Diego Parrilla on Anti-Bubble Investing, Technological Change, and Global Market Risks

Unlock the secrets of intelligent investing with Diego Parrilla, a former commodities and macro trading expert from JP Morgan, Goldman Sachs, and Merrill Lynch. Now at Quadriga in Spain, Diego introduces his innovative "anti-bubble" framework, illuminating how misperceptions in the market create undervalued opportunities. His strategy blends gold, fixed income, and options volatility to provide a well-rounded defense for your portfolio. Get ready to rethink your approach to market risk and learn how to capture premiums during extreme market events.

Discover the fascinating world of game-changing technologies and their market-shaking impacts. From the dot-com era to the rise of AI and ChatGPT, we discuss how technological excitement often leads to growth spurts and inevitable corrections. Learn why these bubbles might actually expedite the adoption of transformative innovations and how to shield your investments from their volatility. Diego provides insights into leveraging gold, volatility, and other precious metals to navigate through these turbulent times.

Dive deep into the economic challenges faced by high-debt nations like Japan and explore the complex interplay of geopolitical risks, economic imbalances, and energy trends. Understand the implications of Japan's soaring debt-to-GDP ratio, the potential for currency devaluation, and the global market repercussions. Drawing from historical analysis and expert insights from Ray Dalio, we unravel the interconnectedness of economic policies and global energy shifts. Equip yourself with strategic protective measures to safeguard your portfolio against these multifaceted risks.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Transcript

Speaker 1: 1:14

My name is Michael Guy, a publisher of the Lead Lagrime Report. Joining me for the rough hour is Diego Paria, who is not exactly in the US. We'll talk about where he's at, but, diego, introduce yourself to the audience. Who are you, what's your background, what have you done throughout your career and where are you located?

Speaker 2: 1:31

I'm currently connecting from Santander in the north of Spain. I'm originally from Spain. I'm a mining and petroleum engineer by training, started my career in investment banking, trading commodities and effectsX with JP Morgan that was in the mid-late 90s and I then worked with JP Goldman and Merrill Lynch, always within the macro NFX. I then moved on to the buy side where I've been privileged to work for some pretty large players such as Blue Crest, diamond, 36 South and Quadriga, where I'm now. In addition to my experience on the buy and sell side, I've written a couple of books. One of them I call the Energy World is Flat, which I co-wrote with my good friend Daniel Lacalle, and a second one called the Anti-Bubbles. Both of them were at least at the time of writing were contrarian frameworks and, yeah, I kept that discipline of writing over the past few years. It's a very humbling exercise and extremely productive, at least for me. So yeah, on a day-to-day I'm effectively managing defensive strategies in usage format under Quadriga.

Speaker 2: 3:04

We have a couple of strategies. One is called Ignail and effectively it builds on the ideas of the anti-bubble. It combines gold, fixed income and options volatility strategies. Using a soccer football analogy, we're the goalkeeper of the team, so we're there to make large absolute returns during moments of crisis and, yeah, we can suffer during more benign periods, but the idea is to be a team player and basically create that dynamic. And that's the second strategy that we run, called Aqua, which basically combines the long equity with the protection and the rebalancing which, for probably the large majority of the people listening, is an easier strategy to understand and to hold because the goalkeepers can be quite punchy. And so that's a little bit of a nutshell of who I am and what I do.

Speaker 1: 4:13

When I hear that phrase anti-bubble I think of Nassim Tala's anti-fragile. I also think of boredom. The reason I say that is that bubbles seem to be just the natural order of markets, capitalist systems. They can be really exciting and then really depressing afterwards, and if you don't have bubbles, things are kind of boring, right. So let's talk about what that means. The anti-bubble framework what exactly is that?

Speaker 2: 4:41

Yeah, you're right. I always like to start by looking at the concept of bubbles and to borrow George Soros' definition of bubbles. Of bubbles, and to borrow George Soros' definition of bubbles, he would define them as assets that are artificially expensive based on a belief that happens to be a misconception, a false belief. So, effectively, bubbles are constructs where we have found. It's a matter of when, not if, that bubble will implode. It's an artificial setup. What I did by coining the concept of anti-bubble is I sort of generalized the framework and said well, misconceptions can create artificially high valuations, but they can also create artificially low valuations. And in that sense, the concept of anti-bubble has these three dimensions. The first one is the idea of assets that are grossly artificially cheap. It is a matter of when, not if, that they will basically go up. It's in some ways a form of extreme value. There's a second dimension, which relates to the idea that bubbles and anti-bubbles are like distorted mirror images of each other. They're two reflections of the same misconception. So, as such, I called it anti-bubble, a bit like an antivirus or an anti-missile. It's a defense mechanism against the bubble. And the third concept, which is very important, is they happen to be reflexive in the sense that bubbles and anti-bubbles can feed on each other. In the sense that bubbles and anti-bubbles can feed on each other and there's an element of risk premium.

