Capital Flows and Asset Markets

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Subscriber George Noble has asked me to come and speak at a X (twitter) space this Friday, 4pm London time. My first time on a Twitter Space - and if you have some uncontrollable urge to hear me speak for more than 10 minutes - then this is your chance!

As mentioned previously, I was caught off guard by the OPEC increase in production. There is a certain irony to this, because way back in 2014, I was shorting oil producers waiting for an increase in OPEC production then. At the time it was a big money making trade for me. One of the reason that I was surprised by OPEC action is that back then US oil production was surging, but not so much today.

At the time capital was pouring into the US Shale industry. Saudis needed to act and get the oil price down. From 2011 to 2014 the oil had been going sideways o, so everyone just assumed the price would stay there. The collapse drove many high cost producers out of business. In recent years oil prices have been much lower than there were then, and costs much higher, and much of the capital has left the industry - so the move is really surprising.

Back in 2014, I thought lower oil prices would drive a big slowdown or even a reversal of US oil production. At the time many of the shale producers were just eating through capital and for me the industry looked like a sham. But despite lower prices, US oil production has continued to grow (see top chart). This has led to oil really underperforming gold, which I think has more closely followed inflation in the US and elsewhere. From a macro perspective, oil has very rarely been this cheap against gold.

In fairness to oil, gold looks expensive against everything but US financial assets - but that is another story. But there were a few things that have changed about the oil story.

Fund management is a funny game. Every manager has a different style, but typically people think a hedge fund manager needs to have a wall of screens to be able to track all the different markets. Whenever I see a set up like this - I feel like someone is trying to represent frenetic activity as an alternative to thinking and strategy (the big car/small car analogy comes to mind).

Also most people assume you need a huge team of researchers and traders. My experience - not so much. Back when I started in 2002, and particularly in emerging markets, gathering the data on Indian or Chinese corporates would need some knowledge and patience. Economic data was also sometimes tricky to find and interpret, so you needed someone with a bit of knowledge of the world to do that for you - which is indeed what I got hired for. But these days Bloomberg pretty much collates and transforms data for you pretty easily. When I want to find all the listed options to play a certain area - I can find a listed ETF, and just go through their holdings (see below for a screen shot of the holding of EM consumer ETF - for example). For me, software really ate the fund management analyst role.

One thing to clarify - there are large fund management firms with the resources to dedicate a single analyst to a single corporate. I could never compete with that - so I don’t bother - and generally assume 99% of funds cannot compete in that way. I have generally felt that funds that claim they do 100s of company meetings generate no alpha - so I don’t see the point in paying for company access.

Even if I just want market hot takes - Bloomberg uses AI to generate reports (not always accurate) to allow me get an idea of market thoughts, and almost instantaneously.

So what do I need? Well all the short term malarkey is already covered by Bloomberg to be honest. As far as macro is concerned - the problem I find here is that I am also inundated with people wanting to sell me macro research, that basically does not work. It used to work - and I made a successful career from it - but as of today, May 6 2025 - macro has been a massive dead end trade. Maybe tomorrow it changes. We have a good test. Every macro trader and their dog has gone long Yen. Looking at CFTC data, people are as long Yen today, as they were short Yen in 2007.

I understand the logic of being long Yen. But here is where the rubber meets the road, and where I think I need some help. The problem is that trying to find someone who can do it has proven difficult, so I have ended up doing it myself. The key question is does the politics make Yen a buy? China, Japan’s largest trade partner has been hit with 120% tariffs rates - is that Yen bullish? Japan auto sector has been threatened with 25% tariffs. Is that Yen bullish? China may well invade Taiwan, is that Yen bullish? And even on a macro side, there are questions. On 12 month rolling basis, Japan is not running a trade surplus. Is that Yen bullish? This worked example shows you why I hate macro and macro thinking these days.

