, or whatever.".

Preston: If you're telling me that this is going to be the yield that you're going to peg it at for

the Fifteen Year, as an investor what incentive do I have to then not have that bid any higher?

Remember, I'm coming off of a thirty, forty year high of it always being bid higher.

So, if I'm a bond investor and I just made money since 1981 from falling asleep and it just

keeps going up. That's what has happened. The bond market has gone up on the long end.

Every single duration it has gone up for that many years, since 1981, at least here in the U.S.

So, now you're telling me that it's not going to do that anymore and it's just going to stay fixed

like I pegged it to the wall? Why would I own that, especially if the coupon is half a percent or

fifty basis points, or whatever? I'm not owning that.

What's really fascinating is that value investing, in my humble opinion, is (hands down) the

best way to invest if you're dealing with sound money. But guess what, we're not.

So, when you're doing value investing it all comes down to what is the internal rate of return

that I'm calculating based on what my projection of the future free cash flows are. So, I do

that. I go in there, I look at the company's previous free cash flows, I'm trying to come up with

an estimate of what I think the future free cash flows are going to look like and then I just look

at the market price, because it's a given (it's not an unknown like every business school likes to

try to treat it). You know what it is, at least in the public markets you do. Then I figure out my

internal rate of return.


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When I'm doing that I'm coming up with various yields that are very close to where all these

fixed-income yields are pointing. There are some that are at 10%. So, I'm coming up with a

yield and I'm saying, "Oh, this is 9%, or this is 7%," these would be the juicy ones in the market

right now. Well, what are you comparing that to? You have to compare it to a ruler like we did

whenever there was sound money. So, right now, the ruler is 0.5% (at least they want you to

think it's 0.5%). So, in that type of scenario where you're saying, "My ruler is a half of a

percent and I just got 7% on this IRR calculation for company XYZ, well, I should own company

XYZ."

Here's where the farce is happening. Your ruler is not a half of a percent. If you go back and

you look at the central banker's balance sheets, and you look at the rate, if you did a CAGR on

the annual rate of return, or if you annualized how much they have expanded their balance

sheets, you are in excess of 7% or 8% if you were using that as your ruler now.

I think that's how people should be looking at the markets. I think they should be looking at

the central banker balance sheets and saying, "How much are they expanding this on an

annualized basis for the last ten years?" Because that is the debasement rate. Whether the

Fed is allowing the bond market to happen naturally or not doesn't matter. Your debasement

rate is your hurdle that you've got to overcome if you're going to outpace it.

So, for me, when I'm looking at how much of a return I've got to get on a company, at a

minimum, it's what's the debasement rate and what do I have to do to clear it? Right now it's

sky-high compared to what the fixed income market is saying. The fixed income market is

completely manipulated.

I think I went off on a little bit of a tangent there, from your point about the yield control but,

dude, I'm looking at this and shaking my head and saying, "How are so many people on Wall

Street still treating this like we're living in a free and open market, because we're not?".

Moritz: Some of them must... sorry just real quick... Some of those pension funds and the

regulations that surround them, they have no choice. They're kind of like prisoners in that

market. So, there's a new bond issuing coming up, "Well, let's buy that because we have to."

Preston: You're exactly right, Moritz, all the statutes that are in place are forcing these banks

to act the way that they are acting because there is nobody with half a brain that would be

acting this way. So, the banks are turning into an extension of the state, at this point, globally.

You're seeing it all over the place. That's the only way they can keep this going the way that

they are doing it. It's nuts.


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Niels: We can now see the pattern, right? The regulation changes that we've had in the last

five, ten years, they help to get to the point where they can actually control these things. But

then we have to add one more thing, which is not so much of a U.S. problem but it's a big

problem in Japan and it's a major problem in Europe and that is the free float of bonds is tiny.

A couple of years ago the ECB was owning more than 80% of the German government bonds.

Today it might be 90%, who knows? So, what bonds are they going to sell back? How are

yields going to go up because who has got anything to sell?

