The Derivative - Butler and Buck Back to Bookend 2020

Episode Date: December 30, 2020

We’ve already covered the first three months of 2020 with Part I of our 2020 review. We’re now heading into Part II with Jason Buck, CIO at Mutiny Fund and Adam Butler, CIO at ReSolve Asset Management discussing how the fall out of the first three months of 2020 dictated the ending 3/4 of the year. Tune into this next episode to hear more on the possible bond fallout, stimulus holding US markets hostage, the future of the traditional 60/40 portfolio, ReSolve’s Riffs, do deficits matter?, commodity’s role in inflation, “am I a socialist?,” technology improvements in commodity production, the Mutiny Podcast, and the VIX at all-time highs – and what that really means. Chapters: 00:00-01:44 = Intro 01:45-16:05 = Where do Bonds belong? 16:06-40:13 =(MMT) Acronym of 2020, Inflation & a Dystopian Outlook 40:14-48:12 = Why we NEED Commodities      in our Portfolios 48:13-52:37 = Back to the VIX 52:38-59:16 = Favorites Follow along with Adam on Twitter and LinkedIn, and with ReSolve on their websiteand their ReSolve’s Riffs series. Follow along with Jason on Twitter and LinkedInand with Mutiny Fund on their website and the Mutiny Fund podcast. And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, or LinkedIn, and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. I believe there is no free will, but I also believe that we need to behave as though there is. Because if we all don't behave as though there is, there's no accountability and society can't function. There are no bilateral or multilateral or any sort of social contracts that are enforceable

either by reputation or otherwise, right? So, or by law. So we need to behave as though the system operates in a certain way. If we don't all sort of make believe that it operates in this way, how does it operate? And what role do I play in this machine? If it's not the way I thought, what way is it? so let's bring it back we touched on the bond problem um where are we going to go what are we going to do what's an advisor supposed to do was that you adam have put out on twitter once of like how do you um right if you're charging one percent in fees as an ra and you have your clients in a

bond portfolio that's 20 basis points what's what's that math look like so just yeah overall 60 40 portfolio where do bonds stick risk parity where do bonds belong a permanent portfolio do bonds belong if they're yielding zero or next to zero or negative who wants to jump on that grenade first um You go, Jason. I'll start. And the one way we think about bonds, I think there's two ways to think about them, right? One way is in like your 60-40 classic portfolio that actually came out of the 87 crash, right? And the Bernanke put was the first time you realized you could get a positive carry put option, right? That's essentially what the bonds became. And so you reduced the stock portion to 60% because that's where all your

volatility were coming from. And then you had this, you could use either, it's either a risk reduction on the stock side, or now you have this negatively correlated put with a positive carry with the bonds, right? So if bonds are at zero or slightly negative, well, you just lost. And you're tying it in with the Bernanke put because basically like there's no way they'll let them default. Well, no, I'll just, that's where the, that's where this idea, this confidence came in this idea, because prior to that, you didn't really have these concepts. And so that, that's where it kind of came into the zeitgeist, so to speak. And we think the Fed puts always going to be there. Now that's a Malthusian bargain, because it might not always

be there or might not be as fast as we would like. So that's one issue. And if, if bonds become negative, well, now you have a negative carry, just like a put option and you don't have the convexity of a put. So that's an issue. The second thing about bonds that I find more interesting, and I really like what Resolve, and especially Rodrigo is trying to bang the drum on this, is that bonds can be still that ballast in deflation. Nobody knows if we're still in a massive deflationary environment. And even if your carry is only 60 to 70 bps, at least that's a positive real carry over

a deflating environment. And quite frankly, if we go to negative rates from here in the US, which most people think is possible, I would say I think the rest of the world has proved it's possible, you still can even make money on the long side as well. And so I hope that provides a segue for Adam on that one. Well, I won't cover the same ground. We obviously agree. Really, the idea is unless you can actually forecast the future, then you need to be prepared for whatever the future might hold. And what typically drives long-term asset returns is the difference between what's realized and what's expected in the dimensions of inflation and growth. If you experience considerably higher inflation than what the market expected,

that has certain impacts on all assets. If you have higher or lower growth than the market expected, that has an impact on all assets, but it impacts the assets in different ways. And so you want to have a diverse collection of assets in the portfolio that are fundamentally designed to react in diverse ways to those different conditions. And that's really just the basic concept of risk parity. Bonds, as you say, are there to hedge against a deflationary shock. Equities are there to hedge against a positive growth shock. And what's missing in most portfolios is a sleeve that is designed to hedge against an inflation shock. And if you go back, we haven't had an inflation shock in about 35 or 40 years. And

that's why most portfolios don't hold any assets that are designed to hedge against inflation. If you go back to the 1970s, which was the last real inflationary period, the only holdings that actually delivered any returns through the 1970s were commodities, which compounded at low teens and gold, which compounded at high teens over the full decade. And so if you don't have a sleeve of the portfolio that's fundamentally designed to protect against this type of environment, it's like having a two-legged stool. A two-legged stool doesn't stand. You've got to have a third leg. The third leg is this inflation sleeve.

The challenge is the commodity sleeve. Two-legged schools stood for 35 years. That would be the other argument. That is true. I'm like, I can balance it for 40 years. Watch. You just have to go back. Okay, fine. Over the last 40 years, long treasuries have delivered a higher return, higher absolute return than equities. So obviously turn all risk premia concepts on their head. So the problem is you can't base the expectations over the next 10, 15 years on what you've observed over any particular economic environment, right?

