Navigating the Next Decade ft. Kiril Sokoloff

[00:00:07] Kiril

I think there’s a lot of frustration among many countries that the US has used its dollar hegemony and they want to get away from that system into something else. I think that we’re not too far away from a major breakout in the price of gold. It’s been waiting underneath its all-time high. It has now been going on for quite some time.

If you talk to chart people, they say this is good. It is marking time, it is gaining power, it is gaining strength to really blast up. When that happens, everybody will wake up. When that will happen, I don’t know.

[00:00:51] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions.

Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:47] Niels

Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is the series that I not only find incredibly interesting, as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle.

We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game-changing issues, and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today’s episode hosted by Alan Dunne.

[00:02:31] Alan

Thanks very much for that introduction, Niels. Today, I’m delighted to be joined by Kiril Sokoloff. Kiril is the Chairman and Founder of 13D Research & Strategy which he founded back in 1983. Kiril has been an advisor to many of the largest pools of capital in the world over the last 40 years.

13D Research’s major clients include money managers, pension funds, sovereign wealth funds, family offices, hedge funds, and business leaders all over the world. Two of their publications “What I Learned This Week” and “What Are the Markets Telling Us” are two of the most influential and widely read research publications in markets.

Kiril is well known for some of his major market calls over the years, calling the bull market and bonds in the ‘80s, the technology boom and bust in the 1990s, and more recently, the reversal in inflation and bonds since 2020. It’s a great pleasure to have you with us, Kiril. How are you doing?

[00:03:25] Kiril

Well, it’s really a pleasure to be with you and thank you for inviting me on.

[00:03:29] Alan

Well, we always like to start off by getting a sense of our guests’ backgrounds in markets. I know you’re widely followed and most people probably know your story. But just to kick off the discussion, can you give us a sense on how you got interested in financial markets and your journey over the years?

[00:03:46] Kiril

Well, that’s a good question. I think that I wanted to get paid for using my brain, and that’s something that you are able to accomplish being in the financial markets. Markets, you never can master them. We attempt, we study, we learn. We hope we have learned. But it’s infinitely interesting and changing. It’s a dynamic that’s never boring. It can be very frustrating as it has been recently.

I’m very happy to go with the trend once it begins, but I’m happiest when I’m alone and when everybody disagrees. An example would be when I wrote a book in 1982 “Is Inflation Ending: Are You Ready?” Everybody thought it was inflation forever and there was a handful of people who believed in disinflation, but long-term, treasuries selling at 14 to 15% yield were the buy of a lifetime and people thought they were “certificates of confiscation”. Or when I was in Hong Kong in 1991-92 which was the cheapest market in the world, the best earnings record, and 4 or 5% yield and 4 to 5 times earnings.

It was selling at a China discount, the Hang Seng Index, and I thought it should sell at a China premium. So that’s the kind of thing that I like doing. They don’t come around often but they do come around, and that’s where you make the big money. But you have to be patient.

[00:05:21] Alan

Good stuff. I touched on I suppose a call you had made recently around bonds and inflation. It was a prescient call back in 2020. Bond yields were obviously unusually low at that time. We’ve since then had a spike in inflation and bond yields have adjusted, and that was very much the theme of 2021 and 2022.

Obviously, as we went into 2023, we had a disinflationary force and equities bounced back and bonds have been I guess a bit up and down on a range since then. But plenty of people I read and listen to are now suggesting we’re on our way back to what things were like maybe in 2019. But I’m curious to get your thoughts, do you still think that structural regime shift call is still valid looking ahead?

[00:06:07] Kiril

If you look at bond markets, and I’ve studied them over the long term, they go in 20, 30, 40-year moves. You had it was a yield bottom I think in 1942, there was a top in 1981, as I mentioned in yields. So we were in this bull market in bonds for 40 years. For me, after 40 years, every single moment we should ask when is the turn going to come. It doesn’t go on forever. And people are linear thinkers, generally. So the longer something is going on, the more confidence they have that it will continue.
We started to see market action telling us that inflation-sensitive stocks were starting to come back and come alive, and that the prior winners were starting to fade, and we took a stand on that in September 2020. In early ‘21, we turned very bullish on oil and oil stocks.

I think that the bull market in bonds is over. It doesn’t mean there can’t be rallies, but I think bonds are to be sold and the implications of a long-term secular bear market in bonds is massive because of the huge amount of capital that’s tied up in fixed income all over the world. Where is that money going to go? So I don’t see that changing.

If there’s a hard landing, if there’s a recession, the Fed will be panicked, and once again, stimulate and throw money at the system. The dollar will get weak and things will be stimulated. We’ve seen this game many, many times. We’re just in a waiting game to see how it plays out. But I feel quite confident that the bull market in bonds is over.

You could actually be very simplistic and you could look at the last 40 years through 2019 and make a list of all the things that had happened and then you reverse them all.

