The Derivative - Gold, Gas, and Global Inflation with Diego Parrilla of Quadriga Asset Managers

Episode Date: January 14, 2021

2020 was ruled by global macro events – are we looking at the same fate in 2021? Our guest today can talk not only global macro, but also volatility, bond yields, correlation, oil, metals and more. To ring in the new year we’re joined by Diego Parrilla, Managing Partner at Quadriga Asset Managers and Author of "The Energy World is Flat" and "The Anti-Bubbles.” Diego isn’t just a global macro manager, and in today’s episode we’ll be talking about Spain, quoting complex options, the switch from gas to renewable energy, Beckenbauer bonds, the double digital, inflation on inflation, what’s happening at Quadriga, soccer, becoming an author, sometimes it’s better to be vanilla, privatized inflation, and what’re we going to do with gold? Chapters: 00:00-02:24=Intro 02:25-17:48=Spain & Soccer 17:49-32:33=The Energy World is Flat 32:34-01:04:17=Inflation-on-Inflation vs Privatized Inflation 01:04:18-01:36:56=What’s Happening at Quadriga 01:36:57-01:39:15=Favorites Follow along with Diego on Twitter & LinkedIn and check out Quadriga on their website. 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. The implication from that is we have bubbles that are too big to fail. And because they're too big to fail, the next decade is, if I had to summarize in one sentence, is the transformation of bubbles into inflation. And it's something that, again,

I was calling in the middle of COVID and even before everybody was, you know, depression and the end of the world and hyper deflation. And look, guys, we knew central banks in some way were going to come in. We didn't expect necessarily the speed and the size and whatever and how far they've gone. But yes, there are lots of deflationary pressures.

You know, economic activity, unemployment, technology, demographics, overcapacity, malinvestment. All these things are deflationary. Yes, granted. But there's one force called money printing, which offsets these and more by a long way. So you create this perception of stability. You think, oh, things are stable. No, they're not. You have effectively things collapsing, inflation rampant. All right. Happy New Year, everyone. We've turned the page, but we're still in an era where global policy can change with

a tweet. The pandemic is still not under control and stock markets are still at all-time highs and bond yields at all-time lows. So we're excited to have as our first guest in the new year, a man who can talk global macro, volatility, bond yields, correlation, oil, metals, and more. We have Diego Perea, managing partner at Quadriga Asset Management, or is it Asset Managers, sorry, who not only heads up the team over at Quadriga, but is also an accomplished author, economist, and linguist.

So thanks for joining us, Diego. My pleasure, Jeff. Thank you so much for having me. And in today's Zoom world, you're calling in from Madrid, right? That's right. And you just mentioned before we got started, it might snow there this week? Yeah, it's unusually cold. Snow? I didn't even know that yeah madrid is uh i think it's about 700 meters high it's in a plateau and it's it's lovely weather pretty dry

but you know it can get cold as well yeah i've been a times. We do some business with a guy, you know, actually at iBroker. But yeah, I'll have to get back and we'll have a cerveza or something. What I love about Spain the most is there's no, in America, right, you say you want a beer and there's like which one of these 40 types. In Spain, you just, they have one beer on tap and that's what you get. Yeah, the flip side is if you ask for wine, they'll show you 40 and you go somewhere else and they only have one wine. So that's granularity for you. Yeah. And how are things there? Did you guys just go back into lockdown?

It's been um moderate um you know we have a curfew i mean lockdown the restaurants are open but you know over the holidays been uh close to midnight and uh you could actually during the festive days you could you even go later, 1 a.m. And they restricted the number of people, but at least things are somewhat normal. Although, you know, the pickup of infections is going up. So I think across Europe, we're starting to see things tightening up. But I must say, Madrid feels, you know, quiet, but somewhat within some degree of normality. So we've been going to museums and going to restaurants, even if that meant there were less people around.

Yeah, the Chicago museums are still closed. Still pretty abnormal here in Chicago, but hopefully get the vaccine spread around and back going uh and so you're a former competitive football and tennis player I'm assuming that's not American football 20 kilos ago uh soccer yeah we have some uh professionals former professionals in the family. And I think soccer, you know, most Spanish people have some familiarity. Some of us have played a higher level. But, yeah, it was a lot of fun to play internationally with university and also competitively here in Spain.

And, yeah, very passionate about sports in many ways. And there's even lots of lessons to be applied and learned into markets, I think, as you look through. So this will be the work of a future book, which we may talk about some other time. Yeah. What position were you in? I've always played offensive um kind of striker but um but yeah number 10 i guess yeah the false familiar with it yeah a little bit uh i coached my son's

team and then i played in high school then chose american football in college i think it looking back i would have should have chosen soccer in college but uh that's neither here nor there and then you're also fluent in a couple languages how many well i'm obviously spanish uh i lived and studied in france in the u.s um and lived in the UK for a long time. I lived in Singapore and picked up Chinese, which I can talk a little bit, studying with my kids and Italian. So I just love it. It's one of my passions. The first one is the hardest.

The second one is tough. I think after the third, it sort of of comes i think your brain gives up and picks them up a little bit more easily yeah i'm always amazed you know americans just don't have that in their psyche of learn the different languages i think it's a failing of our american society overall of like it should be front and center you know we kind of have Spanish or French in schools but it should be a little more important to our schooling system I think I think it's very much part of culture you know and if you get to experience in a country I think you know you get to to really go far deeper than you would if you communicate in English. But you're lucky that you don't have to learn those languages for many of us.

It's a necessity. But yeah. I view it as unlucky. It's fun. I would have rather had to. So how did you get from athlete to into the market? That was some of the first. I've always been amateur.

I mean, I've been a tennis coach and competed, but I wouldn't consider myself a professional, even if I got paid. I'm never really at that high level, but I'm from a family of engineers. I followed my dad's tradition into mining and energy. I was very lucky. I finished top of my university and got a scholarship to study my master's in France at the French Institute of Petroleum and the Colorado School of Mines in Golden. So I did my thesis in mineral economics and I specialized in something called real options, which back in the mid-late 90s was a very new thing.

And that gave me the opportunity to pick up a job in the markets. What were those? Real options? Real, real, like, yeah, just to give you a sense, my professor, which greatly influenced my,

my, my thinking, basically would describe a lettuce as the right, but not the obligation to have a salad. You know, it's effectively a call option and a salad. And that, that idea of everything in life is is uh is an option is uh is fascinating and

and you know if you dig deeper and and into the theory and you apply it life is it's all about options so i think there's a lot of added value, I think, in understanding options theory and options trading as part of every day-to-day decisions that we make. Yeah, you'll like this quick story of a prop firm here in Chicago. The owner thinks in total optionality, everything he sees. And so they ended up buying a a uh i can't remember the team but one of the premier league teams but when they were in the third division

and basically he saw the optionality of like the if these new tv rights get going if they get promoted to the secondly you know he was doing the math and this could be worth so i think they bought in for you know it's like a 10 or 20x trade from where they bought in the tv rights came in they got promoted um and then they eventually ended up selling it but yeah you'd think people buying soccer teams would be vanity trade or something but he was just seeing all the optionality so i even describe books as options, right? You buy it, you spend, you know, whatever, $10. Nobody's going to force you to read it, but that's the premium spent. And the payout of a good book could be worth tens of thousands or hundreds of thousands of dollars.

So everything, I think it's relationships, you know, every decision you make, I think it's anything that is asymmetric gives you this optionality. And yeah, it's I know we use the lingo and Vegas and deltas and things, but it's what it is. It's probabilistic. And I think it's helpful for decision making and risk management. Yeah. So you went from Colorado School of Mines, French Institute of Petroleum. Then you got hired where? JP Morgan in London. Okay.

That was an interesting time. It was sort of mid-late 90s. So $10 oil, $250 gold. And it was a time when most of the banks were actually exiting commodity markets, emerging market crisis, Russian default. And every bank was sort of wondering, why are we in this game? And JP actually kept precious metals. So even if my background was more in the energy space, I joined the foreign exchange and precious metals division.

