Research and Writing

Flash forward 8 years, it is the summer of 2012 and I have just landed in Beijing with my family. Upon getting to our new apartment, I realized that a bag was missing, and that bag contained my underwear. This led to an emergency trip to the Gap. When it was my turn to pay, an elderly woman just walked in front of me like it was nothing and cut me in line. My local friend who was there to help me navigate described it as such: “She grew up during famines where if you cut the line you got to eat and if you didn’t, you didn’t. You think she cares about the social conventions around waiting in line at the Gap???” It turns out that much of what we call “common sense” or “logic” are not universal truths; they are really choices that are shaped by our values, culture, and lived experience. I didn’t expect that old woman to cut me - it didn’t “make sense.” It took years of living in China before I stopped being surprised by how differently those around me would view a situation, how they would make choices, and what they would value and what they didn’t. I learned to be humble about “knowing” how folks from radically different cultures would think.

Which brings us to today. When I apply the Harrington 10% rule to Trump and multiply it by the “you can’t possibly see the world the way an Iranian cleric sees the world” rule, I end up in a place where virtually no one could possibly know how things resolve from here. Or put another way, at this point I believe that more or less anything is possible from this conflict. And yet…when I look at market pricing and market commentary, I see a lot of yawning, a lot of “knowing” that things are going to go back to normal, a lot of “knowing” how Trump and Iran will proceed, and a lot of complacency about how wide the range of outcomes could be. Maybe things will work out fine, they usually do and that is probably the most likely outcome. But scanning across options markets, we see a lot of good value. Specifically, we see some high-stress scenarios discounted as nearly impossible, when our analysis says they are very much possible. That creates opportunity.

Last week I made three claims about the conflict in Iran, prefaced by the disclaimer that “it could age like milk.” Claim #1 and #2 have already curdled. Luckily for me (and our investors), claim #3 was that almost every trader should sit this one out, since “in a scenario where I highly doubt that even the central participants know what they are going to do, it’s a little hard to imagine anyone having a real edge.” In our commodity fund we hedged away as much of our exposure to the war as was practical, and we are up a bit for the month so far.

So this week I decided to take a breather from being wrong about the war, and instead share our firm’s evolution on AI. I share it to pull back the curtain on what we are doing as fiduciaries, but also (hopefully) to be helpful to you. With the exception of James Wang, I suspect no one reading this is using AI nearly as effectively as they could be, in their business or in their life.

Last summer, we raised some GP capital from a few existing clients and showed them a buildout plan. Multiple research hires at different seniority levels, and all expensive. We planned to scale our investment team the conventional way, because even though we were using AI at the time, it was no substitute for humanity.

We never made those hires.

By October, AI research capabilities were such that I went on stage at a conference and said that I was struggling to see why we would hire any junior investment people. For example, that month I wrote a piece where I went back through every Chinese five-year plan and examined whether they did what they said they were going to do. AI did the immense grunt work of parsing all of the plans, separating out testable promises, and then checking what happened subsequently. That would have been a junior person’s job for a couple of weeks, and instead it took me a few hours to do the entire study and write it up.

The improvements continued to compound. Having displaced the junior person, we then went after the gray hair.

Earlier this year we built our first AI-powered system that was designed to be a peer to me and our team in trading one of our most important markets. The engagement model was completely different from “ask a factual question, get back a factual answer.” Instead, we fed it raw data and what we believed were our edges in trading that market. It then went off and did 3 three things:

1. It pressure-tested our assumptions. It came back and told us where our edges were real and where we were kidding ourselves. That kind of honest audit is nearly impossible to get from an employee who’s trying not to offend their boss, and it’s hard to do on yourself when you’ve been trading a market for years and your biases are ossified.

2. It proposed new ideas. Ideas that we had either just missed or were blind to because of our aforementioned biases.

3. It freed us up to do other things. It scans markets and news flow on a regular schedule, checking what’s happening against our framework and flagging when something looks off. We were already doing this work, but now it gets done for us. We can instead focus on other things…like systemizing and launching our equity ETF.

I want to be clear about what I’m claiming and what I’m not. I don’t trust the system enough to give it trading permissions, and I may never. I own the firm’s PnL and it doesn’t make sense to me that I would be disintermediated. Any output that it produces must be checked before using…just like human output needs to be checked. But it’s getting hard to argue that any single human on our team has a better handle on that market than the system does. We are now rolling this out across every market we trade.

None of the researchers we thought we needed are getting hired. Some of that cost savings we’re keeping as a buffer against the inevitable AI price hikes. Some accrues to our shareholders. And the compounding improvement in our research and positioning accrues to our clients — including, as of Friday, anyone who buys the AVOS ETF.

Here are a couple of things we believe — hopefully this helps you navigate the maelstrom of bad takes out there:

Closing the Strait of Hormuz is not a thing.

Putting aside the logistics of whether Iran could actually shut it down for any meaningful amount of time even if they wanted to (they cannot), it doesn’t make any sense for them to try. The strait isn't a weapon Iran points at the world…it's the door to their own economy. Eighty percent of Iran's oil exports flow through it. Closing the strait would be an act of economic self-immolation that also happens to enrage every single one of your neighbors, your biggest remaining customers, and the country currently bombing you. The people who are most confident the strait is closing are operating from a model of geopolitics where countries just do the most dramatic thing available to them at all times, which is a model that describes approximately zero periods of history but does describe a lot of Twitter threads.

Losing Iranian oil is not going to cause prices to spike above $100.

