Transcription
OpenAI and Tropic are essentially looking to build medieval fortresses with huge walls and say, "Come into our fortress and you'll be safe here," to the Goldman Sachs of this world and the JP Morgans, etc. And China's building Dubai. It's not a fortress. It's everybody can come in. Everybody can come out, and you do whatever you want. And so it's, it's two completely, completely different concepts, which is funny because you would expect the US to be the open one. You would, because of all of the US history, and you would expect, given China's history, to be the closed one.
China did not have the option of doing the closed one because the closed one needs ever more compute and it needs ever bigger capital spending. Historically, most Chinese companies are happy to throw money and human resources at things. This time, the US told them, "You can't do it because we're not going to sell you the chips." So, they had to find workarounds. The only workaround was to open source it and have lots of software developers based everywhere around the world help you improve the product, which is completely anathema to the usual Chinese way of doing. Usually, China will just throw money at a problem. This time, they couldn't do it.
Welcome to the Risk Reversal podcast. I'm Dan Nathan. I am joined by my very good friend Peter Bookbar from 1BFG Wealth Partners. Peter, this had to work.
>> Well done.
>> I've had to work a lot.
>> This is a lot easier. By the way, this is one of my favorite pods. Um, I think a lot of our listeners know that. Um, this is Louis Gave. He is the CEO of Gavekal. He is in town. Uh, and he's making time for us, and we really, really appreciate it. Louie, welcome back to the podcast.
>> Thanks for having me, guys.
>> Really quickly, and we're going to get into a lot of stuff. We were going to talk geopolitics. We know that you've had an amazing, amazing call on, um, other parts of the world. There are other parts of the world to invest outside the US. Energy has been a big theme with, uh, you, and you know, we're going to talk about geopolitics. Uh, we definitely, I, I've been reading your stuff, and it's excellent. You've been talking a lot about the data center build, not just here but abroad, and what potentially some of the reverberations will be if we do see a pullback, um, in, uh, in data center capex. And I know Peter, you want to go deep in China. Um, we've done that with you over the last, uh, year or so, and it's been great stuff. But just remind our listener a little bit about your background and your firm.
>> Sure. Uh, my background, I'm French. I grew up in France, in Paris. I went to the US for college. After college, I went, uh, back to France. I was in the French army. I officer school. I was an officer for a while. Then I started work for a French investment bank. And they sent me out to Asia. And I've been in Hong Kong, uh, basically since '97, uh, on and off. I've lived a couple other places, but, um, started my company, Gavekal, 25 years ago. Um, we're headquartered in Hong Kong. We, uh, started off as a research firm. We moved into money management. Uh, so have a private wealth arm, and, um, yeah, our main office is Hong Kong. We have an office in Beijing, an office in Paris, and, um, and yeah, we have, I'm fortunate enough to have a number of clients here, uh, in New York and around New York. So I try to come back, >> about once a quarter, but really it's like two or three times a year.
>> Yeah. And you make time for us, and we were, uh, you gave us a great invite to a client event that you did, I want to say in the early fall, and it was literally some of the best and the brightest, um, in the investment world. So we appreciate you, um, making the time for us, uh, here. Let's, let's just kick it off a little bit about, you know, here we are. Um, we had this, uh, it looked like it was signed at Versailles. It was like, take it to the bank, you know, that sort of thing. No, I'm getting, I'd love to get your take, actually, as a Frenchman, what you thought of that whole thing, um, really quickly. Can we do that for a sec?
>> Well, the first thing, the fact that it was signed at Versailles, it's like, do these guys not read books or, um, or are they jinxing it? Because, uh, you've had two big treaties signed at Versailles. One of them was in 1870 when France lost a war to Germany, which was a big humiliation. We lost a big chunk of territory and huge reparations. And then, of course, the, uh, you know, the post-World War I, um, and both of these peace treaties were essentially disasters that planted the seeds for the next war. Uh, 1870 planted the seed for 1914. 1914 planted the seeds for the Second World War. Um, so you could say, third time's the charm, that, uh, we get another Versailles deal, and that this one will work out. Um, I think, I think it's already, like, it's already seen that it's not, it's not really working out.
>> Uh, >> because defining what works out is is difficult in itself.
>> Defining what works out is diff, is difficult in itself. I think there's, there's, there's a lot of challenges. Uh, to be honest, I think that when the US took out the Iranian leadership, uh, I actually think that was a mistake. Um, because then you don't know who you negotiate.
>> Kind of like Saddam, basically going back 25 years ago.
>> Exactly. Well, turns out they were negotiating with the IRGC instead.
>> Well, exactly. So, it's, it's always better the devil you know than the devil you don't. Um, and so when, when the US took out the leadership, it essentially broke down to every regional commander being in charge of his region. And then now you have to get everybody on board to essentially agree to, to peace terms. But if you have 31 different regions driven by 31 different guys, and they all have weapons, and they all have drones, and they all have missiles, they might all decide, you know what, I actually don't like this deal. I am going to bomb the next ship that that goes through, or unless you pay me so, so much. Not me, not Iran, but me. Um, and so I think we're, we're in this, uh, so President Trump right now is really upset because five boats, five boats, you know, got got bombed in, in the Gulf. Um, and I, I don't think that was really unpredictable. I think that was actually the path of least resistance. That, that was where we're most likely to go. Now, in terms of the, the, the market reaction,
>> Yeah, no, that that's being
>> I, I, I've been a fellow bull and long energy stocks as well, and I was pretty shocked that oil went back down to the 60s. Now, I was not, I was not a believer that it was going to stay there. I, to me, I've been saying that 85 is the new 65 when things eventually settle out. But were you, were you shocked at the, at the world response to what has happened? Because we thought in May, oil is going to go to 150. >> In June, oil is going to go to 150 if this continues. And then here we are now, even with the Strait partially open, call it, it's still a fraction of the ships that were going through prior to the war.
>> Yep. So I think we were all, uh, and by the way, I share, I shared your enthusiasm for energy, and I was, I came into this year massively long energy. I stayed energy long way too long, and I, in fact, I still am. Uh, so I share a lot of the pain. And obviously, it was a great first quarter, and it was a disaster of a second quarter. I, I think I had black hair before the second quarter. Um, it was, um, so, no, look, I, I completely share your, you know, surprise. Um, I think there were two things that we perhaps underestimated. The first was we were caught with our pants down when Russia invaded Ukraine. We, the world, in terms of oil storage, in terms of natural gas storage, etc. Um, and so I think in recent years, everybody built up storage, especially, and I think this is the part that perhaps the world missed, uh, especially in China and, and frankly, in Asia. Um, and so what we saw during this crisis, this time around, um, was something that we've never seen, well, we've seen in the past, but not to this extent, which was China just completely backing away from the market. Um, and, and it could do that because officially, China had about 1.3 billion barrels in, in storage, but really, it's probably closer to 1.8 billion, uh, of storage. And they've probably also increased their capacity to import stuff from Russia, um, and, and doing it a little bit on the sly. So you put those two things together, and essentially what China could do was say, you know what, I'm backing off from the seaborn oil market. I'm just not going to buy anything. And, and that was enough.
>> And it's part of that they stopped, uh, exporting products.