The last 35, 40 years have essentially been one long tailwind for interest rates as interest rates went from high teens in the very early 1980s to where are we today? Are we above 1% on the 10-year treasury yet? I don't know. We're within shouting distance anyways. And so that obviously was a massive tail wind, not just for bond. This is the other thing that everybody thinks everybody misses, I think, when, or many do when they're talking about risk parity and talking about the bond component. Everybody's complaining about low expected returns for bonds here. But equities also benefited from this three or four decade long decline in discount rates. Look at the PE on equities right now is not quite where it was in 2000, but- It will be when Tesla gets added, right? Yeah, right. Yeah, we can see that, right? And so the expected

returns on equities here are also very, very low. So you've got both legs of the stool are very, very long levers and that are very, very tippy. And so there's never been a more important time to try to add that third leg. And that third leg is the inflation basket, right? So you want to own some tips, you want to own some commodities. And the question then becomes, how do you get commodity exposure? Where is the risk premium there? And I think that some of that is answered with this rebalancing premium that we've been talking about for the last few months. I want to get back into commodities, but real quick. So the bond concept, so it's going to pay me no yield. Maybe it pops a little in a crash. You know,

I get some flight to safety return, but you're saying mostly, even though there's no yield here, I want it because there's, if everything else is deflationary, that means asset prices go down. That means equity prices in theory go down. And I'm just going to get my principal back and I'm going to be super happy. Well, sure. So there's some of that, but really it's like, there's two things. One is the bonds are there for a reason because you don't know what the future holds. You don't know if we're going to have a positive growth shock or negative growth holds. You don't know if we're going to have a positive growth shock or a negative growth shock.

You don't know if we're going to experience inflation or deflation. You need something in the portfolio that's going to do well if we do experience a deflationary shock and bonds are really the only- But they won't do well. They just won't lose their principle. Well, yeah. I mean, they might do well. It depends on whether or not we do see negative rates, right? If there is a zero interest rate floor, then certainly the potential returns on bonds are

capped, right? So they can only do so much. And then what you're relying on is that they'll return your principal, right? Really, that's all you could hope for at the zero bound. If it doesn't go below the zero bound, you may get your principal back, right? But the other thing is, you can't just rely on equities because the equities and bonds, if markets are even remotely risk efficient, probably have approximately the same risk adjusted performance expectations. So you're way better off in any event to hold

both stocks and bonds in some sort of reasonable proportion in order to balance off those risks, because there's no advantage to emphasizing equities unless you're leverage constrained. And if you're leverage constrained in this environment and you're, you need a, a four or 5% real return distribution, or you're a pension fund that requires seven or 8% nominal returns in order to be able to deliver on your liabilities, then I think you're pooched. There's really no answer. There's two reasons why you need to own bonds. But again, that is a two-legged stool and owning just stocks and bonds without some sort of inflation sleeve, I think is awesome. I'm curious how you guys think about this. I've been thinking about this a lot lately. The unintended consequences or trade-offs that we experience when we make things excessively

easy. Like when we talk about the target date funds, it's really easy to hit that buy button or for 401k flows to go there. And so there's this debate now, is value dead and all those sorts of things. And I would argue value is not dead, but you have to find that in the private markets, it's going to require lots of digging, lots of work, and a lack of granularity. And then for the first time, I was just thinking about what you're talking is same things for bonds. If you want that income stream, you may have to go into the alternative fixed income, go into the private markets,

whether that's real estate or alternative fixed income, and you're going to have to do some leg work and it's going to require a lack of granularity. And so I wonder with all this CRISPR data and everything now, we've made this so easy that it's just a race to the bottom. To try to find those return sleeves again, it's going to require work. Maybe, but you've got every major institution around the world has built a private markets team 15 years ago. The private markets are the last place that many pensions can go to get implicit leverage. We're talking private equity here? Yeah, exactly. Private equity.

Yeah, private credit. But the enterprise value to EBITDA on current vintage private equity deals are in the stratosphere. The implied returns for current private equity vintages are extremely low, nowhere near the returns that investors were getting a decade ago or even five years ago. And so, I mean, the reality is there's no place to hide. And whether you look at a private equity or private credit or public equity or public credit, you're taking balance sheet risk. They're all the same risk. It's just how far out of the money do you want to be in your balance sheet risk, right? And so those spreads have come way in, right?

Like, so in the old days, I'm going to go to high, bad credit loans, get high yield, huge spread over treasuries. Now it's next to nothing. So I'm taking on more risk in theory and I'm not getting the return for it. Absolutely. And I mean, there's some evidence, I've seen some papers recently that sort of illustrate that sophisticated institutions may actually place a premium on the illiquidity of private markets because they are not marked to market on a regular frequency. And so the reporting to investors and stakeholders and boards is much easier on markets that don't show that the actual underlying are down 30 or 40 or 50%

in an equity bear market. Because the accounting firms are not marking the private assets down as quickly as investors are marking public assets down. And so it just, it doesn't look as volatile. It's easier to hold. And that actually may mean that the required return on private assets is less than the required return on public assets. And there is no illiquidity premium. And one of the most- That actually flipped this, that flipped last year, end of last year, I think, right?