Our base case is that Iranian oil will continue to flow, but let’s just take as a given that we lose it. Iran exports about 1.5 million barrels a day. China adds about a million barrels a day to their stockpiles. They can offset most of the loss in Iranian supply just by tapping the brakes on their SPR build. In the case of any acute material rise in prices, they will go the other way and draw down some oil from storage. The US will do the same from our SPR. In the medium term, you have the ability for other countries to flex their production higher - e.g. the US and Saudi Arabia. There is not going to be some kind of shortage unless Iran somehow cripples the production capabilities of one of their neighbors. Good luck with that.

The overwhelming majority of traders should sit this one out

There are two possible roles oil can play in your portfolio. It can be part of a strategic commodity allocation, in which case the only trading is rebalancing. Or, you can try to trade the market for alpha if you have an edge. In a scenario where I highly doubt that even the central participants know what they are going to do, it’s a little hard to imagine anyone having a real edge.

Bigger picture, we strongly believe that the Fed Put exists, and also that it is likely struck closer than most investors think. We don’t know precisely where - and neither does the Fed - but I would bet on it being less than 20% and maybe closer to 10%.

Why do I believe that? Because it flows logically from the “K-shaped” dynamic in the US economy. There are two very different US economies right now. If you are wealthy enough to own financial assets, you’re doing great. Those financial assets have appreciated and inspired confidence and fueled strong spending. If you don’t have financial assets, you instead are trying to keep your head above water while prices of the necessities of life are rising faster than your wages.

So what happens if the stock market wobbles? It risks taking the top branch of the “K” with it. Which, in turn, risks removing your pillar of strength and causing the economy to weaken quickly. The Fed can either accept this risk (lol) or they can do their favorite thing in the whole wide world…aggressively print money.

Put simply - for most of history, the performance of the stock market reflected the performance of the economy. But now, the performance of the economy reflects the performance of the stock market. And we believe the Fed knows this and will act accordingly.

This isn’t the only “Fed Put” lurking in markets - I’ll write about the one in the bond market in a future letter. But it all comes back to the same conclusion - expect a hair-trigger on the printing presses.

Meanwhile, many emerging countries have much better pitches - smaller fiscal deficits, less outstanding debt, and trade surpluses. No country is without warts, but in many cases in the EM you are at least being compensated for some warts through higher real interest rates. In part for those reasons, we have been structurally overweight emerging-market bonds versus developed-market bonds since our inception, and probably will be for a long time.

The chart below shows the cumulative total returns of three common bond ETFs over the last five years. It hasn’t been a great environment for bonds, so none of the returns have been worthy of writing home. But assuming you care about diversification and therefore want to always own some bonds, the relative returns have been stark.

The beauty of investing globally is that you can hunt down the best deals, no matter where they are domiciled. That’s true for stocks, and it is true for bonds. And in the case of bonds, we think it is clear that the best opportunities live in the emerging world.

At one end of the spectrum is gold and uranium, where the hot money has pushed prices to levels that are a little spicy, but still more or less consistent with underlying fundamentals. And, in both markets, there is a steady drumbeat of price-insensitive structural demand that will keep buying. Nuclear power plants aren’t going to stop buying uranium and global central banks aren’t going to suddenly decide that lending their surplus dollars back to the US government is attractive. In those markets, we think the longer-term thesis is intact, even though we expect more short-term volatility.

In the middle of the spectrum is copper, where prices have disconnected from supply/demand forces, but at least part of that is a “rational” stockpiling demand from folks worried about the Trump administration reversing course and slapping tariffs on refined copper. In the absence of those tariffs, we see tough times for copper over the next year as outsized inventories need to worked through - even if the longer-term picture still looks bright.

At the far end of the spectrum…the VERY far end…is silver. The price of silver at this point is more or less the same as the price of a meme stock or a meme coin, set pseudo-arbitrarily by hot money chasing recent returns.

Like any speculative frenzy, there is a narrative that traders are hanging their hats on, and that the performance-chasers use to justify jumping onboard. Specifically, that 1) the “debasement trade” - particularly in China - is causing buying and 2) there is a shortage in the physical silver market caused by solar panel demand. I wrote a piece in August (available on our website) titled “Plausible Nonsense.” That phrase comes to mind here.

Let’s look at 1). First, let’s get something out of the way - silver is mostly a functional industrial metal. The market is way too small to matter as a “storehold of wealth.” The IMF excludes silver in their definition of reserve assets, and basically no global central banks hold any. The chart below shows government participation in the silver market. No one has done anything for more than 10 years.

That could be ok (maybe) if you had a sustained capital flight into silver from smaller investors worried about their local currency. That is a big part of the narrative around the explosion of Chinese retail buying. We think that explanation is just wrong. Chinese investors almost always pile into the thing that just went up the most. That’s true for real estate, bank products, gold, silver, the stock market, etc. They rarely start market rallies, they just come in later and exacerbate the rally and the subsequent selloff. Silver buying in China is just pure retail performance chasing, like they always do, and has nothing to do with currency debasement. The chart below shows the story in equities (the example with the cleanest data). When markets have recently ripped, households lever up and buy, and vice versa. It’s not that deep.

On 2), the physical silver market has been balanced or in surplus from a supply/demand perspective for many years. We think the idea that solar demand has suddenly exploded to such a degree that it is causing an acute shortage is farfetched. This piece is already long so I won’t dive into the minutia, but there are physical market indicators that would be telling us if this was happening, and they aren’t. Instead what we are seeing is the opposite - a start of substitution away from silver because of the high price, and chatter around higher scrap supply. As always in commodities, the cure for high prices is high prices.

So are we telling you to short silver? Definitely not. In these newsletters we talk about what we believe and what we are doing, but you need to decide for yourself what you should do. And what we believe is that the dogecoin comparison in the title of this piece is apt. A lot of people made money in dogecoin (on both the long and short side), but a lot of people also got taken out on stretchers (again, on both the long and short side). This is the same journey speculators are on with silver. Do with that what you will.