And that was actually a very valuable thing. The link is, to me, it was great. And that triangle of energy, precious metals and effects macro, it's really where I've gravitated most of my career in different functions across trading and managing teams and selling and structuring. And yeah, in different regions. I was lucky to work for some of the best teams out there, like Goldman's commodities team was phenomenal. And then I had global responsibilities with Merrill. And so I've been very blessed. I've been able to build these businesses in multiple dimensions

across London, New York, Singapore, globally. So I did my two decades around the world before I finally made it back home. I never worked before. And in that process, I transitioned from investment banking to the hedge fund world with my own firm and then with some large macros. In those JP and Goldman, all those, were you structuring trades for big commercials or what, what were the trades looking like that you were doing on those desks?

I started out as a, as a market maker of precious metals derivatives. And effectively you have the obligation to to make markets on on certain uh underlines and payoffs and as part of that we were very closely involved in structuring solutions both for investors and corporate clients and for clients, you have both consumer, producer and refiners. So yeah, those roles give you a tremendous amount of a very rounded vision of the industry, of all the players, of the hedge funds, of the specs, of the consumers, of the physical. And I think these building blocks actually add up. And once you understand effects, for example, moving into pressures that are lots of similarities with effects, there are some nuisances of the physical commodity markets. And over the years, as you complement that with energy and storage and contangos, it's all all it's all the same the same building blocks

things just change slightly i've been involved in uh in providing solutions some of them quite innovative uh you know and i have several cases in my career where i've been very blessed to to be able to to develop those solutions, both on the investor as well as the corporate side. Got it. So you weren't necessarily on the other side of all these big hedge funds trades or whatnot. You were just providing the market maker service, as it were, hedging out the book for the bank.

Yeah, that's right. I mean, you provide ideas, you provide liquidity, you execute. But it's not just hedge funds. You have, you know, very often the opportunity or the axe that you might have in the book comes from, let's say, a consumer buying and that gives you the opportunity to be more competitive with a producer that wants to sell or whatever. So I think this is all trying to facilitate liquidity and solutions across players. And hedge funds have been very helpful in providing very often that curve exposure or volatility or volume that you couldn't accommodate yourself for risk limits or differences in timing

with this market. So that source of risk premium has been a very fascinating area of the opportunities in the commodity space because of the extreme volatility and many degrees of freedom that we have relative to other markets. our forward curves are much more dynamic and alive in the volatility and seasonality and physical constraints. So it's a great school, I think, for... And there's been some very big traders that come from the commodities school,

including Lloyd Blankfein or Gary Cohen, which is today in the news. I think he's been appointed vice chairman of IBM. He was the aluminum trader at Goldman. Oh, really? Yeah. So he knows one thing or two about commodity markets. And so then somewhere in there, you found time to write two books?

Yeah, I think this is, it's a very, I mean, I look back, it's a bit like climbing a mountain, you know, you're doing it and when you look back, you realize, you know, what you've achieved. But it's something that came quite naturally. I, I, I had, I always say that, you know, you think you know it, but until you put it in writing, you don't really realize how, how, how well or how badly you know it. And I think you, you know, I think it was Cicero who said, if you want to learn teach i would say if you want to learn right i think those two books have been incredibly educational for me uh first and

foremost and just the process of structuring your own ideas you know putting together the thesis, et cetera, was super powerful. And it's a discipline that I've kept and that I hope, as you said, you used the word, did you find time? I mean, it's the ideas are there. It's something that requires a significant amount of investment and effort. But I strongly recommend that, you know, everybody pursues their passion and writes about what something they care about, because you will find that you know everybody pursues their passion and writes about what something they care about because you you will find that you learn an incredible amount and and sometimes you're able to to help people you know which has been very very uh touching you know to to continue to get you know strong positive feedback from people that have had a positive

experience and they learned something from from that so uh i it's it's something i'm really proud of um it was a big yeah i i've been trying to write a book for like six years now so i can't find the time to but i think what you're saying if it's not you don't really need the time if it's stuck in your head and it needs to get out it's going to get out right um. But what were the two? There's two books, right? Which one was first? First book was called The Energy World is Flat.

I co-wrote it with my good friend, Daniel Lacalle, who had previous experience writing. And it was written in 2014. It took about nine months to write. And it was a very contrarian thesis at the time. The oil market was about $120. Decoil theory with 200 oil was consensus. And we were calling for the flattening of the energy world, the convergence across energies, the convergence across regions.

And it didn't take long before things did happen. And the thesis was not only survived, it was actually reinforced. And I think this framework, this is just the way my i think the the wiring in my my brain you know is something that uh i applied to to a second book this time the book was called the anti-bubbles and also very contrarian at the time i know the ideas if you read the book today they they might look more obvious, but, you know, he was calling for 3,000 to 5,000 gold, very critical of the monetary and fiscal policies without limits. And this, you know, effectively process that we've seen accelerate

over the last few years. And yeah, so both, I would say that they were if you went to um an airport to buy it you could see probably in the science fiction uh department uh and that's the only department i look in and then and then slowly they moved into current affairs and now both i think are going more into history because the the uh the the script has played out or is playing out pretty much by the letter. And I'll be sorry to tell you that I went to find it on Apple Books to listen to on my long drive home last night. And it's not on there to listen to. No audiobooks. Yeah.

But so Energy World is flat. The concept was, hey, natural gas, solar, everything's going to come up and energy is going to come down and it will just have it as kind of all same price, same demand. Yeah, I think the starting point is that energy markets have always been very siloed. Prior to our book, you could find great books on crude oil. You could find great books about coal, great books about natural gas, great books and a lot of work about renewables. But there was no real cross-section because of a number of reasons. The concept of the flattening of the energy world, it probably rings the bell to many of you.

It was actually inspired in The World is Flat by Thomas Friedman, which was a post-mortem analysis of the dot-com bubble. And it's a book that I read shortly after the dot-com exploded. It's an interesting time now because I think we're relatively close to something similar happening. But it was fascinating, the fact that, you know,

as we lived through, those of us who lived the dot-com in first person, you know, it kind of had a bitter meaning, you know, we just gone through the bubble and and this book was fascinating because it was talking about something transformational that happened you said look we have this amazing technology these things called broadband and all these things which is fantastic that basically led to these huge investments, which meant the entire oceans were wired with basically, you know, broadband and fiber optic and stuff.

On the expectation that you would earn a killing for then you would make a fortune of that, which effectively led to overcapacity. And that overcapacity meant prices collapsed and investments were written off and then magic happened because you had an incredible technology in huge size for free and so pretty much overnight places like India or China which have been much more isolated from from you know things like outsourcing you know if you were an accountant

in india you couldn't dream of giving your services to someone in california so that flattening of the world was actually a really optimistic view and in fact it's really what's happened and so that concept stayed in my mind and when we saw a few things happen in the energy space in particular i mean book starts with fushima, you know, how effectively the earthquake, the tsunami and the nuclear crisis that we had created this massive spike in natural gas prices, you know, which went to about $20 in MBTU, which is $120 per barrel equivalent, when the exact same molecules were trading in the US at $2 a MBTU, so at 10% of the price. And this was because of the other big move, which was fracking and shale. So you had this parallel, which was we have this incredible technology.