[00:08:10] Alan

I guess that’s the next question. People who make that case for the structural shift point to, as you say, globalization versus deglobalization, now we’re into decarbonization, possible changes in demographics, rising debt levels, and maybe the end of the Washington consensus under neoliberal order. Of all of that, would you point to one or two factors that’s been more significant in determining this shift or is it a combination of all of the above?

[00:08:40] Kiril

Well, there’s a lot of different factors. One of my themes is wealth creation and wealth distribution. Again, it’s a constant of history. I could argue that wealth distribution began in China in 2009, shifted to Brazil with the Brazilian carwash in 2012 and then Trump, Brexit, and so on. Wealth distribution is inflationary. Reshoring, friendshoring is inflationary.

Security is now influencing economic policy and decisions are being made that are not necessarily economic. You have inflationary expectations. You have water and soil. Water is not in the right place. Soil is being eroded. We’ve been blessed with good weather for so many years, but this extreme weather is going to influence that.

I think the commodity sector is hugely under-invested and if you’re really going to have an energy transition, massive, massive money will have to be spent on copper, for example. There’s a lot of other factors that are taking place. Demographics is another one.

I’ve studied demographics for 25 years. I became very interested in Japan in 1997 because of what I saw happening there. I thought a global baby bust was deflationary. That’s the way it worked in Japan. But now we have the largest retirement of the adult working population in the developed world ever since capitalism began. So that is very inflationary.

Now, obviously, you’ve got robotics, you’ve got artificial intelligence. But the shortages are in carpenters, in electricians and people who are doing the work that you can’t replace with technology. Between 2000 and 2020, the world job force doubled because China entered WTO, the fall of the Soviet Union, Eastern Europe joined the global economy, and a lot of women joining the job force. That is now reversing.

So yes, add that altogether, it’s a big secular headwind that the Fed can’t control, can’t deal with, and can’t solve.

[00:11:17] Alan

Good. You touched on the demographic point and also Japan and I guess linked to that, people talking about possible Japanification in China. China is an interesting one because talking about this argument around the pool of workers, which I think is in line with the Charles Goodhart book, that China will go from being a disinflationary force to being an inflationary force.

But obviously, at the moment, we’re seeing deflation in China and there is this concern that that might be prolonged. Is that just a cyclical phenomenon and do you think over time we’ll work through that and that China will start to become more of an inflationary force in the world?

[00:11:56] Kiril

The Chinese economy is the most competitive economy in the world, so there’s huge competition. They tend to create excess capacity, and that’s what we’re seeing now. I don’t think China is going to go the way of Japan, I think that there’s a lot of tools in the toolkit. China has more policy room than virtually any country in the world, which we’re starting to see them start to use.

For example, the compensation of the management of SOEs is now being tied to stock market performance, which for China in SOEs, this is historic. I think it’s a confidence issue in China, and a good 30 or 40% rally with the public participating would help confidence a lot. But the Chinese government deliberately broke the property bubble. So you’re bound to have a lot of repercussions from that.

Look at what happened in subprime, it was a big shake-up to confidence for a number of years. So that’s what’s going on now. But I think China is going to be fine. One of the things that people mention is China’s debt, but they don’t take into effect the asset side of the balance sheet. The government owns the SOEs, most of their percentage, and the SOE’s net asset value is 70% of China’s GDP.

So if you put a two multiple on that, which is really low, you get 140% of GDP–that’s an asset. On the debt side, the debt to GDP for the federal side is 21%, the lowest in the world, and the municipal is higher, it’s 50 to 80%. So you put 100%, worst case, 110% on the total debt as a percentage of GDP with the SOEs being potentially worth 140%. So it’s really net debt free to the tune of 30 percentage points.

Then you have demographics in China, which people talk about endlessly. Since I’ve been in this study for 25 years, I say that China’s working population peaked in 2012 but GDP doubled since then. So for every argument, there’s a counterargument.

[00:14:30] Alan

Sure. Obviously, a lot of people point to China as being very cheap at the moment from a stock market perspective, but at the same time are slow to invest. There is this question, is China still investable? You’re a student of history, of geopolitics. How do you grapple with that cheap valuation versus the potential geopolitical risks that is there?

[00:14:55] Kiril

Well, we made a shift to invest in deep value and high dividends in November of 2021. Our index, our China deep value index, is up 46% since then versus 11% for the S&P. So even in a big bear market in China, there were ways to make money. This year, we’re up a little under 9% versus 5% for the S&P. So I think that’s one point. It looks to me like there’s been just massive foreign liquidation. I think it fed on itself.

When all the foreigners are out, there’s no one left to sell but somebody was buying. The one who was buying was probably more informed than the seller was. I think one potential risk, but I think it’s probably discounted, is a Trump win and Lighthizer runs his economic policy and they decide to put 10% tariffs on and really force the trade deficit for the US to be drastically lessened.

I wouldn’t say that the risks of that are zero. It’s a real risk. But how much of that is already discounted into prices? Hong Kong has been down for four years in a row. No asset class has ever been down four years in a row. Even in the Great Depression, there were rallies. It’s just historic extremes, and the kind of market that I love to be involved in because there’s no hot money that’s going to rush out. It’s all gone!

