Last updated on September 3, 2020
Moderator 0:02
Welcome to the Contrarian Investor Podcast. We give voice to those who challenge a prevailing sentiment in global financial markets. This podcast is for informational purposes only. Nothing on this podcast should be taken as investment advice. Guests were not compensated for their appearance, nor do they supply payment in order to appear. Individuals on this podcast may hold positions in the securities that are discussed. Listeners are urged to educate themselves and make their own decisions. Now, here’s your host, Mr. Nathaniel E. Baker.
Nathaniel E. Baker 0:36
Chris Nicholson, independent Portfolio Manager. based here in New York, you have a long career most recently at the hedge fund Iron Harbor Capital. And you have a pretty broad cross disciplinary look at assets and geographies. You did a stint in China I know, which I think is valuable now in the present day, considering all the volatility that we’ve seen, and everything that’s happened just from from the COVID crisis alone, but there are other broad forces at work. So maybe we could just start and just for you to get your, to get your views on the market on economies, and how you see things.
Chris Nicholson 1:21
Sure, I mean, it’s a very tough time for forecasters of all biases and capabilities. As you know, COVID has really dominated the landscape. Obviously, sort of forecasting in for interest rates, and exactly how far into the future we get away from impressively real negative rates has actually been vexing to people for a while, maybe far as far back as as 2012. We have the taper tantrum. We had the more recent paper that started to unwind reasonably before COVID-19. And then that really produced a lot of volatility in the markets and of course the markets are prepared for a decent amount of volatility. If you look at some of the implied vol numbers, it tells you people are paying up big for put options on a wide array of assets, right? Implied Vol and oil was well into the triple digits up until recently, and we’ve seen a lot of choppy price action just in the last few days there. And these things trickle across assets. I think the US market is generally dominated by kind of equity thinkers and sort of us focus thinkers that basically on their own experience of meant to think that the US was reasonably dis decoupled from the global picture. And investors here which, dominate the kind of marginal pricing and a lot of global markets have been slowly coming around to the view that well in a global markets maybe really matter. And they’re the marginal contributor to demand or lack thereof, inflation or lack thereof. That is really those two factors that I pay a lot of attention to, to determine where the money flows going to go. And so I think of US equity prices on kind of two axes, one related to equity prices elsewhere, and what could be a near term shift in appeal, across geographies and us equity prices relative to us bond prices. commodities are sort of the major asset classes.
Nathaniel E. Baker 4:04
And yeah, that’s an interesting point. Because this whole, everything is so Fed driven, at least that’s what we would perceive here in the US.
Chris Nicholson 4:14
Right
Nathaniel E. Baker 4:14
And to point, and we have this rally dating to march 23, which was very much a Fed driven rally. But you’re saying now that the the other forces internationally, are at least as powerful if not more, so?
Chris Nicholson 4:30
Yeah, well, maybe two key points where you highlight, kind of fed driven markets as a, maybe somewhat of a broad consensus opinion. That’s, again, lasted for quite a while generally. And for equity investors, I guess that rubs up against an equity investors sense of well, what is kind of a fair forward P/E? And is there something durable? For all time about that, maybe you look at a Shiller P/E even to adjust for cyclicality but, I guess the financial theorists would say, well, you have to look at the fair forward PE, in the context of interest rates and what the, at least sort of medium to longer term real interest rate landscape is going to look like. That’s kind of an uncomfortable idea, I think for equity investors generally.
Nathaniel E. Baker 5:30
Hmm.
Chris Nicholson 5:30
And so, people look to the Fed to set interest rates.
Nathaniel E. Baker 5:36
Right.
Chris Nicholson 5:36
If you’re going to be, sort of an active money manager and try to charge more than the more than the passive indexes charge and provide more value than the passive indexes charge, you have to anticipate Fed moves and, think like a central banker in some ways, sort of outwit the central bankers in some ways, and they don’t like to be sort of front run, and they burn investors really badly sometimes when they try to do that, but actually the Fed has to respond to the global economy. And at the end of the day, it’s important to think of interest rates as sort of the remainder of supply and demand for capital.