All of the above, would actually make more more inclined to short Yen than being long. But I would need “political analysis” here more than macro analysis. And what I find is that no-one is consistently offering good political analysis. Sometimes people get it right - but more because of constant negative or positive bias, not from actual thought or strategy (a stopped watch is right twice a day style of success). Another good example of this is Russia. Even though UK and US intelligence services were warning of a Russian invasion of Ukraine, Russian assets did not move until a few weeks before the actual invasion. This is also despite Putin publishing an essay entitled “The Historic Unity of Russian and Ukrainians” in July 2021. Shorting Russian assets then would have been a huge win.

In 2021 I started reading what the Chinese government planned for regulating Chinese tech - which then fell by 50%. This was a huge win, but I tried to work it within a macro framework, which was a fail.

It also goes without saying, that if you had been reading what Trump planned to do with tariffs, then the Liberation day massacre would have been less of a surprise.

As of today, I think that I need help with politics. Someone who can marry politics and markets - and see where the opportunities lie. I have been trying to do that myself for the last few years - but it is very hard (although I reckon I am better than most - which is why I have launched Brumby Capital). I missed the Trump deal with Saudi to flood the market - focusing more on the likely military action against Iran. But against that - my main political trade has been going gangbusters.

If you do think you can help me, then get in touch. But don’t waste my time - as I get older, time is the one resource that gets scarcer - and I don’t forgive anyone who wastes it. You have been warned and I keep a list.

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I like having a strategy to attack markets with. When you have a strategy, you can makes adjustments to improve it as you get new information. In my career as an analyst and fund manager from 2004 to 2021, I was very heavily macro focused, because that was what worked. But from 2016 onwards, it stopped working. Currency moves, and asset moves that I expected rarely followed through. The only big trade I could right was shorting Chinese tech in 2021 - and that was purely from getting Chinese politics right.

For me, I had always tried to focus on macro, and that had been good for me - but when I look back, I realise how much everything was politically driven. The bond bull market was driven by the politics of destroying unionised labour. One of my best trades ever, buying Irish bonds at 10% yield, even though I justified it in macro terms at the time, I knew was also a political bet. I could not see the US, UK, and Europe could allow Ireland to default.

From a political point of view, I see wages rising, and hence inflation also rising, which is why I have pushed, GLD/TLT as a trade. This is a profoundly political trade.

The macro part of me looked back at the 1970s, the big driver of inflation was surging oil prices. When I look at gold/oil prices we seem to be at very depressed oil prices - relative levels seen only during the Great Depression and Covid.

It seemed to me the politics for a pop in oil prices was also in place. It seemed to me that the US was negotiating with Russia to make sure the oil market would be supplied if either the US or Israel bombed Iran. I also saw US oil investment had slowed, and forward gas market pricing looked firm. But somehow the politics was for lower oil prices -and somehow the US managed to convince the Saudis to increase supply. From a peak of USD 80 a barrel in January, we are now at USD 57.

From a macro perspective, the move in gold, treasuries and oil don’t really fit together. The correlations are all over the place. But politically, they make total sense.

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One of my pet topics, and related to my “pro-labour” views on politics, was that I expected fertility rates to rise. I know that there a number of readers who follow this, and have sent me various articles on this. For new readers, the argument for an imminent baby boom centres to two observations. Firstly, rising wages and steady employment and more opportunities to work from home should all act as a boost to baby making. Secondly, improvements in Assisted Reproductive Technology (ART) should allow women to become mothers at an older age, and during this transition from young mothers to older mothers, we see fertility rates drop, and then rise. In countries like Australia, treatments for ART have certainly increased.

Despite this, Australian fertility rates are still dropping.

Even more negative for this theory is that Denmark, which has by far the most progressive rules on ART, saw bump in births when laws were deregulated in 2015, has now seen births fall back to pre deregulation levels.

I have been sent articles pushing the idea of increased government spending leads to higher fertility rates - but the evidence has been mixed. My last post on this came to the conclusion that society has to want higher fertility rates, then anything is possible as Israel has shown. But I was struck by this article in the Economist. It was talking about a UN Refugee Camp in Malawi, where there is no work, and everyone has to get by on USD 9 a month. Despite authorities best efforts, fertility rates are fully two children higher in the camp than out of it.