The surprises are all going to be on the upside. Not that you just rush in right now, but you gradually start to look around for bargains. The government is really taking it seriously now. There’s no question that they’re moving.

[00:17:06] Alan

The great hope for the Chinese economy that people always are looking for is this rebalancing in economic growth away from being driven by investment and net exports I guess. But that still seems to be slow to come along. As you talk about, there is seemingly a confidence crisis which has accentuated in the last while.

When you’re looking at China and Hong Kong, are you looking for particular catalysts that might drive that change or is it more you’re thinking, okay, we’re just going to buy these assets because they’re cheap and over time things will work out?

[00:17:43] Kiril

You’re absolutely right. When you can have a value trap and what’s going to be the catalyst. The fact is that the government has been doing piecemeal policy actions. But when you add them all up over the last four or five, six months, they’re really massive. They seem small each time it happens, but if you add it all up, it’s really significant. One of these days, it will start to catch.

I know this is not my expertise, but I suspect that we had a low right after the Party Congress, it was a very emotional low, and then we had the rally on the reopening, and then we had a deep test of that October 2022 low, which was done on more bearishness, which is what you want. You want a test quite a time afterwards and you want it to be on more pessimism. So you can make an argument that we’ve seen the low.

[00:18:46] Alan

Interesting. One of the things that you talk about in your publications that I read recently in terms of the inflation picture, you say history is inflationary. I was curious what you meant by that. You’re a student of history, obviously. When you look at where we are at the moment versus the longer-term picture, are there parallels that you are seeing between now and the past or is it like the 1970s? What would you draw on from history in terms of the outlook for inflation?

[00:19:20] Kiril

Well, in the ‘70s, you had the Arabs quadruple the price of oil because the dollar was weak. Burns had pumped up the economy to get Nixon reelected, so there was a lot of inflation in the system. And then Burns tightened up. Somebody made a comment recently that Burns complained that the data was inaccurate. So maybe he isn’t as incompetent as the market seems to think he is.

I would say the same thing is going on now. I think the data in the US economy is extremely conflicting. The difference between GDI and GDP is historic. The fact that hours worked is down so much, and hours worked is more important than job creation. So are we getting the correct message from the data? I would say, at this moment, the ‘70s is as close a period as we can find.

There was a very sharp deflation in the mid ‘70s. You could buy a townhouse in New York City for $40,000 in 1977. Don Bren bought the Irvine Ranch which was the largest undeveloped parcel in California for, I don’t know, $380 million or something, something ridiculous. The deflation bottomed in probably ’76, but there was a two and a half year period where it was very deflationary. But the system hadn’t been purified, if you will. And then of course the Shah was overthrown and oil had another big run.

My study at least in the last inflation since the ‘70s is that it’s been oil driven. It was ‘73-‘74, it was ‘78-‘80, the 2000s was the same. So if you look at the oil picture, everybody’s got a different opinion on it. At various times in my career I have known a lot about oil, and in the 2000s I was the biggest oil bull on the planet. I rode oil from $ 20 to $143.50 in six years.

But I think we’re not investing enough in oil and this could continue to be that way. They keep talking about peak demand, it doesn’t happen. It keeps on roaring ahead. So I think the oil picture if you look out over three to five years is very bullish, which is inflationary. It’s the same case as the past.

I was reading something by somebody I thought was quite astute and he was saying that in the second wave in the ‘70s, inflation really hit the bond market hard. First wave, it didn’t hit it so much in the US. But in the second wave, you had that bond market crash, where in early 1980, Treasuries were yielding 8%, and three or four months later, they were 12%. And then Volcker started to tighten and then they went down every single day in 1981 until September of ‘81 when they bottomed. So that’s what I think at the moment.

But we’re living in unprecedented times, so we haven’t had QE before, we haven’t had QT. We haven’t had central bank intervention on this scale. We haven’t had fiscal dominance. We haven’t had the Treasury in such a bad fiscal situation. There are unknowns out there that we have never experienced and we have to be very flexible, which is why we study what the markets are telling us so closely.

[00:23:13] Alan

In terms of the oil market, you could put copper in there as well, there is that long-term bullish case that people allude to, underinvestment in the sector. But at the same time, obviously with oil, we had a spike on Ukraine, but has since come down and it’s been very stable. Even though we’ve had tensions in the Middle East and the challenges in the Red Sea, it’s just been pretty rangy.

Has that been a surprise or is it just the market in equilibrium at the moment but looking out ahead, things will change? Is that how you read it?

[00:23:46] Kiril

Well, we were looking for a pause or a sideways turn. Oil and oil stocks had done so well in that two-year period. They were due for a rest. If you listen to what the Saudis are saying, they’re very serious about maintaining the price. You have more countries joining OPEC, so OPEC-Plus 1 has never had more power. And then you have depletion and that’s 3-5 million barrels a day.