So if the projects and activity don’t soak up the amount of capital that’s available, whether it be for demographic reasons or otherwise, maybe political gridlock reasons, not letting that capital get to work, then you’re going to have low interest rates. And I guess another factor that quickly drops out of that is what’s the right number for inflation? And how do you anticipate that? So that’s a place I’ve found I’ve been able to add some real value In the last eight years or so, in that, I think investors always looked at inflation in the US as kind of a 2% or so baseline, at least since it got more under control in the 90s. You know, due to NAFTA, due to globalization, due to whatever government policies that may in some ways be controversial, very controversial policies, maybe leading up to the 2016 election through here, but 2% election 2% sorry, inflation is not a given. And we’ve seen that and the risk to the upside that most investors have focused on is not a given. So, that means bonds that are relatively safe yielding 2% and things can be very attractive sometimes, especially if you’ve got some duration on it.
Nathaniel E. Baker 7:58
Yup
Chris Nicholson 7:59
The stretch a little bit in terms of a P/E, if you have maybe sort of medium quality bonds, corporate bonds or something yielding on a three handle that are sort of durably attractive enough, maybe your forward P/Es start to creep up into the high 20s at least, such that the reciprocal is sort of a, somewhat of a risk premium but modest enough and as you mix them in your risk parity portfolios everything that’s out. But so I’ve tried to look at inflation by seeing well, what’s the demand for money? what’s the creation for money? not on the monetary base and central bank buying but those fractional reserves getting recycled at the private banks, and other types of financialization that’s, that’s really what creates money more so than the central banks. The monetary base —
Nathaniel E. Baker 9:01
That’s assuming that the central bank is in line with the demands of the private sector, I guess. Right?
Chris Nicholson 9:10
I mean it in as much as their policy goals are generally inflation and employment, depending on the central bank. Yeah, they have to be reasonably in line with supply and demand, or they kind of cause the recession or sort of let’s unused labor productivity, basically spoil on the shelf, in a way. Yeah, or kind of lose credibility. And sort of de monetize, if you will, but that means then that the US Central Bank needs to be enough in line with the rest of the world economy. And I guess another factor that for investors that trend, maybe 80s 90s 2000s we had a very weak dollar for a lot of that period was spent a lot of money on foreign wars. You know, other things, I mean, even going back to sort of the Cold War era. And we’ve had a relatively strong dollar in the last eight years or so. And even though we have a significant trade deficit, we’re a bit more competitive and higher growth economy than the other large economies, large developed economies, at least worldwide. And I guess the last factor I’d put in there is, China was growing like crazy for years and years, even as it got to be a pretty large economy on the global landscape. And, it’s hit more natural limits, and people were really vexed by how can China grow what’s somewhat of a command economy. How can they grow it so quickly and so durably and there are some good reasons where if you have really talented people at the top, you might be able to grow up command economy very quickly. If you’re a fairly low income economy, and then as you get toward middle income and beyond, things get a lot more challenging. And we’ve sort of seen that seeing that adjustment in China and again, that hurts the demand for capital globally and dampens interest rates. Mm hmm. Anyway, covered a few broad swaths there.
Nathaniel E. Baker 11:34
yeah, I don’t really know which one I want to pick on first. I mean, maybe let’s go to the inflation and the fact that you say that the demand for money I mean, right now, one would think there is a lot of demand for capital from businesses that have been hit right with these financings. You know, they’re just they’ve been in trouble here because they have Haven’t had the receipts for a couple months now many of them not all, but many of these economies in the US. And it’s not just the US, by the way, this has been a global thing. Of course, someone would think that the demand for capital is pretty robust, or maybe even beyond that. And that, therefore, it’s prudent for the central banks to keep individual gains on. Yeah. So what does one do there? So, so that it looks like then that that alone would speak to more inflation in the future, right, or is it the other way around?