Yep. That the public markets had a, you can explain it better, Adam, but yeah, I saw it flip. But part of that, isn't that though, that this is interesting, like Adam, you need to have all these different stools and that's a truly diversified

portfolio. And if you're really diversified, you hate one of those stools, at least one of those legs of the stool at any given time. But I really wonder though, like you just said, if we're going out the yield curve, if everybody's moving to private equity, private credit, and there's trillions of dollars of notional value of all these things out there, but there's nowhere left for it to go. It's gone to the end of the universe and back. And then, like you said, we can maybe try to hedge out with commodities, but commodities is a capacity constrained environment. It can only take so much flows. It's like, where do the returns come from? Like, do we really have like too much notional exposure to the world's assets currently right now coming towards,

you know, peak population? Doesn't that signify a long deflation continuation from here? I don't know the answer. I'm just asking. I don't know either. That was a Ben Hunt tweet the other day that the world's stock market value has surpassed the world's GDP. So financialization, now it's just we can keep going to two, three, four times, who knows? Yeah. I mean, it's kind of like a global PE, right? Yeah.

And we've never seen this before. And who knows how high this tree can grow? Maybe the tree does grow to the sky, right? But I think making that bet is excessively risky and it's not necessary, right? Because you can think about your portfolio in the context of maximizing diversity. And then also you may get this icing on the cake, this rebalancing premium from having a most diversified portfolio and rebalancing back to that most diversified weighting scheme on a regular basis. So everybody seems to want to concentrate in equity risk and really equity risk. It's not even equity risk. As you say, Jason, it's balance

sheet risk, right? It's every dimension of the balance sheet has now been bid up to stratospheric levels and there's nowhere that you can generate a reasonable return for the risk that you're taking. And in a financialized economy and financialized markets, maybe that's just a situation that we all have to live with. And the government's just going to subsidize that missing carry that we all need to finance our retirement distributions and our pensions. I've been hitting on that on a few pods recently. People are starting to think I'm a socialist, but I'm like, it feels to me, right? We're holding the markets, US markets hostage of like, need more stimulus, need more stimulus. Once you open that up, I think it's going to be hard to close that up, put the genie back in the bottle. Just, hey, this makes everything go higher.

We need more stimulus. All the corporations are going to ask for it. The politicians are going to love it. Who's going to stand up and say, stop giving away money? You're hitting on the acronym of 2020, right? MMT. And this is where Adam's brain explodes. Yeah.

Yeah. I just keep coming back to everyone focuses on the potential for MMT to unleash the inflation genie. And I mean, obviously that is a risk and it's something that you should be managing in your portfolio. And actually, Chris Cole on his interview, I think with Grant Williams, did a really good job of discussing some of the potential externalities from MMT. We're all fascinated with markets and we talk about risk in the context of how these policies may impact markets, but we may see some of these risks manifest outside of markets. They may manifest in political upheaval. And one of the inevitabilities of the expansion of federal balance sheets is that every dollar of deficits

that are created from federal balance sheet expansion is offset by equal and opposite credit in the private sector's balance sheet. And so if you put $1,000 a month into the account of somebody who's earning $30,000 or $40,000 a year, a household that's maybe earning $50,000 or $60,000 a year, so sort of a median income household in the US, that dollar is getting spent. It's getting spent on groceries. It's getting spent on gasoline, on maybe the kids can attend an extra hockey tournament or basketball tournament.

They can stay in the hotels or whatever. That money is being spent. It's flowing back into the economy. Every time that money flows back into the economy, it gets spent on a service or a good that a company is providing. And therefore, that company is earning profits. There's a layer of profit margin and that profit margin flows to the capital class, right? And so you've got, you're pumping money to the economy to help support those with below average incomes who are genuinely needy. In the end, that flows to the savings of the ultra wealthy, the capital classes.

And of course, if you go the other side, if you put $1,200 a month into the bank accounts of the capital classes, they have no marginal propensity to spend. They're not going to spend any more money because they have an extra thousand dollars a month in their bank accounts. So it just sits there and continues to accrue as savings, right? So what that does is it increases and perhaps even accelerates this wealth disparity. And so there's lots of research on the fact that people don't just care about their absolute level of wealth. Once they are able to make ends meet with basic shelter and food and safety, they begin to turn their attention on their relative

happiness, right? There is a relative situation, better or worse than their neighbors or better or worse than those that they're seeing on TV, flying in private jets and influencing political decisions. And that I think is how democracies come unraveled. And I think that that's a risk that's not being discussed nearly as often as it should be. Can you, one of you, just for the listeners,

just explain MMT real super quick? Do you want to go? Well, sure. Well, I like to start by defining that MMT is just how monetary operations work. But lately it's been used as this Rorschach test for everybody's political leanings to make them lose their minds on whether whatever political party they're involved with but the idea is that a a sovereign currency like the u.s dollar that they could print as much as they want and then it's in all they have to worry about is employment inflation and they can monitor and they can toggle that via taxation it's basically an acronym for deficits don't matter yeah not really though it. Though. It's really, yeah. But that's how it's being used as a political football.

But I do think it is funny because of course you do have, I think this is a whole narrative construction. So now I'm on like my conspiracy theory, but I do think that there is a political movement that put some academics front and center to talk about the mechanics of the monetary system. So as Jason was saying, MMT is just describing the plumbing of the monetary system. That's been happening for decades.

Absolutely. Yeah. It's that the government is never funded by taxation. The government is funded by asking the treasury to create money and then using that money to facilitate spending. And then later on, there may or may not be taxation that comes into the treasury and through an accounting trick seems to offset this monetary creation. But the two are not really related at all. It's like a philosophical moment here. We're like, this is all fake. Everything's fake here.

Like, why do we care? Why are we getting so upset about this? That actually is the other dimension of this that I think is not talked about enough. And that is that everybody, if 99, 999,000 out of a hundred billion, out of a million people, now my math is bad, but it was the vast majority of people believe that taxes fund spending, right. And they believe that they pay taxes in order to fund spending on the goods and services that they value as members of society. Well, yeah, that's my kids. We're in the car. Why do you pay taxes? So I can pay for these new lane lines and this policeman and that fire.