Preston: Yeah, they can't issue the debt fast enough at this point. That's the other thing is

that you've got people that aren't from finance saying, "Oh my God, these governments have

got to slow down their spending." Meanwhile, the central banks are saying, "You need to

speed up your spending." It's just so counterintuitive.

You look back at history and you see these events where hyperinflation happens and you just

think to yourself, "How in the world could they..." I remember thinking this ten, twenty years

ago, "How in the world could they possibly have been that dumb; or how could they have

done that?" But when you're living through it (and I definitely believe we're living through that

type of event), you can see how all the incentives are pointing in the wrong direction but you

have to keep moving in that direction for one reason: to prevent the social unrest from

happening in society. It's the choice of the lesser of evils that, "Well, if we keep doing this at

least we'll prevent people from getting chaotic in the streets." So, let's just keep going down

this path of least resistance that has the least amount of pain because there's no way we

could step in and stop the momentum of this massive fiscal event that is happening right now.

If you do it's going to be worse than what we're already seeing. So, it's kind of crazy times,

man. This is wild.

Rob, you had a point.

Rob: Yeah, it just sort of sprung to my mind. I can follow your logic as to why the hurdle rate

for value investments or investments, generally, should be higher because it is kind of hidden

in risk, or maybe not so hidden, but not there in the price. But I don't see how that would

affect relative valuations.

I can understand how it would affect absolute valuations. You could say, well actually, the

market is much richer than you think it is. The S&P is pretty rich already, in my opinion. But

that wouldn't affect, necessarily, the fact that certain companies are still cheaper than others,

right? Are you basically, then, saying that the kind of pool of cheap companies is so small that

you're kind of like Warren Buffet in (whenever it was) '68 who sort of gave up for a few years

and said, "You know what, this market is crazy. I can't see any opportunities out there because

of this effective really high discount rate that you should be using?"


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Preston: So, I guess the way I would look at it is, going back to one of the comments that I

made earlier where I was saying that gold and bitcoin are outperforming the market, the S&P

500. If you measure the S&P 500 in bitcoin it's down (I don't know what it is today but), I

would imagine, it's around 20% to 25% down from the start of the year. It's the same with

gold; it would probably be 15% down since the start of the year.

So, when I'm saying that hurdle rate of, call it, 7% or 8% or a debasement rate of 7% or 8%, I

think you have to select an equity that would outperform that 7% or 8% hurdle rate to

outperform the S&P 500, is my opinion. If you picked something that was under that amount I

think it's going to underperform gold and bitcoin, is how I would look at it.

To be quite honest with you I don't know how anything is going to outperform bitcoin based

on my opinions of how I think it's going to perform in the coming year and a half. I don't know

how anything can outperform that simply because the market cap is so low.

With gold, you've got a mature market cap and so as the central banks go into printing you're

going to see it go straight into that, in real terms (if you're comparing it in terms there) you're

going to see gold just perform at that debasement rate. I think bitcoin, because it has only got

a market cap of, call it, 200 billion, it's got room to expand into that store of value (that global

store of value), and I think that's where a lot of the upside in bitcoin is going to come from.

So, I'm looking at that and if I had to go back and rephrase what I had originally said there, I

would say that the hurdle rate of 7% or 8% (or whatever it is), is probably a benchmark

compared to gold not necessarily bitcoin.

Niels: Before we leave interest rates and all of that good stuff and move on to other things.

I'm sure this might come up later on as well but we talk about what can drive yields higher?

Well, one thing that could drive yields higher is, of course, surprise inflation. People forget

because this is something that I picked up from one of your recent conversations, Preston,

with Grant Williams when he said that from 1915 to 1917 inflation went up (these are CPI

numbers, by the way) from 1% to 20%. From 1945 to 1947 it went from 1% to 19%, and from

'72 to 1974, from 3% to 12%. We just can't even imagine that that could happen now, but

anything... I think the last few months have shown us that anything can happen and we should

prepare for that.