Speaker 2: 6:34

If you think about it. There are times when there's no good and bad guy in this movie, sometimes equities. What would be a good example of bubble-anti-bubble is the relationship between equities and volatility. Let's say the S&P and the VIX. There are times when equities might be artificially low and there are times when equities are artificially high and vice versa. There are times when volatility might be artificially low referring to your point, mike, on boredom and there are times when you have the opposite. You have volatility exploding to levels that are artificially high. So really the idea here is to create this team that effectively embraces that volatility, embraces and takes advantage of those artificial setups in a way that you can combine the bubble-anti-bubble and embrace that opportunity.

Speaker 2: 7:38

If you take it to an extreme, you know, tail events such as, you know, a pandemic or war, can result in pretty extreme dynamics that you're only going to catch if you're in, and that's why this becomes a structural source of risk premium or protection that may come with some sort of pain, sometimes in the form of cost and bleed through some time, but it more than pays when this is happening. And I think there's a lot of science, a lot of work, you know. The other thing I didn't mention is the intro. I'm also a visiting lecturer at Imperial College, so there's an academic side to how we think about portfolio construction, beyond the monkey brain sort of linear understanding of something made money, something lost money. It's about the non-linearity. Maybe we can expand on that later, but the general idea of this bubble and anti-bubble as a framework can be extremely helpful, both to understand what's happening in the macro side as well as help us make better decisions from an investment perspective.

Speaker 1: 8:48

Is it that easy to identify artificially low versus artificially high the reason I say that? I know it sounds like it should be, but I've seen studies that show, for example, volatility for markets is highest at extreme valuations. It's also highest at extreme low valuations. Meaning the commonality in terms of overvaluation undervaluation is volatility is extreme in both cases. So how can you determine if something is, in quotes, artificially too elevated or too discounted?

Speaker 2: 9:19

Yeah, I think the first thing we have to say is that we don't have a crystal ball, we don't try to pretend that we're here to tell you exactly what's going to happen and when it's going to happen, but certainly these relationships hold and when it's going to happen, but certainly these relationships hold and eventually, two plus two equals four. So in that sense, and to your point earlier, it's not obvious to you know. Going back to Soros and the bubbles, when you're inside of the bubble, I think it's not so obvious to reflect and realize whether this is a very obvious bubble. And even if it is, these bubbles, as we will know, can last a lot longer, go a lot higher than anyone anticipated, but they also tend to go a lot lower, a lot faster than anyone expected. So I think part of this framework and there are relationships that are more mean, reverting, such as volatility there are others that might have other drift elements to it, such as inflation and other assets, but I don't think the word easy applies. I think it's generally the discipline of creating these portfolios that effectively will embrace these dynamics. But the artificial nature, going back to the bubble and the bubble, and can we spot them, I'd say that show me the misconception and I'll tell you what the bubble and anti-bubble is in some ways. So, on that idea, part of the macro framework is there are multiple levels of artificial setup in our system and think about artificial interest rates, yield curve control, all sorts of shield curve control, all sorts of money printing and debt. So it's relatively obvious to see the manipulation and the impact that that has on the market and the fact that it's distorting the world. Is less obvious what the end game might be or what those things play out. But my general framework and the application is that if we were to think about what are the misconceptions in the system and what are the bubbles and what are the anti-bubbles I've had this view ever since I wrote the book and before.

Speaker 2: 11:46

I don't think the biggest misconceptions are the belief that you can actually solve problems through printing money and debt, ie the misconception that monetary and fiscal policies solve problems. The reality is they're not solving anything. They're not solving problems. They're doing four things in my view. The first thing is they are delaying the problem. They're kicking the can down the road through spending and debt. The second thing we're doing is we're transferring the problem. So monetary and fiscal policies without limits have an impact of exchange rates and currency wars, trade wars. This is not really solving the problem, it's just passing the hot potato around. The third thing is we are transforming the problem.

Speaker 2: 12:38

So something that might be, let's say, a bubble or a problem with valuations could actually be transformed into inflation if you do monetary and fiscal abuse. And unfortunately along that path you end up creating big problems. You know inflation and you know social unrest and geopolitical issues and polarization and all the close cousins of inflation and monetary and fiscal abuse that we know through history. And lastly, we are enlarging those problems. So unfortunately, this is not a zero-sum game where we're just passing the ball around. It's actually enlarging the problems and perhaps in some cases reaching a point of no return where the monetary and fiscal abuse has gone so far that it will not be able to be reverted. And that's why I think you know, from a game theory perspective, the end game of these macro framework is likely to result in, you know, more, not less, monetary and fiscal abuse, which will end up lacking badly.