>> And then they also stopped exporting products. Um, which, which is something maybe we can come back to, because because I think that's important. But to your point, China used to get all this oil from Iran and from the broader Middle East, goes to these tin pot refiners who, uh, who then export this all across Southeast Asia, down to, down to Australia, to India, to, to everywhere. Um, and so as oil prices shot up, I think you had two factors. One of them was the poor countries, the Sri Lankas, the Indias, the Pakistans, they backed off. Um, so that was one factor, and then the other factor was China just completely stepped away from the market. So I think we essentially now live in a world in which, to your point, if oil gets to 65 and below, China just like buys every boat and ships in as much as it can and stores it. And because it has the capacity to store it, it's kind of unique. Storing oil is costly. And, but China's built up huge infrastructure to, to do just that. And it did that partly because China always believed that if and when the US really comes for us, they'll block us on energy. Uh, because that's what they did to Japan in the '30s, because the US essentially controls the Middle East. So China's perception was, we always have to have huge energy storage. So at 65, they buy as much as they can. 65 and below, and at 100, they stop buying. So you end up, if, if that's the case, if you think, okay, well, China sets the oil price. We live in a world where we're in a $65 to $100 range. I actually think that's great news for most energy companies. Like, you talk to any energy co, and they're like, 65 to 100, I'll sign with both hands. It's like, it's happy days because there's not going to be great capex. I don't have to worry about everybody increasing capacity. I'm making great cash flow. Well, most companies make, most companies,
>> 65, they were making healthy cash flows.
>> Yeah. 65, you're making healthy cash flows. If the new normal, if the average, we spend most of the time is 85, you know, you talk to most CEOs of energy companies, like, sort of happy days. Now, there is, to your point, there is one additional to this, though, uh, which I think people aren't worrying enough about, is while the oil prices have stayed muted, crack spreads have really blown out.
>> $60 in the US.
>> Yeah. No, it feels like we're going to get to the point where spreads are, crack spreads are higher than the oil price, which is, of course, never happened. Um, so, and I think there's several factors behind that. There's essentially three factors. First, Russia and Ukraine keep bombing each other's refineries. Seems like every day there's another refinery that goes out in Russia.
>> Yeah. Or in Ukraine.
>> Or in Ukraine, too. Right.
>> They, they keep taking out each other's refining capacity. That's number one. Number two, during this Iran war, you had six major refineries in, in the Gulf that were taken out, including the second biggest in the world in, in Bahrain. So, um, that's the one of the first things Iran went for was, you know, the big, uh, refinery in Jaffa in Israel that's offline. The Bahrain refinery offline. So in a world in which it's not like we've got excess capacity in refining because nobody's been building refineries for 20 years because everybody knows we're moving to electric cars. So why would you, why would you build a refinery? So that's the second factor. And then the third, you pointed to it, China saying, you know what, we're going to keep our refined products for ourselves. Um, sorry India, sorry Australia. Um, you know, we, we don't have enough to go around. And so, um, it's been fascinating because crack spreads in the US are super high. Crack spreads around the world are super high. Um, China, because of these controls, the, the gasoline prices are moving up. But so, we're left in this quandary. We're like, okay, oil prices isn't that high, so that shouldn't hurt. And then you get people at the pump like, well, I'm actually paying a fair amount here. And it's, it's the crack spreads. And then President Trump bashes the refiners. It's like, oh, this is, this is like all the re, you know, like oil companies making too much money. Of course, like nobody, when semiconductor prices go through the roof, uh, and when your iPhone's going to cost, you know,
>> Well, Apple's bitching right now.
>> Yeah. No, Apple's bitching. Nobody, nobody is like, no politician is saying, "Oh, how come the, the, uh, the, uh, semiconductor prices are going up?" But the fact that refining margins are going up, but it comes down to supply and demand, and either we live in a market or we don't. I, I think China is watching what's going on in Russia very closely because also Russia just announced that they are halting the exports of their products at least through the end of July because of the long lines now people are waiting for to get, uh, gasoline. So now the, the teapot refiners in China become greater in importance if we're losing the Russian capacity. So I do think that there's, to your point earlier, China licking their lips at $70 crude. They're like, just okay, at this price, just give me as much as I can because now my refining business is going to have to replace Russia. And the stat that I just learned when I read the diesel news, uh, in terms of Russia halting the exports, is that Russia provides about 11% of the world's diesel.
>> Yeah. Know.
>> This is a real, and, and diesel prices jumped this week.
>> Yeah. We're going to move in world. It's going to be F. It's like we're going to have $75 oil and shortages at the, at the pump.
>> All right.
>> I mean, that's where we're heading. So, what do we do with all that? As if you're a US investor, um, and you guys said you came in long. I know this has been a trade for you guys, energy. You said you stayed with it a little too long, but we've seen, you know, forget crude, but if you look at the large integrated, you look at drillers, what are they down? 10% or something like that from those above where they were. And, and by the way, refiners, you look at your Valeros, Marathon, Petroleums, etc. They're at all-time highs. And they're, they're just starting to break out again. They've been consolidating. They went up, consolidated the past three months, and now they're breaking out again. So, to your point, what do we make with this? Well, if you think, okay, if, if you think refining is what it is, like, uh, and these guys are going to be making margin for quite a while. Um, I mean, Marathon is going to be buying five or 10% of their stock, uh, like for the next few years, every year.
>> The free cash yields are enormous.
>> The free cash are absolutely enormous. They have nothing to do with it. They're not going to go out and build new refineries. They're just going to buy back their shares. So I, I think that's, you know, one to your point, what, what do we do with this? Um, that seems like a fairly obvious trade. Now, to be honest, I think we live in an inflationary boom where inflation is is decently high and economic activity is fine because every government out there is running budget deficits of between four and 7% of GDP. I mean, look at the US, budget deficit 7% of GDP with full employment. So we're in an inflationary boom environment. In inflationary boom environments, investors look for scarcity. Now, in the first quarter, scarcity was energy. There wasn't going to be enough oil for everyone. So, all the oil stocks went through the roof. Second quarter, it was semiconductors. Um, in the second quarter, the global market cap increased by $10 trillion, seven of which was semiconductors. Um, and so the second quarter was all, oh, we're not going to have enough semiconductors for everyone. Maybe the third quarter is going to be, oh, we're not going to have enough refining capacity for everyone. And it'll be the, Now, I'm not saying the refiners are gonna go up by $7 trillion in market cap because that'd be crazy. Um, but maybe that's just that simple.
>> Yeah, it's interesting. Um, and just tell me if I'm overthinking this, and I think the way that you just framed, you know, what's going on with Iran, who we're negotiating with, and and the IRGC, and what their prerogatives are. You know, it, it's not lost on me that after basically a month of just really no hostility during this kind of ceasefire period, that Trump is in Turkey at a NATO summit. We know how he feels about NATO, right? We know how he speaks about Erdogan, or, you know, all of these sort of strongmen, right? And they basically, um, start agitating again. And, and who is in favor of that? Well, Putin's in favor of that, right? Putin wants to see NATO go away. Trump seems inclined to do that, right?
>> He also wants a higher oil price. Correct. Right. And so then I think about China and everything that you just said about them. Well, they love us getting mired in the Middle East as long as it doesn't affect, you know, I mean, oil, but you just went through that too much. Oh, and maybe I'm overthinking it, but I'm thinking that China's sitting back and they love us getting bogged down in the Middle East. They love us not really having, um, you know, the back of NATO. And so, as long as what goes on with Russia and, uh, Ukraine, it's great. So, if you just think of like, who this, what do they call the access of what? We have Iran, we have Russia, and we have China. And it seems like they're winning, to some degree, um, as far as like destabilizing the world order. Is that, is that, am I overthinking that a little bit too much?