We have this price signal. And so it became fairly clear to me that places like Australia or others would make these huge investments. I mean, even Israel became a major energy producer because of some findings in gas and and natural gas which had been for obvious reasons very much uh a regional commodity because you have to either build a pipe or you know liquefy it which is a five to ten billion investment suddenly you have this major investment so the idea was look you have the technology you have this price incentive you have this huge overcapacity, we will see things like natural gas becoming global and more abundant. And then, you know, this creates a number of dynamics, but everybody's very familiar with what I call the battle for supply in the case of energy. So this is, you know, Canadian oil sands competing with fracking, competing with

offshore, competing with conventional, with whoever. And this is like a civil war between producers. And then what is less well understood is the battle for demand, is the fact that, you know, and this is, it can lead to people to think that, you know that OPEC, for example, the success of OPEC is driven is because they have an oligopoly of oil. It's like, look, I control the oil, I control the price. And it's not really true. The reason OPEC was so successful was more because they had a monopoly of demand. So if you wanted to drive your car or a plane or a truck or or a boat

it was oil oil oil oil you know gasoline diesel so in a world where you have you know trains that can go on lng or cars that are electric you know effectively that battle for demand is real and so all these flattening forces and i think think in the book I analyzed about 24, which we packaged into 10 big forces, effectively reinforced this thesis that, look, the silos are going to break. Energy is going to become more global. And then it was pretty clear who the losers and the winners might be. And things like oil at 120 bucks, it was just a matter of when, not if, that oil would collapse. And I think we had this quote, which was, at the time, it was considered to be outrageous.

It was like beyond science fiction, Mad Max, which was, and the last barrel of oil will be worth zero not millions and at that time people looked at us saying are you out of your mind yeah you were off by negative 36 exactly and then and then it went negative and that's just insane so no i think that process was a lot of fun. I talked about learning earlier. And it was fascinating because as we have these thesis, it's a very humble approach.

When you have a thesis, you're already positioning yourself in a position of, this is just the thesis. I'm not in position of the truth. So you're there to be proven wrong. And as we were throwing basically things like, you know, not gas and whatever to the thesis, then you mentioned solar and renewables.

It was fascinating because I must admit, I didn't know that much at the time. And the question would be, yeah, how does renewables fit in the process? And one of the fascinating things is that it not only, it actually reinforced the process and things clicked even better.

And we've seen, you know, how the flattening of the energy world continues. I just bought my first electric car, which I will get delivered on Friday. Nice. And I think it's... A European version. European.

We went for an e-tron, an Audi e-tron. So we replaced a Q7 for an e-tron. And I think we're at that tipping point where they've been viewed really like city cars. And I think we're starting to see the network developing. So look, the flattening continues. All these things that we discussed have happened in a number of ways and but it's a very dynamic world one of those things like you said looking back it seems obvious right like in what we feed all our animals here in uh the united states if corn gets too expensive we give them soybeans if soybean gets too expensive give them rice whatever so it's like fungible what you can feed them and you go to the lowest cost. Same thing with American and the world, right? If beef gets too expensive, food, people switch

to pork. If pork gets too expensive, they switch to chicken. So it's the same thing, right? Like just over a much longer timeframe, you can't switch your factory in a day like you can at the supermarket, but you could switch it in six months, 18 months. That's 100% correct. And I think this is a major mistake that many oil companies have made. I mean, it's happened many times in history, right? People forget that what we really need, nobody needs oil per se. You don't need oil. I don't need oil. You want basically, in terms terms of transportation i want to go from point a to b in the cheapest most reliable most environmentally friendly way possible that's the the ask so but many oil companies they think we need oil and and uh and we don't. If you find a cheaper, more reliable, abundant, cleaner way of doing this, we will.

And this is why technology is at the forefront of these battles and these boundaries. And it's fascinating. And you can see how the limits that might have been negative energy prices, right? That immediately creates a massive incentive for batteries and all sorts of accumulation of energy and other things. And so it's fascinating. It's all interrelated. It's very fluid.

And as you said, I think it's down to us consumers. We have that choice. And people who don't understand what they're really providing and they get, you know, whether it's Polaroid or Nokia or an energy company. If you don't really understand the need, but focus on your product, then you probably have a problem. Nokia did all right. They made a nice sale to Microsoft for it. But the product, yeah, became obsolete rather quick. The second book was the same concept, but FX and gold, you're saying?

The idea is similar i mean to me i guess both books were challenged in the state of school both books presented a contrarian thesis which was um again considered science fiction at the time and uh in the second book i challenged this idea that you can actually solve problems by printing money and and borrowing uh this this and we we had seen already at the time you know negative interest rates being introduced in europe and to what challenged, I mean, what I found shocking is how they were pushing the boundaries, you know, and changing the rules of the game. And you sort of wonder, look, is it really as simple as this? You know, can we really just solve problems, whether it's Lehman or whatever, by literally just printing and borrowing? How does this end, right?

And as you start this chess game in your head of how do things go from here, and you start pursuing those paths, you actually can go in multiple directions. But once you push this far enough, you get to conclusions like I did, which was a paradigm shift. And that paradigm shift is what happened in the energy markets, which I described earlier. It was just a matter of when, not if. And that paradigm shift has happened in the last few years and it's accelerated with COVID. and we're in a in a new phase i mean if i was to summarize the the previous call it decade of of financial markets it's very simple i think it's the transformation of risk-free interest into interest-free risk. And that's really what we've done. Once upon a time,

you had the 10-year bond or the 30-year bond or the 10-year treasury paying you 5%. You had this concept called risk-free interest. You get paid 5% for doing nothing, for taking no risk. You were effectively making real returns because inflation was low. And on top of that, if there was a crisis and interest rates went down to zero, your 10-year bond at 5% would make you 50% capital gains. So the entire industry was built upon, yeah, I have, that's why I called it, for those who follow soccer, I called the Bund Beckenbauer. This very famous German footballer in the 70s. Yeah, he was a great defender at the time.

The guy is 74 years old today. The Bund played that great defending job. When I say a life jacket, you get paid to wear, right? Exactly. A lot. And that paradigm has changed. There's no such thing as risk-free interest anymore. There's negative interest rates in Europe and the US is on its way.

That's in nominal terms. We have, I think this week, we've seen 10- break events, inflation, you know, breaking 2% and, you know, deeply negative real yields in the US. So you are getting paid 90 basis points for your 10 year treasury, you think you're making money, but the reality is, is your purchase power is being eroded by over 1.1% net of inflation. And then on top of that, your defender is no longer there.

So that's the entire model, the industry built on 60, 40 portfolios. Okay. I have some equity, some bonds. The idea was, look, I am protected, right? I have my strikers, I have my goalkeepers, my defenders. Now you have effectively what you've created is artificially high prices. Artificially low interest rates have created artificially high prices. Anything that it's valued using discounted cash flows, right?

Which is most things, right? If you are going to receive a cash flow of $100 in one year, or 10 years, or 30 years, or 50 years, with interest rates at 5%, you know, the present value of that thing will be whatever, 60 cents, 30 cents, 20 cents, 8 cents. Okay, today, with interest rates at zero, it's 100. So any company with, you know, not only the present value of those cash flows is artificially high, the desperation for yields and the PEs are so high, the equity duration is so high, that long story short, what we've done in the last decade is we have created these massive bubbles that are now too big to fail. So we're in a situation where the enemy has changed. The rules of the game have changed, and central banks somewhat unwillingly or unknowingly have been forced to step in to provide the support that, of course, is trying to prevent the utter collapse of the system. But the only thing it's done is created these bubbles that by now are too big to fail.

So we're in a situation where... But it's also too big to fail. So a few things there. One, I read an interesting article of like, this is how money should work, right? Like, if I want to give someone my money to keep safe, and then they give it back to me in five years, shouldn't I pay them something to protect that and give it back to me? Right? It's kind of like the whole concept of me giving you my money, you give me interest and then give it back to me safe seems like you know you can turn the whole thing on its head and say that doesn't make sense either even though that's what we are accustomed to for hundreds of years um look what we're experiencing there's no other word this financial bullying okay we are being forced you know this idea of saving you know we are obviously penalizing savers with negative

interest rates, we're forcing people to spend to invest, some of it will be needed, some of it and useful, a lot of it is marginal, a lot of it is highly speculative and malinvestment. And so we're in a situation that is very fragile. And this is not, this isCOVID. I mean, we're in a situation where the damage was already done. What COVID has done is obviously created a huge shock that has forced central banks and governments to do more of the same. We like tripled down on what we already had in place. And all it's done. Yeah, that's another good concept. Everyone was saying the same things after 2008, right?