Yeah, absolutely. And it does get a little bit messy because a lot of these things are paid for at the municipal level or at the state level. And there is no MMT at the state level or at the municipal level. Yeah. Chicago needs it, but yeah. Yeah. Yeah. That's true too. But if they begin to understand that you don't need taxation in order to fund the goods and services that deliver on the values and priorities of the citizens of a country. How did they begin to think about taxes? Why are they paying them at all? What is the value system that anchors the social contract that we've all entered into or that we believe we entered into before we raise this, the actual mechanical plumbing of the monetary system and demonstrate to people that

their taxes only matter in order to reduce the demand for goods and services to the extent that their demand doesn't overwhelm supply and cause inflation, right? That's a whole different conversation about a social contract that I wonder if society is prepared for. And I wonder how that conversation takes place. But piggybacking on that, don't you think that part of, like you're saying, 99 out of 100, 99 out of 100 think that we have fractional reserve banking and that money is not credit. Money is credit based on a contractual obligation that's created whole cloth by private banks. And that's what increases money supply. So it's a very similar thing is that it's actually just a social contract or legitimately just a

contractual obligation that puts more deposits into the bank, which then increases the money supply. But part of that too is if, okay, then we have to look at taxation then as representing the money supply, that social contract that becomes a contractual obligation to pay your taxes, that the subtle underlying is violence by the state. It's a way for the state to encourage confidence in that actual unit of measurement or account or transfer. So that way, we all adhere to the same rules under that social contract. Okay, so I'm not all of us anymore. I don't know what the same rules under that social contract. And so it's just- Okay, so what- Well, not all of us anymore.

I'm not sure what the social contract is there though. I mean, the fractional reserve banking system creates money for the private sector explicitly and only for the private sector, right? And it does so at the behest and demand of the private sector. Whereas MMT describes the way that a sovereign creates money to pay the bills of the sovereign. And there is a myth that is generally believed and adhered to by citizens of the country that their taxes are harvested to pay for the goods and services that are used in the economy and that are provided for

by the government. So there's this distinction, I think, between private and public goods and services that I think has the potential to cause, to be a challenging conversation as we move forward with this type of policy. You would say as that zeitgeist moves, it leads to social unrest as people adjust to the new paradigm in a way. And that's why I was trying to stretch the analogy of that credit is a contractual obligation, is thinking about the taxation is like a social contractual obligation for all of us to believe in the same USD. Agreed. And that's, I think, the way it is now. And I think there is a risk that that narrative unwinds. And part of this year was also, I'm curious though, part of this year,

we also started talking about the Eurodollar markets came back into vogue this year. And so when you think about MMT or QE, how much of that may be just topping up the coffers of lack of liquidity in the Eurodharma markets around the world. And you have to think about how that plays into the domestic markets and public, private, and government debt, and then current accounts. I mean, it's just, you're overlaying complex systems. And to think you've got your arms wrapped around it seems just insane. I agree. And you're blurring the lines between private and public too, which I think is a recipe for some challenges.

Sorry, Jeff. No, I'm just going to ask what, like surely there's a piece of it that my tax dollars are going to, right? There's trillions of dollars in revenue coming in. So you can't just say those go into the abyss or can we? Yeah, they do though. You know, they're credited on the government's balance sheet,

but those, those funds are really just taken out of existence, you know? So if they're not used for spending, the government spends money that is created by the central bank and then deposited on the treasury for spending. And then, you know, that money gets distributed as literally zeros and ones, you know, somebody, somebody writes a program that says please put put change the numbers in these bank accounts yeah right who's that guy if you're listening call us we want to know how that works he just that's like that uh that uh sean connery katherine zeta jones movie right where they're like still that's right that's right that's a good one and that's like like i'm saying you're just controlling like more of the money supply and then jeff to your point

you go then we'll buy on how do you handle you know fist fiscal like domestic spending on construction highways etc that's just that's an accounting convention as within that system and then that obviously leads us to the other 2020 zeitgeist that Bitcoin's back. Yeah. But I'll finish your thought on there. So if you take that to the far extreme, okay, none of us have to pay taxes. And okay, just, hey, Mr. Walsh Construction here in Chicago, we need a new road. I'm going to just take some money out of the, I'm going to create the program, add some zeros, put it in your bank account.

Done. I don't need to get taxes and put it back to here. But if you follow that through, that leads to a, none of us are paying taxes. Everyone gets paid money. Is that inflationary or does it even matter or is, right? Is this the future society where everyone just gets paid for doing some work and everyone contributes? I mean, you'll have bad actors. That of course, the other side, of course, the conservatives would say, well, if you're just going to give people money, then you take away the incentive for them to have to be productive members of society, which, you know, I tend, probably everybody would call those, I lean pretty progressive left. But,

you know, I do think that there are ramifications on that side that definitely need to be discussed. But I feel like that's where we jumped the shark, so to speak, here in 2020, that both sides of the aisle are pushing for stimulus money. They're saying, no, we got to support the real people in the real economy to an extent. You're saying what happens when this happens. And I think Adam and I are saying something very different. This has been happening for decades. It's just you acknowledge it or not. Like this is the fiat system.