Speaker 2: 14:29

I mean, for those of you who've got a copy of my book and have dedicated it, I tend to dedicate the anti-bubble saying I hope you like it, I hope I'm wrong. I feel like a doctor diagnosing a terrible disease to a friend as a friend. I want to be wrong. As a friend, I want to be wrong. As a doctor, I want to be correct. My view of the patient is that these measures that we take through monitoring, fiscal policies without limits are creating again, are delaying, transferring, transforming and, unfortunately, enlarging these problems are delaying, transferring, transforming and, unfortunately, enlarging these problems.

Speaker 1: 15:10

So I love that framework of show me the misconception and I'll show you where the bubble is. It seems to me that the misconception, more often than not, is often around the time through which a narrative plays out. Right? So, okay, we can all agree about AI, but the misconception there might be about how quickly it gets integrated into every single aspect of our lives. Same thing with robo-taxis and automatic self-driving cars. Sure, you can see the endpoint Investors bid it up thinking that it's going to happen tomorrow, when in reality it would take decades, right? So how much does sort of the misconception around time factor into bubbles playing out?

Speaker 2: 15:52

No time is huge and obviously, you know, it's impossible to predict with certainty and there are multiple dimensions. But I found, you know, back in 2003, I think it was, I read a book that really changed my perspective. It was Thomas Friedman's the World is Flat. Those listening that are old enough to remember the dot-com bubble, basically what went through left many of us with a bit of a sour taste. Right, it was effectively a situation that, upon reflection and that was really the amazing message from Friedman's book and the framework which I will discuss shortly, has stayed with me and actually was key in developing my first book called the Energy World is Flat, applying some of these ideas. And I think the framework is very much alive today with, arguably, the AI bubble. And so, for the benefit of the listeners, maybe I'll touch on it.

Speaker 2: 17:00

And I think it all starts with the idea of a game changer technology. So a game changer technology. There's no question, looking back at 2001 and also today, that there are technologies that effectively divide the world into a before and after. You know, before the internet, before AI on a mainstream basis. So sometimes the bubble comes because what looks like a game changer technology and might be widely acknowledged as a game changer technology was not. It was either fraud or it was just impossible or whatever. But generally speaking, even game changer technologies, the first point is they change the world right. The second phase is we all get super excited about it, right, and we start investing and deploying capital and that results obviously in expectations in growth, in growth in income, in investments, and that incredible amount of influx of money results in humongous growth in capacity. So think about today, for example, how many chat GPTs are going to be out there between. Everyone will have a version right. You're going to have plenty of engines and ways in which you know these basically tools, get and grow.

Speaker 2: 18:33

And I would say that one of the key misconceptions that we've seen it in many times is the idea that people invest as if they were the only one doing it right. So you go and say back in, the dot-com was like okay, let's literally wire the oceans with fiber optics and we're going to earn, you know whatever one euro per megabyte or whatever the crazy number was at the time. And you build these expectations and this investment based on a very linear view of the world, extrapolating dynamics, ignoring the fact that everyone's doing the same, and so what happens afterwards is that you end up with overcapacity. So, believe it or not, there was a point in the dot-com where we laid so much fiber that it became almost virtually free. You had a situation where people had made these investments based on huge expected returns and just that didn't happen. And this is basically when the magic happened, because you had a game-changer technology in huge capacity for free. And that's when the world became flat, because if you were for lack of a better example an accountant in India, mangalore suddenly you could do your work for someone in California right, and the world became flat. And so from there, I think what I loved about that book is plenty of big messages, but one of them was in some ways, bubbles accelerated the impact of technology. So back to your question on timing what should have taken a very long time to implement at a regular pace, it was this incredible flow of money in and capacity that was built that effectively accelerated things in a major way.

Speaker 2: 20:27

We are now, I think, experiencing something similar, except that effectively all technologies tend to follow some sort of what we call an S-curve right. So initially they're relatively flat, then you go kind of exponential, but every single technology has limits. When you are in the exponential phase, you may not appreciate it, but eventually these things flatten out. At the same time, I think the pace at which things are happening you referred earlier to people embracing an impact we are building S-curves on top of S-curves on top of S-curves, right. Anything from Uber through anything else is built on multiple things, from GPS to internet to mobile payments. So as we look at the opportunity set that we have right now, I'm super excited about what it means for the world, the game-changing technology but I don't necessarily think that we will see those valuations playing out because of the dynamics I'm describing, and the expected winners may not be the ones that we're pricing today, but they will certainly be new. But they will certainly be new. I happen to be an acquaintance to what I believe is the first $1 billion one-man company and I think there'll be more of those in the future as productivity grows and we have a world where you can have literally an army of analysts doing tons of things for us. So it's a very exciting.