Like there's too much. We've taken on too much. This is going to create a huge bubble. And then it has, but it's, it's like, if I can sell my artificially inflated stocks and buy gold or buy real assets. So, you know, to me, like it's artificially inflated, but you can still use those profits to purchase real goods. Of course. I think this goes down to the wealth effect. Whoever, we're not going to discuss.

I mean, I have no interest in going too deep into Bitcoin whatsoever. But I'm of the view that the emperor has no clothes okay and and um and and there's these things that you just create i mean i was i was offered to do my own crypto for 25 grand right uh you can you can you you do your malik coin tomorrow for 25 grand you have your own it's like okay so i can do my my own coin uh use it for this and and i'm going to be a billionaire come on guys it's let's get real it's uh it's um i i can see the benefits i can see the rationale i know exactly what's happening with the dollar we know exactly what's happening we know the problems of fiat all these things but at the same time you know that are there's money that is created out of thin air because of Tesla,

which, by the way, I think it's, I don't know, an adventure to say that we're going to see 20%, 30% one-day move in one of these assets any day. And that money didn't exist. It's not real. It's just castles in the air. It's a house of cards and multiples of 1,400. It just doesn't exist.

But it creates this sense of wealth. People feel rich. They spend and whatever. But we've seen this movie before several times and um and i think that those tesla options and sold out the money's real you you got the money out of course it's it's always the uh the greater fool right yeah yeah yeah so that's the same for many things i mean look we are i think the point I was trying to make is, first of all, we've gone through a transition where we've gone from risk-free interest to interest-free risk.

The implication from that is we have bubbles that are too big to fail. And because they're too big to fail, the next decade is, if I had to summarize in one sentence is the transformation of bubbles into inflation and it's it's something that again i was calling in the middle of covet and and even before everybody was you know depression and the end of the world and and hyper deflation and look guys we knew central banks in some way were going to come in we didn't expect necessarily the speed and the size and whatever and how far they've gone. But yes, there are lots of deflationary pressures. Economic activity, unemployment, technology, demographics, overcapacity, malinvestment.

All these things are deflationary. Yes, granted. But there's one force called money printing, which offsets these and more by a long way. So you create this perception of stability. You think, oh, things are stable. No, they're not. You have effectively things collapsing, inflation rampant. And so what we're starting to see, and I think is something that will accelerate is precisely to your point that you made just now is, yeah, you can transform these things into real stuff, okay, into real assets, whether it's land or houses or gold. So ultimately, there are things you can print, you know.

Yeah, you cannot print Bitcoin. Yeah, but you can print, you know, other cryptos. How many? There are 10,000 cryptos. I mean, of course you can print cryptos. There's 10,000 of them. So in that sense, look, I think we are in a very, very fragile moment. And you're saying when I turn those into real assets, that causes real inflation.

No, inflation. Let's define inflation. OK, this is a very simple idea, but it's not, I think, well enough understood. Inflation is not about your house going up or bread going up. Inflation is about the value of the money with which you buy a house and you buy bread going down. And it's a very big difference yeah okay if you go to argentina if i just gave you a bunch of papers from venezuela you laugh at me i mean

the kids kids play with it it's paper okay so those bolivars were worth something those argentinian pesos were worth something those uh I mean, it's the value of the money that is going down. And you don't need to be a genius to realize that the money is going down because we're printing trillions of it. And it's as simple as that. So inflation comes because you have finite things. And it's the denominator that is changing. It's converging to zero, right? So in a way, this is the reason why equity markets are going up.

Of course they're going up. I mean, there's some degree of, you know, your interest rates are low, the units that you sell, everything is worth more. So in a way, the high equity prices are a reflection of inflation in one way. It's asset price inflation. But this is what some people are shocked. It's like, oh, my God, we're in the middle of a crisis. There's all this unemployment and house prices are going up.

How is that possible? It's like, dude, it's just about the amount of money in the system. And that's what inflation is about. There's separate inflate right there's one the one percent inflation of the top one percent people i'm saying not the of course not the rate of inflation but they have their own inflation right of like houses in aspen and private jets and those and but the price of bread may be perfectly fine um yeah i think inflation is going to be it's the single most important asset

and risk in the next 10 years and it's accelerating and this is it's the way out think about it if you took a trillion dollar mortgage can you afford it?

no yes you can at 0. Yes, you can. At 0% interest only, you can. Now, you can, I can. At 0.1%, I cannot. That's the reason why interest rates are not going up full stop. And this is the bluff of the central banks. We have this perception that you think you can print and borrow and increase your debt

20-fold or whatever you want, and then everything looks okay because you've printed this money, you've spent, you kept activity, you build bridges and whatever the reality is you're only able to support that debt because interest rates are artificial right and if interest rates go up and or credit spreads go up you go bankrupt immediately a country like spain you know which was in the brink of collapse and and have to be pretty much uh bailed out you Spain, you know, which was in the brink of collapse and had to be pretty much bailed out. You know, as you know, once the 10 year reaches the seven, seven and a half percent, the cost of service and the debt is so high that you can't you cannot do anything else. And you go automatically just spirals into into the abyss. Right. So that's kind of a tricky, critical 7.5% in the 10-year.

That's when everybody just goes, knock, knock, we need some help, right? And we were there. And just a few years later, we are borrowing negative interest rates in the 10-year. I mean, that is not a reflection of the market. That is a reflection of someone printing trillions of dollars and giving them at artificially cheap levels. So the central bank, the left pocket...

Your economy didn't improve a thousandfold, right? To go from the negative rates. In fact, the problem is this, you take so much debt and you can afford it because rates are artificially low. At negative interest rates, you and I can take a $10 trillion mortgage. What are we buying, an aircraft carrier? Exactly. So at negative interest rates, you're incentivized to maximize your debt because you're getting paid for taking debt. Yeah. Yeah? Yeah. incentivize to maximize your debt because you're getting paid for taking debt yeah yeah yeah so of course people will do that and and of course countries will do it and and greece and spain

that doesn't mean that that's the fair value of which you should be lending them it's 100 artificial interest rates are artificial credit spreads are artificial everything's artificial valuations are artificial but it's so big the problem that there's no way back because let's define what you mean by artificial so not tied to reality you're saying not tied to the real supply demand economic that's right that's right so artificial yeah it's it just means it's not real it's not a reflection of if if you if the central bank stepped out just went to the toilet for 10 minutes and didn't wasn't there supporting the price right um you know nobody would would do this and nobody would we're getting philosophical but that's why they'll never step out, right? They can't.

But that's why it'll stay inflated, perhaps indefinitely, right? And that's why... Is there a problem if it just stays inflated? Well, this is the thing, that the perception, in fact, the narrative of central banks is, you know, for decades, if we were talking to our our grandparents let's say the they they know who the enemy is the enemy is called inflation yeah because they've seen it right and if you talk to an argentinian person or venezuelan or whatever now they actually told us that the enemy is deflation our friend friend is inflation. We need more inflation.

We want more inflation. We'll do whatever it takes to get this inflation. And before you talk about, obviously, a very important point, which is inflation, your inflation is different from mine and from others. CPI is complete crap. It's not a reflection of real inflation. And so many of these dynamics are all related. But ultimately, I think this idea that it's incentivizing.

So let's say you want to buy a house for, pick a number, $100,000. And you take a mortgage for $99,000. As inflation comes in, in 10 years, your house might be worth $500,000, but your debt is still $99,000. So in a world where interest rates are artificially low, they cannot go up, inflation is coming. It leads you into the second wave of inflation. Inflation is there are two phases. OK, phase one is two plus two equals four. So, you know, you print more money, things go up. Yeah. And phase two is inflation expectations. This is when you go to a supermarket in Argentina to pick one. And you've seen these pictures

where they say bread, 100 million. And then that's 9 in the morning. 12 in the morning, scratched, 150 million. Of course, the central bank didn't print 50% more money in that process.

