Research and Writing

This “lag” dynamic happens all the time in markets - an event happens, but then it takes time for the event to actually change outcomes in the real world. And most of the time, most markets are pretty efficient at sniffing it out. Central bank policy is famous for this. At the moment the Fed lowers interest rates, nothing changes in the economy, but the market reacts and prices in the things that will eventually be changed by a lower interest rate. You also see it when there are public market proxies for private market investments - public markets will mark down a troubled REIT or private credit fund, even if the sponsor hasn’t yet marked down the underlying private assets.

Which is why we find what is happening in markets today so bizarre. Instead of light coming from the sun, we have oil (and fertilizer and helium and LNG) coming from the Middle East. And instead of 670 million mph, those huge oil tankers travel around 15 mph, or about the same speed as a very fit person can travel on foot. A catastrophe is slowly moving through the system, as tankers finally reach their destinations…but without another tanker behind them.

The chart below from JPM shows the picture. Lack of incoming supply is being replaced by drawing down inventories, and global oil inventories have rolled over and are falling off of a cliff.

“But wait Josh, we still have roughly 8 billion barrels? That doesn’t seem so bad” is a thing you could be forgiven for asking. The problem is that you don’t get to draw all 8 billion, or even anything close to that. You need some minimum amount of oil to keep tanks, pipelines, etc functional. It’s impossible to know precisely what that number is, but the most credible sources peg the amount of oil that remains actually available at meaningfully less than 1 billion barrels. We are not far away from needing to defend tank bottoms through soaring prices.

Iran seems to believe that if they block the Strait, eventually the pain for the rest of the world will be too great and the US will cry uncle. The US seems to believe the opposite, that it is Iran that will cry uncle first. This has spawned one of the dumbest and most destructive games of chicken in human history. A lot of humans, particularly in the poorest parts of the world, have already experienced the equivalent of the sun exploding. The more this thing drags, the more the blast radius will spread. We see incredible value in betting that even the damage already done implies a resolution will not be as smooth as markets are discounting - with more damage still likely to be done.

We have different expectations for the safety of different products. If you go to a grocery store, you aren’t thinking about “caveat emptor.” The store isn’t selling bread with arsenic as an ingredient, if its on the shelf you can assume it is safe. The worst thing that could happen is that you could get a tummy ache from buying and eating too many Hot Pockets.

Home Depot operates at a different point on the spectrum. They sell a lot of stuff that is super dangerous if used poorly, but also super useful in the hands of a professional. I have a tree branch that is hanging alarmingly close to the line that brings power to my house. If I wanted, I could go into Home Depot right now and buy a gigantic ladder and a chainsaw. The government isn’t going to stop me, what stops me is fear of maiming myself and going viral on Tik Tok when my neighbor posts the video “Idiot with chainsaw falls off ladder.” Eventually I’ll call a professional and they will use those same tools and take care of the problem without a hitch.

You could imagine more extreme examples. I can’t go on Amazon and buy enriched uranium or a bazooka. The government has said “there are no legitimate uses for these things, they are illegal.” Reasonable!

Which brings us to financial products. Where are they on this spectrum?

When we decided to use the ticker AVOS for our ETF, we checked to see if it was already being used on other exchanges. It is - there is a product on the London Stock Exchange with the ticker AVOS. What does it do? It gives you a 3x levered short position in Broadcom. I have to ask - what legitimate use is there for this product? I don’t need it - if I lose my marbles and decide to go 3x short Broadcom, I can easily do that myself without paying their exorbitant fees. It is targeting precisely 1) people who aren’t sophisticated enough to do a relatively simple thing themselves with 2) a fund that is ultra risky and has no reasonable legitimate uses. Folks who buy this fund are either going to get lucky or get hurt. So I didn’t worry too much about “confusion” between this fund and ours, since their fund is obviously going to blow up and disappear before too long.