>> No, I don't know if you're overthinking it. My take is somewhat different. Um, I, I think take on Russia's fine, but I'm not a Russia specialist.
>> I think on China, we put too much emphasis on China's geopolitical thinking. Um, I think Chinese political leaders, their north star, their guiding light is always first and foremost domestic social stability. That's, that's, that's 99% of their job. Like, and, and the rest, China doesn't even have much of a diplomatic service. Um, and, and so for them, what, you know, a lot of people thought, oh, you know, why did China back away from the oil market? They could have really screwed, uh, President Trump. They could have really like pumped oil up to $150 bucks, and then like his midterms are gone, and he's a lame duck, and, you know, why did China do none of that? Because first and foremost, China cares about domestic political stability, and $150 oil would be bad, would be bad for China. China would rather, I think, would much rather take $60 oil and a US economy that's humming along with a US consumer that's humming along, to whom you can sell a lot of stuff, than a President Trump that's weakened, etc. Because China doesn't really care about the next two years. It's like, what matters is the next 20 years. Um, and there really is no incentive for China to have a US consumer that that implodes. Um, and so look at their actions. They helped stabilize the oil market. They didn't want to destabilize. I think Putin wants to destabilize it because he needs high oil. China, China's not trying to do that at all. Uh, so.
>> Yeah, I, I agree. I mean, China just doesn't have a, outside of Taiwan, and that's a whole separate discussion. China doesn't have territorial aspirations. You know, when, when I read and I see all these military contrasts between, oh, China's building up their military and, and compared to the US, and they have X amount of ships versus our amount of ships, and, and it's like, who's got a, you know, a bigger stick? But China is not going to be, and again, separate from Taiwan, that's its own political dynamic. China is not in the business of wanting to invade other countries. So this military they're building up is not because we're going to have another world war and they're going to attack somebody or whatever. It's, it's, it's presence. They want. They want to play in the global stage. They want to do that economically. They want to at least portray that militarily because they want to be able to flex the same muscle as us. So that, that's how I view this. It's more their military spending is more symbolic in a way because they may not really use it. I don't think they want to use it.
>> I look, I, I agree. Um, we were talking about Iran, uh, which did have one of the first sort of big empires, and it was said that Darius was a traitor. The first big Persian emperor, Darius was a traitor because Darius would conquer different regions. He typically, he did the same as Alexander the Great, leave the same government in place. He'd build roads. Um, and because the history of every empire is fundamentally a road-building exercise. Every empire tries to bring in commodities cheaper from everywhere around the world, transform these commodities at home into higher value-added goods, and then ship them back. Um, that was the whole thing with Gandhi and India. It's like, oh, we're sending all our cotton to the UK. They change it in the Lanker mills, and then they sell them back to us at, and they keep all the profits. Um, and so when you listen to Xi Jinping, Xi Jinping is fundamentally an imperialist president, and that when he talks about, he talks about the One Belt, One Road, the Silk Road Fund, the Asia Infrastructure Investment Bank, all these things are fundamentally imperial projects. It's, we're going to build a road, we're going to bring in all the commodities from Africa, from Central Asia, from Russia. We're going to transform them in China, and then we're going to sell you a car, a tractor, a telecom switch. Um, and we're, we're going to, we're going to do all these things. So the history of every empire is interesting because the building the road is actually the easy bit. Most people are happy to have a road, a train, a new port, a canal. Um, the problem becomes as trade moves, you get raiding parties, pirates, like people start to steal your stuff. Now you have to send soldiers to defend the trade. As you send the soldiers, you get friction. Um, so China today is in the phase of, I'm building the road, and everybody in Africa is happy to have the road. They're happy to have the power plant. They're happy to have the canal. Um, then, you know, down the road, you need to send the boats to protect this. You need to send the soldiers. That's when the friction starts. Um, and for me, this is one of the big lessons. You say, you know, why is China building all these ships? The big lesson of the Iran war. There's several lessons, but the first and most important lesson is that the US no longer controls the world's sea lanes because warfare has changed. Um, because we now live in a world where you cannot protect billion-dollar ships with million-dollar missiles against $10,000 drones. The math no longer adds up. So, the US couldn't control the Red Sea. US can't control the Persian Gulf. This is a massive, massive shift because we've lived in a world for 80 years, we could take for granted that the US Navy controlled the world sea lanes. And so as long as you weren't an an out-and-out enemy of the US, you benefited from this protection. Um, this is no longer the case. So if you're China, you think, okay, first of all, I'm not sure that the US is going to protect my ships because the US is became, you know, the US-China relationship is becoming more and more antagonistic, number one. But number two, even if they wanted to, I'm not sure the US could. So if you're China, you're like, okay, I've got to build my own navy.
>> So can we expand on China? Because one of the things that we talked about last time we, we were together was this growing presence of China from a competition standpoint in a variety of different products and that US tech companies for the first time probably since the Japanese in the '80s are facing a level of competition that they've never dealt with before. So fast forward in just the last month or so, the progression of of of of presence that China AI models now have on the data router sort of standings where they're like 60% of their models and now in the top 20. This is now a big deal. And and I say like for those that are are trading Micron, I say, "Have you ever heard of a company, uh, called CXMT?" About >> or Yangzi Memory Technology? Have you ever heard of those two names? And if they say no, I say, "You better go learn because that 85% gross profit margin that Micron has today, they're coming after it." Now, the pace at which they will, I'm not sure, but talk about how it just seems that China's race down that road of technological advancement continues to really go fast, and I don't think US investors enough appreciate this coming onslaught of competition on a pricing perspective, a quality of product perspective, and so forth. And also what we've learned is China seems to focus first on market share and secondarily on profit. That's not good if, if that, that's not good for record US corporate profit margins, particularly with a lot of these tech companies.
>> So, um, I don't want to answer your question with other questions, but I think, look, the most important, as you look at the whole AI excitement, which has many elements to it. One of them is excitement over the LLM, the programs themselves, and, you know, is Anthropic worth a trillion dollars, and is OpenAI worth a trillion dollars? Um, then there's the excitement around all things semiconductors, the premise that there won't be enough for for everyone. Um, the big question when you see China enter both of these spaces, the semiconductor space with essentially unlimited funding from the government because for them it's a national strategic imperative, and the LLM space and, and the model space, um, to your point, where they're growing very fast, and essentially what they're doing, their strate, the strategy of most of these is to say, well, look, if OpenAI or, um, or Anthropic delivers you a Ferrari, something that's like really, really top-notch. We're only looking to deliver you a Toyota. Um, now, if you have, you know, $300,000 and you want to drive a Ferrari to work, use that. If you don't have $300,000 and a Toyota is good enough to get you to work because really you don't need to get to work in 200 miles an hour, uh, and the Toyota is going to do the job just fine. Here's our Toyota. Maybe I should say a BYD, not a Toyota. Uh, but, but you get, you get the analogy. Um, this is what you're seeing on on the model side, and so on both of, when you look both at semiconductors and the model side, which is the both ways people have played this very exciting new world of AI, the, the big question is, uh, right now, both of these are priced to essentially never be commoditized. Um, when we know that when China enters a space, it gets commoditized. I think when I was last here, I said, when China enters a room, profits work out. Um, so, um, it seems to me that we are like very rapidly advancing in the process of commoditizing those two things, the models and the semiconductors, um, and yet the markets are priced for completely different.