People know that that money is worthless and it's just burning in their hands. And once it starts burning your hands, because it becomes very obvious that, you know, inflation is accelerating. Yeah, I don't care to give you 50 million more. Then it creates inflation. It's worth zero anyway. You just, you know, so in a way, this is why 2% is such an important number. I define this in the book as the frog in boiling water. You're probably familiar with what happens. I've never seen it, but I understand that if you put a frog in boiling water, it jumps.

But if you put it in mild water and you increase the temperature, it will die. It will never jump. So we are frogs in the boiling water of inflation. But we got put in the cold water and the heat's been turned up. Exactly. So at 2% per annum, it's not big enough for us to jump but we've been diluted by two percent per annum officially by by a while which means that in 10 years your purchase power is lost over 20 percent if you compound that over 20 years or 20 a few 20 odd years i I've stolen 50% of your purchase power in 20 years.

20 years at my age or 20 years, not what it used to be. It used to be a long time. Now it's yesterday. But 50% of your money has been stolen by money printing. So that's a 2%. If inflation increases at 5% or 10%, you know, very, very quickly, all your money is gone. And this is something that, you know, I saw a tweet today, someone was saying, oh, inflation expectations, you know, break-evens in the 10 years above 2%, the Fed will hike rates before the end of the year. I'm sorry, mate. If you play this game and if you go by the rules of the game, you take a textbook, any of the books you have there in your background,

you pick one of those books and it says if inflation goes up central banks will hike rates because they need to fight inflation right that's that's what the book says the reality is we cannot hike rates because if you hike rates the entire system collapses so i've been saying that on here for a while the real estate guy we had on i'm like what there's no way rates are ever going up. The whole economy is built on low rates. They're not going up. And I think this is something that when I first wrote about this, it was considered science fiction.

It's like, okay, guys, the rules of the game have changed. Think about it as you will have zero interest rates and inflation. This is why, for example, I think the 30-year tip, even if CPIs or break-evens or whatever are not a reflection of inflation, it's not about trade because you have the full upside on nominal yields plus inflation pickup. So it does make sense to play the 30-year tip. year tip um do you feel like private lenders and right like groups will split from the fed and say like hey i've got to make a return here i know the real risk i'm gonna raise rates myself or that's a losing game because they well you have two components right you have the actual interest rate or three interest rate credit spread and inflation right right? And interest rates are controlled and the central bank will set them and they will be zero or negative globally, I think, and they won't move much.

I think there are limits to how negative you can go. I don't think you'll go beyond 1%. Okay. Credit spreads, yeah, I could basically lend differently to Walmart or to Jeff Malik. But even then, the reason central banks stepped in and not only buy government bonds, but they buy corporate bonds, it's because they want to short circuit the credit process and they cannot rely on me buying the treasury of the bank and hopefully the bank will lend it they just go and say screw that i'm lending directly to these people and even if it's in the in the uh investment grade space the higher quality firms obviously it creates a big difference because if your top telecom is able to find itself from the Fed,

then the number two or three in line benefit from that, right? So it creates a domino effect. And then the inflation side, I think, is the degree of freedom. And I think this is, it's pretty obvious. I mean, it's, but the problem and the sad thing is, this is the reason why we have inequality. And this is the reason why, you you know if you read a bit of or listen to Ray Dalio he talks about all these

things of the repeat of the effectively the mistakes of the 30s and how they got us into trouble but it's happening and I think the sad thing is you know you can see people unhappy people losing purchase power they've been told

that there's no inflation but they go to the supermarket and they can afford less and less or schools or houses and and these people are not happy and and and of course i think you know yeah well i think in the us we see it most in healthcare, right? Of like, I can still afford food, housing, little problematic, but healthcare is just a straight line up. Yeah. And this is leading to inequalities, leading to many issues, which they can't point at who is to blame, right?

We're always looking for scapegoats and Trump was looking after China. China's the guilty guys, like, come on guys, this is all coming from these things. And central banks, I'm reading this new book from Mervyn King now, quite interesting. I only just started, but it looks interesting and on on the

decision making process um and and it's it's just very humbling how he's the former governor of the bank of england openly saying you know our decision making abilities and tools we have no idea what's happening we have no idea what we're doing and we have no idea what will happen and let's face it you know all these it's it's fascinating you know he calls it he's the former head of the central yeah yeah radical he's broken up he's broken ranks and said we have no idea oh yeah big time big time he he wrote uh you know the alchemy of finance and he's a very critical guy of mmt and and i think it's fascinating and and it's interesting but it's really all these things that are happening it's not it's just people are worried about how we do we eat you know it's hand

to mouth it's how do we avoid the next company blowing up how do we and you're taking these many steps that are taking you into an abyss and no one's planting a tree for 15 years from now yeah back to your question i think it's it becomes an issue of um you know how we are are we solving the problems and the answer is no we are doing four things we're delaying the problems so when you take excessive debt you're kicking the can down the road. So you're delaying things. Second of all, you're transferring the problems. So effectively, the devaluation of the dollar, it's transferring the problem through competitive devaluation to Europe and others, right? We saw this clearly in 2008 and how Europe blew up partially because of the weaker dollar, etc. The third thing that is happening is that we're transforming the problem

from bubbles into inflation. But all these three things, delaying, transferring, and transforming, are actually enlarging the problem. And this is the thing. It's like today... Enlarging it in the future. Exactly. So the issue is anybody who's lived through what our grandparents or whatever had to live through

realize that that's the evil problem. If you ask somebody in Argentina, but we are foolishly thinking, oh, that will never happen to us. And of course, it sounds like science fiction today, but the path we're taking and some of the measures that are being taken are brutal. And this is the reason why I'm not hitting on Bitcoin whatsoever.

I just think, of course, people say, screw that. I mean, who wants to keep their money into dollars? Let's just go somewhere else. But I think ultimately, I want to get ant here on here and have you guys debate it because right they would come you could get 10 people on here to say hey it all all that dead all those deficits don't matter we can wipe it away we can remove ones and zeros from the digital balance sheet at the fed um everything's fine right and as proof they'll point to we did all this in 08 and everything is fine right now no they didn't to, we did all this in 08, and everything is fine right now.

No, they didn't. Because all we did in 08 was test the limits of monetary policy. We did something that was within the rules of the game, which was, let's bring interest rates to zero, print money, lend it to the governments, and hope, cross our fingers, that their actions will actually work and they will be able to repay things back. But let me be very clear, QE1 was needed. The way, to put it simply for those who are less familiar with macro, you basically sat all the seven banks and said, OK, how big is your problem? 100 billion. Yours, 150.

Yours, 200. Whatever. They sum it up, 600 billion. And they said, OK, I'm going to print 700 billion and give it to these guys to cover the hole. That action was needed because not stopping that snowball would have resulted in much bigger consequences. And it was offsetting deflationary pressures and it kind of increased the monetary base by a somewhat not marginal amount, but it's what it is. The problem becomes when Europe defends itself because the euro went to 150, 160. So we need to do it and we even need to go further.