Speaker 2: 22:04

As an engineer, I'm a big fan of technology, I embrace it, and things are happening very fast and it's difficult to know in the timing where we are and I would ask you and the audience, if we were in the dot-com, assuming that we're going through something similar are we closer to 1997 or 2001?

Speaker 2: 22:55

And you know, despite all the big challenges that we're seeing at the global macro level, this has been the one that I have thought for a while that we were closer to 1997 than 2001.

Speaker 2: 23:09

And therefore, I think these forces continue to play out and timing is absolutely impossible to, in my view, to predict, and that's why I think it goes down to, you know, embracing this volatility and creating teams and portfolios that have strikers, midfielders, defenders and goalkeepers. You can't just build portfolios based on strikers, which eventually fall in this very important concept of false diversification, right, which is confusing a portfolio with a lot of things, with a diversified portfolio, not to pick on any sensitive topic. But a portfolio of 20 cryptos is not really diversified as far as I'm concerned, right, they're all likely to behave is not really diversified as far as I'm concerned, right, they're all likely to behave in a very similar manner. So, anyway, I think some of the fascinating features that we're experiencing now, some of the challenges, but I think it's really reinforcing the free work in terms of what's happening, what might be ahead and how we can take advantage of that.

Speaker 1: 24:14

Got a question off of LinkedIn from Pablo Flames I'm going to show on the screen here. Question for Diago Do you still believe that the best way to profit and protect a portfolio against a bubble like we are seeing today is via gold, volatility and correlation? How about other precious metals whose price derives more from their scarcity?

Speaker 2: 24:35

greetings, pablo. Great to thank you for the question. Very good question. Uh, yeah, I do believe.

Speaker 2: 24:42

If you think about protecting a portfolio, the first thing we need to understand is what are we trying to protect it against, right? So we generally look at a portfolio and say, well, I'm long equities. Right, I'm long risk. So that's what we tend to in the industry. That's our starting point. But it's very important to understand that each of the listeners today has a different starting point. Some people might be lawyers, some people might be construction companies. There's tons of different profiles which give you completely different roles. So you yourself and your income and your assets and your wealth past, previous and future, you know, might be a striker, a midfielder, a defender, right? So I think the starting point is that, but assuming that you know, as it tends to be the case, the starting point is we have a risk portfolio. Then we want to basically try to come up with you know as many ways or the best possible portfolio to protect against you know, pretty much any risk that could take place and some of the hedges and some of the protection will give you, you know, effectively insurance against multiple things at the same time.

Speaker 2: 26:06

But I'll give you an example, and this is a relatively quantitative exercise. You know, when we define the features of a good striker, you know you want him to score goals, you want him to do certain things. The goalkeeper is a very different animal. You know, if you're judging your goalkeeper by the goals he scores, then it's obviously the wrong metric, right? You want to look at different things. So what do we look for in a defender and goalkeeper?

Speaker 2: 26:35

And the single most important variable is called reliability. And for those that are more math oriented, this is effectively the conditional probability that something will work, meaning, if the market's down, one, two, three sigma, ie the market's standard deviations. If the market's down heavily, how likely is it that this asset will protect me? So reliability, you think about something like gold. Gold's not particularly reliable in the sense that. Or oil, or certain assets. Sometimes oil works very well in a crisis If the crisis is driven by geopolitics and war. Some other times, like COVID, oil went negative. So in terms of the reliability of the protection, even volatility may not be as reliable. You could have a year like 2022 where the big risk back to Pablo's question was correlation. It was the core drawdown risk between equity and fixed income. It was inflation up rates up that resulted in equity fixed income lower. At the same time, 60-40 portfolios not being protected, showing hidden leverage, and there were things that worked really well during that scenario, but volatility or gold or fixed income were not there In our case. We had other things like long dollar and other things that actually more than offset that, and so I think it's really about creating these portfolios that will give us the most reliable protection as possible.

Speaker 2: 28:27

The second key variable is what we would call reactivity, so that again, for the math-orientated people is the conditional beta is how do you react? And you want things that, as the market goes down, they become more and more reactive. They ideally become exponential on the upside, and things like the VIX can be extremely reliable and reactive under certain scenarios. They're also potentially quite convex, but they have other challenges, such as, you know, the negative carry and other considerations. So, as a professional goalkeeper, you know we have an array of a menu of things that we look at, which is very broad. It goes from puts on equities, calls on VIX or volatility and all sorts of variations. We have duration, we have dollar, we have correlation. We have plenty of things that effectively are at our disposal and we will try to create portfolios that give us the most reliable reactive, convex, asymmetric protection per unit of cost and carry. It's not an easy task. We have a self-imposed risk limit where we only buy options.