>> So they're not priced in China for that, right? Like, so if you think about like what, how Alibaba, right? If you think about their cloud business, you think about Coin, their their model, right? And, and they guided, I want to say maybe at the start of this year for capex, they don't guide like quarter by quarter. They guided for the next three years, they're going to spend $70 billion. And our three, uh, big hyperscalers are going to spend $700 billion. They're going to spend $700 billion this year, right? So, you think about it. So, you know, it comes, brings me back to, you know, everyone likes a road, right? Digital Belt and Road. Let's, let's talk about that. So, if they can get their open-source models out there, and you spoke about this in December, you know, like your point about the Toyota is is the exact analogy, right? OpenAI and Anthropic want to sell you a Ferrari, and, you know, China wants to sell you Toyotas for the world, or BYD. And by the way, that's what they're doing with BYD too, right? So speak a little bit to this notion that, you know, we're going to be commoditized. China's coming after it, but they're also going to be exporting this much cheaper, maybe not as good technology around the world, and they have the ability to really get, um, with open source, to, to really get a lead on on us. And we're being so protective. All of our hyperscalers are going after the exact same thing. So, I think right now, you know, the point on selling a Ferrari that's got to be made is these guys are selling you a Ferrari, but they're selling it to you for $10,000. It's like, hey, do you want a Ferrari? Yeah, maybe. Do you want it for $10,000? Yeah, I'll have a Ferrari for $10,000. Thank you very much. So, we all use it. We're like, wow, this is awesome. This is great. The business model is for them to turn around at some point and say, by the way, it's no longer $10,000. It's actually $300,000. Um, at which point, you know, do you still want it, or do you say, "Ah, you know what? I'll go back to my BYD or my Toyota." Think about.
>> But isn't that exactly what's happened in the last two months or three months? Token maxing to token minimizing. I mean, think about it. And that happened very, very quickly. And it's not very clear that consumers or enterprises are actually going to play along with that.
>> Yeah. Because look, the, the reality is, you know, these companies, the OpenAI, the Anthropic, that are burning $10, $15 billion a quarter. You get to a point where, you know, it's now, you know, they're going to do their IPOs, so you could say, well, they're going to get another round of funding so they can keep selling you the Ferrari at $10,000. Um, but no, it'll be interesting how long the market gets excited about funding people's Ferraris at $10,000.
>> Well, what I find interesting too with this is that it's not just China and the US going at it. It's, it's, it's going after the global customer. If you're that startup in Singapore who's bootstrapping it, and China comes to you and says, we can offer our model to you, our BYD, at 80% cheaper than US model, you're going to do it because you don't have much money.
>> Just by the way, it's not just Singapore, everywhere in the world. Mark Anderson in an interview, what was it, a couple months ago, said that, um, you know, he runs one of the biggest VC funds in, uh, in, in Silicon Valley, that three-quarters of the startups they see use Chinese LLMs because they're essentially free. And to your point, most startups bootstrap it. But I think also, and I think we discussed this last time, it's also not just the fact that it's, uh, it's cheaper, but it's also the different architecture. It's, do you want a closed-end model or an open-source model? The beauty of an open-source model is you take it and you can modify it. Uh, and, you know, off, off you go. Uh, a closed-end, if you got a closed-end model, you have to, you know, if I use OpenAI, I got to go back to them. Can you change this for us? Can you change that for us? It's a very different concept. And I think we used the analogy when I was here last time where OpenAI and Anthropic are essentially looking to build medieval fortresses with huge walls and say, "Come into our fortress and you'll be safe here," to the Goldman Sachs of this world and the JP Morgans, etc. And China's building Dubai. It's not a fortress. It's everybody can come in, everybody can come out, and you do whatever you want. And so it's, it's two completely, completely different concepts, which is funny because you would expect the US to be the open one. You would, because of all of the US history, and you would expect, given China's history, to be the closed one. China did not have the option of doing the closed one because the closed one needs ever more compute and it needs ever bigger capital spending. Historically, most Chinese companies are happy to throw money and human resources at things. This time, the US told them, "You can't do it because we're not going to sell you the chips." So, they had to find workarounds. The only workaround was to open source it and have lots of software developers based everywhere around the world help you improve the product, which is completely anathema to the usual Chinese way of doing. Usually, China will just throw money at a problem. This time, they couldn't do it. So they end up with a, they, it's, it's quite funny. Meanwhile, in the US, usually the US is very careful about returns on invested capital, very, you know, companies say, if I invest this, what returns will I get, etc. But I think the, what we saw this time around was tech companies that had such a great run, the Microsofts and the Amazons and the Facebooks and Googles, they had such a great run that essentially the cost of capital for them was zero. So they could afford to be like, you know what, this is probably the next big thing. Let's just, Amazon threw money at cloud, and that was that was great. So let's throw 20 times as much money this time on AI because that's going to be the next big thing. Um, and because these guys had an essentially an free cost of capital, they could afford for once to be quite, you know, free with it.
>> And now that cost of capital is going up.
>> And now that cost of capital is going up. No, because all this started when essentially when you had $18 trillion of government debt yielding negative yields, uh, which is, you know, anathema. It was just capitalism on its head. When you say, we, you know, pay us to take your money, it turns the whole capitalism around, right? It's like what Churchill said back in the days. It's like, you know, capitalism without bankruptcy is like Christianity without hell. It just, like, it doesn't work. You need, you need the hell for Christianity to work. And we, we prevented bankruptcy. So we made the cost of capital zero, and here we are, and the cost of capital obviously is going up. And we've seen, you know, these major hyperscalers, they spent basically all of their free cash flow. They've really leaned into their balance sheets, right? And they remain very committed to this. You just mentioned Amazon. I mean, Amazon's capex, when they came into the year, I think they had guided to 100 to 120, and then last quarter, I think they guided to 180. I mean, just think of that, right?
>> I think they've increased their debt by $100 billion.
>> Right? And they, they're out there right now selling $25 billion. Um, you know, Google has sold debt and equity, right? SpaceX does their IPO, $75 billion, and then they immediately do what was $20, $20 billion. That's a.
>> Yeah, they paid off a bridge loan.
>> So, but it just keeps going and going. Now, it goes back to this point where if, you know, OpenAI, great news for banks, >> right? Right. Yeah. But if you're OpenAI and you're Anthropic, and you're sitting in the middle of this, there's really, like, you have to go public, right? Because you need to find, you know, like a new funding source. And, and for the most part, I mean, people are pretty full up with, you know, you've had access to these.
>> Well, that's the interesting thing with OpenAI is they need to tap the IPO market because they now need equity capital,
>> Uh, at least this round. And the news that they are deferring it to 2027, I think was very interesting and not necessarily a good thing because I would argue that OpenAI, from a strategic standpoint, and the extent of its reach throughout this whole AI ecosystem, is too big to fail. Not from the perspective that the government's going to come bail it out, but if OpenAI fails, it brings down everything.
>> Oh yeah, for sure. The capex needs to to grow at a pace where essentially it becomes, and you saw this the past couple of quarters where it was three-quarters of the improvement in US GDP, and the numbers are now so big, you mentioned $700 billion this year, according to McKinsey, you're looking at $6.5 trillion between now and 2030. Uh, I mean, these are gargantuan, gargantuan amounts. It's, where is all this money going to come from?