Chris Nicholson 12:35
Yeah. Well, you have to sort of spread this effect from 2020 forward a bit. And if there’s sort of an anticipated contraction in demand or capital, later on as sort of somebody pays back those loans. That gets factored in somewhat and you have kind of a smoothing of inflation. Yes, maybe If you do have sort of a short term pop that quickly Peters out, due to sort of base effects. In part, right, your first level maybe creeps up a little bit. But then, you know, that prices out maybe portions of the economy, portions of the labor market, they’re stale. You have some slowdown. And there’s a reversion to that underlying trend of inflation. And there’s a political process just to satiate that demand for short term capital for companies and passing through to their employees to feed everyone a float here. Right?
Nathaniel E. Baker 13:40
Right.
Chris Nicholson 13:40
I think there was an interesting moment in the sort of healing from the global financial crisis, where strong growth, maybe inappropriately strong growth leading up to the financial crisis had crept up the price level and sticky prices caused a painfully slow readjustment to 2008 2009 demand forward. And you had the European debt crisis lingering through into 2012. And what some might call sort of German austerity, dominating that question all the way until maybe just very recently, or, at least partially here for which put a damper on demand in the wake of that. But in that period, I think Ben Bernanke, in his wisdom gains from his studies of the Great Depression, said, “Hey, we have to support inflation from the bottom and insufficient inflation is not a good thing. A really dangerous thing, it takes too long for the price level to adjust without sort of the nominal prices not taking care of that.” And so you cut rates and you kind of pull forward demand in a way and other central banks started to get on board with that idea, and maybe even somewhat haltingly fiscal stimulus to help with that was significant in places like China. You know, there might be controversy on this kind of statement, but maybe insufficient fiscal stimulus in the US, certainly insufficient fiscal stimulus in Europe. And other places don’t have as easy access to capital as those places that sort of support the world economy. But clearly, buying mortgage bonds etc. You have to anticipate some of these factors that are kind of coming from the Fed or coming from big movers in government that dictate markets.
Nathaniel E. Baker 16:12
Right. But you figure that all the central banks have got their religion by this point. Right? You go back to 08 and Trichet famously raising rates there, talking about ill timed, right? But since then, I mean with with the Draghi ECB, and BOJ, you know, obviously and very much in inflation creation mode for a long time. The world’s central banks seem to all be following this Bernanke playbook of you know, throwing money out of helicopters, right?
Chris Nicholson 16:46
Well, yeah, in part, I think they’re, I think they’re aware of sort of the technique, and they’re aware of the risk, but I think it was just a few years ago. Bernanke was sort of upon opining on the continuing lack of inflation in Japan and advising them, hey, maybe you need to really make a credible statement that you’re going to issue unlimited bonds and unlimited stimulus until you get to the right inflation level. And folks have continued to put out what they thought were significant rounds of bond buying. And then they may be moved to sort of yield curve control. They tried to stoke up their credibility and sort of unveil that much more about their projections and data to kind of poke that inflation rate up while still having some worry that Gosh, are we going to go too far at some points and kind of lose credibility? Are we going to have a currency crisis with respect to other major currencies or what so So, if you look at what the core inflation has been, or the headline inflation and kind of US, Europe, Japan as some majors, you have to look at China as something kind of on that dashboard to sure. It’s been pretty convincingly sub 2% in each of those three, particularly outside the us of those majors. And it continues to fall in China. So I just wouldn’t say that they’ve gotten fully on board, okay. And fully address the problem. Okay. And, you know, investors don’t like low interest rates, a lot of folks want to make more money, shorter, no risk. But you find that that really tanks, your economy, and at the end of the day, we need people to be borrowing enough capital and sort of cyclically employing enough labor So you can’t choose high rates in a vaccum.
Nathaniel E. Baker 19:04
Right. Okay, so if you’re a currency trader now, and you’re looking at the world’s major currencies, and obviously, a lot of them are driven directly by Central Bank policy, more than anything else. And again, you have Okay, so you have a few here that are not completely on board with the inflation or else mantra. Do you think that those will come into line like the BOJ being a big one? And do you think then that the trade is to short those currencies against say, the dollar? Yeah, where does one go now as a currency trader, I guess is the question.