Speaking about anything can happen, this will shift to something and I'm sure that Rob and

Moritz will bring it back to something closer to home, but, given your background, the U.S. has

had a trade war with China. We know that geopolitics is pretty interesting at the moment, but

I was wondering, just out of curiosity, do you even think or worry about the prospect of a hot

war involving the U.S., China, or one of the other superpowers? Is that a real possibility?


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Also, there is this war cycle that some people know about, which is about a hundred years and

we're coming up to that. Of course, we did see something come out of the White House which

Grant Williams also brought up in one of your conversations which, when you read it (this is

from May of this year), it really sounds like a de facto war declaration against China. So, given

your background, I was just curious whether this is something that you have in your realm of

possibilities?

Preston: I definitely think it's in the realm of possibilities. Ray Dalio has mentioned this many

times that at the end of these types of supercycles, debt cycles, armed conflict is sometimes

one of the most common outcomes because of the social unrest. Everyone is pointing their

finger at pretty much everybody else but themselves, and it turns into physical remedies. You

can't solve these through policy so then it just turns into a physical solution. So, I think it's a

major concern.

Now whether China and the U.S. want to go toe to toe, I think both sides understand the

implications of what would come out of that, and it would be insanely bloody. So, I think that

there is an incentive for both sides to not get themselves into that type of situation because,

in the end, I don't think anybody comes out a winner, especially with the weapons and

munitions and the technology that exists today.

So, it's something that I think is possible. It's not something that I have built into any type of

financial models. I don't think we're anywhere close to that, today. But those are events that

can escalate in a month and just happen out of nowhere. So, could it happen? Absolutely. Is it

something that I'm thinking about today? Not really, but the trend is not a pretty trend at all.

The trend is not one that I wish would continue going the direction that it's going.

Niels: Sure.

Moritz: Wow, pretty depressing stuff.

Preston: Yeah sorry.

Niels: On a Monday morning.


14


Rob: Sticking with the kind of big secular trend theme, a slightly less scary prospect, or maybe

not, I don't know. How do you feel about the way demographic change can potentially affect

the markets? So, obviously, I guess we're pretty much halfway through the baby boomers

retiring and there's small stuff to play out there. Obviously, the Chinese population has

undergone structural change because of the one-child policy. Now, potentially, they're moving

into a situation where their population could be aging quite quickly. How do you see that all

feeding in on the markets since there are the flows of money that these retirements will

generate?

Preston: It's interesting to see how, as these debt cycles, these supercycles that we're talking

about that are eighty to one hundred years long, at the end of these, things start getting

expensive. I would argue that the reason most people don't have four kids or five kids, is

because it would be insanely expensive to have four kids or five kids.

Rob: Yeah, I've got three and that's enough, thank you.

Preston: It is, it's a lot, especially in today's day and age. I would argue most families only

have two kids and even that's a struggle anymore. Where, if you went back into the 1940s,

1950s you could have bigger families because, relatively speaking, you were making more

money. The capital was being pushed down into the entire population. It wasn't nesting itself

into only a small percentage, 1%.

So, in a fascinating way you see these demographic issues come up for all of these cycles, at

the end of the cycles, because of that dynamic of the cost and how the capital isn't working

itself into the population. I kind of suspect that's one of the driving factors is just I think people

would have more kids if they could afford to have more kids.

So, will that trend get stronger? I think that trend is only going to get stronger as you continue

to see this Cantillon Effect continue to play out, which is not advantageous to the whole

situation. It only compounds on the situation making it worse.

Moritz: So, before we get into this bitcoin discussion, which I'm sure Rob and Niels will like,

the impression that I get is because you've mentioned bitcoin and gold and I guess you're long

both of those or at least bitcoin I think you are.


15


Preston: Yeah.

Moritz: So, your view is probably an inflationary future for markets, whenever that will come.

It's probably difficult to say whether that's happening in the next six, or the next sixteen

months. I wouldn't be able to say that. I think what I've mentioned a couple of times, also on

this podcast, is in terms of bitcoin, even if you're an institutional investor (be it institutional or

private), I think it's a greater risk (more of a risk) to not be exposed to bitcoin on the long side

than being exposed.