>> And I think also some people are missing, they they assume that, okay, this is a high level of spend. Oracle, in fact, is spending 100% of their revenue on capex, a little less than that if you take in some of the prepayments. But people assume, okay, this is a three-year cycle. They're going to spend all this money, and then in year four and on, they're just going to reap the benefits. But they're, they're, they're embedding a very high level of maintenance capex that I don't think people appreciate. The leases that they're signing is essentially debt. Uh, the leases are enormous, and they go out, you know, some of them are five-year extensions, but a lot of them are guaranteeing out 30 years. Uh, having to to upgrade the technology and, and, and the new Nvidia chip that's hugely expensive. Like the maintenance capex and the depreciation expense. This is, they're not, this, there's no rainbow in year four here.
>> No, no, the numbers are just so big, indeed. It's, no, it's sort of mind-boggling. And look, the reality is, going back to the semiconductor, because that's how now everybody is playing this trade. Semiconductors are now essentially a fifth of the global equity index, which, and semiconductors are historically the most capital-intensive, most cyclical industry. To put things in context, it was 2% of the global benchmark. Now, you guys are lucky. If you were an Asian manager, you now have three companies, TSMC, SK Hynix, and Samsung Electronics, that make up 40% of your benchmark, uh, for the Asia MSCI. Um, knowing that most managers can't own more than 10% in a stock, right? So you're now stuck in a situation, if you're an Asian manager, you're like, well, benchmark says 17% TSMC, but I can only buy nine because it goes up and down 10% a day. So I'm gonna hit my 10%. So I can only own nine. Um, so now I'm going to have to go out and buy crappier semiconductor companies that I don't really want to own, but they'll, like, they're sort of a proxy for this thing that I can't legally own. And that's now the game that everybody is stuck in Asia. And so, you know, to your point, the problem becomes, once it feels like the growth of sales and semiconductor rolls over, all these second-rate companies that are in everybody's portfolios because you have to, but you really don't want to own them because they're crappy companies, you don't want to own them, like those things, there's going to be no market for them.
>> Well, we've seen that like in Micron, we've seen it with DRAM again and again. And if you had asked me, let's say, um, I don't know, 18 months ago, when Micron had like a hundred billion dollar market cap, whether it was more likely to go out of business than have a trillion dollar market cap, I would have bet my left pinky, it's going out of business. You know what I mean? Because we've seen this before. Um, you know, so when you think about, um, the hyperscalers, which have basically rolled over for the most part, right? And even with like a Google that is, you know, vertically integrated, I think that was a consensus sort of long, especially as people started to lose faith in Microsoft and their relationship with OpenAI and Amazon, it was kind of a different sort of thing, and they had smaller models, but they kept on investing in both. I find it really curious the back and forth. We've seen like an Amazon investing in OpenAI and Anthropic, and they're all trying to kind of hedge their bets. Microsoft did the same thing, but Microsoft now, after offering Incilot, uh, OpenAI and Anthropic, now they're thinking about putting R4, DeepSeek's model in there. And it speaks to a little bit of what we talked about, how Chinese open source might rule the day or might win the day. They also might rule the day, um, if you will. But how are you thinking about like, you just mentioned like the Cosby, you know, that could be absolutely devastating, right?
>> That's two. That's two. Not just the stock market, but also their economy. Is that fair to say? Like right now, they're on the other side. Right now, they're.
>> Taiwan, too. Half their 50% increase in exports.
>> So, exports are going through the roof. People are getting huge bonuses. Samsung workers are getting half a million dollar bonuses. Like, you know, for Korea, that's a lot of money. Um, but I want to go back to a point you made about Amazon investing and, and, and everybody investing in everybody else, etc. You, you probably know, you might know my friend Kevin Weir, uh, the macro tourist. If you haven't had him on the show, uh, you should definitely have him on the show. He's great, and you should have him on this topic because he just wrote a great piece highlighting it's like, yeah, but, you know, what US earnings are great, etc. Now,
>> Uh, within the earnings, you know, what part of the earnings has been growing the fastest?
>> The other income, which is all the investments. It's like, oh, I invest, uh, I invest in Anthropic at a hundred billion dollar valuation, now it's a trillion dollars. Uh, even though I haven't realized it, I still have to book it in my earnings.
>> By the way, we sit on the desk at Fast Money, Peter comes on all the time between 5 and 6 o'clock, and you know, the, the earnings come out, you know, let's say 4:15, right? And we're kind of combing through it a little bit, but we can't get that granular. The show starts at 5, and then we're meant to opine on this, and people like, that was a huge quarter, that was a huge beat, but it took guys like Jim Chanos or probably like Peter Weir, you know, something like that, basically, you know, taking just another 15 minutes to figure out, wait a minute, a lot of that upside came exactly with what you're talking about.
>> A great thing you can do is look at S&P 500 against national income earnings. Um, so, you know, the government, or you just look at tax receipts, because tax receipts is a great way to look at what I mean from corporate income, because everybody's always trying to minimize, uh, you know, nobody's trying to pump up their earnings to the tax man, uh, but of course, without making fraud. Um, and so you look at the divergence between S&P 500 earnings and national income.
earnings, uh, over time. Now, over time, over very long periods, you look at the past 70 years, they, you know, they they move together. But S&P 500 earnings always go like this, and then they go like that, and then they go like this. National income earnings go like this. And when you're at an extreme deviation, either on the upside or the downside, it usually means on the upside, it means you got financial engineering of of all kinds going on. Uh, on the downsides, it's usually you're at the bottom of your bare market. You've had the CEOs be fired, new CEOs brought in, they they cleaned out they cleaned out all the mess and, um, and today you are back at one of these stretches, just like you had in 2000, just like you had in 2007, of record divergence between S&P 500 earnings and national income earnings, and a lot of it is linked to these capital gains taxes.
If you look at Q2 earnings that were up like 28%. If you take out the other income, it was like 17%. If you take out semiconductors, it was like mid-single digits. So when people throw out earnings are just off the charts, there there's no like under the hood analysis. I I do want to sort of take this to we talked about the cost of capital for the hyperscalers, but the cost of capital is rising for everybody. We're seeing long-term interest rates which have remained elevated. We're in a bond bear market, it seems to be clear. And that what was most interesting to me was that the 10-year yield oil went from 120 intraday to $68 and the 10-year yield is stuck at 4.5% and now is above that, and the 10-year JGB just closed at a fresh 29-year high, and French oat 10-year yield just broke out. Um, and UK and so on. This is an issue, um, that I think that people aren't appreciating. There's something else going on here. And whether it's debts and deficits now matter, it's investors that just don't want to take duration and lend these governments money because, uh, of the the still sticky inflation and persistent, um, uh, uh, impact that has on owning fixed income, wanting to own hard assets. There's something going on here with long-term interest rates that I think has big implications if this continues.
Look, we're we're in a structural bond bear market. Uh, we have been for five years, and I think it was kicked off by all the silliness around COVID, which was, you know, the biggest policy failure, both the lockdowns and then sending free money to everyone. And it was just policy, it was just compounding policy failure after policy failure, and some did it for longer than others, but the costs in terms of, you know, financial costs are high, and the easiest way to pay for these financial costs is always inflation if you're a government. That's always the path of least resistance. Um, and today, in all those countries that you mentioned, you do have a very, you know, you have higher than usual inflation rates, higher than for comfort, which does mean that you're very prone to whenever there's a shock, whenever oil does go from 65 to 120, um, you risk moving into the very bad environment of inflationary bust. Right now, I'm not saying we're there because we're not. Um, so you've got that as your first driver, and your second driver is, look, we mentioned it earlier, but fiscal policies around the world are ludicrous. There's, again, the US is running budget deficits of 7% of GDP at a time when asset prices are making all-time highs, when capital gains taxes should be great.
