Capital Flows and Asset Markets

Whatever I commit to, I try and commit to until you reach a natural end. I learnt how markets worked in the 1990s and 2000s, which is an era I would call the pro-capital era. And I committed this theory until 2021, when it became clear we were entering a new era. This was an era that was good for bonds, as many of the free market policies were deflationary. Long dated bond yields began falling from 1980 onwards and kept falling. In my view 2020 market the end of this era, and we are now in an era of rising capital costs.

One of the most effective signals to short in the 1980 to 2020 era was when the Fed Fund Rate was above the 10 year yield, known as inverted yield curve.

Generally speaking, investors would tend to get bullish as the Fed cut rates, and the yield curve steepened, as it happening today. Below is the 2/30 curve, which sent bearish signals in 1999 and 2007.

I see things differently. For me, we were in a deflationary era, which is what the long bull market in bonds, and ever falling yields was telling us from 1980 to 2020. We are now in an era of rising yields, for political reasons that I have expounded on at length on this website, and for me most closely resembles the 1950s, 1960s and 1970s. In this era, the time to get bearish was not after the Fed raised rates, but after the Fed had cut rates. Why? Well the long term bonds are telling you interest rates are going higher, and the time of peak bullishness is when Fed Fund rate is too low compared to long term yields. In essence, the Fed (and most other central banks) have their forecasts on interest rates and inflation completely wrong, and the bond market is correct. At the old age of 51, I would take the bond market over the Fed forecast every day of the week, and twice on Sunday. The time to get bearish is not when the Fed is TOO HAWKISH, the time to get bearish is when the Fed is TOO DOVISH.

I prefer looking at the 30 year Treasury, as it is far less influenced by the Fed. 2022 was the last big down year for equities. That was preceded by a heavy steepening in the curve.

Whenever I do anything, I like to commit to it. And it does seem like time to commit. I am also encourage by too other market signals. Japanese 30 year bond yield is at new cycle highs. And the BOJ plans to raise rates, while the Fed is talking of cutting - very odd.

Also gold has touched a new high versus the S&P 500. This tends to be a bearish signal.

Finally, I have been doing this job a long time. I think people are coming around to my way of thinking, but they won’t really believe it until they see it. My job is to believe before seeing. I believe, and I have the short book in place. Now its time for us all to see - one way or another. My next few posts will be more thought pieces than market pieces, I hope you enjoy. Season Greetings to you all.

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I see a lot of chat about getting bearish on AI - with exhibit A being Oracle CDS. Borrowing from a Doubleline presentation, you can see the interesting price action in Oracle CDS relative to the market.

But as can be seen above, the market is sceptical more of Oracle’s financing plan, rather than AI itself. Huge capex, that will be much larger than cashflow implies heavy borrowing. Heavy capex can certainly point to a top in the market, but it is not the capex itself that is a problem.

Capex is only a problem if it leads to over supply and falling prices. The problem with being bearish on AI was that Nvidia, TSMC and ASML had basically cornered the market in high end semiconductor market, which meant the idea of falling pricing causing a bear market seemed relatively unlikely. True, there was a scare when DeepSeek was launched earlier this year, but as we can see with the the share price of Nvidia, the market went straight back to assuming strong pricing for their GPUs.

With the market transitioning from CPUs to GPUs, it was very hard to tell what the right “price” for a GPU could be. It is a bit like asking what the right price for a Birkin bag should be. For me, I think it should be much lower - but then again I am not the target market. But recently, the AI mania has upended a much more transparent market - DRAM. DRAM is memory that is used in most products. It has been a commoditised product - and given the normally constant improvements in yield from DRAM producers, the price tends to fall over time. For me, the second-hand pricing for GPUs is not transparent, but the pricing of DRAM is. As you can see below, DRAM pricing tends to be volatile, but this year we can seen it surge to prices not seen for a decade. This is highly unusual.

As this is a standardised chip, that first came into production years ago, arguments about hitting the limits of shrinking transistors does not really hold. Here, we can plainly see that demand is out stripping supply. In previous periods of excess demand, it becomes common for customers to overorder as they know they will not a full allocation. When demand slows, they then need to cut orders radically, leading to the volatility you see. Typically, the shares of DRAM producers tend to weaken BEFORE pricing falls.