And Japan and the other. And so as everybody does the same, this is subject to the law of diminishing returns. It's like an asymptotic process, right? Where you have to print bigger and bigger quantities of money for smaller and smaller and smaller benefits and this is the reason why qe3 if you remember was called q infinity because the market was like come on how much you're going to do five trillion whatever

two minutes it was gone it's like no no we're going to do whatever it takes and and that's the dynamic we're in this whatever it takes that's the's the dynamic we're in. This is whatever it takes. That's the narrative now, right? We'll do whatever. But what happened, exactly, but what happened then was monetary, was really on the monetary side with zero interest rates. What we've seen since then is negative interest rates. It's lending not just to governments, but also to corporates. and we are seeing effectively money printing which is directly being given to consumers uh in the form of checks and grants and things that will be never paid back so the perception it's going fiscal the perception that nothing's happening it's stupid it's the equivalent of going to chernobyl you know after a nuclear accident and sitting there

taking pictures and saying you see nothing's happening and within two days to chernobyl yeah within two days all your teeth have gone you're green and uh it doesn't work right so meaning green meaning that you glow you're yeah you're dead right not that so so in that sense there's a delayed effect with many of these things i think it's naive to think that you can just solve these things by by just printing and removing zeros something's given and yes you may resolve one problem but we are delaying transferring and transforming and on a global scale this is something that i don't think is as easy to um to solve in fact i think it's it's it's getting worse and it's gonna no matter even if it works long term there's going to be second order effects that nobody's thinking about as well right absolutely

so we've identified all the problems in the world, maybe not all of them, but one really big one. So talk to us about what you're doing at Quadriga, how you kind of tackle these thoughts that you have and what your risk and reward payoff is if you get some of these ideas correct? Look, what I've done is, I think going back to my point on portfolio construction, I use this analogy of a soccer team. I think, you know, this investment game, I think Warren Buffett describes it. He says there's only two rules, you know,

one, never lose money, and two, never forget rule number one, never lose money and two, never forget rule number one, right? Everybody knows that, which is a bit cynical and not entirely true because they can lose 50 or 60% in a big crisis. But I think what he really means with those two rules, which is the way I would translate them, is this is a game of capital preservation and compounding on capital preservation. Because if you lose 90% of your money, you need to go up from 10 to, you need to go 1,000%. So effectively, to do that, if you bring the football analogy, we can talk about most people think that investing is really about making money.

So Jeff, here's 100 grand invested for me, make me money. And that means capital gains, income gains, whatever. Now, in reality, that's what I would describe as a striker. You know, you have people in the team that are responsible for scoring goals. They're responsible for making money. But the team also has to protect the capital. They need to protect the goal, et cetera. So there are people in the team that are more goalkeepers, defenders, and midfielders, people who generate alpha. So I am the goalkeeper. My strategy is designed to do very well during crisis. It's based on the anti-bubble

concept, which is the title of my second book, which is an idea that I coined. It's almost like if you think about bubbles, bubbles are about asset prices that are artificially high based on a misconception, based on a false belief. So what I said is, look, yeah, misconceptions can distort prices, but not only with artificially high valuations, you could also have artificially low valuations. So an anti-bubble has three dimensions. The first dimension would be assets that are grossly artificially cheap based on a misconception. The second is, you know, bubbles and anti-bubbles are like distorted mirror images of each other. They're effectively two reflections of the same misconception. So they can think about, so by construction, the moment the misconception is understood and the bubble bursts

is the exact same moment that the anti-bubble reflates and and third and there's an element of risk premia because you know if you think for example about or a good relationship is the vix and the smp the smp and the vix in my view are bubble anti-bubble relationship because you have artificially low volatility can actually contribute to artificially high equity prices. So ultimately, around the framework, the macro ideas we discussed, the concept of anti-bubble, we basically invest, we have a strategy that looks for assets that are anti-bubble, anti-crisis. They do well during the crisis. These are things like the VIX or gold or inflation or many, right? You could buy puts on the S&P.

Effectively, yeah, it's by construction, that's my mandate. So we were the best. You're hesitant to call yourself like a tail risk fund. Yeah, except that tail risk is slightly different. The goalkeeper is a bit more, you know, the tail risk funds will do well in very extreme scenarios, in those very, very small tails. We're designed to do very well in those tails,

but we are also designed to do, we were up, I mean, yesterday, for example, we were up 4%, you know with with the uh s&p down and gold up um is you don't need a 30 percent move in the s&p to make money but as a goalkeeper the beauty is is how the team works so i think ultimately my recommendation to people is build portfolios that are well diversified. I think one of the key consequences from my thesis and one of the key things that we've seen is false diversification. So the risk of false diversification

is the fact that when people build a portfolio, they have their long equities, credit, high yield, EM, commodities, whatever, private equity, private debt, and you say, I'm diversified. But the reality is that when, excuse my French, shit hits the fan and boom, we have a Q418 or Q1 2020, turns out that every single position, your portfolio collapsed at the same time. So the reality is that you were not diversified. You had false diversification. You thought you were diversified, but you weren't.

We were the best hedge fund in the world in February. Effectively, we did well. But the idea is that you have something that when the team does well, you have strikers. When the team needs it, you have goalkeepers. So I think the process has really three steps. Step one is you need to decide how you're going to play. Okay. But you can't play with 11 strikers. You can't play with 11 goalkeepers. You need to have a balanced team. The second step is you need to pick your players.

Okay. Do I want my striker to be the SMP or the NASDAQ or whatever? Do I want my striker to be the S&P or the NASDAQ or whatever? Do I want my goalkeeper to be the VIX or my strategy or whatever? And the third thing, and this is hugely important, is how you rebalance the team. And so instead of fighting the volatility of the market, instead of fighting the stupidity of the market, what you want is to take advantage of it. So if for the sake of argument, your team was 50% strikers, 50% goalkeepers, let's say the S&P and my strategy. And there are periods where the markets will move and we have the S&P at 3,400 and the VIX was at 11 prior to the collapse and then the market goes to 2200 and 80 vix and then you know now we're back to 3700 and the vix actually holding well and looking like it might it might go again but this process if you did a basket that is passive just 50 50 you would earn X. But if you're able to rebalance back to 50-50, so look, the market's going to be crazy. The strikers are super expensive. I'll take some profits and buy

some goalkeepers and vice versa. The strikers are not very cheap, etc. You can actually achieve incremental returns, which are hugely relevant. And so ultimately, investing for me is not about having a crystal ball it's not about oh i'm smarter than you this is going to go up tomorrow whatever it's about build your strategy so have a balanced team with strikers defenders and goalkeepers and pick your players that do their job and rebalance and if you do that you make money whilst you sleep at night because you will always be, I think, balanced and on the right position. The problem comes when you're either you have the wrong strategy, you only have strikers or you build your team. You think you have defenders and they turn out to be a CTA that is max long at the top. And right. Yeah. I'm in equity and private equity i'm diversified well yeah and

or you don't develop and then you know you don't rebalance and then your your 50 50 has become 80 20 yeah and by the time the market collapses you everything goes so just to be clear you're not you're not you don't have the beta you're not the striker you're just the the goalkeeper we're the goalkeeper we're which our strategy has three pillars we invest in in gold we're big believers in gold we think will be three to five thousand in the next three to five years i we believe in treasuries and uh and tips but the most uh exciting part of the strategy is the third bucket, which is insurance options. We only buy options. This is something that differentiates us. We don't sell options.

So the risk is controlled by the premium. And we buy stuff that is 5, 10, 20 times premium in terms of payout. And we do this in a totally asset class agnostic manner. So we spend 5% to 7% per annum. We have options in 2021, 22, 23, and beyond. And we do all sorts of stuff, things that will benefit if there's a crisis. VIX higher, gold higher, equities lower,

China lower, whatever. Yeah, and you have, it's a unique strategy there. So it's what termed complex options, right? So you're not just buying puts on the S&P or calls on gold or whatnot. No, that's right. It's a bit like, yeah, insurance options markets are insurance markets. And, you know, I give you a simple example to show you what I mean. When I lived in Singapore, I was working for the bank.

And then I left, I set up on my own. And in Singapore I was working for the bank and then I I left I set up on my own and I took over the insurance from the bank I had a very comprehensive package and they quoted me and I'm just going to make the numbers up but for the sake of argument I have a family and stuff it's like okay Diego that's going to be thirty thousand dollars a year like wow that's a lot of money and I say say, yeah, but you have global coverage. It's like, yeah, but I, so what does that mean? It's like, yeah, for example, do you ever go to the US? And I was like, yeah, but on business, right? It's like, oh, that's fine. If you don't go to the US, then it's 10 grand. And I was like, what? 20K out of the 30K insurance from a global insurance was attributed to the US.

