Research and Writing

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.

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.