Why do I say that? It's because [it's] inherently asymmetrical - that position, right? Let's say

the downside is zero, it's probably very difficult for bitcoin to get to zero because even if the

government came in, and declared it illegal, you can't turn over the internet.

There's going to be some tribe that will use bitcoin and will have some prize. Maybe very low,

but probably not zero. But, who defines the upside of that market? What is the price tag for

bitcoin? Yeah, of course, stock to flow model plan B, all of that type of stuff, you can use that

as guidance. But honestly, I think nobody knows, right? So, it's probably a good thing to be a

little bit long.

If you're interested, Preston, I just yesterday night put out an article on TwoQuants.com about

the bitcoin market and the high implied funding rate that's implied in bitcoin futures contracts

trading on the CME and backed. I'm not sure if you're following that, but this is one of the

discussions that I had, before you came on, with Rob and Niels. I was saying, "You know, you

have all those insured custody solutions for an institutional investor who is afraid of being long

spot bitcoin because they're afraid of losing their key or losing the coin." Yeah, you can pay for

that and be on the safe side.

So, coming back to the bond market here's a bond market where you, essentially, earn

nothing. You have interest free risk, and here's a market that is 200 billion, give or take, but it

allows you to do a trade where you can be long spot bitcoin, and you sell a futures contract

against it and you're looking at making 10% a year, so how about that? Why don't we do

that?.

Preston: How about those apples?

Moritz: Exactly.


16


Preston: There are so few people that understand that derivative trade that you're talking

about and what a whopper. What a whopper of a trade that's a slam dunk win. I just don't

understand why more people in finance aren't on it.

Moritz: Yep, I agree.

Preston: I think as you go through the coming year the amount of people that are going to

pile into that and narrow that, they have to show up because it's a slam dunk win right now.

You talk about a massive guaranteed return, it's wild.

Moritz: Yeah, it requires that you have some liquidity and excess cash because the margin

requirements on those futures contracts are fairly high and bitcoin could jump up, say 5X

overnight. The variation margin that you need to come up with in order to stay in the trade is

significant. I guess there's also a lot of pressure on the long side for futures contracts at least.

This is a hunch that I have that I put out in the article is that those institutions... You've

mentioned Paul Tudor Jones, maybe he's doing the spot bitcoin, I'm not sure. He didn't tell us

what, exactly, he did. But I guess some institutions that go, "Yeah, I go to the CME because I'm

trading e-mini’s and I'm trading futures contracts, so it's a futures contract. I faced a

clearinghouse, that's fine, alright, so I'm just buying bitcoin futures and that's a better trade

than buying spot bitcoin." Obviously, then, that makes the market one-sided and the futures

basis goes up. So, [that is] I guess, probably one of the reasons why that trade is, like you say,

a whopper trade.

Preston: So, here's the thing that fascinates me on this one: so, the derivatives market that I

participate in for bitcoin requires 100% equity of the coin to put on the position. If you're

going to sell a call on the exchange that I'm using, you have to come up with a full bitcoin in

order to write that contract. So, now think about what that does as you sell a call for a year

and a half or a year because there are long-dated derivates out there. Think about what that

does as they lock up one bitcoin into escrow for an entire year. That coin is now off the

market.

Moritz: Less bitcoin.


17


Preston: You got it. And if there's a spread where people can capture 10% by buying long and

selling short at the same time, guess what? You've just created a massive incentive to lock up

a whole bunch of bitcoin for a long period of time, all around the world, in a global market.

Here's the other point that I think is really important for people to think about, not only that,

but they started off as being cash-settled. But why, why would I participate in a cash-settled

market when I can take physical delivery of a bitcoin in literally a millisecond? I can take

physical delivery, right here in my house, now. What other market have you ever seen in

history that you can do something like that? Where you can take physical possession? Now

you remove the whole piece where cash-settled derivatives can be a manipulated game like

you see in, potentially, gold. That always comes up.