So if you buy a vanilla option, you're buying health insurance in any country, any time, any whatever. But if you fine tune that insurance and you say, look, I don't live in the US. If I go to the US, then maybe I'll get my insurance for a week with my Amex or whatever. But that's my point. So when you actually fine tune the markets and you say, look, yes, I want, you know, I'll give you one example. You could say, I want insurance in case S&P goes down 5% and the market will pay you 3 to 1.

And you say, well, I also like insurance if gold goes up 5% and the market will also pay you 3 to 1. What if I want insurance when gold goes up and equities go down at the same time? And here the market might pay you 12 to 1. So you're not only, you're basically reducing the premium, increasing the payoff,

and improving the carry by fine-tuning a distribution because the market says, Diego, if gold is up, equities will be up. That's kind of, if the markets were uncorrelated, the implied correlation in the market was zero, theoretically, your 3 to 1 and 3 to 1 should be 9 to 1. But if you actually get to play with better odds because the market has a different view on correlation, then you can get better

things. So the fact that we do more let's say customized insurance doesn't mean it's riskier it means it's less likely to pay off according to the the models but it's cheaper and it's more explosive and potentially better carry and i and i view them as like parlays and sports betting is that similar yeah i'm not an expert there but yes yeah well it's instead of i'm gonna bet on one team to win i'm gonna bet on right and the odds are absolutely 250 if i parlay that with two other teams the odds go in my favor but as you're saying it's much less likely to happen you have to get all three right that's right so this is an interesting point though because a professional sports gambler would basically say never do parlays but they're also right but

they're also fixed odds and the the house has it you know skewed heavily in their favor but how do you how do you weigh that so you're basically betting that your probability calculations are better than the the banks oh the the first all, there's a supply and demand of correlation. So what happens is many of these structures, you asked me at the beginning, do you work with corporates or whatever? Some people, let's say that in Korea, a Korean bank wants to do a gold product. They want the gold product denominated in Korean won, not in US dollars.

So the gold option that they buy pays the upside of gold in dollars, which is that's what people see. Oh, gold is up 20% in dollars, but they want it paid in Korean won. So in a scenario where the Korean won is gone up or down, let's say 20% relative to the dollar,

even if gold is up 20%, maybe if the won is down 20%, the payoff would be zero. So to hedge that correlation, the bank offers this product. They obviously do it with a nice spread on correlation, but the client gets what they want. The bank protects itself. And now the bank has a correlation risk. So they go to people like us and say, or the other way around, I will generate this. But I'll say, look, Diego, correlation can only be between minus one and plus one. Someone just did it at plus 0.9. I've done my full full size but i'm beyond my limits i'm happy to do this

at mids or whatever get me out and uh and so we only do this when it makes sense but the key thing i want to say is that we don't create more customized options for the sake of making them more complex we do them because they add more value okay in some cases you know it's like in some cases it feels stupid because the the market is giving you better odds with things that i use i like to use one example i use soccer but uh you know what are the odds of barcelona winning the league and the market says 2-1, okay and you say, what are the odds of Barcelona scoring more than 100 goals in the season

or winning the league and scoring more than 100 goals in the season and they will give you 6-1 and it's like it's the same trade if you're going to win the league so you're like and win the league. They're going to score that many goals. So you're like,

and then Messi will do better than, and you're like, it's the same trade. But instead of doing it 2-1, you might be getting it at 6-1 or 10-1. So what's the point of doing it at 2-1? Of course, it's not the same trade, exactly. But my point is that

what for you might look like the same trade, you could do either risking less money or getting better odds. But either way... But somewhere in there by you or the bank is a real probability of that happening, right? Yeah, the probability is... Look, you can look at the probability. Let's look at something super simple right gold and euro okay let's look at the probability distribution of gold you have an options market very developed

let's look at the euro dollar same thing probability distribution options market okay how about gold in euro what's the probability of gold in euro? It's interesting because the correlations are actually very unstable. So you could have a situation where gold and euro are moving the same way and this looks normal. And so if gold and euro are moving the same way, it means that gold in euros is not moving at all. So the implied volatility of gold in euros could look really, really low.

But you know that in a crisis two things happen one is volatility might explode and second correlations might break so something as gold in euro if you take advantage of very high implied volatility and low vol what happens is when the crisis comes, this thing becomes super explosive because you have two things compounding in the same direction. And this is what you want. Because I, as an engineer, I look at the parallels between some of the stuff, science and markets, and there's lots of them.

But I think volatility is a bit like fluid mechanics you know you go from a laminar regime to to a turbulent regime and so in that sense this this jumps in in behavior are something that the when the market makes when the bank makes your market on correlation is giving you some sort of implied correlation how they think the market's going to behave. But in a binary world where you're either laminar or explosive or turbulent, if you're able to accumulate correlation at laminar prices, when the crisis comes, you get this massive payoff. And that's in a way what we try to do. Of course, if this crisis- Yeah, you're almost long volatility through the volatility of the correlation not the volatility as well both both but it's a fixed payout right

well you have you can you can construct these things as you wish you can do you can do uh so i usually hear you quoting it 10 to 1 15 to 1 but that's just as example so some of your options will have convexity and they can pay out more as the trade goes. Correct. The 5 to 1, 10 to 1, 20 to 1 are digital payouts. So it's literally like in sports.

You will get $100 payout and we buy them at $1 payout and you buy them at $0.10 on the dollar. So that would be a 10 to 1 and so and but you're not seeking out anything in the world like if S&P goes up and Tesla goes up they're all still within your exactly mandate with your thesis of I want it to be protective I want it to be crisis performer exactly so that means that, for example, on the equity side, we have a bias to be long puts on the short term. But from an inflation perspective, we're actually long calls, let's say, contingent on pretty cool rate, pretty cool trade.

Equity is higher, rates lower. That's a trade that we did last year at very, very good odds, 10 to 1, because the consensus of the market and implied correlation is the opposite. And because of the shape of the forwards. And that's a five-year trade, but it's an inflationary trade that will benefit if equities are higher and rates stay where they are lower. That, you know, above 3,200 and below 50 basis points in the five year, um, that that's 10 to one. Um, and just to be clear for our listeners, this isn't, uh, I can't go on my interactive brokers account and click on these options. So you're calling around to different prime brokers. You're getting quotes.

Uh, how does that whole process work? I used to run those desks. I know exactly how they work. You need a special documentation, things like ISDAS. We do this customized to our needs in terms of size and maturity and strikes. And in some cases, we are the market. I mean, we are in a way the providers of liquidity and and but as you said always within the angle of what our mandate is so my the way i understand

our mandate is can you protect our capital can you make money in a crisis and can you you know do it in the with the best carry possible right that that's the goal and and within that you know we think that gold and treasuries and options are are nice way to to achieve this and so we can't and we don't just do whatever we want we wake up in the morning and it looks like this thing is you know oh now we like the brazilian one and i think the odds are 80 to one i'm gonna buy um it's it's always biased to to to crisis pain during a crisis but you need to you could hedge yourself and find ways that hopefully will keep you alive. And is the crisis skewed towards a U.S. crisis, towards S&P? We do.

We do. For practical reasons, we do. And it's been, it's part of liquidity. It's part of, it's a global index. We would have been better off buying puts on other things most of most of the time because it's been a great striker to fight against but uh but uh but yeah it's it's that old german guy it's part of the decision of or the discretion that we have when we look to to buy those puts and when you say buy puts they're often like a synthetic put structure right no we could do

listed vanilla if it's cheap enough we could do other things so it doesn't mean we don't have to this is like in football you know you can only score with your right leg no maybe i can score with my left leg or with a heather it depends where the ball is coming but if you put a player and he can only do four hands in tennis that's like you can only buy vanilla listed okay that means probably rafa nadal would still beat everybody six love six love uh yeah just with four hands because he can run around but most of most humans would uh would struggle i think my point is you know sometimes it's better to do something vanilla sometimes it's for example in the vix we only do vanilla

stuff listed but for fx or gold or equities you can actually do pretty cool stuff in other forms do you think that's vix because the banks just haven't caught up yet they're too scared of the the spreads are too big multiple reasons you know liquidity yeah and also the ability to structure this stuff as you as you pointed out earlier you know, liquidity. Yeah. And also the ability to structure this stuff. As you pointed out earlier, you know, the bid offers, the capacity, you know, you can't do this in anything. You need the ability to get in, you need the ability to get out and you need to be able to do it at the right price.