So you have to replace that and then you have to meet the new increase in demand. It really was shale that saved everybody’s day and the shale is really the Permian. We have consultants who study the Permian and the Permian is not going to produce as it has for much longer. There’s a very good case to be made that the rate of growth has slowed significantly and that there could be some significant downside surprises.

One point I would make that is not probably well known is that OECD demand for oil peaked in 2005 and it was emerging market demand that drove the demand, and that’s the same case now, except these are big countries. India, Indonesia, making a lot of money with people wanting a better standard of living.

Africa is coming along. Brazil is booming again. So I just don’t see oil demand being curtailed. I just see it continuing to increase. And if you don’t explore for it, you’re going to have a problem.

[00:25:46] Alan

You’re talking about India, Indonesia, Brazil, you didn’t include China in that. And it’s interesting, China seems to have shifted heavily towards solar. What’s your read on that? It’s obviously driven by their partially geopolitical, I guess. How do you see it?

[00:26:03] Kiril

China installed more solar last year than the rest of the world put together. They’re turning a resource that was a negative, the Gobi Desert, into a solar field. That’s how you’re supposed to do these things. But on the other hand, China’s coal usage is also increasing. China is definitely leading the green energy revolution. There’s no question. It’s amazing what they’re doing and how advanced there are.

A friend of mine went to China to look at these solar-powered trucks. A solar powered truck? This was news to me! So there’s a lot going on. But it’s a transition. Vaclav Smil did a wonderful book on this subject, “The Way The World Really Works” and he argues that energy transitions take 50 to 150 years, but this time because fossil fuels are so ingrained into our system, it’s going to be longer.

Is it 2050? I don’t know. I don’t know what the numbers are, but I know that not enough is being done. We are not exploring for copper, and we can’t make the energy transition without copper. Mines are being depleted. I think last time I looked at this, copper exploration budgets are one-third below their 2012 highs in nominal terms.

We’re going to have increased demand of 13 million metric tons a year by 2035. So I don’t know what will happen, but the logical assumption is that the copper price is going to go up dramatically. It’s what the assumption is. And I think we’ll wake up one day and that’s what will happen.

[00:28:02] Alan

I guess on a related topic, we’re starting to see this with uranium, which I guess is a similar theme. Obviously in the markets in the last year and certainly the last month, uranium prices have really accelerated to the upside. Do you see that as being pretty much the same scenario?

[00:28:20] Kiril

I do. I’ve been studying nuclear for decades and concluded that it was the best source of electricity. But you had all of the accidents, Fukushima, Three Mile Island, the uranium nuclear explosion in Ukraine, and that just turned people off. But there is a massive shift going on. I think at the recent COP28, 22 countries declared their intention to triple nuclear energy capacity.

I own a company that owns the hard rock uranium in Sweden and up until a couple of months ago, it was worthless. But the Swedish government went 180 degrees from abandoning uranium exploration to every CEO of a major company in Sweden writing a letter to the government saying we need to go nuclear. So this is going on. And because of the under-investment, there’s a shortage of probably 40 million pounds a year and the price has to be significantly higher to stimulate exploration.

It’s the same wherever you look. They’re not investing enough in energy, in oil, not investing enough in copper, not investing enough in uranium. So, somewhere out there is this crunch.

[00:30:02] Alan

Just taking that on to the next level, there’s a few different dimensions of this. Obviously, at some point it’ll be inflationary is one thesis. The second thing is within this, there’s winners and losers. Obviously, the US has a lot of cheap, natural gas. China has progressed on solar. Europe is caught in the middle with external energy dependence but no obvious solution. How do you see that playing out, US versus Europe versus China?

[00:30:34] Kiril

Germany has shot herself in the foot and it’s now buying imported LNG at three or four times what it paid for imported Russian natural gas. So it lost its competitiveness. The Europeans are not going to be able to compete against China in electric vehicles. The Chinese were very smart because they understood a long time ago that they could not compete against the German engineering on the luxury conventional vehicles.

So they made the shift into EVs, which they own. I think their prices are, I may be a few months out of date, but half of what the global prices are. They’re so price competitive. And the Europeans are in a bind because they have a lot of industry in China. There is a lot of car sales, for example, by big German manufacturers. So if they put up barriers to Chinese EVs, there’s going to be a backlash.

Also, a vehicle that can be 30% cheaper, why should it be banned? So I don’t know how the politics will play out, but logic tells me that it’s going to be very difficult for Germany, Europe, to keep Chinese EVs out. Very difficult.

[00:32:06] Alan

You talked about possible Trump tariffs as well. But is that a concern over the next 1 to 2 years that we’re heading toward with more protectionist, tense environment?

[00:32:18] Kiril

Well, I’ve studied protectionism a lot. I think it’s terrible. Hugely against it. The US already has the highest tariffs since Smoot-Hawley. There was a guy named Jude Wanniski who wrote a book in 1978 arguing that the passage of Smoot-Hawley caused the ‘29 crash. And he showed how as it was going through Congress, it looked like it wasn’t going to happen then the market rallied, it looked like it was going to happen, the market went down.