Anything that's difficult to settle physical delivery of, well, they always lean towards these

cash-settled markets which are equivalent to playing a game of poker and I'm holding all the

chips and I can control the participants in the game. Well, you can't do that with bitcoin

because I can take physical delivery right now.

I think, because of the nature of bitcoin being the security piece of it with the private keys and

managing the private keys. I am not going to enter into a contract. If I'm going to buy a long

call on bitcoin, and you say, "Ah, I'm just going to put up .2 bitcoins instead of the full bitcoin

for the contract." Guess what? I'm not participating in that market if I'm buying the call side.

I demand, as a buyer of a call, I demand 100% escrow sitting in that account because I

understand the implications that you have to produce this and the only way you can produce

it is if you have the private keys. So, if I don't see those sitting in escrow I'm not buying that

call. I won't do it. I think everybody else in the market thinks the same way.

So, you finally got into a situation, in financial markets, where people are demanding sound

money. They are not going to settle for anything less than that. You've got these swaps that

are massive and their massive because the volatility on it is obscene and that makes sense.

They should be priced that way. But if you've got a spread where you can make 10% right now

by buying long and selling short, well, I don't know how you're going to be able to fend off all

the Wall Street types from making a guaranteed 10%. You're not going to do it; at least you're

not going to do it for long. Boy, it's an exciting time.

I'm kind of curious what reservations, Niels, Rob, what reservations do you have because I

would love to field whatever those questions are.

Niels: I hate to spoil this bitcoin party but I will just remind at least Moritz and Rob of one

thing and that's from one of the guests which the episode is not published yet, but Julian

Brigden came on and we had a good chat with him and he just said that one of his worries was

that one day authorities would go in and confiscate anyone who had bitcoins and that you


18


could end up as (and I'm trying to quote him as accurately as I can), "In a big hole with a boy

called Bubba who calls you Shirley."

Preston: One of the reasons I'm so active on Twitter is because, for five years, I've been

duking it out (I mean we've been in virtual fistfights with people on Twitter for five years)

about questions like that. I can't even tell you how many threads I have been involved in over

that topic right there. In fact, we did a whole podcast episode with a person who used to work

in finance, got a law background, and she is heading the Cryptocurrency Task Force for the

state of Wyoming. She is like, "From everything I'm seeing, I'm seeing the exact opposite, from

a legislature standpoint, where they're trying to make it more accessible."

What I think you're going to get into (it's the same thing that we were talking about earlier on

the show) where you have competitive devaluation happening amongst nations of central

banks. What I think you're going to start seeing, in my humble opinion, is you're going to see a

competitive race to see how much bitcoin and cryptocurrency nations can suck into their

country opposed to prevent it from coming into their country. Because they're going to see it's

like BitTorrent, you can't shut it down.

If you can't shut it down and there are other countries that are capturing it, now you get into a

tragedy of the Commons type situation where it's competitive, "How can I come up with laws

that actually don't have high capital gains so we can suck that business and suck those coins

into this country." I think that's a really counter-intuitive thought that very few people in

traditional finance are saying, but I see as the more likely outcome just because of the game

theory. If I was going to say to the gentleman who said that, how are you going to possibly get

the private key?

So, let me give you an example. If someone came knocking on my door and said, "Preston, we

want your bitcoins."

"Dude, I'm sorry I lost them yesterday. I lost them yesterday. I don't know what the private

keys are anymore."

How are you possibly going to take that person's coins? It's impossible. It's literally impossible.

Are you going to physically beat the person to get them? That could maybe be a solution but

that's pretty much the only way you could potentially convince the person to give you their

private keys. So, it's a little different than gold in that regard.


19


Niels: On a serious note, to answer your question about reservations. To some extent, I would

say that I don't have reservations in the sense that I think that it's perfectly possible that

bitcoin can fly from here and it's going to be fantastic. OK, so that's one thing. There are a

couple of things that worry me a little bit. One is that a lot of people, right now, say, "Gold is a

sure thing; bitcoin is a sure thing." When everybody comes out saying that it's a sure thing,

especially what we see right now, it worries me because nothing is. Secondly, we've just had

the biggest crisis, potentially, that we have seen in our lifetime. What happened? Bitcoin sold

off and gold sold off.