Like it's been. Well, it's not whether we acknowledge or not. It's like, I believe there is no free will, but I also believe that we need to behave as though there is. Because if we all don't behave as though there is, there's no accountability and society can't function. There are no bilateral, multilateral, or any sort of social contracts

that are enforceable either by reputation or otherwise, right? Or by law. So we need to behave as though the system operates in a certain way. If we don't all sort of make believe that it operates in this way, how does it operate? And what role do I play in this machine? If it's not the way I thought, what way is it? Right. And to your point, that's American pragmatism. There was never any Canadian pragmatist movement, was there? I mean, so sorry to exclude the Canadians. Sorry about that. But that's American pragmatism, right? It's William James. I know I don't- We're not saying this is an American thing. This is a Canadian thing. This is all central banks, right? I'm just saying that the philosophical construct comes from

William James, Charles Saunders Peirce, all of these American philosophical movement. But that leads to Jeff's point. I think part of the Bitcoin or crypto movement is the idea of central bank digital currencies, and that's how they could very specifically control that money supply. So it's not necessarily taxation. It's a form of taxation. And everybody goes to this dystopian outlook for it. But that could be the realm that we're moving into next. So say more about that, because I think there's a common misconception. And I'll admit that until very recently, I was under this misapprehension as well. But I think there is a pervasive misunderstanding about whether cryptocurrencies are likely to give governments and central banks more oversight over spending or less oversight over spending. And I think a vast proportion of crypto aficionados believe that it enhances their libertarian

freedoms when in fact, I'm persuaded of the view that cryptocurrencies give governments and central banks much more granular oversight over wealth and spending. So maybe you could go into that, Jason. I think that's where you're going. Am I wrong? Yeah. Or you can phone a friend and get Taylor on. I think that's what's interesting about it in general is on this call, we happen to be all like pessimistic or we tend to have dark or dystopian way we think, right? So I always challenged myself and I was in a room of hedge fund managers not too long ago, and they were or dystopian, you know, way we think, right? So I always challenge myself and I was in a room of hedge fund managers not too long ago

and they were talking about the dystopian effects of central bank digital currencies. And I just raised my hand. I was like, maybe sometimes we need to think a little harder and we need to think about the optimistic side, right? And so to your point, or quite frankly, the optimistic side is what life is, is it's just a clusterfuck, right?

And so, you know, if they- The first time, the optimistic side is what life is, is it's just a clusterfuck, right? And so, you know, if the first time the optimistic side is clusterfuck, I hate to see the pessimistic side. Well, because honestly, the great part of American governance and the Constitution is a clusterfuck, right? It doesn't matter what these politicians argue about, as long as they keep arguing, we can go about our daily lives, like people forget about that great part of it. And so I really wonder that the central bank digital currencies, if it's really just replacing the cash-based system. And then you think about if private banks are still creating credit-based money, that's where you can have these trade-offs where we end up in this realistic, hopefully, it's not a utopia, it's not a dystopia. We keep muddling along and you're replacing this outdated cash-based SWIFT system. And you have

these much more acutely or quickly transferred digital coins, but it's just a function of like the reserve-based system. And we still have private banks offering credit supply to the actual individual consumer. And you don't have all of these dystopian outlooks that you could potentially see if you just take it to the philosophical limit without thinking competing human interests involved. Is that fair? Yeah. I think it's almost a little bit trivial to try and discuss the pros and cons because this is almost certainly coming down the pipe in some form. Every central bank in the world or major central bank of the world has described a policy of investigating these types of blockchain-based transaction systems.

And so we are going to deal with this. All of our transactions will eventually be able to be audited by the authorities. And there's going to be some benefits to living in a society where there's a higher level of oversight and accountability. And there's going to be some compromises. Right. I don't want you to government to put a thing in my car and I can't every time I go over 55 miles per hour, I get a digital speeding ticket in the mail, right? Like that's dystopian to me. Like that drives me crazy.

But if you follow through and now we have a digital currency, every time you do something not approved by the digital currency police, you're going to get fined or you're going to get extra tax or whatnot. They've been moving in this direction for a while, right? I mean, you can't go to a bank in Chicago and withdraw more than $10,000 without having to alert the authorities to the fact that you're withdrawing this amount of cash, right? You can't take cash across borders in any material amount.

I mean, they've been squeezing the mobility of cash for a long time in the commensurate liberty of having cash. Real quick, did anyone read the article on George Clooney where he gave the $12 million to his friends? I did read that. That was awesome. Yeah. He was like, well, I don't want to die. And then they get it. I'll just give it to him now. And he's like, in cash. So he's like, turns out there's a place in LA where you can go get $12 million in cash. So he's like, I'm driving around in a minivan with suitcases full of cash. It's like right out of one of my movies.

But don't you think what I concern myself with a lot is you could tell if you're watching the video version of this, that Adam and I are agreeing, Jeff may not be, but we're all getting older. And throughout history, preternaturally, as people get older, they just like to disparage the young or whatever's coming along. And they tend to tend to be much more pessimistic. And so like you were saying, Adam, like these things have always been in the pike and these things have always been coming. It'd be like, you know, when the when the telegraph came out, they're saying this is the destruction of language, right? Like or whatever. It's just like, so if you know, this is the next thing central banks, currencies, and us old people are like,

this is going to be a nightmare dystopian outlook. Society just muddles along in this clusterfuck. I mean, it's just, we muddle along. I mean, there's no utopia or dystopia. It's really based on the lens of how you view the world. And I think we'll be okay. I like that there's a bit of a wild west out there too. I there's there's now very well-established infrastructure for how to create custody and trade cryptocurrencies in a very safe way in a safe environment and you're starting to see active funds um come out and and you know the most markets are so well-developed now that all those... Remember being able to trade using very simple breakout rules and stuff in the 1970s and 1980s across the commodity markets and just earned astronomical sharp ratios. There are very few public markets out there where the vast majority of participants are not professionals.