Speaker 2: 29:52

I, like most people in the call, like to sleep at night.

Speaker 2: 29:58

Most people in the cold like to sleep at night, and I think it's effectively throughout my experience.

Speaker 2: 30:16

You know I want to warn everyone on this call about the risks and perils of hedges that are highly leveraged through, for example, long shorts, right, we've seen big accidents and things happening through correlations breaking down, and so I think, ultimately, you know the idea of creating these portfolios that are giving you the most reliable reactive protection per unit of cost and calories is what we try to achieve.

Speaker 2: 30:39

You can do that and buy it on a standalone unit, but that's only part of it. You're delegating, I would say, what to buy, but I think in experience, what's more important in portfolio construction is not only what to buy, but also how much and when, and I think those are incredibly important questions. It's not just about you know how much gold, you know should I buy gold or not, it's how much and when. And building those portfolios and embracing that volatility, I think is very much critical to the success, the long-term success. And this all goes down as very closely linked to emotional and behavioral biases, which is when you become a professional investor or a professional sports player. It's a big part of the game, so you need to find ways in which you are unemotionally, in a very disciplined basis, taking advantage of these opportunities.

Speaker 1: 31:43

And that's what we try to do. The issue there, of course, is that if you're going to have a portfolio like that, your upcapture is going to be less because you're not fully exposed to the best performing asset classes, and, as much as people may understand a framework like that, fomo always gets the better of them. It sounds to me like it's a bit philosophically like a permanent portfolio or risk parity type of approach.

Speaker 2: 32:02

Yeah, except that the key thing is the reliability. So when you think about risk parity or other type of strategies that rely heavily on historical correlations, you're driving the car with the rear mirrors. You're basically often assuming that what happened in the past is what's going to happen in the future, and if you are running a 60-40 balance portfolio, thinking that fixed income is going to protect me when the crisis comes, you might be for a surprise, and so the essence here is being able to effectively understand the sources of this reliability and reactivity, and that includes positioning and many other factors.

Speaker 2: 32:59

But setups like you know risk parity, vol target, even CTAs, right Trend following strategies have great merits, but they're often portrayed as you know uncorrelated defenders to the portfolio, and I don't think you know that's necessarily the case, particularly when you have very sharp drawdown risk, right? I mean, how can you be a defender if you're max long equities at the top and, ironically, the way many of these strategies are constructed, they fall in the bubble and the bubble trap Because as the equity valuations increase and implied and realized volatility goes down, what happens is the model is telling them to lever up and that lever up pushes valuations even higher. It creates more complacency, which pushes volatility even lower and, before you know it, you end up max long at the lows in volatility and as the market unwinds and equities collapse and volatility increases, that effectively creates a very mechanical process where you have forced liquidation. As volatility goes up, you're forced to reduce risk, and it's happening when everybody else is long and you're potentially selling into a vacuum. So I would just be. In essence, I agree with you.

Speaker 2: 34:31

The difficulty is effectively finding, not with the rear mirrors, but on a forward-looking basis, what are the things that would protect me in the portfolio. And over-reliance on historical correlation is possibly one of the most dangerous things you can do, because it can lead to especially combined with leverage, because it can result in bankruptcy, it can result in pretty big accidents. That's why, to your point earlier on potential underperformance on the way up, of course, in some ways in the short term, that's what you see, as you have effectively some money spent in insurance. The fact is, when you think long term, what are the benefits? Those minus one, minus one, minus one plus 20, is it worth it? And ultimately, for me it's all about buying the right thing in the right size at the right time. And that right size and the right time is you know very much. You know as humans and many people that I've seen throughout the years, we tend to do exactly the wrong thing at the wrong time, right? So people are buying insurance right after COVID, I mean, that's the point where, arguably, insurance is high. The accidents already happen.

Speaker 2: 35:57

At that point in time, what is cheap is the equity, it's not the insurance, right? That's why I make the point that this has to be a process where you're in, your goalkeeper should be in at all times. Real Madrid, barcelona, it doesn't matter who they play, they always have a goalkeeper right At all times. And I think this is critical to understand. So those emotional behavioral biases of owning insurance and FOMO and throwing the towel, I think, get offset when you do something like Aqua, which is we combine them and it's much easier to understand, much easier to buy, much easier to hold when the market for you know, I think right now market's up, whatever you know 16, 17, and this thing might be up whatever 14, right, but if the market's flat or minus 10 or minus 20, these things are flat or up.

