Bitcoin, Gold, and the Risk No One Sees - Steve Diggle #6308

really had a proper test of crypto. Yeah, I know, there have been several instances where it's lost seventy eighty percent of its value on all his bats back, but we've never really been an environment where we've had to test. You know, is this thing actually reliable as money?

was a very successful fund. We made our investors over three billion dollars in that period when pretty much doubled our NAV and our AUM, which made us by some margin, the most successful edge fund in Asia, which was where we were operating out of in Singapore at the time.

But you know, with the bailouts that came and and the enormous amount of money printing that the the financial the central banks felt obliged to do, you know, volatility went down a surprisedly started going up, and by twenty ten, you know, we come to the conclusion that they weren't going to stop, and that the more liquidity there was in the system, the lower the volatility would be, because you know, essentially they're they're two sides of the same

Cointility only really spikes when liquidity is drained out the system for a variety of reasons, usually a panic withdrawal of you know, or margin equidation or whatever it is. So with super abundant liquidity, we decided that this is the style that this fund just wasn't going to work, and so we made a decision to shut it down and return investors the Romainian money, which was still over

three billion dollars. There's not many people voluntarily have closed a multi billion dollar hedge fund down, but we just did. We felt it was the best way of preserving our track record, and we didn't think it was going to be a successful strategy for our investors or for us, And indeed that that's been the case. So, you know, with the exception of maybe a few brief periods, especially around COVID, volatility has remained pretty low in financial markets

for a long time. And the SMP in particular, and US markets especially has had you know, spectacular run over the last ten years, attracted an increasing amount of global cap from all sorts of places, including Asia. We see you know, an enormous amount of speculative money from Asia at play in the US, especially in the tech space and the crypto space, and really you know, a complete lack of interest in speculating or playing in their own markets.

You know, there's some of these some of these stock markets that used to be very hot we are back in the Asian tiger days are now stone cold. You know, the returns on some of these markets has been very poor, and the level of liquidity is very poor because an awful lot of that Asian saving base is now at

play and sometimes very leathered in the US. So we've seen a gradual change in the market dynamics, and we just feel now, given a confluence of characteristics in the market, that the risk reward between the you know, the option seller or the volatility seller the volatility buyer has moved significantly in favor of the of the volatility buyer or the auction buyer, and that right now that's not being reflected in prices so after fourteen years of doing other things,

largely private equity, we've reopened these long volatility funds to investors. And you know, we think that there are significant risks in the marketplace right now that aren't being reflected in risk prices, and that there are now fault lines in the market that should give any thoughtful investor pause.

two point seventy two point eight. You know, maybe not the official FED target of two of two, but it doesn't feel like they're really wedded to that two target anymore. So you know, maybe inflational level you can live with ain, know, and then and then there's the market having had this heart attack in the first three days of April after the tariffs, you know, back at an all time high. You know, vole price is pretty low, so you go, well,

this is a pretty benign environment, isn't it. But behind that there are things that should make us know concerned. One is the US. The returns on the sm P of the last ten years are about you know, two hundred and sixty percent, incredibly imbversive, but you know, you know, profits are only up one to eighty percent, so the multiples expanded, you know, twenty five times. The S and

P is definitely not cheap. And in a four four four and a quarter percent interest radi environment, it really leaves the equity risk premium back at pretty much zero. And there's only one time in my career that it was back at zero, and that was ninety nine two thousand and after that the S and P halved, So you know, there's a warning sign right there, you know. And behind it, all you know is this ticking time bomb, which is what it is of the US deficit. Now

a lot of people talk about it. It doesn't feel like a problem because so far the US has managed to increase that deficit very steadily and very and always, you know, pretty much well, with a very brief exception

during the Clinton years, it's always been one direction. And we're up to one hundred and twenty five percent of GDP now at a time of peace and prosperity, literally higher than it was in nineteen forty five, and pretty much with no inten shouldn't by either party of bringing that number down at some point that's gonna matter to

the bond market. Not yet, but you know, you just can't be the reserve currency of the world and to have your bond market being you know, sort of the subsupposedly safe even asset of the world and continue to you know, print money and extend your deficits without expecting at some point there's going to be some consequences. And what those consequences are going to be is difficult to predict. But the US is already spending about a trillion dollars

a year service in that debt. Any sort of revolt in the bond market is going to rapidly blow out the budget and blow out that that that trillion dollar number into any you know, anever bigger number. So that's the kind of the background that is just ticking away there and at some point it's go it will. I think it will unleash some very significant unexpected consequences on markets. They're unlikely to be good. And you can see that

in the dollar. You know this year that it does as it's been widely observed that the dollars have this worst start to a year since nineteen seventy three, at stand ten eleven percent against most currencies. Hard to fathom why given the things that look look they're going pretty pretty well. It's that US stock market and all time high. I think it's concerns about a this deficit which keeps on going up. And secondly, there is definitely some concern about the way in which the US A, as the

global Hegemen, is conducting itself on the global stage. You know, the administration, this new administration has come in with an explicit agenda that's going to shake up the world order, and I think we should do it. Believe them. I think I should believe them.