Chris Nicholson 19:46
Yeah, stepping back and sort of talking frameworks and how I look at that problem. As you kind of lay it out, this is a big opportunity. A lot of the market has one framework, and not that many investors really do feel comfortable looking at currencies or looking at interest rates and inflation, but it certainly does affect equity prices, risk assets. There’s another factor to that maybe I’ll just put on the table briefly. But then aside here, which is commodity prices, and oil prices, specifically being such a huge factor in the commodity complex, what is a reasonable forecast for oil prices? That’s a very big input to inflation. And over the shorter run, maybe looking at core inflation makes sense. But over the more medium term, depending on sort of different paths of oil prices, you really need to pay some attention to the headline inflation. So anyway, oil is a big factor. And I think maybe central banks have gotten their forecasts on that. Wrong a bit. So if you look at Japan, it’s interesting. If you want to make money as an active money manager, you have to look at where is the market mispriced? Why is it mispriced? Can I really track down factors and assumptions that other folks have built into their models, if you will? And where’s my catalyst? Right, when is my catalyst? Because there could be sort of other mini catalysts that take prices in the exact opposite direction of where you’re betting and that’s, and that’s painful. What’s my number one? What’s my number one recommendation for investors now and most of the time in terms of the best portfolio move? It’s take the cheap borrow, right? You got a lover if money is coming at you at negative cost, but you have to be really sure that you put in a place where you’re going to make back more in the future. And so that for me, I take a really close look at sort of the volatility and the, kind of histogram and scenarios for the assets. And that is equal to more important than the return forecasts in the long term. Yeah. So people look at Japan and it’s immediately synonymous with safe haven, right? So you don’t want to be short Japan or short the yen at least coming into any kind of messy period. And you can have a really brilliant analysis, but then not really understand enough about virology, etc and not have any real ability to anticipate there’s going to be a new Coronavirus popping up in the world and you’re going to be roasted on a yen short just coming into that kind of period
Nathaniel E. Baker 23:10
right?
Chris Nicholson 23:11
Now of course, markets are reasonably liquid and so you can get out of a bad move when it becomes so, and I’m not shy of having pretty tight stops on my trades and for the title of your blog, or sort of podcast blog and kind of professional sphere of competence. I don’t want to be a contrarian in terms of the real money trading right now. I want to go with the flow if you will, and not be complaining to folks about hey, I’m losing money but I know that I’m I’ve got the right idea. Not everybody is a price taker in that regard. I want to have some contrarian ideas about the future and act when assets are starting to act in my favor,
Nathaniel E. Baker 24:12
Mm hmm.
Chris Nicholson 24:13
So with regard to the yen, I like to play in the options. If something’s not moving in your favor, but which direction it sort of has to go, then maybe you want to sell calls on the yen against the dollar, and take some yield there. And, you know, sort of have them kind of cash covered. You could say naked but really cash covered if you’re the rest of your portfolio risk isn’t really to fully allocated. And if folks are really feeling risk averse and want to get coverage, they might pay you up pretty well for the calls you’ve written. But eventually, the sort of other side of that trade starts to be pretty attractive. And, you know, folks aren’t paying up very much at all for puts. And that’s what I found, as this Bernanke idea sort of maybe slowly disseminated around the world. The yen was at about 75 for the dollar. And it it kind of destroyed their corporate sector entirely. The whole Nikkei was trading at book value. You know, private companies obviously had to sort of implicitly take a discount to that which meant nobody was rationally putting new money to work milking every asset you could write for, for kind of cash flow. And so Japan had to do something about that. And you could buy puts on the on the yen, sort of October 2012. For fractions of a percent per month kind of holding costs. And lo and behold the the Japanese central bank move The next month to get the yen down in a big way. Yeah. So I do think, in any kind of alleviation of the sort of global economic crisis at present, short yen is an interesting bet. And by the way, another thing that I think is almost as synonymous with Japan, a lot of people’s minds is low margin companies. And so low margin companies that are exporters, right, major export surplus there. And so if you have a cut to local labor prices, and that’s basically what the currency is, that’s amazing margin boost for one and 