Looking at Micron over the last year - if you are a brave soul, you could argue it is time to short. Personally, I would like to see the 200 MDA stop moving higher before thinking about taking this on.

The other problem with shorting AI is that you are not seeing any real weakness in the “hyper scalers”. If we suddenly saw some financial distress in Microsoft, Google, Amazon or Meta, then the case for shorting would hold more water. With maybe the exception of Meta, Mag 7 share prices are not suggesting problems.

Maybe things will change in the new year - but for me, I think being patient on the “AI is a bubble trade” makes sense.

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With school finishing soon, and markets winding down I feel like its a good time to do an end of year review, and outlook for 2026. A quick summary would be that 2025 was very good given what the equity markets did, and I think we are well positioned for 2026.

I, like almost everyone else it seems, thought the Trump Presidency would be extremely good for crypto assets. Certainly, when Trump won for the second time we saw a surge in the crypto space, but it has been pretty poor since then.

The bullishness that President Trump created for Bitcoin in some ways has created problems for Bitcoin. For years the market has tended to be very bearish on Bitcoin. If we look at the short interest of Strategy (previously Microstrategy), it used to be 35% of shares outstanding. As explained previously, when a share is shorted, it creates huge illiquidity in the underlying, as the owner of the share cannot sell until it is recalled, and the short seller can only buy.

What that meant in practice was that Strategy would trade at a premium to its NAV, and was incentivised to issue shares to buy more Bitcoin. This is something that Michael Saylor did with gusto. Shares outstanding rose from less than 100m in 2020 to over 300m today.

Unfortunately, with relatively little short interest, Strategy now trades below NAV, making issuing shares to buy Bitcoin a value destructive trade. Or in a weird way, bullishness has reduced demand for Bitcoin.

The other big problem for Bitcoin, was that is used to be difficult to monetise or even hedge your holding. This is not the case anymore. IBIT US, is a large US ETF that allows you to short sell. It also allows you to buy and sell at anytime. Until recently, it only saw inflows.

In essence, what I am saying is that the structure of Bitcoin until recently only allowed inflows. Previous volatility in Bitcoin probably came from leveraged players getting margin calls, but now volatility in Bitcoin comes from normal two way markets. For me, I generally look at the market capitalisation of Tether to get an idea of liquidity in the crypto space. This continues to rise.

And if I look at silver, it is hard not to argue we are still in a speculative, dollar debasement era.

But here is the problem. Strategy has fallen 64% from its peak this year. When I check the borrow cost, it is still GC (i.e. very cheap).

And its software business no longer generates cash.

And here is the problem. When Strategy traded above its NAV, it made sense to sell equity to buy bitcoin. But now it is trading below NAV, it would make sense to sell Bitcoin to buy back shares (in theory you are buying Bitcoin at a discount).

In the most recent filing, it reported buying more Bitcoin.

To get excited about Bitcoin, I think I need to see either rational actions from Saylor (buying his own shares would be buying Bitcoin at a discount here), or much more bearishness in the market (spiking short borrowing cost for Strategy, liquidation of IBIT or perhaps liquidation of Tether). We have not seen enough bearishness to get excited about Bitcoin in my view.

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Of all the years to get 67 entries - it had to be 2025.

Before we get to the winner - a special shout out to the two funniest haikus of 2025.

We have this one from Tom O’Hara.

My forecast correct

Wealth blossoms, though joy eludes

My wife still hates me

Apparently money cannot buy love. But maybe a haiku can and I hope you are okay Tom.

And then we have this clever one from MM

This is a Haiku

I’m not really sure how to

make another one

Of the remaining Haikus, four stood out to me as excellent, but with one better than all the rest. So in joint second place, we have:

From RobertJ

Tide retreats at dawn

Shells of leverage exposed

Gulls circle the shore

From JL

Storm clouds briefly fall,

prices bow but roots stay strong—

new buds wait to rise.