It’s very authoritative the analysis he did because what protectionism does is it breeds similar protectionism. You shut me out and I shut you out. It’s called “beggar thy neighbor”. It’s very destructive and we just have to watch. I’m told by people who are close to the Trump team that this is politics but it won’t be done. I’m just not so sure. We just have to watch this.

[00:33:20] Alan

Just to take another one a bit to the next level in terms of some of the specific themes you’ve been talking about and writing about, and I think a lot of them are all linked to this general shift towards a high inflationary or a higher inflationary environment and probably more volatile. Firstly, from an asset allocation perspective, for 40 years, the 60/40 worked very well. Equities went up, bonds did fine, and they were negatively correlated. And then we had a shift and a lot of people said it’s the end of 60/40, look at alternatives.

And then obviously last year, even though the correlation between bonds and equities stayed positive, there was less talk about the end of 60/40. From a high-level asset allocation, if somebody was saying to you what should a long term portfolio look like for the next 20, 30 years, what would you be saying to that person?

[00:34:15] Kiril

Well, I would not want to own bonds. I would want to have a high allocation to gold and gold mining, copper. We like India tremendously. I think China deep value and high yield is interesting. We have a food security index. We love uranium, as I mentioned. Japan is doing well. The government really wants to get the stock market up and wants to get more participation.

I like to be in markets where the government wants higher equity prices. I tend to be in my own portfolio extremely focused, but that’s not the way the world invests, and you need to have many different themes. But I think de-dollarization and a secular inflation is a good way to be positioned.

[00:35:20] Alan

You touched on gold, which is often an asset that elicits very emotional responses, gold bugs versus skeptics. Obviously, gold had a very strong run start of this century and then flattish for a period, starting to pick up again. I guess if you took the starting point at 1970, it probably outperformed cash. But obviously, if you went back another 40 years, it was fixed. So it’s kind of hard to assess. Why are you such a fan of gold on a long-term basis?

[00:35:56] Kiril

Well, any asset is really a supply-demand story. If you’re adding $2 trillion to the dollar universe and you’re adding 1% a year to the gold universe on a supply-demand basis, you know who wins in the end. If you look at the last 25 years, gold is up 617% versus the S&P up 288%. Obviously, what period you choose to look at is significant, but gold has done a lot better than people are aware of and it’s been consistent.

I would argue it’s been manipulated. You look at bullion bank traders in gold who were sentenced for manipulation, you don’t have to reach too far to see the evidence. I remember after Volker left the Fed, he said his greatest mistake was let the price of gold go up so much in 1979. Every central banker is thinking if gold goes up, this means that our currency is not respected. But the central banks are now buying.

I think the confiscation of Russian foreign exchange reserves or whatever you want to call it, freezing, which is really confiscation, it’s never going to be given back to the Russians, was a wakeup call for many countries who hold treasuries and who think China-US is going to go at it.

It’s going to be decades. There’s never going to be peace. It’s never going to be resolved. It’s going to be less tensions, more tensions. This is not going to be resolved. But will America force me to trade less with China? And the lever is the Treasuries that I own. I think we’re seeing quite a bit of this liquidation of Treasuries and by surprising places.

I was in Singapore last March when the Singapore Monetary Authority announced it had boosted gold holdings by 30%. And I had lunch with two prominent Indian business people, one of whom was building grain reserves for the Indian Government to double grain reserves for security reasons. I said, what do you make of this? He said, well, I can’t tell you what it means to Singapore, but I can tell you what it means to the Indian government. They’re going to see this decision by Singapore as de-dollarization.

I think there’s a lot of frustration among many countries that the US has used its dollar hegemony and they want to get away from that system into something else. The Chinese are leading in quantum communications. They’re creating a communication systems for BRICS countries. I think that we’re not too far away from a major breakout in the price of gold. It’s been waiting underneath its all-time high. It has now been going on for quite some time.

If you talk to chart people, they say this is good. It is marking time, it is gaining power, it is gaining strength to really blast out. When that happens, everybody will wake up. When that will happen, I don’t know.

[00:39:21] Alan

Is that a gold story and a dollar weakness story, do you think? As long as I’ve been in the markets, which is since the mid ‘90s, people have been worried about the long-term role of the dollar, its reserve status, etc., and it seems to chug along. But the concerns have come up about again after the financialization of the dollar. What’s your thoughts?

[00:39:44] Kiril

Well, currency, it’s a unit of account, it’s a medium of exchange, and it’s a store of value. The medium of exchange is definitely shifting dramatically. Countries are trading in their own currency. The Chinese are paying for oil to the Saudis in RMB. So that’s well underway. The reserve currency status I don’t think is as important as it was.

I was very involved in the emerging Asian crisis. We actually got it really well. The lesson for those countries was you must maintain large foreign exchange reserves because hot money in, hot money out. Now these countries are trading maybe in their own currency. They’re not dependent on the US.