Speaker 2: 36:48

So the general idea is, if you're too greedy and you're like only focused on maximizing the upside and you don't want to have any defenders or goalkeepers, on maximizing the upside and you don't want to have any defenders or goalkeepers, yeah, uh, timing will be critical, uh, and some, some people might be very good at it, but I I generally believe that the success is more about emotional indifference, it's about discipline and, as I said at the beginning, I think each one of the listeners has, um, they themselves have a different team and a different team and a different in their own strategy. So you listen and you're the coach of your own team. You decide, you know how you want to play the game and some parts you will do yourself, some parts you will delegate to professional stock pickers or defenders, like might be our case.

Speaker 1: 37:38

I think the broader point is and I've seen this from a asset management perspective as well you don't want to chase convexity, because that's usually when the drawdown is about to happen. It's your point about. All these black swan type funds end up getting all the AUM after the event actually takes place, and then those investors blame the manager, saying you haven't performed that well. Why is that? Well, right, because you're supposed to be in it before the events, not afterwards, and that's always the dilemma about FOMO when it comes to those types of strategies. There's a question here. It's actually well-timed, so I wanted to pivot this anyway. From Nicola Lampas Ciao, Diego Cheers from Lugano. How do you see the latest move in the yen and the impact that the restriction in BOJ monetary policy can have on global markets? Sounds like somebody's tracking my reverse carry trade thesis. Do you see it in volatility in the next few months?

Speaker 2: 38:30

Look, I think Japan is at the epicenter of monetary and fiscal abuse. Right, and they have been. In my opinion, they've been leading, you know, with zero negative nominal yields. So if you read my book I've been talking about, you know Japan for a while and in some ways you can. It's what's been happening, it's it's, it's, it's been letter by letter a little bit the dynamics. The point is, you know, if you fall in the misconception that you can print at infinitum and you can borrow at infinitum and that's okay because the enemy is deflation and other things, I think you're really you know there's a lot of second and third order effects. So what's happened in Japan, and you know it's critical also to introduce the concept of yield curve control.

Speaker 2: 39:33

Going back to effectively what we talked about earlier of manipulation of markets and artificial settings, when you said, interest rates historically were really about front-end rates, so central banks controlled monetary policy in the front and there were some expectations of what we'd have. But when you had the very long-dated stuff, you know, like 10 years, 20, 30 years, that market was driven more by things like not only expectations for rates but more importantly, inflation and also credit risk. Even if it might look like local currency bond doesn't, or a dollar Argentinian bond doesn't, there is credit risk and other forms of penalties. So when you introduce yield curve control and you say the 10-year JGB yield is 0.10, 0.1, so almost zero, why? Because I say so and I have the bullets to buy infinite amounts and keep it there, I think what's happened in the last few years is that bluff has been called and, effectively, as inflation has become a problem and this is not the pandemic, it was a problem before. It had been accumulated through a lot of abuse the pandemic just added a whole new level. But as inflation becomes a problem and you have 250% of debt to GDP, amongst many other problems you're really not able to hike interest rates as you would like, because you're literally going bankrupt. I mean, bear in mind the European crisis in 2012, where countries like Spain or Italy were at the end. But the other guys, you know we're talking about levels of debt that were dramatically lower than that and with rates of 5%, 6%, 7%, it was literally impossible to pay that.

Speaker 2: 41:32

So a country like Japan effectively has sacrificed in many ways, monetary policy because of the monetary fiscal abuse, and so what's happened is you know, I think they're trapped in the sense that and the bluff that they can actually hike rates has been played out and we're in a situation where dollar-yen went all the way over 160 to the dollar. In this dynamic where effectively becomes a bit of a snowball, where you have interest rate differential to other countries going up, you can't really quite hike. If you do, then the problem becomes in your fixed income market, in your equity markets, you can't really hike. If you don't, then you're forced to defend those yields by printing money. You're effectively diluting the currency, which is creating inflation which is feeding into your issue as the currency devalues. So this sort of dynamic got to the point, I think, quite critical.

Speaker 2: 42:39

Where you know, boj started to intervene, but I think the fate of the BOJ falls arguably a little bit more in the hands of the Fed than the BOJ. The Fed effectively and others start easing. I think that gives a bit of a respite to Japan. But overall we're in scenarios where there are limits really to how much you can hike in Japan, or Europe for that matter, or places that have too much debt, and we've seen that limit in rate hikes and expectations start to with the benefit of better numbers. Things are starting to tame. We've had some cuts already in Europe, and so overall, I think.