Employment rates in the fours.
And unemployment rate is essentially like, if you want a job in the US today, you find a job when you're in the fours because you always have a compression that it's hard to go below. So, you know, what's it, you can't you can't help but think, what's it going to be, what's the budget deficit going to be in the next recession?
12 or 13.
Yeah.
Uh, so given this backdrop, why would I want to be a bondholder? Uh, there's, you know, what's, what's the, what's the bull market call for for for bonds? And I think there's a democ sword. You mentioned oats, and I think it's important for actually a lot of European bond markets, but also the US. Japanese investors own three and a half trillion US dollars worth of foreign assets. That's 80% of their GDP, like it's unprecedented. So just ludicrously high, um, and the yen keeps on falling, and the JGB yields keep on rising. There will come a point, I think, uh, maybe I'm wrong, but where Japanese investors say, you know what, at, and I don't know what that point is, but at 4.5% JGB yield, that's good enough for me, thank you very much. I'll lock that in. Um, I'll end with the yen at whatever that level, it's cheap enough, I'm now bringing my money home. Um, and so you have this damically sword over the head of the bond market everywhere because they mostly own bonds elsewhere, which they bought, uh, mostly because you had a huge yield differential between Japan and the rest of the world, and that yield differential keeps on shrinking and shrinking and shrinking, and at some point, it'll shrink enough that the Germany say, yep, thank you very much, I'm out of votes, I'm out of treasuries, uh, I'm bringing it home, and then who will be on the other side?
And some of these developed bond markets too have very large foreign ownership.
US still has 30% of treasuries that are owned by foreigners. I think it's roughly the same.
15% in France, and or maybe.
Well, so it depends if you count the that's owned by the ECB. So if you strip out the stuff that's owned by the ECB, because ECB, you know, unless they want to screw France over, isn't going to turn around and sell them. Um, but we're roughly at 30%. And and that brings me actually to I think an important point is a lot of people look at debt to GDP as a potential, uh, you know, sign of impending doom. You look at every debt crisis, Thailand, Argentina, Greece, etc. The problem is never debt to GDP. The problem is always what percentage of your debt is owned by foreigners, because one day people wake up, there's bad news in France, and you come into the office, you're like, why do I own French oats again? Um, and if you're doing it, everybody else in the street is doing it, and you're like, you know what, just get me out of these French oats, and like I don't want, I don't want them. And then this, that's what happened to Greece, and that's what happened to Thailand. That's what happened to Argentina. Now, you could say the bar for us is not there, actually, because I don't think anybody comes into the office and say, why do I own US assets? Because the answer is obvious, because it's the biggest economy in the world, because it's the world's reserve currency, because there's some absolutely world-class companies. And so there's always a level of US dollar and US dollar valuations where foreigners will come in, be like, you know what, you put me Microsoft at 15 times earnings, I'll buy it all day. Uh, you put me Central Park, uh, real estate, uh, at a cheap enough dollar, lots of buyers. When places like Greece, like it can fall 50%, there's still no buyers. Like nobody cares. Now, France, Britain, both have 30% debt held by foreigners. Um, I like to think because I'm French, but I might be wrong, that there's still a level at which people say, "Oh, you know what? Paris real estate, yeah, I'll buy myself an apartment in Paris. Why not? It's cheap enough. It's a nice city." Uh, but maybe I'm wrong. Uh, but I'm not saying we're at that level today. So, if you're looking for potential crises, I think France and Britain are much more likely than the US.
Yeah, a a massive crisis for France would be losing to Morocco, uh, this afternoon. Just like, let's get that out of the way. And by the time you're listening to this, you'll know the outcome is.
16 16 of the Moroccan players out of the 23 are French.
Yeah.
Oh.
So it's it's like the A team against the B team. So we're still in it either way.
Yeah. Yeah. That's funny. Well, you've been in the States for a little bit now. Um, last couple weeks or no? Uh, what, what is your perception as a foreigner, um, of of just kind of the reception of the World Cup being here? I'm just in general, I'm just really curious.
Look, I think it's been, I think it's been a successful World Cup. Uh, it's, uh, I thought I was.
This is a hard turn by the way. We we'll get back, we'll get back to the other stuff.
I, uh, I, I thought it was, uh, look, as a foreigner, I looked at ticket prices. So my son's interning here in New York, and he called me up. He goes, "Oh, France Sagal is here. Yeah, come over." Well, and I don't really care for soccer, to be clear, but it's like come over, etc. And then like tickets are like three grand. I'm like, "I'm not spending like" and he wanted his other brother. I'm like, I'm I'm spending 10 grand for the three of us to go watch a sport I really don't care about. Uh, and also to watch the France A team against the France B team, because also the whole Sagal team was born and played in France. So 100 players at this World Cup were born in France.
Wow.
Wow. Uh, France has now become like the training ground essentially. We train soccer players, and so we got that as an export going for us. Yeah.
We got the wine, got the luxury goods, and we got better than us. And we got the soccer players. French oats.
And better than French oats. Exactly. So we got, we we still can make money if we explain the soccer players.
I I want to tie this into the dollar because I have a few thoughts on this. Um, firstly, we talked about sort of the Mag 7 trade, the whole hyperscale or AI buildout. Over the last couple years, it seems that these these Mag 7 stocks became a reserve asset. Yes. Owned by everyone around the world. Every fund.
You were an asset manager. I'm not ex US. You had to own these stocks. Or if you were like, imagine if you're managing the Abu Dhabi Investment Authority or the Norris Pension Fund, you're literally managing two, three trillion dollars.
Swiss National Bank.
Swiss National Bank is like Swiss National Bank. They came out and said, we just buy the top 20 market caps in the world.
And that's it.
So you, you can, you can literally draw a chart, and I've done it, on the MAG 7 ETF and the DXY. Now, DXY obviously is missing a bunch of other currencies, but you know, get a sense of the of the relationship. The relationship sort of broke down over the past year when the AI trade took off again, and the dollar index just stuck between 97 and 100. So let's just take this one step further. Hyperscaler trade, MAG7 trade, AI trade rolls over. Let's just assume. Does the dollar resume its downward trend? Is that sort of a a death net? Absolutely. I think it does. Absolutely it does. I think the whole world is owning this trade, and the dollar has is is on the line here on the sustainability of it.