This week we had the pleasure of visiting the Nasdaq building in NYC to celebrate our listing. It’s weird that the camera only added 10 pounds to me and not everyone else.

During our visit, we saw a big firm ring the opening bell for their ETF launch. This beauty was described as a “Nasdaq Dynamic Buffered High Income Index ETF.” Or, to translate, the Nasdaq index return but lower, with more fees, and with worse tax treatment. I ask again - what legitimate use is there for this product?

So to answer the question posed by the title of this piece: no, buying ETFs is absolutely not like buying groceries. An alarming number of ETFs are, objectively speaking, bread made out of arsenic. Now we are also getting an expansion of crypto and private asset products that are available to the masses, and again, a lot are pure arsenic. So to the extent this piece has actual advice and isn’t just an old man yelling at the clouds, I’d give the following 1) anytime you hear the word “democratization” around a financial product, you should probably run away 2) if you yourself can’t tell the difference between products with a legitimate role in a portfolio and radioactive gambling, find someone who can to help you 3) if the person or company creating the product is not buying it with their own money, you shouldn’t either.

The benefits of commodities have felt very theoretical for most of our investing lifetimes, shaped instead by living through the biggest equity bull market of all time. This has created the prevailing wisdom that commodities are an anchor around your neck, underperforming financial assets like stocks and bonds and therefore not worth including. The average institutional allocation to commodities is less than 1%, with a lot of zeroes in the sample.

But is the premise right? Are commodities an anchor around your neck? We now have some new data to help us wrestle with that question. In a recently published academic paper with the pragmatic title “An Index of Commodity Futures Returns Since 1871,” the authors do the horrific grunt work of slogging through primary sources back to the Ulysses S. Grant administration to reconstruct commodity returns. This gives us the ability to compare them apples-to-apples to other asset classes. The paper includes many interesting nuggets but perhaps the most relevant is that commodities outperformed equities in 43% of years and 40% of decades. Hardly an anchor! Here’s the chart:

Commodities and equities basically battled to a tie in the first 135 years of the sample, before equities ripped ahead post-GFC. As the chart shows, that has happened a few other times in history, and every time the real assets reeled in the financial ones. Do with that information what you will. For us, a healthy slug of commodities always made conceptual sense for a portfolio; now it makes empirical sense too.

For those that are interested in the details, the paper is here.

This seems like a good point in the story for a quick side quest. I’ve always thought that a good definition of “common sense” was “an emergency brake for your logic.” If thing “A” logically implies thing “B,” which in turn logically implies that you should buy all the silver in the world, “common sense” is the thing that should ride to the rescue and tell you that your logic is bad, even if you can’t see why, and you need to abort mission.

Back to the story. When their plan inevitably went south, the Hunt Brothers started getting margin calls. They needed to get cash quickly. When you need cash, you sell what you can sell, not what you want to sell. They couldn’t really sell their silver without tanking the market, so they sold their other assets - oil assets, real estate, and cattle to name the big three. Innocent bystanders in those markets saw a wave of selling pressure, saddling them with losses. The Hunt Brothers had historically been a friend to other investors in those markets, providing investment capital and bidding up prices. Not anymore.

Which brings us to why I am telling you this story now. Central banks have been a great friend to gold investors since 2010, stockpiling it as a way to store their sovereign wealth. However, many countries are seeing their fiscal positions degrade quickly from the elevated cost of their energy imports. This is dragging them into the same paradigm as the Hunt Brothers, and selling whatever isn’t bolted down. Turkey has been the canary in this particular coal mine, selling it hand over fist since the war in Iran started. They need the money! And they have been an important contributor to the fall in gold prices over the last month. What troubles us, though, isn’t just Turkey. We’ve identified 7 other countries who 1) have hefty energy import bills 2) hefty gold holdings and 3) some cracks that imply they may need to sell. There is no evidence yet that they are actively selling, but the longer this drags on, the more likely it becomes. And if they do, the gold market could have a real mess on its hands.