So, nothing is sure and it doesn't change what you're saying at all but it's just something to be

aware of. Again, I don't know much about bitcoin anyway but, for what it's worth, I would say

that I think China (within the last month) confiscated accounts, bitcoin accounts. Of course,

what are the central banks going to do? Digital currency as a concept I definitely believe will

come. I actually think that what we've seen in the last ten, twelve years with negative interest

rates in many countries that it has destroyed the banking system. I can see that we're all going

to end up becoming clients of central banks because it's all going to be digital and we don't

need the banks in-between. It's much easier for them to control everything. I can see that for

sure. But then what happens to all the other digital currencies, when that happens? I don't

know.

So, if I was talking from a trend following perspective, the only reason I think a lot of trend

followers (I know Moritz already uses it and it's fine), but for a firm like ours, we think it's

interesting because of the way it behaves and the uncorrelated nature of it, but it's just not

liquid enough for us to trade as a firm (at least not in our opinion) compared to other

opportunities. But yeah, I find it very interesting for sure.

Preston: I love your point about nothing is a guarantee and anytime somebody says, "This is

going to happen." That's pretty much the best time to run away from them. So, I share your

sentiment and having been in markets for enough years now, I'm with you 100%. I think that

that is something that people should definitely be concerned about that there are so many

people saying that this is going to be a big thing. If anything it will cause people to go and do

more research and get some mortar on the topics so that they can have confidence. The worst

thing you can do is put on a trade and not have a lot of confidence in what you're doing or

why you're doing it.

So, I think that all of those concerns are good concerns for people to have because it's going to

help give them the conviction that they're going to need in the trade.

Rob: Just to round up this discussion, I'm kind of on the same page with Niels in the sense

that I have nothing against trading bitcoin, particularly futures because I trade futures. If


20


anything, bitcoin would be a good addition to my futures portfolio because it's definitely a

diversifying market.

So, my concerns are more about the kind of relative costs and margin requirements that don't

make it an efficient addition to the portfolio, at the moment, rather than a specific bias. I do

like the kind of arbitrage trade that Moritz is talking about. It reminds me of post-2008 when

there was money lying on the table to do cash CDS basis trades because nobody had the

capital to do it. So, if you were a hedge fund with capital you could just help yourself.

I want to briefly change the topic, if that's OK, as this is probably my last question. One thing

that was interesting about a couple of years ago is I was noticing that when I was dropping my

kids off at school I had other parents coming up to me and saying, "Well, what do you think

about bitcoin?" So, for me, that was a clear sign of an overheated market. It was at the time

probably a clear sell signal. But I'm not really seeing that now. Actually, generally, what we're

seeing, I think, in the less informed end of the retail space (shall we say) is that you've got

things like Robinhood, you've got people trading leveraged ETFs, so, what do you think about

that? Is that having a big effect on the market? Is it something to be worried about?

There have been stories, anecdotal evidence of people losing very large amounts of money

doing leveraged trading when they really didn't understand. Is this something that concerns

you? Because I think a couple of years ago I was probably really concerned that there were a

lot of people piling into bitcoin that didn't really know what they were doing. Now I think it's

less so. It's much less. This is more smart institutional money that's now thinking about it, so it

has matured in that sense, but this is the kind of the next scary bubble for me. What do you

think?

Preston: So, I would tell you that in any other year I would completely agree that, when

people are walking up and they have nothing to do with the markets and they're asking about

stock this and stock that or bitcoin this, it's usually the best sign to liquidate and run. 2020

seems to be the year where you do the exact opposite of whatever used to work.

I think one of the reasons that that is happening is (and why I say that is because we're seeing

something that is not something that any of us have seen in our lifetime) it's really the

closeout of this eighty-year debt cycle. When you look at how markets perform at the end of

these big credit events, and when you see a currency blow up, it's very counterintuitive to

how you would normally position yourself.