And here you have a market where the vast majority of participants at the moment are not professionals in actively managing this asset class. I don't know if I believe that then. I think Bitcoin was created by a few Chicago prop firms. Just like, we're bored. Let's create this thing that we can digitally exchange and basically show who's smarter and who can make more money trading against each other. prop firms of just like, we're bored. Let's create this thing that we can digitally exchange and basically show who's smarter and who can make more money trading against each other. And just right there, they're huge in the space. They're like mining it, they're trading it against each other.

They're writing options on it. You know, this is some on exchange, some off exchange. Maybe, but I mean, even simple trading rules are highly profitable in this or have been highly profitable in this space. Yeah, which speaks more to the individual trader. Yeah. But just it's right. If you were going to create something in a lab that these traders could trade, it'd be exactly this thing. Bitcoin, like, OK, we can trade it digitally. We don't have to settle anything, although there's nuance there.

But yeah. And it just immediately goes boom. Yeah. anything um although there's nuance there but yeah and it just immediately goes boom yeah um now just do you either of you see more and more managers adding it right my question is adam are you guys adding it or how do you guys thought about adding bitcoin we've we've kicked the tires on it for over a year the challenge is that the regulators frown on it still so i mean we the easy way for us to add it is through futures and they're highly liquid and you could easily trade them, but the disclosures on all your offering documents make it essentially prohibitive. So we've opted to not do that. We are investigating

maybe pushing that through sometime in the new year. And at the moment, we're investigating how to launch an active crypto fund. The tech we use to run futures is just as easily applied to crypto. There's long-term higher frequency data for many coins that are extraordinarily liquid. Like I say, the mechanics of custody and trading through exchanges is now fairly well established. Fund administrators are getting in on the act. So this is going to become mainstream over the next couple of years. And I think the opportunity to get in and make some pretty substantial profits in the short term is not to be overlooked. But you wouldn't just buy as like a believer, right? You'd say you'd add it to your models and it's either trending up or trending down. Oh, absolutely. Yeah. I mean, I don't have any fundamental view as I think, um, Jason, you may have a stronger fundamental

view on, on the space for me. They're a trading asset, the same as, as, um, any sort of futures market there, there, you know, you've got to, you've got to be aware of the impact of your trading. You've got to make sure you are trading in liquid coins on the big exchanges and have reliable custodians. There's lots of infrastructure to put in place, but these are now tradable as, I think, products that you can distribute to a much wider variety. In the futures, the brokers haven't caught up, right? They're like charging the full nominal value of the contract is your margin.

You're like, hold on, this is futures. I should put up 12%, not 100%. So I feel like CME needs to push on the FCM and say, hey, let these people trade this like a normal product. And it's going to increase tenfold in volume. Every trend follower will just add it as another market, as another currency or metal. Where do I put it? What buckets is it in? Doesn't quite matter.

I think we're all in agreement. You need commodities in case inflation pops up. How you do that, which we briefly mentioned, right? It's the worst return and most volatile asset class over the last 20 years. You can trend follow it, but then you don't have necessarily a mandate to capture inflation. So it's tricky. And most there's not many trend followers out there who only do commodities. So I sign up a CTA and I've got equities, I've got bonds, I've got currencies and some commodities.

So it's a tricky thing for an institutional or an individual investor to get that commodity allocation to protect against inflation. Any solutions? I guess I'll go. So I think there's a few things. One is alpha beta separation. Like I think you want to have a strategic allocation to commodities

and you probably want to have an active layer, right? Whether that's through trend or more sophisticated strategies, there's definitely opportunities and idiosyncratic active strategies that you can apply in commodities that are highly profitable. But the starting point is a basic commodity beta. And I mean, sadly, those who are informed and are trying to get commodity exposure typically go to an index provider like the GSCI, maybe the Bloomberg Index. And those indices are invested in crude oil.

Yeah, like 30, 40% in the energy complex. They're very highly concentrated. traded. And so you're not getting protection or hedging against a very wide spectrum of potential dimensions of inflation. Let me jump in there real quick. Now, Zoom is worth like more than the whole energy sector, right? So it's like, is that where inflation is going to show up in the future, in the energy sector? Yeah, I mean, who knows, right? Maybe it's in food, right? Maybe it's in softs. Who knows where it's going to show up? But the point is that if you're getting your commodity exposure through one of the liquid indices, then two things. First, you are very concentrated in just one type of potential inflation, mainly in the energy sector.

But secondly, that concentration has a very substantial opportunity cost. So just as an example, we did an analysis of the GSCI. So the GSCI has a little over 20 contracts as constituents. And in their constituent weights, you get a little over two independent bets from that portfolio. So two weighted average dimensions of risk. If you take those same contracts and create the most diversified portfolio that you can, you get almost eight dimensions of risk. Those same contracts just weighted differently in the portfolio. So that has two impacts. The first is you're now hedged against a much wider array of potential sources of inflation. But the second is you have the opportunity to generate a much higher rebalancing premium from this more diversified portfolio. And that rebalancing

premium can be ridiculously large, like way larger than anybody I think has previously expected. And then Jason and I argue, I don't think we have till another four hours, but we are, we'll leave that for another podcast of like, if you're rebouncing into something like corn that went down for, you know, 17 years, like you're, that's adding to your losses, right? That You can't harvest a rebalancing premium on something that continues to go down. Is that for me? You said Jason, I don't know. No, I'm just throwing that out there. I'm waiting for Adam to weigh in. Jeff likes to argue this all the time. Let's let Adam weigh in on rebalancing premium.