We think the secular trend of governments using gold instead of fiat-denominated assets as a way to store wealth is still in the relatively early innings. And, we think the turmoil in the Middle East is likely to strengthen that trend in the medium and long term. In our longer-term investing portfolios we have no qualms about holding gold. However, we think that in the short-term, there is the possibility of more pain, and in our tactical portfolios we are sitting this one out for a while until the specter of forced central bank selling subsides.

The charts below show the picture. The dotted line is when the war started. We’ve inverted the purple lines to make the relationships easier to see. We’ve also included the prior 6 months so that you can see how much the relationships have changed. Finally, we’ve slapped pre- and post-war correlation numbers in the corner of the charts for the mathy folks who read this, but they don’t say anything the chart isn’t already making clear.

Equities are just oil:

Bonds are just oil:

The US dollar is just oil:

Metals are just oil:

What are the implications of this? Use March as a gut-check. Virtually every strategy, fund, and asset class lost money at the same time. It should feel like “oof, that really sucked, but I can live with it.” If it feels worse (or better!) than that for you, it is probably a good indicator that you need to tune the risk level of your portfolio, and maybe to some degree the composition.

Fungibility ensures that there is one price for a commodity. If copper costs 5 bucks in Boston and 10 bucks in New York, you’ll quickly get people buying copper in Boston (pushing up the price) and selling it in New York (pushing down the price), until the price difference doesn’t make up for the transport costs of moving it from one place to the other. There are ridiculously successful companies that do this globally across commodities - buy it in one place, move it, and sell it for a profit someplace else.

At least, that is how it works on paper. Reality can be messier. And with the duel wars going on now - the trade war and the hot war in Iran - the very meaning of the word “commodity” is getting mangled.

If you can’t move a commodity from A from B, there is no mechanism to force prices to converge. This could happen, hypothetically, if you were afraid your ship was going to be blown up by mines or drones. Bloomberg published this great chart last week, showing the dynamic in oil. You can see how similar oil prices were before the conflict, and how dissimilar they are now. Fungibility has been broken.

Relatedly, I’ve been getting the question “why hasn’t the price of oil gone up more?” Part of the answer is “what do you mean by ‘oil.’ ” Based on the chart above, I doubt Asian refiners are asking this question.

Some commodities are difficult to store and move. Natural gas is a classic example. If you produce gas in Texas, it’s hard to sell it in Europe. You need to liquify the gas - creating LNG - and then put it on special ships. If you go and read about this topic, you will encounter another vocabulary word: “cryogenic.” I’m pretty sure nothing that utilizes the word “cryogenic” is cheap or easy. But the world has been trying to change this. Our capacity to move natural gas from A to B has been growing rapidly, increasing the efficiency of the overall global market and bringing us modestly closer to one global price for gas. At least, that was the case, until Iran blew up a bunch of LNG capacity that will take many years to repair and rebuild.

Metals are less exposed to a dustup in the middle east, but more exposed to a trade war. If New York put a $5 tariff on all copper imports from Boston, then it makes no sense to buy for $5 in Boston, sell for $10 in New York, and then pay all of the profits back via the tariff. So tariffs just structurally make prices different in different places. The chart below shows one stark example. CME Copper is the price in the US and LME Copper is the price in London. Copper is cheap to move and store, so the prices should be basically the same. Last year Trump said he was going to slap a tariff on copper, causing an expected tariff rate to get priced into the spread between the two. Then Trump said “just kidding” and the price of US copper collapsed back to the global price, where it has remained ever since.

Globalization compressed physical distance into an afterthought—capital, commodities, and information started moving with a kind of frictionless efficiency that made markets feel almost continuous. But that same interconnectedness is now showing its fault lines, with geopolitics, tariffs, and protectionism reintroducing friction into the system - particularly in commodities. Understanding the implications of that in a granular way will be an important part of managing money for the foreseeable future.