From D1bDub

Soft rain on stone roofs

coins golden like honeybees

balance found in bloom.

And finally, we have Ryan, with this evocative Haiku - which I think captures the name and nature of Brumby Capital.

From Ryan

Frost creeps up the curve

Stalking horse watches the herd

Hooves shatter thin ice

Well done to all involved. All 67 Haikus are in the comment section of the original post if you wish to see them all.

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We have 43 submissions so far. I asked ChatGPT to do a word analysis.

Unsurprisingly, gold , Japan and bearish terms (winter, cold etc) dominate. Feel free to submit more than one entry. I will announce a winner on Monday next week.

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When Russia invaded Ukraine in 2021, we also saw Russian natural gas flows to Europe become curtailed, and sanctions placed on Russian oil producers. There was a huge shock to the energy system, which saw European natural gas prices surge 6000% from 2020 lows.

But since the highs of 2022, energy markets have been very weak, even as the Ukraine/Russian was has dragged on. The oil market has been particularly weak.

So much so that gold is approaching all time highs relative to oil.

Usually a surging gold to oil ratio suggest an economic crisis of some sort - oil falling with reduced activity, and gold surging as fear drives inflows. However, other economical sensitive commodities are breaking out. Copper is at all time highs.

As is silver.

The problems for oil come from supply side. With the shale revolution, US oil production use to fall with lower prices. But this time, we have record production.

Saudi oil production is also at close to peak levels.

Politically, I can see both the US producers and Saudi government being asked to help keep oil prices low to put pressure on the Russian government. And given the nature of the Trump administration, it would seem wise for them to follow along. But should we get a deal between Russia and Ukraine, would higher oil price necessarily follow? There is a political logic I could see making this happen. Saudis could easily cut production again within the OPEC set up, and perhaps the Trump administration reduces energy exports - perhaps with a tax on exports. This would force up international prices, but keep domestic prices low. But why would they want to do that? Well China is now the biggest importer of oil, and higher oil prices would hurt China, just as high oil prices hurt the US in 1970s. Chinese crude imports are at close to all time highs.

That is Trump could try and pry Russia from China’s orbit by agreeing a deal on Ukraine, and helping push up international oil prices. It makes sense to me, and it certainly seems possible. But the big issue is getting a deal between Ukraine and Russia. But I think I will take a look in capturing upside in non-US oil prices.

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In a previous note, I described how the economic policies implemented from 1980 to 2016, tended to lead to the same action and reaction in currency markets. And it was possible to trade the reaction in currency markets more cheaply via equities. Now, in the new era that we live in, the “pro-labour” era, where policy makers are trying to raise real wages, the action and reaction seems to exist in bond markets. The problem is that it is no longer as cheap as it was to short US treasuries. Back in 2020, 30 year treasuries yields 1%. If your view was that they would go to 3%, as a rule of thumb the capital loss would roughly 50%, with a carry cost of only 1%. A no brainer trade.

Today, being bearish on bonds is trickier (we will only focus on the 30 year - where yield changes generate large movements in capital values. As a rule, 1% increase in yields leads to 25% fall in capital values). The big issue is that the carry cost of putting this trade on is not 4.3% a year AND you run the risk that yields call, giving you a capital loss as well. Is there a way around this?

Markets are efficient. I know that there are thousand Substacks claiming the opposite, how everything is a bubble, and we are moments away from collapse. But the fact is that markets are very good at pricing in information in a logical and timely way.

The inevitable comeback to the above statement will then be, if markets are efficient, then why did we have the dot com bubble, or the GFC or the Eurocrisis or any other financial crisis that we care to name. The simple reason is that markets move in such a way to generate a reaction. Commodity prices surge to generate an increase in supply, and fall to generate a fall in supply. This is easy to understand for most people. But markets will also reduce to cost of credit to generate credit, and increase the cost of credit to reduce the supply. Exchange rates will decline to bring trade and other flows back into line. In other words there is action and reaction. Reaction tends to be called a crisis.

