Coffee with Grant Williams

I had the good fortune to have breakfast with Grant Williams last week when he was in NZ for a conference.

For those unaware, Grant is the author of 'Things That Make You Go Hmmm"



and, along with Raoul Pal, is the founder of Real Vision TV, an on-demand financial channel via the internet



Grant is a strategy adviser for the Vulpes Fund which manages hundred's on millions of, primarily, partner's capital and is based in Singapore.

I have followed Grant's writing for some time and in particular share his views on macro events and the role that gold will (and is) playing for investors as this cycle develops.

I am taking the time to share this conversation for two reasons:

(1) I quite enjoy the HC 'community' and believe that what comes-around-goes-around ... if I share some of my info, others will provide in-kind and thus we all benefit from the shared input

(2) I think that any investor managing a high six figure, or seven figure portfolio (or greater) should subscribe to both of the above services as a cost of business. Subscription fees are largely irrelevant relative to the implications of acting on good / bad advice ... and I distinctly think that both 'Hmmm' and 'Real Vision' offers excellent, actionable advice that have saved / made me 100's of thousands in recent times. To that end, if any HC'ers subscribe, I don't think Grant would be concerned if our conversation is shared.


Grant's current position is that on a risk - reward basis the markets (bonds and equities) are not attractive. He is currently sitting on the sidelines with a bias towards physical precious metals stored in a safe jurisdiction. In his case Singapore.

The rationale for having a precious metals exposure (as part of a portfolio) is three fold:

1. Financial Crisis Insurance

As an insurance policy against a Western led financial market crisis, of which the alarm bells are starting to ring. A good quote is that "you can't buy house insurance when your house is on fire". But why would you own gold as insurance?

Quite simply, in his view which has been formed from conversations with many astute industry participants is that 2008 was not a crash, but instead a near miss. The entire financial system was on the verge of collapse and it was only the actions of the FED et al that ensured the financial system remained intact. Since then, however, there have been no structural changes implemented to avoid another crisis and, in fact, our set-up is so much worse than just six years ago. For example, global debt is now $57 Trillion greater than in 2008 (McKinnsey) and all the tools in the CB toolbox have been deployed - interest rates are at +700 year lows ... not since the Roman Empire have interest rates been this low in Europe and in the US it goes back a couple hundred years.

The insurance component relates to counter-party risk and where and how assets are held; either within the system or external.

An anecdote comes from Grant's employer, Stephen Diggle the founder of Vulpes. He and his partners correctly forecast the housing crisis and through correct positioning they made a lot of money during the crisis (Real Vision interview). The issue was extracting their money from their various counterparties as the 2008 crisis was so severe the very solvency of many financial institutions came into question (and there were many well documented failures).

Once the process of extracting his funds were achieved Stephen received a life changing sum (nine figures). The immediate concern was 'where can I put this that it'll be safe'. Stephen was so concerned that even after making this amount of money he didn't take a single day off work for fear that when he returned the funds would be gone through a counter party failure. Subsequently these funds are redeployed into 'safe' sectors.

Grant's view is that gold represents a store of wealth that sits outside of the financial system, if held in physical form (i.e. not an ETF) and within a jurisdiction that has strong property rights (i.e. not the US !).

So what is the likelihood that this insurance will ever be required?

As investors we all read extensively and I won't unnecessarily add this this (long) post. However, Grant's latest edition of Hmmm, written after our conversation last week highlights the number of very astute billionaires and industry legends that are now ringing the alarm bells that, in their opinions, a material market event is approaching. These include:

- Stanley Druckenmiller
- Carl Icahn
- Sam Zell
- George Soros
- Crispin Odey
- Andy Redleaf
- Paul Tudor Jones II
- Ray Dalio

All titans of the financial industry. In addition, figures from the public sector are now weighing in, in an effort to preserve their legacies; formally putting on the record warnings that, after a crisis they can point to and say "I told you so". These include:

- Allan Greenspan
- Rob Fisher

Additionally there are institutional warnings:

- BoE
- IMF
- BIS

It's time to really sit up and listen to the signals that are presenting themselves (Dr Pippa Melmgren's book "Signals") and think through what could happen if an overly extended and leveraged market were to suddenly lose confidence. Kyle Bass's quote springs to mind "It's a five lane highway going in and a goat trail getting out" ... i.e. liquidity will evaporate.

Crispin Odey has already commented on this. Having seen the signals he has exited some positions and commented recently that it was surprisingly difficult to exit positions as there was no liquidity ... and he is one of the first to act !!

2. Increasing wealth amongst EM nations that have cultural affinity to gold

This is a fairly straight forward driver and a longer term one. It is well documented that people from EM's have a bias toward gold as a store of wealth (often in the form of jewelry) that we Westerners don't. This is most likely due to the proximity of those in EM's to instability and conflict relative to us in the West who are at least two generations removed and haven't ever had to worry about our property rights.