The PBOC has swap lines with them, so that’s another source. So the need to hold large foreign exchange reserves has drastically reduced. In fact, foreign central banks stopped financing the US government in 2014. So it was well underway, this process. I think when we think about reserve currency, we have to think that it just doesn’t have the importance that it did once.

It was the head of the Dutch Central Bank, who wrote a letter to the head of ECB, I think it was the fall of 2022, who said to the ECB, you’ve got big losses in your bond portfolio, why don’t you mark to market your gold holdings? I forget what they valued in that but it’s less than the US.

There’s a lot of moves underway. There’s a move to have a BRICS currency that is gold backed. There’s conversation in Russia about having a ruble that’s gold backed. There’s a lot of things that are in process that could change this dynamic of a so-called reserve currency.

[00:41:56] Alan

With respect to China, they seem to have been stop-start in terms of the internationalization of the renminbi. They seem to want the dollar to have less significance, but they’re not overly keen for the renminbi to take up that mantra as a reserve currency. Is that how you would see it?

[00:42:15] Kiril

I was going around the world during the GFC and I was in China for a week or two and it became very clear to me that, first of all, China did not want to be dependent as much as it was on the fickle US consumer. But also, China understood the danger that systemic risk could impose on the Chinese economy, which is why they have been slow to open up their capital account.

This is why my friend Charles Li so brilliantly invented Hong Kong-Shanghai Connect, Hong Kong-Shenzhen Connect as a way to get around this capital issue so you can buy Hong Kong stocks or the outsiders can buy Chinese stocks. It was a brilliant conception. But I don’t know if that is going to change and I’m not sure it’s necessary for it to change the way that China is going forward.

If let’s say the Saudis want nuclear power plants or they want a 5G system, and so China buys oil, pays with RMB, and then the Saudis then buy 5G or nuclear power plants from China. No longer the old idea where there was this huge wealth transfer after the Arabs quadrupled the price in ‘73 and Kissinger devised the system of recycling these huge imbalances back into the US Treasuries and back into the US banking system.

That no longer works. That is not being done. That money is being kept for domestic purposes or for political purposes to finance other countries in the world.

[00:44:13] Alan

Is the implication of that then with less surplus being recycled, does that mean higher yields in the US over time or a more challenging financing situation?

[00:44:24] Kiril

That’s exactly what we’re seeing. As I said, foreign central banks stopped financing US Treasuries. It’s like you add two trillion to the number of dollars every year and at some point, would you have enough? And the US Congress just doesn’t seem to understand that there is a finite amount that you can keep doing this. We would argue the US has fiscal dominance now, and it is Janet Yellen who’s really controlling things.

[00:45:00] Alan

Before we get onto that, you mentioned the bullish case for gold. Two related ones. Gold miners seem apparently out of favor and haven’t participated in this run up in gold to any great extent. I’m curious to get your thoughts there and then obviously what people think of as digital gold now. You seem to be a fan of Bitcoin as well.

[00:45:19] Kiril

Well, I think that gold mining stocks are the cheapest asset on the planet, and the next cheapest asset is gold itself. You’ve got a market cap of the gold miners which is $250 billion to $300 billion. When Meta announced its buyback and dividend, its stock went up almost by the entire value of the gold mining industry. If and when gold breaks out–I believe I can argue that there’s a severe shortage of physical gold. And when it breaks out, that physical shortage will be really manifested.

You will then be forced to get exposure to gold through gold miners. The miners always go up more than a bullion in a big move. So that’s one. The average annual gold price is up 20% since 2011, which is close to the last top, yet the miners are down 40%. It’s an incredible discrepancy. Granted their costs went up the last few years, but their costs are now going down anywhere from 14 to 25%.

The reserve life of the big miners has declined 30% in the last 10 years and they unbelievably under-owned. The percentage that’s owned globally of gold as a percentage of AUM is probably under 1%. At the peak in 1980, it was 8%. So it is massively under-owned. When the Fed pivots or something breaks or something changes and the dollar gets weak, this will be the catalyst to set this off, or maybe gold taking off is the catalyst. We’re in uncharted times and I don’t know which comes first.

[00:47:28] Alan

One of the headwinds for gold maybe going back a couple of years was actually people were buying Bitcoin as an alternative. Do you see them both benefiting in this type of scenario this time around?

[00:47:38] Kiril

I’ve invested with crypto VCs, and many of them are buying gold. What’s interesting is I can make a case, and I have done this, that gold is the best barometer of inflation-deflation. You see all through the ‘80s and ‘90s, gold was trending down and gold bottomed in 2001, which is when I turned bullish on it at $250.

What happened is gold bottomed in December of 2015 at $1,050, and that was the end of the deflationary pressures. There was a very severe crash in oil prices and then gold went up as in stair step fashion. But gold peaked in August of 2020 just before the inflation arrived. Now, you would say, how can that be? You can say, well, gold went up in anticipation of the inflation and then it anticipated that the Fed would tighten and real rates would go up, so that’s what it changed direction.