Perhaps my favourite example of this is the Yen in 1990s and 2000s. As Japan entered a deflationary credit contraction cycle, the authorities did their best to generate an inflation cycle by devaluing the Yen. A surge in Yen value in 1995, put huge pressure on the Japanese economy, and the BOJ pushed interest rates to zero, and was able to devalue the Yen versus the USD dollar - going from 80 to 145.

If the action was Yen devaluation, then the reaction was Korean Won (and Asian currencies in general) devaluation. Japan was not only a large investor in Korea, it was a near competitor in autos, semiconductors, ship building and machinery. The weak Yen, eventually forced Korea to devalue, and was a catalyst for the Asian financial crisis - action and reaction. Yen weakness from 2004 to 2007 led to Korean won again devaluing in 2008. The Won weakness tended to be much more abrupt than Yen weakness - probably reflecting the greater use of USD financing in Korea.

If you look at the cross rate between Yen and Won, you can see the difficulty either nation has in sustaining a competitive exchange rate, against each other.

The problem is that when trading the “reaction” that is Korean Won will devalue back against the Japanese Yen, the cost of doing that directly is expensive. Pre Asian financial crisis, it cost you 25%. Pre GFC, the carry was 5%, but the Won also appreciated some 50% against the Yen. That is the cost of shorting was extremely high, and would have a substantial cost before you made gains.

However, using equities you could reduce the cost of taking a view on the currency. The trick was to look at the “exporters” to Korea, not at Korean companies themselves. As mentioned, Japan was a key exporter to Korea, and competitor. When Korea devalued, you could short Japanese banks. The Topix bank index fell 70% during both Korean devaluations. The other huge benefit from this was that the profits from shorting were in a currency that was appreciating in real terms.

The other option is to short American Deposit Receipts (ADR) or Global Deposit Receipts (GDR) - these are USD listings that track the performance of foreign stocks. There are a few Asian ADRs, but ADRs really work well for Latin America, Mexico and Russia. Brazil is a good example. Typically the Brazilian Real devalues against the US dollar, but during the commodity super cycle it appreciated in value, generating large carry gains.

But shorting the Brazilian Real is always expensive. Interest rates are mainly above 10%.

But companies like Telefonica Brazil (VIV US), with a large tradable American Deposit Receipt (ADR) give you a leverage trade on Brazilian Real weakness with local currency revenues, and US debt and capex. That is weakness in the Brazilian Real feeds directly through on the movement of the stock AND weakness the profits of the company. Again your profits are in the hard currency of the US dollar in this case. The cost of shorting would typically be 3% annually, against maybe 12 -13% for shorting the currency directly. Similar analysis and strategy could be employed with all of Latin America, Mexico and Russia.

What I really liked about using equities as a cheap way to short currencies was that I really did not care that much what the company did - I just knew when a currency crisis hit, everything would fall. So when you could see USD strength coming, you could ramp up the short book massively. If you ever wondered why I was called the “most bearish fund manager in the world”, you need to understand that I was looking at currencies to guide me. From 2002 to 2008, the US dollar had been on a weakening bias, but from 2009 onwards, I was a dollar bull.

Which led me to basically run short from 2011 onwards. . Below was the gross and net I used to run. When I thought China was going to devalue, I was mega bearish - but China has seemingly been able to avoid a large devaluation, even with extreme Yen weakness.

The problem I have had since 2016, is that the currencies has stopped trending in predictable ways. I think we are in a new world, where currency crisis is not the predictable “reaction”. But oddly, I think we can use equities as a cheap way to arbitrage the future crisis I see - but that will be for another post - and behind the paywall.

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I ran a competition to find the best finance haiku last year and was overwhelmed by the response.

From over 50 submissions last year our winner was this beauty from Kevin:

Bull slips on black ice—

Frantic dance of hope and fear

Fortune rolls her dice

I give you this haiku as my 2025 offering:

The majestic Brumby

Far from the stampeding herd

Fearing coming cold

Think you can do better?!? (I really hope so!) I am offering a free 6 month paid subscription to the winner. You have two weeks - you can reply directly to this post or in the comments.

If you have never written a haiku they are a poem of three lines with 5 syllables in first line followed by 7 and then 5 again. It should reference nature in some way. Good luck!

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