Let me add some water to your mill. Um, I think it's fascinating. Look, what is it, four months ago? People are expecting two rate cuts. Wor comes in. Sounds a little hawkish. Everybody's like, "Oh," and of course oil prices go up and inflation numbers go up. It's like, "Oh, we're not going to get two rate cuts. We're going to get two rate hikes instead." So the market moves from two rate cuts to two rate hikes. Gold gets smoked. Silver gets smoked, a lot of assets get smoked, miners, energy, uh, Hong Kong, and we can come back to that. Um, all these things get smoked, but the dollar itself really didn't go up all that much. It went, it went up a little bit, but like if you were, you know, to your point, you were at 98, you went to 100 on a DXY. Meanwhile, there is something that's been going on is that if you look at the past 18 months, the REMBI is going up 50 basis point a month like clockwork. Like it's literally going up 50 basis points a month almost regardless. So very clearly, China has shifted its FX policy to we now want a, um, a stronger rem. Um, now I think this is actually creating, um, some perhaps tensions and, uh, things in Asia where on the one hand, you're having a yen that continues to weaken, um, and the yen is is stupidly stupidly weak, and now a rem that continues to go up. One of China's policies for the past five years, we've written a lot of pieces on this, has been to try to stabilize all the other Asian currencies against its own. So you look at the volatility of the Singapore dollar, the Thai baht, the Malaysian ringgit, the Filipino peso, all these currencies against the, they used to be managed against the US dollar, and now they're all managed against the remmin. And so I think you have this this quandary now for China, which is you have this this different divergent tension in in Asia where the yen keeps on getting weaker, the yen and the Korean won keep on getting weaker, the remmin keeps on getting stronger, and it's like this rubber band. And if you compare, if you look at the US dollar as a whole, like, oh, the dollar is not moving. Um, I think this thing is going to snap, and I imagine that it's going to snap with the yen and and the yuan moving starting to move up. And when that happens, um, yeah, I I think that's going to be really tough time for the US dollar. Now, most people look at the DXY, which is probably it's 2/3 euro, right? And and Europe has it own its own problems. So I I think most people are not realizing that in an environment where the US dollar should have been going up, everything was favoring the US dollar, NASDAQ outperformance, rate hikes, etc. Rate hikes starting to get discounted. US dollar didn't do great against all the emerging market currencies. Not at all.
And the commodity currencies actually traded pretty well. So when the dollar initially rallied, when the war began because people punished those countries that were big importers of energy, the commodity currencies actually traded pretty well. The Aussie dollar traded well. Canadian dollar traded okay. Uh, so to your point where the DXY is sort of deceiving because of its heavy weight against the euro, and it's important for investors to look at the dollar against a bunch of different cross rates. Absolutely. To get a real sense of direction.
The DXY is 2/3 euro, a quarter yen.
Right? You know, it's like it's not, it's the index of the world of yesterday. It's the index of a world of 25 years ago when Japan was really important and Europe was really important. It's not the index of the next 10, 20 years. Uh, doesn't have China in there. Frankly, it has a little bit of Mexican peso, but but peanuts. Uh, to your point, it doesn't have commodity currencies, or it has a little bit of of looney, but peanuts. Like that's not the that's not the benchmark for tomorrow. Now, now taking this another angle with the the dollar and and the renminbi, you know, China is also trying to develop its own Swift system, its own payment system.
The chip system.
Right now. It still has a low market share. It's still single digits, but it's been going up, you know, going from 3% to call it 8%.
It's still low, but that's a big move. And obviously the Swift system will probably still dominate, but it's that sort of encroaching market share of China's presence in terms of trade and that they want to denominate more trade with their partners in their own currency. And so this this issue with the dollar is it's not an event, it's a process that I see only continuing in the years to come.
Oh, there's no doubt. And look, China now settles more than half of its trade in its own currency. And but so China is getting to where it wants to be. If you settle your trade in your own currency, nobody can put pressure on you. Nobody can force you to have a certain monetary policy or fiscal policy. You become, you know, in truly truly independent, which is of course the goal that any superpower would want to achieve. But it's.
Then how long does that Hong Kong peg last then? Oh.
I think the Hong Kong peg lasts for.
Sorry to interrupt. No, no, I think the Hong Kong peg lasts forever because if you're the if you're China, the Hong Kong peg is all all upside, no downside. Hong Kong essentially, look at it this way. Hong Kong was the first tokenized currency. It's China has its own US dollars. It can when it says to Russia, hey, let's trade in, um, let's trade in renminbi, if Russia does it because it doesn't have a choice. Um, but other countries who say, "No, I don't want to do it." Then China can say, "Well, let's do it in Hong Kong dollars, then." And other countries are fine because it's it's a quasi US dollar. So, if you're China, there's really no downside of keeping the Hong Kong dollar. Uh, it's, it's, it's all upside. It's they have their own US dollar. They have their own currency. And in fact, China is kind of unique, uh, in the history of countries in that it's the first sort of financial power, because it is becoming a financial power, to have two currencies and two central banks. They have the renminbi with the PBOC, and they have the Hong Kong dollar with the HKMA. So if I'm China, and I don't know, you're South Africa, I can say, okay, I'd rather do this, but if you really don't want to do this, we can do that advantage. Let's talk something near and dear to both of your guys' hearts. Uh, that'd be gold. This would be the next sort of, uh, I guess place we'd go with this conversation. And you guys have long been in the camp, I know both of you have, that this would be, you know, an allocation. Most folks say, you know, low, mid, single digits, sort of thing. And and I know there's been times where you guys have been heavier than that. And you know, we had gold at what, 2,000 bucks, I want to say two years ago. It got as high as 5,500. It's come back to 4,200ish. Um, you know, we had that sort of meme sort of action earlier in this sort of year. Uh, and that was when I I guess the Dixie and we just spent some time on that, but went from 108 to 98 or something like that, and that might have had something to do with the, um, that sort of trajectory to the upside. Where are you guys on this right now, and where do you see it as an allocation to a portfolio? Because I know you get a lot of questions on, I know Guy gets a lot of questions on, I don't know, Jack about it. That's why I'm asking you right now.
We could spend two hours on this, but I think we have to acknowledge a few things. First, um, when the war started, uh, Dubai is roughly a quarter of the physical gold market in the world, and essentially that market shut down. You, when drones were flying overhead, essentially India basically buys its gold in Dubai. They fly over and they buy gold, and when the airport shuts down, so you had a quarter of the physical market, global market, that essentially shut down. So you had that, that created a first, I think, big air pocket. So that's number one. I think number two, if I go back to to the lessons of the past few years, the big gold bull market, you've had several waves, but the last bull market started when Russia invaded Ukraine, and we seized, uh, Russia's, um, treasuries, not only of the country, but also of rich people. Uh, all the Russian oligarchs, we said, "You think you own the Chelsea football club? Uh, your wife's Ukrainian, you've got nothing to do with this. We'll take it anyway." Um, you, uh, you think you own this house in London, you don't. Um, and we did this absolutely without going through the courts, by just by political decision. We undermined our single biggest, uh, our, if you look at the western world, our biggest comparative advantage is the rule of law, right? You could be brown, black, yellow, Jewish, Christian, Muslim. You go in front of a court of law in New York, in London, in Paris, you got the same fair shake as the next guy. And then we added an asterisk to this and said, "Except if you're Russian." If you're Russian, we can just grab all your stuff because we don't like your leader and he's a jerk. Imagine if you're Chinese. You hear this, you think, what do you mean except if you're Russian? What do you mean except if you're a jerk? Like if except if your leader is a jerk. Like if I'm a rich Chinese guy, I'm not very reassured by this at all. I might think Xi Jinping's a jerk. Um, and so all of a sudden, you start to see central banks that were huge net sellers of gold for 25 years become massive net buyers, and individuals as well. Chinese purchases of gold went through the roof. Indonesia, Thailand, Saudi Arabia, everybody started buying gold. So the lesson of 2022 was don't buy treasuries, buy gold. Don't buy OECD bonds. What's the lesson of this latest crisis of the Strait of Hormuz crisis? The first lesson is, I said it before, the US no longer controls the sea lines. So imagine I'm India. India, on the second day of this war, Modi picked up the phone, called Xi Jinping, and said, "Mate, you have huge strategic, uh, fertilizer reserve, you got enough fertilizer for the next five years. Can you sell me some, please? Because 40% of fertilizer comes out of the Gulf, and I'm not getting any, and it's about to be planting season." Xi Jinping says, "I'd love to help you, but I won't." Um, so now you're India, you think, sweet, got all this gold, I've got all these treasuries, I got 700 billion of treasuries, and I need fertilizer and I can't get it. The lesson of this Strait of Hormuz trade is that rather than treasuries, rather than gold, you actually need to stockpile commodities. You need to stockpile whatever you need to, uh, to, if you're India, you need to stockpile fertilizer. You need to stockpile oil. If you're, uh, you know, the US, you need to stockpile rare earths because you don't have them. If you're in a world in which all of a sudden you have more tensions and the US doesn't control the sea lanes, you need to build strategic reserves of it might be pharmaceuticals. It might be, you can no longer assume that you can throw money at a problem and have it fixed. Um, and so I think that's, uh, that is now, I'm, I remain a bull on gold, but I'm much more bullish on the other commodities, much.