If we think of gold as a magnificent barometer, it will help us understand what appears to be the conflicts. Gold is supposed to go up in inflation. Well, it does, but it anticipated inflation and anticipated the Fed’s response to it. So, Bitcoin,–it’s not–either-or, I think it’s both. You want to have both.

[00:49:12] Alan

Obviously, throughout your career, you’ve been very good at identifying structural shifts in the macro landscape and in the economic landscape. The big question people are grappling with at the moment is AI and is AI going to be a huge change for our day to day lives, our working lives and markets.

Obviously, we’re seeing the benefit or the impact of AI on stocks like Nvidia. From an economic perspective, you can make a bullish case on productivity, etc., that would offset some of the concerns around resource capacity that we have. How do you balance those two forces that are underway in the economy?

[00:49:54] Kiril

We’ve been studying AI for 10 years and really drilling down on it starting in 2020, so it’s not new to us. The adoption rate of AI is like nothing that’s ever happened before. I think in India, 83% of the Indians are in some way or form using generative AI at least once a week at work and I think in the States maybe it’s 46%. So it is a huge adoption rate.

There’s no question it’s going to be big. The only question is, when will it be big? Is it now or is it 10 years from now? I don’t think anybody has the answer. I don’t. Certainly, the Mag 7, which is now the Mag 4, reflect a very bullish case. So it’s in the market. Can it go up more with all the money they’re spending on AI development? I would argue probably not, but stranger things have happened.

[00:50:57] Alan

Is there a parallel with the internet and dot-com boom in 2000? Ultimately, it did change the world but valuations were too high at that time.

[00:51:06] Kiril

Yes, I think there is. I remember that period very well. It was a very painful period while we were waiting for the bubble to burst. I remember my good friend, Julian Robertson, who was a value investor and had the largest hedge fund at the time, closed his fund the day that the NASDAQ peaked. That’s the irony of the pressure of markets on psychology.

[00:51:31] Alan

I know your good friend Stanley Druckenmiller also went from bearish to bullish just at the peak as well momentarily, so it was a painful turnaround. You mentioned India there briefly and their adoption of AI. A lot of people now looking at India as the next China or as the next source of growth. Is that how you see it?

When you think of India, the case has always been, well, they’ve got the demographic support, but politically, it’s a lot more difficult for India to enact a policy than say versus China. That’s always been a challenge. What’s the bullish case for India do you think?

[00:52:14] Kiril

We’re very bullish on India. I have a very simplistic answer, then I’ll get into a more technical answer. If we were at 100,000 feet and looking down, we would have said, how would we have invested over the last 2,000 years? We would have invested with the people who had a lot of vitality. We would have invested in ancient Greece, ancient Rome, Ottoman Empire, Spain, Portugal, Renaissance Italy, and so on.

There’s no question that the vitality in India is exploding just like China in ’92 when I was there when Deng went to Shenzhen and said “to be rich is glorious,”¬–a communist country and he said to be rich is glorious, it’s just this huge dynamism in the people. I think Modi has done just an absolutely spectacular job, how he’s connected people to bank accounts, how he’s building out infrastructure, how he’s brought the underground economy into the real economy.

He’s fixing the problems. It’s just extraordinary what he’s accomplished. It just shows what one really good leader can do. We’ve liked India for a long time. We have an office there, we have staff. When I look on our Monday Zoom call, I look at the faces, most of them are Indians. It’s not necessarily a deliberate choice, it’s just because they were the best people.

[00:53:45] Alan

Very good. Just conscious of time, there was a couple of themes I wanted to pick up on before we close out. One was around natural resources. I know that’s been a theme. I guess it fits with the underinvestment theme. But also, I guess how do you think the decarbonization is going to evolve?

Obviously, we’ve had some progress, but the general consensus is not enough. Do you think there’s going to be an acceleration on that front and then again, you’ve got the possibility of Trump coming back and would that derail things to an extent in the US?

[00:54:20] Kiril

Well, Trump doesn’t believe in climate change. It will be drill, baby drill, which will tear the country apart. My view, we began focusing on climate change in 2002. There was a 500-year flood in Eastern Europe and that’s the type of outlier event I look at to tell me that something has changed. Not 50, not 100, but 500 years.

According to my theory of contagion, if it continues and there were other extreme weather events, then it’s a contagion until proven otherwise. The next year was the hottest weather in France’s history. Katrina, the Tsunami. But I concluded that it would be extreme weather events that would drive the climate change focus.

In many parts of the world, it’s too hot to work and then there’s flooding and the governments are really scared about what this means. The glaciers in Switzerland are melting. So they’re scared because they see where it’s going, and I think it’s the extreme weather events that’s driving this.

One day, there’s going to be a big one somewhere. By that, I mean, a hurricane hitting South Florida, the San Francisco Bay, the levees breaking. There are many places where you could have a big tragedy. God forbid it happens, but it’s just unavoidable.

[00:55:49] Alan

Before we wrap up, obviously, you’re famous for some of your contrarian calls. If you were to pick one top contrarian call, we’ve touched on a couple at the moment, what would you say at the moment?