2% margin exporters. And that’s why you saw Japanese stocks rocket, I think maybe 100% In the wake of the sort of yen cut, late 2012, right through the next, I don’t know, five months or so. So yeah, I think we might see a bit of a repeat of that scenario. And it’s an important thing to look at, for global investors where we’ve gotten cheap money reflating, our equity markets, in the US in particular, right. You know, people sort of looked at treasuries as another key safe haven, and they got frustrated with Treasury rates. And you started to hear people rightfully talk about US equities as the safe haven. But I don’t want to hold a safe haven when there’s another good place to be. So just like in the taper tantrum, you could, you could lose a lot of money. Holding a safe haven asset if it’s US equities and Japan equities look better and I think the yuan weakening is also fairly close fairly close at hand and obviously, anytime you have neighboring large economies, they need to compete with each other then trade with each other. And their currencies sort of diverging too much can be somewhat of a problem. Yeah. So, anyway, yeah, weak, weak yen and weak Yuan are important themes I’m looking at and I think they’re getting pretty close at hand
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Moderator 28:43
you’re listening to the Contrarian Investor Podcast. We are on iTunes, Spotify, Stitcher, and other platforms where podcasts are found. Subscribe and supply an honest rating. We are on social media search for Contrarian Investor Podcast on Twitter and Instagram. Youe can find us on LinkedIn as well go to linkedin.com/contrarianpodcast. We want to hear from our listeners email your thoughts to feedback@contrarianpod.com A repository of all podcast episodes and materials is available on our website contrarianpod.com. Now back to the program. Here’s Mr. Baker.
Nathaniel E. Baker
Wouldn’t the weaker yuan create a stronger yen though?
Chris Nicholson 29:25
Tell me more about kind of your logic on that.
Nathaniel E. Baker 29:32
because, well especially if the yen is a safe haven right? And especially in that area and the RMB is kind of the risk on trade. Then and if China starts getting into, you know, the Chinese economy keep slowing or if they keep if they start creating more inflation, the PBOC does, yeah. Then investors go to the end Right. Yeah. Wouldn’t that be what happens there?
Chris Nicholson 30:03
Yeah, I think that’s you’re raising an important tactical issue that and I haven’t looked really closely at the weakening of the yen over just the last, the weakening of the yuan, excuse me over just the last few years to see its effect on the yen. I don’t think they were really significant, right. But they, they probably were something that we all should have taken some note of. But I think that’s really just a tactical issue where if the boj has to get the young, lower, they have to get the young, lower. And if China makes it a little bit tougher in terms of global perception, they need to do something more aggressive and more credible. And if China starts to think, hey, maybe the yen is going to weekend, and that’s going to cause a modest additional challenge for us Japan is thinking, hey, maybe the yuan is going to weaken. And that’s going to cause a modest or significant challenge for us going forward. We maybe want to get ahead of it, or we maybe want to really game it out and make sure we have assets to carry this out and be credible.
Nathaniel E. Baker
Mm hmm. And what is the RMB? Now, I mean, it’s been going it’s been losing value, at least in dollar terms for several years. Right. I mean, going back to 2015, when China had the hiccups, they’re middle of the year and their equity markets and they started, you know, creating looser monetary policy. So it’s been I haven’t, yeah, but it’s been pretty significant.
Chris Nicholson
Yeah, I mean, there were some pretty big reversals in there. China, of course, has a little bit more challenge than the developed nations in terms of kind of credibility on their, on their monetary moves, although people have given them a generally a decent amount of credibility and had much more than looking for the yuan to be in kind of continual appreciation. And of course, they were looking for the Chinese economy as a whole to be in continual high growth mode. And, gosh, you know, I feel like people have been saying for quite a while here when global growth gets back to normal, which we’re thinking of as sort of a pre financial crisis, maybe number, when that then that’ll be China growth, maybe back to normal, and will they be putting up seven or 10% annual growth? Again, I think the answer is no, not in dollar terms. Sure. And that’s kind of a permanent factor. So anyway, yeah, the yuan has been kind of weakening as a general maybe kind of, I don’t know, 5% annualized path of late but with some pretty nasty hiccups.
Nathaniel E. Baker 33:03
All right. So we’re looking globally here. You got equity markets in the US, which you seem to favor, but not as much as you favor equity markets in Japan. Is that correct?