So to add to that, yesterday, uh, there was a story that the Department of Defense in the US is going to start stockpiling lithium. There was a story last week, Germany is going to create a strategic reserve of natural gas. This is going to be.
I mean, it's mind-blowing that Germany hasn't done this already.
Shocking, right? Let's turn off the nukes, but let's not have a strategic reserve of another energy source. Uh, this is going to be a multi-year thing, and it's going to be spread out, and it's going to be an underlying bid in a variety of different.
By the way, while you built this, building a strategic natural gas reserve takes a lot of construction, takes a lot of commodities, takes steel, takes plastic, takes, uh, and so all these things, you're going to have, I think for the coming years, the double demand for commodities because A, you need to stock them up, by the way, because for the past three or four months, everybody ran down their inventories to zero, so we got to rebuild inventories, build bigger inventories, and build the storage facilities to to build the inventories to put the inventories in, while we're also everybody's like, maybe I need to redo my grid. Um, and as we do this, there's also the perception of, uh, maybe my friends aren't who I thought they were. So again, India, I don't want to pick on India, but India is another great example of this. Modi three years ago said, we don't want Chinese cars and we don't want Chinese solar panels. I bet you on that second day when he was calling Xi Jinping to say, "Hey, can you sell me some fertilizer?" He probably hung up the phone and thought, "You know what? Some Chinese cars and solar panels, maybe that wouldn't like, maybe being 100% dependent on Qatari, uh, and Russian gas wasn't the right trade."
And those cars look pretty good. Maybe we should buy some.
I should, and I should have covered the Rajasthan desert with solar panels to feed into electric cars. Maybe that would have been a smarter trade.
So this is all inflationary, right? I mean, when you think about it, sorry. So, so let, let, if I can kind of wrap it up, at least from the way I think about things. I mean, we hit wars in in Fed policy. We're talking inflation. We talked about the labor market. We talked about geopolitics. Um, we talked about the dollar. So, let's assume for the next 12 months, okay, we have a a pretty firm dollar, right? We have, uh, you know, unemployment rate, let's call it 4% or whatever. We have inflation that is running a bit hot, you know, probably just below, um, 3%. Um, you know, 10-year yield, what, four and a half percent. We'll just pin it there. You know, stock market, S&P 500 is a percent from its all-time high. It's up 10% of the year. The NASDAQ's up 18% of the year. So, the the stock market here has not been bothered by a lot of the things that we just talked about, right? The things that we spend a lot of time talking about and trying to be, I don't know, flesh out one way or another. What do you think about for US equities in general? And I, I know we talked about, you know, differentials and and and the need for a lot of these strategic, um, or these, uh, you know, Nor and all these sovereign wealth funds to own our stuff, but what happens here, like, just if you kind of think about the US market and the dependency that we have on just so much foreign buying also, you know,
So I look, one of the interesting trends lately has been the outperformance of financials, uh, and not just in the US, but everywhere around the world, and that to me makes a lot of sense. We're going to live, move to a world where the demand for capital is super high.
Even European banks are breaking out.
European banks are breaking out. Chinese banks, everybody's like, you know, everybody's favorite dog with fleas, right? I mean, these guys are loaded up with bad debt on bust real estate, etc. They're breaking out. Japanese banks, other dogs, historical dogs with fleas, they've been breaking out like banks everywhere. Now, I think this corresponds, you could say it's different drivers. Japan, you've got the steepest yield curve you've had in a very long time. That brings me to your point on, we have a firm dollar. I'm not sure that we do, because the next, look, right now the market moved from saying, "Oh, we're going to go from two rate, uh, cuts to two rate hikes." Do you think that over the next six months, we get those two rate hikes? I personally don't.
I don't think we we're not going to get them.
I don't think we get them. I don't think we get them for a number of reasons. Um, therefore, I think the long end sells off a little bit because that long end is sort of thinking, oh, you got a, you got a, um, a hawkish Fed, etc., which you're not going to get. Uh, and here, I'll disclose a full-on, uh, you know, one of my biases, I firmly believe that in my career, 52 years old, in my career, Japan has been the trailblazer on monetary policy for everybody else. They were the first to do, uh, they were the first to do zero interest rate. Everybody thought it was nuts, and everybody did it. They were the first to do QE. Everybody thought they were nuts, and then everybody did it. They were the first to do negative interest rates, and then most people did it. And now today, what are they doing? They've got 3% inflation, and they got short rates at one, and they're sitting on their hands, and they're dragging their feet, dragging their feet. Long end shows sells off every day. Yield curves gets steeper and steeper, and banks go up every day. Like literally go up every day. Uh, and I think that's what we'll do. We're going to have central banks that keep short rates very low because governments now all fund themselves at the short end. A third of US government debt rolls over the next 18 months. Worsh can't raise interest rates when you got a third of the the debt that that that rolls over. Investment has locked them in to keeping rates unchanged.
Unchanged. So, and the long end sells off. So, you're going to get a steeper yield curve. And so, with that, it's like, what, what do I buy? Do I do I buy the tech or like super crowded? So, look, I, I look at asset classes through four prisms: fundamentals, momentum, investor positioning, and valuations. Um, and, you know, yeah, the tech is a fun story. It's exciting. The valuations seem quite stretched. The the investor positioning is is massively extreme. Um, and the momentum might be stalling as we as we speak. And I look at the financials, which is another really big sector in every market. I think the fundamentals look look pretty exciting. I don't think people are overweight that stuff. Uh, the momentum is now there, and the valuations are still decently attractive. Uh, you're not, you're not at stretch levels. So that to me seems like the easier trade here. Um, meanwhile, the other easy trade is if we're right that look, they're going to drag their feet, uh, US dollar goes down, your cyclicals do well, and your consumer stuff in a weaker dollar doesn't do quite as well. Uh, now the consumer stuff has all been sort of lagging, like your consumer cyclicals, they've they've dragged. Um, the momentum isn't there, and I don't really see what changes that momentum. So, so in terms of the markets, I'd be overweight cyclicals and financials.
Well, as I started this out, um, two brilliant guys and, uh, and one dud. So, uh, I really appreciate. I love being around people who are much, much smarter than me. It's, it's kind of a low bar, but you guys did it. And Lou, we really appreciate you coming in here. We know that when you're in New York, you got a lot of stuff to do, so it's very much appreciated. So, thank you so much.
Thanks so much for having me. I really enjoyed this. This podcast is for informational purposes only. All opinions expressed by me, Dan, Nathan, Guy, Donnie, and any other participants are solely our opinions and should not be relied upon for specific investment decisions.