of changing, you know, shacking things up. And as we saw in three days, you know, in April, when the market fell nineteen percent and the bond market started to go in a little dou lally, and then you know, the dollar wasn't behaving well. The capacity of this administration to surprise people, not always in a positive way, I think,

is there. And you know, there's this idea now that you know, coined by by one of these journalists, the taco trade as Trump always tied chickens out, and so no matter what he says, you just have to ignore it and just carry on buying. I think that's a really dangerous assumption. These are you know, these are these are people who are quite determined to get what they

see as a necessary a deal for America. And I can't blame them for that, but I think anyone who's playing in this marketplace, particularly in a releveraged position, who thinks that it's safe to play out there, you know, is being reckless. Because this administration is going to be a catalyst for volatility. If you're a strong believer in what they're doing, you may believe that eventually, you know, that's going to be a very positive outcome for the US.

Maybe not for everyone else, but in the short term we should expect the unexpected, and market prices are not doing that right. Credit defaultse WAPs are very benign, you know, very low prices, you know, to bet against credit and volatility. Germany is very cheap. So got some inquiry question.

a while ago. Now we did all right, you know, because there was these very wild arbor charge opportunities, but I got increasingly uncomfortable about settlement risk that we were taking because you know, people talk about these places as exchanges, but it was quite clear that they certainly worked. They were more like they were more like those those curb brokers in the nineteen twenties, I mean a lot of them well, and then FTX obviously proved it a lot.

Even some of the bigger ones were very unsafe places. So you know, ah, money is whatever people think it is, right. Money's been weird things in history, right for several hundred years, you know, comp shells were considered a safe form of money, and in life arge parts of you know, Africa. You know, gold has no value, yet it's been accepted as money for four thousand years. Money is whatever people want it to be, and as long as people believe it's money,

then yeah. But when people tell me they're investing in crypto, you know, I get a little pedantic, and I'm like, no, you're not. You may have, you may have bought crypto, you may be speculating it or playing it, but you're not investing in it because it has no yield, it has no fundamental value and it has no residual value. Now you may make money, and of course anyone's bought it has made money, so they're smart. I'm done. But you know, all money, all money is a Ponzi ski right.

I mean, ultimately, you know that that thing in your back pocket that says it's worth a dollar isn't worth a dollar. It's just a piece of linen. You know, that shiny that shiny piece of metal you have in your pocket is not worth three thousand, two hundred dollars. It's just a shiny piece of bec And it's only worth three thousand hundred dollars because someone's going to give you that for it, you know, saying with It's the same with crypto. I think that because the volatility has

gone down or the performance has been so strong. You know, people who said, oh no, it's going to be an investable asset class, I think they're just that's just wishful thinking. You know, we've never really had a proper test of crypto. Yeah, I know, there have been several instances where it's lost seventy eighty percent of its value and all his bats back, But we've never really been an environment where we've had to test you know, is this thing actually reliable as money?

You know, argue it needs quite a bit of technology to make it run. You know, if someone said I'd like to buy your house and I'll give you crypto for it, I'd say I'd rather have dollars.

grow pretty slowly. But you know, scarcity alone doesn't guarantee value. You need a bunch of other things. And look, I've always been fascinated by the blockchain, but you know, I think it's as a solution to things like real estate, for example, or or fractional ownership of of hard to verify assets like like fine art or or fine, why I think the blockchain could have immense value and impact.

I think has money. You know, I don't have any problems moving money around the world, whether it's in yen or dollars or or pounds. You know, it settles pretty easily. Yes, it's Could it be more efficient, for sure it could. Does the bank take more than it should? Yeah, for sure? But you know it works okay, So so what you know, I don't see. I'm not against crypto in any way, but I'm not a believer because I don't see the

problem that it's solved. Now. I understand a great you know, a great number of people have made a great deal of money out of it, and you know, well done then, But you know, I don't see. I don't have a use for it, as in, you know, in the business we run. You know, I can't really use it when we when we traded it, we only traded it in

an arbitrageable way. In other words, you know, if someone was prepared to painting it, you know, at the time like eight thousand, you know, one hundred bucks for a coin in Korea, and I can sell it for you know, eighty two hundred bucks simultaneously in the US. I like that. I didn't like the settlement risk I was taken, but I love the arbitrage. But you know, is you know, is it an important or a significant part of my asset base? No? Not because I you know, I'm against it,