Chris Nicholson 33:15
Yeah. Yeah. Well, I mean, kind of reading between the lines with me not maybe making that specific of a success on the US saying, Yeah, rates are low. That’s great for equities, is us more resilient to COVID interruptions and this being kind of a many quarters, disruption or more or less resilience, I think I would say, sort of structurally, were more diverse economy kind of geographically than a lot of places. were reasonably less densely populated. In kind of adjusted for where the GDP comes from, that’s all good. You know, we’re relatively high income, that’s a really good strong innovation sector, etc. But on governance and political sort of effectiveness standpoint, we have not been so good. And that may be dominant the investor narrative going through the recent dip here, but maybe there was a bit of excess complacency coming back to equity levels of two days ago. I mean, still, you see those implied balls, maybe they were like high 20s, two days ago and they’re like high 30s here, that’s a really high number. And the quants are certainly ready to bid that number way down. On any real sign of sort of steady healing and the relative impossibility of sort of big announcements causing panic with regard to kind of COVID and our, our measures to sort of stay healthy and at work. And and the quants know, hey, those low rates are they’re going in, but even though they see maybe kind of assured returns in the future, they care about Sharpe ratio. And of course, they don’t want to take too much volatility. So there’s a little bit of a ping pong back and forth between some,
Nathaniel E. Baker 35:39
Of course, but it is interesting that you’re thinking here, as you speak of safe havens and such that there is very much in the calculus from portfolio managers like yourself, appears to be a concern about a second wave of COVID is not selling successive waves, not just this year, but maybe even next year. Do you think that’s a fair statement?
Chris Nicholson 36:06
Yeah. From what I know, getting a really effective vaccine for respiratory virus is not an easy thing to do. It seemed like the timelines of developing vaccines in general, maybe has significantly shrunk, before I mean, monumentally shrunk from maybe 20 years to like one year or less here, but that doesn’t mean that that vaccine is actually 100% effective. And people point to the flu vaccine in various seasons as a kind of endemic disease and it’s very dangerous for people in certain classes, but generally older and not too debilitating in the grand scheme of things such that we’re doing socially social distances. etc. Certainly I could see seasonal mask wearing and stuff took up quite a bit in the US. But I think I’m optimistic that the array of approaches we’ve taken to managing COVID-19 will limit the amount of disruption to the economy that we really get next season let’s ever becomes a more seasonal thing. You know, and the evolution of the virus sort of favors it becoming, of course, less deadly. Or maybe even less supremely debilitating. I think technically, what they mean is kind of continuation of the first wave in areas outside of some of the hardest hit. And, yeah, I mean, there seems to be kind of insufficient seriousness of how some states are looking at controlling the spread. And I’d never heard the phrase social distancing before however many weeks ago,
Nathaniel E. Baker 38:07
I call it anti social distancing, by the way
Chris Nicholson 38:09
yeah, yeah
Nathaniel E. Baker 38:10
more appropriate description. But yeah, right,
Chris Nicholson 38:12
right. I mean, there are definitely you know, I think I’m an introvert. I love people and exchanging information, but I like to hide away a chunk. But, but it’s not very human and natural to tuck away for long periods of time. And a lot of us that don’t have a family can afford to go out to eat or drinks or do whatever, we like to do that a lot. I’m in New York City, maybe stereotypically we’re doing it like seven days a week. I think it’s too small. We don’t have anything in the pantry. But even for folks that are used to a fairly different lifestyle. Yeah, they get stir crazy and they go out. And, and they don’t necessarily do much of their own research, they cut snippets. And, you know, government has a very powerful effect on their opinion of the dangerous and they’re kind of duty to society to try to slow the spread. You know, there’s a free rider problem there. And I think sometimes people like to think Gosh, New York, like that’s a very different city. It’s packed with people and they don’t even really have cars. They’re taking the subway, like, they’re paying crazy prices for really small apartments. Yeah, they have, they have a much bigger problem with this COVID but we’ll be fine in this other area. And it’s not the case with something that’s contentious enough.
Nathaniel E. Baker 39:53
Mm hmm.