Speaker 2: 43:31

Japan is a fascinating place to watch, and it's not just an idiosyncratic Japan only problem, because if, for whatever reason, this trend and this positioning right now there's a lot of pain in the market right, so all the trend followers were playing that the market starts to reverse the force to sell and they're now short gamma and they might be hurt in both ways. But if dollar-yen was to go back to previous levels which I don't rule out I think you might be in a situation where the only way to you might have forced repatriation of assets, which could result in forced liquidation of treasuries, which creates higher global yields. And before you know it, that backend requires yield curve control again, which seems to have been a little bit out of people's worry list, but I think it's part of the end game. So there's no way to control the backend, in my view, without more printing, and so watch out for Japan. Right now, again, I think there's a repositioning, forced liquidation, cpm, wind, amongst other issues, but the structural issues remain.

Speaker 2: 44:59

I love the country. It's cheap, you know now. I love the people. There's a lot of opportunities there. They're not necessarily in a crisis themselves, but what it is is something gives up eventually, and if you abuse monetary and fiscal policies, what happens is, with pretty much 100% certainty, is the currency, is the degree of freedom of the system. You know, argentina knows that, venezuela knows that, zimbabwe knows that and Japan knows that and China will know that. So, if you are pretending that you can actually you know print and borrow your way out of problem, you might fail. They look good for a while, but eventually these imbalances show up and they show up through the currency and that's why things like gold are doing what they're doing, because ultimately, fiat with exactly the same issues, and why I think gold I talked about gold's perfect storm it's playing out. Gold I defined had a few hundred dollars of downside, a few thousand dollars of upside. That's starting to play out.

Speaker 2: 46:33

Yeah, I think again, japan, it's definitely a gray swan over there in terms of how the monitoring fiscal abuse play out and that could potentially have second and third order effects in other areas, alongside with many others, alongside with many others. But it's a key part of my framework and a key part of the opportunities to potentially protect against these things, because you have this beautiful blessing now that you can actually have tail risk with positive carry, which is not the norm right. So there are opportunities and pockets where you can accumulate what I humbly believe is artificially cheap insurance that could be very reliable, reactive and convex at cheap and positive carry. So for someone like us, again, you can't put all your money in this sort of opportunities, but it's part of this. Going back to the point of artificial setups, these artificial setups actually give up and there are opportunities and risks on both sides. Sorry for the long answer, but it's a long.

Speaker 1: 47:36

I'm in agreement with everything you just said. You did say print and borrow, and that's always what ends up happening, but you typically need some kind of excuse or scapegoat. I had put out that post yesterday, stealing it, admittedly, from Gerald Salente. When all else fails, they take you to war, and war is often the thing from a geopolitical perspective. That gives all the policymakers an excuse to continue to print money. I am curious your views on heightened geopolitical risk here, given what's going on between Israel, iran, if the market is maybe mispricing, the risk of something really getting out of control. I joked and it's a sad joke. I said I don't know if this is World War III or World War IV. I'm losing count.

Speaker 2: 48:26

I think geopolitics is here to stay. It's a byproduct. You talked about scapegoats earlier. It's very hard for most people to pinpoint that monetary abuse and fiscal abuse are behind. You know a lot of the issues and if you think about you know there are so many things that are lined up here in terms of you know the geopolitical risks, but I do think they are, and I'm very much with Ray Dalio on this as a student of history. I think there's plenty of pockets and risks and, to your point earlier, scapegoat, excuse or just simple need.

Speaker 2: 49:21

Ultimately these imbalances are accumulating. People are not happy and you can see that. You can see inflation is impacting purchase power, it's enhancing inequality, it's creating a larger polarization of the world, clearly a polarization of politics, and this is obviously fueling populism, social unrest and worse. Add religion, add oil, add many other things that are difficult or impossible to resolve. And, yeah, china, taiwan, russia, ukraine, israel, iran I mean in some cases talking about nuclear powers as well it's a really meaningful tail risk and I personally think it's here to stay. It can show up any minute and yeah, it's part of the game we live in and hopefully things will not escalate. But if inflation was to get worse and the economies are doing badly and you need these scapegoats. It's quite easy to blame. Pick your guy, putin or anybody else.

Speaker 2: 50:53

I think one of my favorite sayings of all time is the bad guy is the good guy of his own movie, right? So I think in that sense I'm'm not defending anyone, but clearly people tend to. You know there's different perspectives here and uh, these are very complex and multi-dimensional problems that we will not fix um easily. Um, but that polarization of the world. You know things like pretty much confiscation or freezing Russian assets. It's a game changer. It's a game changer for the world. Who do you trust and where do I keep my money? And if the SWIFT system is no longer acceptable for certain people, of course they're going to build their own and that's going to create, as part of this trend that I think, the globalization versus.