[00:55:59] Kiril

Well, I mentioned it a little bit, oil. I had been a big disinflationist, bearish on oil all through the ‘80s and ‘90s, did not bottom fish, I didn’t buy oil or natural gas in the ‘90s. And then I noticed that after emerging Asian crisis and 9/11, there was a global recession and commodity prices were not going down, they were actually going up.

This is the anomaly that tells me something that should be happening and isn’t or shouldn’t be happening, but is. So I was saying, why is this going on? And then I read a book by Ken Deffeyes on Hubbert’s peak, which is in effect about peak oil. It’s very sensible that you cannot get 100% of oil reserves out of the ground.

When he wrote it, it was 25% or 30% recovery rate. With horizontal drilling, maybe it’s 35%. But you can’t get it all out because oil doesn’t flow, it’s viscous. If it’s a geyser, that’s natural gas. I said, wow, now I get it. I didn’t understand yet that China was going on this infrastructure boom. We turned super, super bullish on oil and I became the biggest bull on oil on the planet at $20 in January 2002, and we rode it all the way up until the June of 2008. It was at $143.50 when we got out. I would say that’s the major one.

This happens. Uranium in 2018, I would argue gold miners now. But you have to be patient and your timing has to be right. You could have turned bullish on oil in ‘99. Some of the smartest people in the world were buying the oil patch in the 1990s. They just were early. You can be early and wrong. As they say, the graveyards of Wall Street are full of people who were right too early.

[00:58:02] Alan

Absolutely. Just before we close up, good to get a sense on your process for idea generation. Obviously, I guess you read widely, you talk to a lot of people. Is it a formal process or do you just let it all sit and then the ideas come to you? What would you say about that?

[00:58:22] Kiril

Well, something will grab my attention. A good example is in 1988, I read in The Wall Street Journal that it took 70 years to put a landline system in the UK, 50 years in the US, 30 years in Japan, 20 years in South Korea, but you could do a mobile phone system in one and a half years.

I saw just from those few sentences that mobile was going to take over the world it would be cheaper and faster, which meant the developing world would boom and it meant if you thought about it, that all information would be available to all of humanity. I saw that as being just so massive. I’ll see things like that, and like this 500-year flood.

I think the Saudi-Iran rapprochement is massive. I don’t think we understand it enough. But to me, that’s one of those seminal events that occurs from time to time that people see and they don’t attach enough importance to. My clients often say to me that you see things that others see but they don’t think is important. And I’m able to pick that one thing and say, wow, that’s a big deal.

[00:59:35] Alan

Very good. Well, the final thing we always ask our guests is advice for people starting off, for people who want to get better informed on global macro and investing in general. If you were doing it all again or starting off again, what would you say to people to get if there were things to do, things to read to get better as a global macro investor?

[00:59:56] Kiril

Well, I think studying history is very important. I love history. I’ve read an enormous amount about it. Financial history is fascinating. There’s this book out by Edward Chancellor called “The Price Of Time”. He writes about the dangers of free money and very low interest rates and how it distorts the system. That’s the history that gives you a lot of insight. “Lords of Finance” is phenomenally interesting.

There’s another book that is not easy to find, but it’s “The Bubble That Broke The World” by Garet Garrett who is a fantastic writer. He wrote about the ‘20s and the ‘30s. The thing that grabbed me was he said they tried to solve the problem of debt with more debt. Exactly what we’re doing now.

It wasn’t the ‘29 crash that caused the depression. It was the Wall Street investment banks had gotten bonds from European countries and sold them to American savers. And when the depression came and when those countries defaulted, they lost all their money.

There’s a story about this guy in the late 1920s who was on the Long Island Railroad, and in those days, prices were in the newspaper, and he saw these quotes of bonds he’d never even heard of, countries he’d never even heard of. I remember I was in Hong Kong, I can’t remember the year, maybe 2016, an African country, they’d never come to market and they were selling bonds. It was four and five and six times oversubscribed.

Now, where I come from, that kind of debt should have a double-digit interest rate, not a 4% and 5% interest rate. This is what’s going to hit us–that risk was not priced into a lot of the debt and rolling that over, which is inevitable here at a higher interest rate but also in a different credit environment, is when we’ll start to find out where the real problems are.

So I think studying financial history is so crucial and so important, and so much fun actually.

[01:02:16] Alan

Absolutely. Well, Kiril, thanks very much. It’s been an absolute pleasure to speak to you today. Truly fascinating to get your perspective on the global economy and the structural trends driving everything. As you can tell, it’s a truly global macro world we’re living in, so it’s as important as ever to stay informed. Tune in again on Top Traders Unplugged for more content and we’ll speak to you soon.

[01:02:42] Ending

Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today’s episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you’ll be sure to get all the new episodes as they’re released.

We have some amazing guests lined up for you and to ensure our show continues to grow, please leave us an honest rating and review on iTunes. It only takes a minute and it’s the best way to show us you love the podcast. We’ll see you next time on Top Traders Unplugged.