And, you know, for our sort of size where we have billions of this kind of insurance, then you want to make sure these things are liquid and both on the way in and out. And that's interesting. So how many of these are there at any one time in the portfolio? Dozens? Hundreds? Probably about 100, although they fall within clusters. So we try to avoid having the exact same expiry strike, etc. So, yeah, or counterparty. So we may have a few. But I would say probably about 20 trades, 20 themes, kind of 20 differentiated trades over 100 lines. So, yeah, some of them is the same trade over a different maturity or strike and the maturities are going out you said 30 all the way out 30 years yeah 30 years so how does that work with an investor you need does the investor need to be around for

30 years or in a market market over whatever the market to market i mean 30 years that option is a is a small part i would say you know everything we do is very liquid we are daily liquidity fund so about 80 percent of the fund is let's say gold and treasuries 20 is in options okay yeah out of that out of that 20, you know, at least 15%. So 95% of the fund is inside of three years. Yeah. And, but even though it's just 20% in the options, is that's going to give the biggest kick in a crisis?

Yeah. That could be, if you have 20%, let's say an average of 10 to one, that could make you 200%. Yeah. All right. I love anything else on the parlay so you've mentioned the double the double digital that just means it says fixed payout and then the other options have normal payouts there's just two conditions too digital is you know

rafa wins or loses what are the odds yeah and the dual digital is rafa wins and roger wins right two matches and if if the market thinks that uh they're uncorrelated which probably are yeah you should be but but if the market's telling you that they are strongly negatively correlated or strongly positively correlated if r Rafa wins, for sure Federer will win. Then it depends. But yeah, you could do, think about this as Lego. You have these pieces and ultimately we're playing to identify value and and buy optionality that hopefully will would pay and that you know will pay a lot when we need it and and and that if you're wrong it will cost you

less and it will bleed less while you wait but it's not an easy job i mean we had a very strong q1 we had a difficult q2 and still finished the year up nicely. But, you know. Yeah, I was going to ask you about the difficult second half of the year. What was, you think it was a change in environment or what happened? I mean, it's obviously it was in hindsight, you know, I think remember doing some uh similar interview in in uh in in a big event and uh s&p was breaking 3 000 and everybody was like what the hell this is like everybody had been shorting the thing from 2 500 27 29 3 000 this is nuts and and and i was like is you know it's just i mean it's just a number right but um but it was now at 3700 nobody's blinking and just a few months ago 3000 i mean

we've we've had some pretty major move uh it's happened secretly i think the one thing that hurt us a bit was the big move in gold which which is honestly, I think a bit of an anomaly, or I don't see it. I can see that the whole market's telling you the dollar is worthless. Bitcoin is worth infinity, yet gold is useless and worthless. And the treasuries are telling your story. Real yields are telling your story. And inflation is telling your story and the one thing that that didn't add up was gold and we're starting to see that reverse a little bit so i think in we'll see how how the the movie ends but we we are we think there's been a major cleanup in gold hopefully uh that part of the book will will make it back uh and some of the

other insurance you know yeah i think there were lots of good ideas but outcome i think we you know who knows were the options priced higher too because of the high volatility so you were yeah we will you know we it's it's part of the game i mean think about this it's a bit like insurance right um yeah the hurricane had just come through they're going to price the hurricane. Yeah, exactly. Exactly. So ultimately, you want to be, this is a game in the long term. You want to be, you want to manage your risk, be focused on what you're doing. And our strategy, I think, is predictable in the sense that you know what you own.

Yes, some of this insurance, as it goes down and you rebalance the portfolio back and you buy more insurance and things keep going down and down and down, you can hurt. But it's also the same process that made us very significant returns in other periods. And so we're very focused on the process and how we do it. You're not changing anything. You're not saying the market. We are. We're just focused. It's like a goalkeeper. You know, you're parts of the match when everything's happening the other side.

Sometimes you get attacked and you're part of your team player. We're trying to do our job the best we can. I think we are proud of what we've done and we're very appreciative of the gold. The gold piece. So you lost on the gold piece but it's not always long right we have a big bias on gold yeah long long bias we have uh we have a core we are not pretending to be timing or having a crystal ball now we think it's going up now it's going down our mandate is to be long gold long treasuries

long options it's just can you beat in the smartest way possible okay but investors know what they own we're not a black box so you might be a little uh more weighted towards silver or something like as a proxy to gold we have we're primarily driven by gold but we have the ability to do uh relative value and options and other things but i i believe gold is the one even if silver will be way more explosive i i about i mean most of our precious metals exposure is is linked to gold and what how do you right so you take like an ensemble approach in the options sleeve silo but then you have a third of it in gold right like why not have gold just be part of the overall uh diversifier like it seems overweight to gold well gold is central to our

thesis um and i and i think gold will play a big role and um but a delta one just a long position on the atf may or may not on the ETF may or may not be, or miners may or may not be the most efficient way. I mean, what we do is we have a core allocation, roughly about 50% into precious 20 to 30 in treasuries and tips and 20 in options roughly. And that's, yeah, we have the ability to rotate and whatever, but that's fine.

But the 20% in options, if you link it to gold and others it can actually be way way more explosive so we're hoping hopefully superior to just uh and complementary perhaps to other other ways to do goal keeping but ours is focused on anti-bubbles anti-crisis and within gold um treasuries tips and volatility the VIX and insurance are and it's just US and tips yes I've had a long love-hate relationship with gold so you'll have to convince me to come come to the dark side right because 20 years that right as i was coming up in the business 20 years it was just flat to you know just went nowhere even it went down for those 20 years so but the last what has it been last 20 years it's been pretty good yeah look um i think it's it's here to stay um it's going to be interesting i think uh all this debate of gold versus bitcoin and whatever is maybe put some

people off others i um i think we have it's going to be an important asset going forward um and and i think as i because of many of the dynamics that we discussed i think it's going to gain an even bigger role so it's a it's a good uh i think the risk reward is is good particularly uh with everything that's happened on the currency front but yeah time will tell i think the the book is uh it goes into a lot of detail into many of the arguments that have if anything strengthened but look i think we cover a lot of ground i hope for sure you guys found it of interest. If anybody wants to reach out, feel free. You have two minutes to go through a quick favorite section. Sure.

We won't have any debates. We just ask some favorites here. So, yeah, thanks for being with us. I'll go through real quick. Favorite team, Real Madrid, Atletico quick uh favorite team real madrid atletico barcelona atletico atletico all right uh favorite investing book outside your own full by randomness all right love it um favorite place you've lived outside of madrid singapore singapore never been i'll get back there um and are you uh do you consume

podcasts or just participate on them you have a favorite podcast i participate mostly all right i'll give you some to listen to thank you uh favorite spanish athlete of all time rafa nadal yeah he's unbelievable is he still going is he gonna retire i love him yeah it's my fourth son according to my wife uh and lastly favorite star wars character yoda yoda all right all knowing all seeing uh awesome well we'll put links to uh all your stuff in the show notes as well as to the books. And we'll talk to you soon, Diego.

Thank you so much. It's been an absolute pleasure. Guys, much health and all the best in 2021. It's been a great pleasure. All the best. Thank you, guys. Take care. you've been listening to the derivative links from this episode will be in the episode description of this channel follow us on 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.