Speaker 2: 51:47

You know protectionism. I think protectionism the rise. You know tariffs, things like that. They're all closely related to what we're discussing. You know Currency wars. We're all about beggar thy neighbor, devalue your way out of trouble until someone comes in. If you want to devalue by 20%, I'll tariff you by 20% and that's kind of game over for the guy who's been doing that abuse. So I think these dynamics are piling up and again, once again. I hope I'm wrong, but I think it's something we'll have to live for the foreseeable future.

Speaker 1: 52:30

So you mentioned at the start a number of books that you've written, and it's on your ex-profile at Ria Diego. That is a hell of a banner to just have nothing but your own books at the top. I am curious if there's one book that is perhaps most relevant to today that you've written, which is the one that you'd say this is the one you should read right here, right now.

Speaker 2: 52:58

Well, in all fairness, what you see there is there are really two books the Empty Bubbles and the Energy World is Flat. The three on the right are basically the Energy World is Flat was published in English, in Spanish and Chinese, so very proud of that. To get a book published in Chinese is not something I had thought about, but I think they're both relevant because they're both meant to be frameworks, so they are more trying to teach how to fish or how to think than giving you the thoughts necessarily. So I think the energy book is back in the sense that the ideas I presented there. They were challenging effectively a lot of misconceptions in the system. Right, and it's things like, you know, peak oil at the time, or a number of things, and some of them are very relevant and, I think, very important to understand. I mean, I'll pick on a couple.

Speaker 2: 54:11

But if we were to do a poll now with everyone in the audience and we said, okay, why has OPEC been so successful? I would think 99% of the people would say, well, it's an oligopoly of supply or a cartel right. The reality is that that's a necessary but not sufficient condition. There's a lot of markets where people have an oligopoly and they haven't been nearly as successful. The reality is that they had a monopoly of demand and so, in particular, transportation demand. So our cars or buses, or trains or ships, they were all running with, effectively, products derived from crude oil, whether it's gasoline or kerosene or fuel oil, and so effectively. To understand that is very powerful, because when you get the super cycle that we've seen in natural gas through LNG and shale, and now the story is back after the war in Russia, ukraine, where we can't rely on Russian gas and there's no shortage of gas, there's gas everywhere you can, many, many places. So as we build these LNG liquefied natural gas plants, which require very large investments, and you create this regasification terminals, you literally wired I called it the energy broadband. You've wired the world with floating pipelines and suddenly natural gas becomes a global commodity.

Speaker 2: 55:46

Prices go down. Think about in the US. One of the fun things in commodities is that, because we use different units, it's very difficult to compare apples with apples. But in natural gas, dollars in MBTU translate to approximately $1. Know, $1 is 5.8 barrels of oil equivalent. So natural gas at $2, $3 in MBTU is $10 to $15 barrel of oil equivalent. And of course you know that means that someone like Warren Buffett would buy the train company which was the second largest of consumer of diesel in North America and transformed some of those trains into what was reliable gas, et cetera. So, as you have these dynamics and you have what I call energy flatteners, suddenly the monopoly of crude oil in transportation is challenged. We're starting to see more cars, electric cars or buses with LNG or many other ways, or trains, and so I think part of the silver lining of what's happening in this crisis, this volatility spikes and this search for energy security, is this again massive investment and capacity. So I think over the next few years, in the short term there's not much we can do, but over the medium term I think there'll be some fascinating dynamics playing out in the energy markets. So I think that framework hopefully people will find it helpful.

Speaker 2: 57:18

And for the rest of this discussion, we've spent most time talking about bubbles, and the bubbles and macro, which I, so both of them are are relevant. The other thing you, you, you, you can see in the banner is front page article of the FT, which my mom's very proud. Now I it just I just wrote an inside column and, and when I went to buy a copy just as a memory. I saw it on the front page and I didn't quite anticipate that, but anyway, there it is. It's called Gold's Perfect Storm and it was written before the anti-bubbles, but it was based on these ideas that we've discussed, where gold, I think it's from a game theory perspective and, given everything that's happening, it showed a very asymmetric case and things are being confirmed and playing out.

Speaker 1: 58:08

Everybody. Please make sure you follow Diego Priya on X on LinkedIn. I appreciate those that watch this live and were asking questions, so shout out to all the LinkedIn folks that put some good topics here. This will be an edited podcast under LeadLag Live hopefully in 24-48 hours and hopefully I'll see you all Lead Lag Live hopefully in 24, 48 hours and hopefully I'll see you all on the next episode. Thank you, diego.

Speaker 2: 58:29

Appreciate it. It's been my pleasure. Mike, All the best and thank you everyone for listening. Anything you need, do reach out and hope people found it helpful. Thank you again.

Speaker 1: 58:40

Cheers everybody.

Speaker 2: 58:41

Cheers. Thank you.