No, no. I mean, I think, look, you only need the weighted average of your asset compound returns to be positive. And actually, if you have a diversified enough portfolio, it can be slightly negative and you can still generate a positive return. So it's the return at the portfolio level, not the return at the asset level that matters. And so, yeah, you're going to have a few assets that are going to drift lower over your entire investment horizon. And so, yeah, you're going to have a few assets that are going to drift lower over your entire investment horizon. What you're betting is that two things. On average, you're going to have other markets that are going to drift higher and offset those. And historically, you've got more markets that drift higher and they drift higher at a higher magnitude. And so

on average, your weighted average compound return is positive. And second, just by virtue of having such a diversified portfolio, you're still able to generate an excess return in excess of that weighted average compound return of the constituents. And that's this rebounding premium that we've been talking about.

You want to throw a Shannon's demon at me, Jason? Adam said it perfectly. All right, we'll leave that for another pot. I want to bring up one more thing on commodities. Like, where do you see technology? Right, I see this in the grains most of all, but it's everywhere. Like energy, we can drill down 3,000 feet

and then go sideways 3,000 feet, right? Like it doesn't exist in a vacuum of there's going to be inflation. Like as prices go up, the whole world's going to be funding projects to like get more supply and lower those prices. So any thoughts on that? Then you have supply, demand and distribution. And so it's more of a function of distribution blockages or the, you know, the, the supply chain dynamics that can create tail whip effects. It

doesn't necessarily manage matter that technology is driving down the actual in-ground costs. Okay. Yeah. But to me, even if there's inflationary pressures from the overall economy, but you have deflationary pressures always from, which might be the reason we haven't had any inflationary pressures since the 70s because the technology ramp has been so drastic. What's missing there is that, yes, there's new technology that allows us to access resources that were previously inaccessible because we didn't have the technology to access it. But if you're drilling into bedrock four kilometers below the Gulf of Mexico and then shooting three kilometers in any direction, the marginal cost of building the infrastructure in order to extract those resources is much higher.

The marginal cost of extracting a barrel of light sweet crude in the 70s was, these are not exact numbers, but the order is right, was on the order of $3 or $4 a barrel. In the 80s, it was $8 or $9 a barrel. Currently, it's $25 to $30 a barrel to extract it at the margin or the marginal cost of an extra new barrel of oil, of light sweet crude. And so this doesn't happen for free. In the foods, as an example, you've got better technology for planting, harvesting, crop rotation, that sort of thing. But also you've got resource constraints on fertilizer, right? You need potassium, phosphates to replace those lost from the food that is grown and distributed.

And that comes at a cost and there's a finite resource. I mean, there's really only a couple of different places that you can mine phosphate anymore, right? One is Morocco's got the largest resource of above ground phosphate in the world. There's some in Southern Florida. The known potassium mines are, there's a handful of them, but these are finite resources, right? So there's offsetting dimensions there. Technology definitely works to allow us to produce more, distribute more, and access resources that were previously inaccessible. But there are other types of resources that are required for us to be able to access them. And they're just more complex.

All right. So own commodities, own them smartly. Back to the VIX. Last time we were at new all-time highs, the VIX was at 14. Now we're back at all-time highs and the VIX is at 22. What gives there, Jason? Is it this echo effect? Is it people are still worried? Yeah. What you just pointed out is we haven't seen vol up, market up since 99. Since we referenced earlier when people are call buying on tech names, this is the effect we've seen.

Typically, like you just said, the VIX has been lower when we're making all-time highs due to volatility suppression, but it could just be that effect. We have the echo effect of the sell-off. We have, you know, we could be in a high ball regime for potentially years, or maybe tomorrow it comes back down. We don't know. So essentially VIX exhibits a bimodal distribution, as they say, but I think of it more as almost like a trimodal distribution. You have, you know, VIX below 15, you have VIX 15 to 30, and then you have VIX 30 beyond, right? We spike above 30 beyond, it tends to mean revert, you know, below 15, it's VIX suppression, you just have, you know, it just keeps mean reverting over time. But 15 to 30 is where we phase shift into these higher ball environments that can potentially last years. And so that can be part of why you have VIX up, S&P up, is just a melt-up scenario. And so we don't know how long this is going to have a carry-through. But do you think the current VIX at 22 is because of the market up? Like because it's reflecting that call?

Or is it more the echo chamber of the spike? Well, at least that's what we saw in post 2008 you had higher vix gone for another three years and so it's probably more behavioral than anything else but um i hesitate that you're you know putting me on the spot for saying exact causality when there's no exact causality right we can caveat it all but um right to me, but it's, right. But it is an actual price, an index of actual option prices. So it's reflecting that people are still paying up on both sides of the market for, for these options. Why are they doing that? Yeah. Your guess is as good as mine. Is this a, is it a VIX phenomenon, Jason, or is it, you know,

do you observe the same type of thing in fixed strike straddles and other ways of viewing the vol complexes? The entire complex is just pricing higher here. And yeah. Okay. Yeah. I wonder this, this might go back full circle, Adam, we've spoken privately, you know, whether you have VRP volatility risk premium or ERP equity risk premium, I'm not sure if these things really exist. If ERP can be negative for 13 to 17 years, do you really have positive ERP? It's very similar with volatility or even fixed strike ball on directly in options is fear runs rampant in the markets and it stays around for a long time. And people are looking to make their money back after they got their face ripped off in March. Yeah, agreed. I mean, it's like you say, I mean, I actually am sympathetic to your view that all risk premium derivatives of all, right? And so, you know, now we're right at the heart of it, right? Everyone's been trying to seek risk