So, go look at a chart of the stock market in Venezuela. You can name the country where they

have hyperinflation of the currency. The currency completely debases. Look at those types of

stock markets, in nominal terms, and see what it looks like. And the market goes up because

they provide so much liquidity that everything bids.


21


I don't know if, because we're dealing with a currency that's a global currency, it's the reserve

currency of the world, whether we're going to see that type of chart. I'm not convinced that

we will or we won't. I'm just kind of standing by and saying, "They've got to print a whole lot

more than what we have already seen, and we have already seen a lot." I think that the

printing that is to come is going to be of epic proportions - way more than people can even

fathom today. At the end of the day, you're having impairment on all these balance sheets.

I just saw that Chesapeake had (What was it?) seven billion dollars of impairment. So, what a

lot of people don't understand, when businesses like that go bankrupt, it's literally like this

seven billion dollars that used to be tradable, that used to be there in the market, has just

been completely removed which is the same thing as the Fed stepping in and pulling seven

billion dollars off the market. Well, this is just one company. This is one company that literally

had seven billion dollars of units that vanished out of the system.

So, when you have that happen all around the world, you see events like we had back in

March where, why did gold go down? Why did bitcoin... Well, they went down because the

units in the system became impaired. The derivatives contracts (that existed, that are cash-

settled in USD), a lot of them [saw] supply and demand numbers [that] were completely

different than what people thought. So, guess what? It's almost like the Fed is clawing all

those units out of the system when you have all that kind of impairment. So, what happens?

It's a race to the dollar.

Every single thing on the planet has to be sold in order to come up with dollars to adjudicate

the differences of the trades and the differences of opinions and the impairment that

happened on the balance sheets. That's going to happen again. That event that we saw in

March is going to happen... It could happen this week, for all we know. When it does it's a race

to the dollar, the Fed has to step in and say, "Alright, we just had a trillion dollars worth of

impairment on our system, on the dollar-based system, now we have to step in and we have

to print that and we have to get it back onto the market in order to keep everything sane."

So, trying to say that I think the market is going to go up, it's going to go down, it's all coming

down to what the policymakers are going to decide and how much they're going to supply and

then who they're going to supply it to. So far the weapon of choice has been straight into the

top right into the bond market; then it trickles down into the equity market; and if you had a

bunch of money, and you own those equity positions and those bond positions, you made out

like a bandit and you got richer and everybody else (relatively speaking) got poorer because

they didn't get a piece of the pie. That's been the weapon of choice.

If they continue to use that weapon of choice, moving forward, they're going to continue to

polarize the money into the hands of the few and it's going to create more social unrest. So,

when I look at your question, and you have everyone running out there and buying Hertz, a

company that's literally going bankrupt, and you've got people on Robinhood bidding it,

buying it like crazy, do I think those kinds of things are going to continue to happen? Yeap. Do I


22


think that these zombie companies are going to continue to be kept alive? You bet I do. Do I

see young kids trading on Robinhood making tons of money doing that? Probably. Are they

also going to lose a bunch of money and then tell you they made money? Of course.

So, I think we're seeing a situation we have never seen in our lives and it's only going to get

crazier as the year goes on. I don't see this normalizing at all. If anything I see it amplifying as

the year goes on.

Niels: What about you, Moritz? What are your thoughts?

Moritz: [I have] no more questions. I thought it was fascinating. But I'm all good with the

bitcoin discussion so I'll leave it to you, Niels.

Rob: He's all bitcoined out.

Niels: Yeah, I've got a couple of thoughts. One thought, by the way, one to make just a quick

comment on which is this thing about the Fed buying everything and now, obviously, they're

into junk. I saw that this week (I think it was, either published or they did it this week) they

bought a shit load of (pardon my French) big tobacco and big oil. I'm just thinking ESG policies

clearly don't apply to the Fed. It does seem to apply to everyone else.