Chris Nicholson 39:53
So anyway, long winded answer somewhat to just say, in the very near term. It doesn’t look like we have this thing fully under control in terms of, you know, next winter and beyond in the Northern Hemisphere, I’m pretty optimistic. It’s not going to be that huge of a disruption.
Nathaniel E. Baker 40:13
Okay.
Chris Nicholson 40:14
And I mean, let’s say, yeah, let’s say we did a great job with it in the US. But there were major problems in significant other parts of the world economy. US stocks are not going to be in great shape, because we have to trade with the rest of the world and, can’t just stand alone. So it’s an issue we all have to track closely.
Nathaniel E. Baker 40:38
Yeah. Are there any other issues as you look forward here, the rest of 2020 we have a certain little election coming up in November. I know as far as other catalysts, potential catalysts that you are eyeing,
Chris Nicholson 40:53
you know, just to reveal two other things that are kind of key to my process that I think are also particularly relevant. Like one, we started to talk about oil prices. Right? I think that there’s been, for a long period, a general investor, rule of thumb, without, you know, much ability to sort of derive the equation from first principles, that oil prices always go up, you know, maybe even more so than housing prices that we all thought through to the late 2000s. You know, the supply curve goes up, generally, it gets harder and harder and more expensive to find more and more oil, fracking put a big dent in that story. And, you know, renewables and kind of electrification of the auto fleet, put a big dent in that story. Those things of course, going back to your thought about sort of short term demand for capital and such. It doesn’t need to be the That electric cars are such a big share of the auto fleets or that renewables are so competitive right now to have a significant effect on oil prices right now. Because OPEC, the sort of oligopoly there would like, of course, to have high oil prices, whether it be to, you know, balance their budget at a certain assumption based on the last plan, etc. And they’ve been able to do that successfully for decades, but they have to keep a lot of oil off the market sitting in their reserves, right, artificial shortage, to maintain the price. And if at some point in the future, the value of their reserves is going to go down, even though the current price maybe stays okay. You have to factor that in right mix the sort of interest temporal choice. And so, you know, many, many countries have 30 years of reserves proven, and their economy relies on oil being there, for the long term. But if renewables and electrification of the fleet means that the sort of marginal price of energy trends to very low levels or zero 20 years from now, you know, those countries have to reevaluate their production decisions now, and maybe try and sell more of that oil sooner. And so that’s really taken some of the legs out of, I think global inflation. And we talked a little about GDP and inflation is kind of two key factors determining prices and you know, sort of all prices being relative lower lowering of inflation expectations, almost always In the short term, hurts equity prices and helps bond prices. And so an equity investor really wants to pay fairly close attention to the, you know, the implied prices there, maybe look at playing inflation breakevens as a hedge or playing oil as a hedge. So that’s a big factor. Then the other factor I look at a lot is volatility and implied volatility. I know you’ve had some other guests that talked about implied volatility is kind of an interesting counter indicator equity, price risk, but, you know, I sort of look at options and think, well, if I buy the underlying, you know, I’m, I’m, I get all the upside, and I accept all of the downside. But depending on what kind of fixed offer folks will give me to not accept any of the upside and just take the downside, I really have to compare that right to my decision. To buy the underlying
Nathaniel E. Baker 45:01
Mm hmm.
Chris Nicholson 45:02
And so when implied volatility is really high, and I have a sense of the bounds of what the future might hold, you know, I really might prefer to be sort of selling options against that direction that I feel comfortable at. And if I can get really cheap options, low implied volatility, there’s too much complacency out there in the market. And that’s, you know, key to me rectifying what’s really going to be true in the future. What if people think I want to load up like crazy on options that I can buy for cheap because, you know, you can make 10s of times your money on that and very little volatility, zero downside risk beyond a certain level. So anyway, the commodity markets oil mark, markets tend to have really high info right on volatility kind of excess demand. hedging that, you know, not enough investors are willing to show up and accept that. So I look at that often as a place to make money and I don’t need a catalyst. I just need a, I just need to avoid the sort of anti catalyst that’ll hurt me.
Nathaniel E. Baker 46:17
Right. How does how do you go about doing this? If you’re right if you’re so you’re talking so options are simple enough. How do you see what has to get options on futures? Right?