3. The Great Game

The geo-political winds are changing as we move from a uni-polar world dominated by the US after the defeat of the USSR to a multi-polar world. The US is not taking this change well and is resisting at every step.

There are many dots to connect that show a cohesive strategy from the BRICS and EM nations to slowly and steadily wriggle out from under the thumb of US control via the petro-dollar and military superiority. Some of these dots include:

- Strengthening of Russia / Chinese economic ties to include development of oil pipelines, high speed rail connections and bi lateral rubble / yuan trade

- Establishment of alternative institutions to the US dominated World Bank and Asian Development Bank that bypasses US dominance. For example the Chinese led Asian International Infrastructure Bank (AIIB)

- Multiple bi-lateral currency swap agreements with Chinese trading partners and establishment of yuan trading hubs in global financial centres

- Moves to sell / purchase oil between Saudi Arabia and China in Yuan centered out of Zurich

- Establishment of Chinese based commodity trading hubs to create price disclosure in Yuan, not USD

- Free Trade Agreements between multiple countries and China

As these BRICS and EM nations move away from US control and trade with each other with their own currencies, excluding the USD, it is important that each nations' respective currency maintains the trust of the other trading nation in terms of stability.

This is where having a % of physical gold held in the foreign exchange reserves of the various trading nations provides confidence to the other side that trading and holding the counter-party's currency is a good idea. This doesn't necessarily mean that the various currencies are backed by gold but instead each nation can show a healthy store of gold on hand. There have been many overt purchases of physical gold by nations in recent years who would form this group. These include:

- India
- Brazil
- Russia
- China (data can only be estimated as no official record has been provided since 2009 ... and who knows if that is accurate)
- Mexico
- Kazakhstan
- Philippines
- etc

Where to from here

I have exposure to gold via investments in the miners, which should act as a derivative of gold. These are, however, also equities and may be caught up in the maelstrom of a financial market collapse. Of the above, a financial crisis is the biggest threat (obviously).

Grant's view is that if there is a crisis gold may act differently this time around compared to when Lehman collapsed. Prior to Lehman gold had run strongly in USD (to c. $960 oz) and, in his view, there was a lot of levered long trades in gold that had to unwind during the liquidity crisis.

This time around, however, Grant believes that the levered trade is actually short gold and if these trades are unwound this may be favourable.

If gold were to fall, his view is that it would be very short lived and we'd enter a phase analogous to the 1930's where miners and gold performed very well.

Additionally, it is likely that the next crisis will present similar - and likely worse - counter party risk for financial participants (i.e. the problem that Stephen Diggle had in 2009). All that gold requires for an upsurge is a marginal buyer. There is a lot of research that shows how imbalanced the supply-demand for physical gold is (e.g. Sprott, Jensen, et al) and if a marginal buyer were to emerge (e.g. hedge funds enmasse seeking to protect assets outside the financial system) then there will simply not be enough physical gold available (mine supply and recycling) to cater for the demand. The result would be materially higher prices.

Grant's view, possibly a USD centric one, is that it is too early to invest in the miners. I differ from his opinion, in that Nov-Dec 2014 presented an excellent opportunity for Australian investors to invest in quality producers and, to-date, have made good capital gains - in my portfolio NST and MLX have performed remarkably, whilst BDR much less so.

Grant bases this view on the fact that gold is bumping along the bottom and not doing much (yet). This is obviously a USD view as in AUD and BRL (plus many other currencies) gold has lifted materially off it's lows.

My view

Having become overly exposed to the sector since Nov-Dec 2014 and having made some good gains across my portfolio I am going to heed the warnings coming thick and fast from the guys that influence others (as investors are prone to psychology).

I will selectively reduce some of my positions in favour of cash to ensure that I do not need to be a forced seller during any upcoming market event and that I replenish my dry powder to, hopefully, purchase select gold miners cheaper than they are today during any upcoming crisis.

I can certainly remember how illiquid markets became during 2008-9 and will heed Crispin Odey's warnings that even he is finding liquidity an issue and move ahead of others, possibly leaving significant upside on the table.

I will certainly not exit all my gold exposure as these businesses are currently making excellent profit and free cash flow. I will likely slowly sell down around 30-40%, locking in my gains since Nov-Dec 2014 in the best performers and keeping exposure to those that I believe are still materially undervalued.

Lastly, I would highly recommend any investor - not just those interested in gold - to seriously consider a subscription to Grant's two offerings. Since 2007 I have realised just how dependent markets are on the macro environment vs. company specific performance. Correct analysis of those tea leaves is vital. There are a lot of companies doing great things at present but I do think we're fast approaching the cliff where everything will be hammered and the smart people / billionaires looking ahead are now jumping from the bus ahead of the cliff.

Cheers
John