But anyway, it wouldn't be a real conversation with you, Preston, if we didn't have just one

Warren Buffet question, I think just to throw it in as a calming way to end our conversation.

Again, I'm not an expert but this is what I have heard and that is that someone like Buffet who

is as brilliant as he is, and no doubt about that, but I think he has, actually, underperformed

the markets the last nineteen years and I'm just curious, and you know the concept and him

better than anyone I know, how does he get away with that and people still love him? In our

business one month or two months or one year, God forbid if you underperform the market,

and the phone starts to ring.

Preston: Well, the one thing that Buffet has that very few people in finance have is he has

humility. I think a lot of people were attracted to that because it's so different than what you

find in finance. You go to a shareholder meeting and he'll be the first person to tell you, "Yeah,

I made a mistake there. I probably should have bought more of XY and Z because it has way

outperformed what I did buy, which was this." So, you just don't see that in a lot of finance.


23


So, I think a lot of people love that and I think that he has this endearing quality and character

to him, even though he's underperforming. In my opinion, his performance over the last ten

years, considering how much cash he has been sitting on throughout that period of time, I

think has actually been pretty good considering he's been running with a blindfold on with

how much cash he has on his balance sheet. He's not employing so much capital that he could

be employing and yet his company's performance is pretty decent. I want to say it's only off

the S&P 500, over the last ten years, by a couple of percentage points, not a lot, maybe 10% or

something like that over a ten year period of time.

So, his performance isn't too bad. I think that when you look at how little he has actually been

allocating into the market because he and Charlie definitely know something is up. I think his

performance has actually been kind of good when you look at it from that vantage point of

how much he hasn't been investing.

Niels: Just, sorry to interrupt you there because I think that's a really interesting point, it did

surprise me that they didn't buy anything (in fact they sold something) during this last move

down; a 35%, 40% down move and didn't employ any capital. What do you think they know

we don't know?

Preston: I think he knows that there is something up. I'm looking up the performance here,

I'm going to try to tell you what it was over the last ten years, but I think he and Charlie, and

they have talked about it during the shareholders meeting, many a time where they're just

like, "Hey, this is way different than anything we have seen in the past (talking about this

cycle)." Because of that, I think they're acting very conservatively because, at the end of the

day, I think Warren is more concerned about not losing money for the shareholders than he is

making money for the shareholders. He's playing very defensively.

So, here's the difference, so, from the bottom of the 2009 cycle, Berkshire Hathaway,

compared to the S&P 500, let's see here, Berkshire Hathaway had a 267% return and the S&P

500 had a 287% return. So, there's only a 20% difference and that's over eleven years that

there has only been a 20% difference between the S&P 500 and Berkshire Hathaway. I think

that's pretty good considering how much he did not invest.

He's sitting on over 100 billion dollars of liquidity on his balance sheet that he doesn't even

invest - 100 billion. So, I think that's an interesting take and I would tell you he was

outperforming the market only until the start of this year. In fact, hold on, this is pretty

fascinating. So, Berkshire Hathaway was outperforming the S&P 500 since the bottom of the

crash in 2009. He was outperforming the S&P 500 by 10% up until the start of 2020.


24


Niels: Yeah, that is fascinating. Actually, that's a pretty good way to end our conversation

today because the world we come from, trend following, we feel that we are pretty humble

because we say, upfront, the philosophy is knowing what you don't know. So, we have no

clue, and we make that clear, what's going to happen tomorrow. Unfortunately, it doesn't

quite work as well as it does for Buffet but we're still hoping.

Preston, we can't thank you enough for spending some time with us. We really do appreciate

it, as I'm sure our listeners do as well. By the way, of course, make sure you follow and

subscribe to Preston's work on Twitter and, of course, the Investors Podcast.

As you can tell from today's conversation, we are living in a true Global Macro driven world

and it is, perhaps, more important than ever before to stay well informed. From Rob, Moritz,

and me thanks so much for listening and we look forward to being back with you as we

continue our Global Macro Miniseries. In the meantime be well.

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