Chris Nicholson 46:28
Right options on futures and you know, expiry works against you in the sense that you need to reset your options and, you know, your relationship or thing maybe are always evolving. Yeah, so I can maybe make a bet on Okay, well, you know, shales coming offline. Let me look at the rig count. What’s the kind of minimum price that West Texas is going to be or Brent is going to be or the relationship between those and the, you know, six to 12 month period, even when If global demand is really lousy, but Saudi, Russia, etc, kind of try to collaborate to hold up a minimum price I might be willing to sell puts, you know, at 30 bucks, a few months out and feel pretty good about that. And there are definitely a lot of oil holders that, you know, will pay me a lot to write those notes for them. They just, you know, they feel like they have to pass on the tongue.
Nathaniel E. Baker 47:27
You know, although we have seen that Saudi Russian collaboration is not something you necessarily want to bet against. It’s no Sure thing,
Chris Nicholson 47:36
at least as much shorter term, right. I mean, isn’t that interesting? How, how long ago was it that they, you know, sort of made that collaboration to support prices? I feel like it was me was that less than two weeks ago, even that was the support. Maybe it was a little bit longer than that now, right? And, you know, they make those announcements and it seems like they’re definitely able to drive prices in the very short term, but they’re not able to sustain it. If it’s outside the kind of, you know, economically equilibrium price. But you could also go out there and say, Well, how many people are out there, you know, hedging their oil as an input cost. I mean, people use it for a million different things in the US, right. autos airlines. You know, a lot of investors just want to hedge inflation through oil and not see sort of all of the milk and honey go to the oil producers, and that really hurt kind of equity holders elsewhere. So you know, what, people pay me to write them a call option for oil at, you know, 55, 60 bucks, where I’m betting, hey, fracking is going to come back online. You know, Saudi and Russia actually might have pretty nice incentives. To control the top end of oil, you know, so I’ll take that perceived risk that I think is really not much of an actual risk at all, and take a risk premium on that side, too. So that I, you know, my underlying beta foil is more contained and kind of, you know, sort of declines, kind of particularly in the middle of that, of that spread. So that’s awful it sometimes but sometimes it’ll be in a very directional and in sort of a rel Val ball world, you know, maybe maybe long some bond volatility, maybe long some currency volatility, equity volatility. How do you trade those? I can buy back my risk so much cheaper, you know? Yeah, well, so it depends. I mean, like, obviously in equities, we have VIX futures, right? And you can look at the whole curve. And there’s some very interesting curve dynamics there that you can play the the asset itself, even if you are right about the general direction is quite volatile, and you don’t necessarily want to take too much of that idiosyncratic risk doesn’t necessarily all get kind of diversified away and your balanced portfolio, if you will, but just by writing some options, and then adjusting your beta with the underlying you can kind of synthesize, you know, a ball play. So, you know, that’s the gist of it. And I think a lot of investors shy away from options because they think, Well, you know, you got to be very precise and very quantitative, and it’s really not that true. Hmm. If you’re going to be an investor, I think it pays to be comfortable with numbers reasonably, but we’re really not talking about crunching a lot of calculations here. Yeah, yeah.
Nathaniel E. Baker 51:02
Cool. Well that’s all very excellent Chris Nicholson maybe in closing you just tell listeners how they can find out more about you. I can see you have a Twitter account I believe
Chris Nicholson 51:11
I do. I’m more of a user of LinkedIn So okay, definitely follow me there. I think I’m under Chris Nicholson, CFA, Chartered Financial Analyst. Okay. And certainly they’ll see iron harbor in my background there. And then on Twitter, I think my handle is @2Christopher number two Christopher so folks can certainly follow me there. And I’ll just do my best to be visible if folks want to connect and challenge ideas
Nathaniel E. Baker 51:48
yeah, there’s a very active, pretty active community, especially on Twitter. So I suspect you’ll have people take you up on that offer.
Chris Nicholson 51:56
Sounds great.
Nathaniel E. Baker 51:58
Very good. Thanks so much again, Chris, for joining And we look forward to speaking to you all again next time.
Moderator 52:04
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