premium on the periphery with different types of direct currency carry or commodity carry or the equity risk premium or duration premium or whatever. And now everybody's just gone right to the source. Let's just collect the volatility risk premium directly and it's compressing vol and then that drives leverage higher in vol targeted funds. And there's all sorts of peripheral consequences. But in the end, maybe it's just all a volatility risk premium and we've basically compressed it to zero. I thought you were going to say at the end, it's all sound and fury signifying nothing. Nothing. Not to get us philosophical again about this eternal recurrence, but if we think about Minsky, right, it's like stability breeds instability. And it just, we muddle along for 10 years and we rise and we rise again

into Ponzi find, it crashes back down. And then we rise. It just makes the question, what does instability breed? More instability. More stability. Instability breeds resilience. Yeah. There we go.

All right, let's finish up. I'm just going to ask you both. You've both done a ton of interviews this year. Jason on the pod and on Real Vision. Adam on your riffs and your pod. You guys still doing the pod or you put some of the riffs on the pod? What does that look like? Yeah, I'm still doing the pod, but I haven't done a more sort of technical

Gestalt U podcast in a while. Yeah, get back in there. We love it. So just want to ask you guys, like, what was some of your favorite conversations, things that stuck out to you most, like over the course of the year? You want to go first? Sure. I actually did an interview

that didn't really see much light of day, but with Steve Diggle, yeah, out of his home in Italy. And, you know, Steve was a long volatility trader in 2008 and used his proceeds to go out and buy, you know, a tranche or ensemble approach to land speculation, right? So from different straddles of farmland around the world, from avocado farms in New Zealand, to protein ranches in Uruguay, corn farms in Illinois,

to rental real estate in Germany. And I thought it was really interesting because the topic that Steve and I had was, you know, what the fuck is money? You know, WTF is money. And it was really interesting to see how people's perception of what money is changes over time. And, you know, when you're young and hungry, and you just think that nominal dollar is most important versus when you have a nice windfall profit, how do you create multi-generational wealth and how do you create income more than a capital gain? And that was one of the most fascinating, I felt like one of the most interesting topics that I covered in the last year. But more importantly, I like watching more or listening more than anything. And I think both you guys do some of my favorite pods there are. So

I look forward every Friday to Resolve Riffs coming out and having a drink with the boys. We appreciate your gentle ribbing as well. That's always good fun. Well, I mean, you mentioned earlier that the Mike Green conversations are always very illuminating. And I'm intrigued by that view that he has. And it's Wayne and he come at this from a very

different angle. So it was neat to get Wayne on the pod and hear how he compliments Mike's thinking on a more sort of technical or mechanical level in terms of actually managing the option book that they that they run. So, so that was a lot of fun. And you know, I actually, I have a lot of love for some of the podcasts, the riffs that we just did internally, you know, I actually, I have a lot of love for some of the podcasts, the riffs that we just did internally, you know, I think it's just nice to be able to, to put to open air some of the things that are discussed internally. And there's, there's a, there's a lot going on beneath the surface that we don't often get a chance to, to discuss. And what does that look like?

Are you guys basically debating that internally? And then you're like, this was a good debate. Let's go do it on the thing. Or you're doing it for the first time there on the wrist. Sometimes it's, so maybe I'll write a paper. And it's like, okay, let's jam on this on the podcast, right? And the guys will raise some questions or raise some comments or link it to something practical

or challenge an assertion or challenge a chart or analysis. And I think that's really useful. But some of it's just like, this is topical. So let's get on and riff on this. And that's sometimes just a lot of fun. Which it seemed like that's where the riff started, right?

Like way back in the beginning when March of like, there's too much going on. We got to talk about this and share what we're talking about. Well, that's right. I mean, there's such a wealth of great guests. I mean, Corey and I, every time we get together is a lot of fun. And so his interview on his Liquidity Cascades paper was awesome. The one withason is always a

um so there's you know there's a good group of people that uh we have the privilege of being around and and who are generous with their time and um so we're we have a lot of fun with that jeff you've been cranking out the pods who is your favorite uh i i might say my um meteorologist guy or actually the pro sports one was super cool of they're like building a model to value sports franchises um like a factor model of the like okay everyone thought it was this but actually ticket sales do matter and this tv market matters and so that was super cool and then the uh i forget his name jeff masters yeah he was a hurricane hunter he flew in the hurricane hunters and now he writes this anytime there's a hurricane anywhere like that spins up i'm reading his blog you know front to back so it's cool to just and that's all a huge model right it's a huge algorithm

that they tap into every uh i'm not gonna remember to remember but they have one kilometer squares across the planet and the satellites are doing that everything and then they're forecasting what it's going to do in that next square and that's how they create those those cones and where the hurricane's going to go so that was super cool and so sorry to all the actual hedge fund managers that we've had on, but those two were awesome. No, you're right. Some of the peripheral ones are neat. We had Steve Merrill on talking about sports betting. I actually didn't interview him, but Mike and Rodrigo did. And I thought that was a really good one. That was awesome. I'm going to borrow that guest name, I think, and ask him to come on ours because that was enjoyable.

All right, guys, I've taken way too much of your time but this has been fun um so check out the mutiny podcast check out resolve riffs check out gestalt you go to both their websites put them in the notes and uh have a happy new year guys best of luck in the new year Back at you. Twitter at RCM Alts and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you.