or I think it's worthless or I'm not. You know, I believe it's a it's a scheme, but it doesn't really solve any of the problems that I that I'm looking to that I'm looking to, you know, solve. And you know, do I see it as a potential cause of volatility? Oh? Boy? Do I? I mean, what's what's the value of it now? Is like thirteen fourteen trillion dollars out there in terms of all cryptos. I mean, it's a huge amount of value. Right, that's that's appeared,

you know, just like a mushroom. Right. And you know, if people are really thinking, I've got, you know, I've got, if they've really counted that as part of their permanent asset base, I don't know what happens if there was to be a severe challenge to it. The other thing is, you know, at some point, and I'm surprised it hasn't

happened in more places than China. You know, given its it's potential threat to the monopoly of money that central banks have, that it hasn't experienced more legal challenges, and I think, you know that's that's something that could at some point come back to buy it. But you know, say,

I haven't really been involved for a long time. We watch it, I think as a potential source of volatility, both upside and downside, because as you point out, given the size of the asset, of the of the asset class now and the amount of liquidity in it, its potential to move a lot is huge. Uh, the actual experience volatility has been pretty low, but its potential volatility is enormous. So you know, as a catalyst for volatility, say both on the up and downside, I'd be very much.

I'd always want to be long the wings of a bitcoin out there, and that there's a pretty decent option market out there for it. But are we using it? You know, no, we're not evangelists for it. We say we've had a we did have a fun. We closed it for various reasons, personnel being one of them. They want to go off and do other things. I'm sure they've done really well if they they stayed long. We don't run crypto anymore. And you know, Singapore's Singapore where

we were running it. They've become a little more, a little less welcoming about it. There's been a few scandals there as ever to be there. We're being a new asset class. And yeah, so you know, I see it as an area where people have been very richly rewarded for having faith, as an area where there's an awful lot of speculation, and I see it as a catalyst for volatility. But we don't use it. But I say it's not because we're against it. We just don't really have a use for it.

the same people chasing this rally in gold. I mean maybe some of the algos, because you know, they're just bet non momentum, but I think they're fundamentally the people who feel that they need more gold are probably not the people who think that nasdak's a bargain that you know year up here, I think you so maybe maybe indicative of a big bifurcation in in investor sentiment, and this leads to a potentially very interesting trade. It's a

little nerdy, but you know, as an auction's nerd. Indulged me for a second, which is that the correlation between gold and the US stock market is very very low. Indeed, in fact, Kate's chaotic. Sometimes it's correlated, sometimes it's negatively correlated,

very often has no correlation. Both the S and P and gold are showing relatively low option pricing relative to historic volatility, so particularly the US up depending on the period you measure, because if as long as you include the April period, you know, volatility is very cheap relative

to historic. So if you put those two together, if you're long, let's say you're long out of the money, put some calls on the S and P and out of the money puts some calls on gold, you get a very interesting payoff because you've bought things that are pretty close to the historic volatility, and anything could could happen that could dislocate those And in a sense, you've got four ways to win and only one way to lose, which is that everything kind of stucks around where it is.

So between the two of them, they represent a very interesting way to be exposed to current markets shocks on both sides. So you know, when the dollars we gold is strong, okay, So that explains part of the part of the problem. And just as you refer to the very limited amount of liquidity in in cryptocurrencies relative to the outstanding numbers, so it is with gold, right a tiny amount of gold trades, tiny amount of gold trades

relative to the outstanding amount. So it's ability to move, you know, very rapidly with relatively small changes and appetite, you know, leads it to be a place that just being long volatility alone is a great is a very interesting trade, but the fact that from time to time it has a big impact because other things are going on geopolitically, also makes it a great place to play. However, one thing to always remember about gold is that, like

everything else, you need a marginal buyer. And you know, let's not forget that in two thousand and eight, when everything was for their part, even gold went down. Now it baounts back, but you know, gold is the ultimate hedge against the market. Dislocation doesn't always work. It didn't work in two thousand and eight, and if liquidity were to dry up for any reason again, it might not work again. It works really well as a store of value, It's worked really well as an inflation edge. It's had

four thousand years of being accepted as money. I'm not you know, I'm not a gold bug, people, and no gold bug says it's a gold bug. But you know, if I had to believe in one thing that was going to hold its value through a dislocation, I'd rather have this, this, this permanent, shiny yellow metal with four thousand years of belief than this new fangled electronically dependent one that's had, you know, fifteen years of belief. All right, Hey,

so it's been good talking with you, Steve. Where do we find you?