This fits in with my observation of Eastern Europe, which saw birth rates plummet with the collapse of Communism. Below is Polish total fertility rates. Socialism, apparently, is good for fertility.

The conclusion is that pro-labour policies are good for fertility - but I suspect for most people, a move back to Socialism would be a price too high. Perhaps in a Trumpian America, where workers are protected by high tariffs, a fertility turn around can occur. Or perhaps a more comprehensive program to make housing cheap and affordable? Time will tell.

CLEARINGHOUSES

I have yet to see any political movement to reform clearinghouses. They continue to create the odd market conditions where no risk is priced in, and then all risk is priced in. They were no doubt also at the centre of the recent sell off in treasuries (if this is a new topic for you - please see my tab). Its been a few years now, so whenever you get unexplained sell off in mildly important markets - like US treasuries, or currencies - you can expect the braindead clearinghouses to be involved. They have no ability to price risk on a forward basis - almost everything they do is reactive. Looking at LCH - which is the most important interest rate derivative clearinghouse - margin breaches had fallen back to low levels in the most recent reported quarter (q4 2024)

This meant that initial margins has also fallen back to lows, even though President Trump was reelected with a mandate for change in Q4 2024. This led to reported initial markets being low was as well. Perfect conditions for a bond market panic.

Even though clearinghouses have clear problems in managing risk, there is no political appetite for reform. I suspect that the size of the US treasury market now requires the clearinghouses poor risk management. The basis trade, where hedge funds buy treasuries and then sell futures against them has grown massively as clearinghouses have moved to the centre of financial system. Banks would never lend in the size that hedge fund needed - but clearinghouses have no qualms. This has allowed the private sector to become the biggest foreign owner of treasuries.

Its a financially unstable setup - but politically stable as the US government de facto backstops clearinghouses, who then provide hedge funds the leverage to participate in basis trades. Just expect the treasury market to go no bid from time to time.

VOLATILITY

Korean issuance of autocallable was strong into April, and the weekly numbers I have seen for April show a buy the dip mentality. That is no change in below trends.

Popular products remain S&P 500, Eurostoxx50 and Tesla. While all have been volatile, I don’t see any of them getting close to knock in levels - which means that we should still see heavy volatility selling from all this products.

Kospi 200, which probably has the most influence from autocallables has seen volatility return to 20ish. This is despite South Korea being a main trading partner to China and the US, and also seeing 25% tariffs being imposed on Liberation day.

From what I can see, autocallables look still in place, meaning a spike in volatility still remains very possible. Despite the spike in volatility in April, there does not seem to be any reduction in volatility selling - which is unusual.

Please do drop me any questions - or have a look at my other posts if any of the above is interesting.

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The old finance joke is that trading works in practice but not in theory, while macro works in theory, but not in practice. Macro investing in general has been pretty poor in my experience. I had my best success when I looked at what worked from a trading perspective - and THEN worked out the macro that explained what we saw in markets. Doing it that way, then highlighted areas where markets were mispriced, and gave us areas to attack.

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I know a lot of people and investors have been left confused by this month. How can we have “Liberation Day Tariffs” tank the market, a treasury market crisis, surging gold price, and basically have market back to flat? Has nothing really changed? Was it just a fever dream? Is it just buy the dip to infinity?

For me, I don’t mind these markets, they are pretty much playing out as I would have expected. And what I really love is that broadly speaking investors are in deep denial about the changes that are going on. The continually want to analyse the world through a lens that comes from a past that is no longer with us.

For me, I am happy the market has reversed a bit - it gives me much better entry point for Brumby Capital. As you could imagine, the fund was up big in early April, and has given back some of that gains. But now it time to liquidate my personal portfolio, and transfer cash to Brumby Capital, which will invest in a similar, but not identical manner to my personal portfolio that I have been publishing for the last few years.

During the crisis years of 2008 to 2011, investors learnt that safe assets (or risk free assets) were US Treasuries, JGBs, German bunds, US Dollar, Yen and Swiss Franc. Yen in particular had a very strong propensity to rally over this period.

The long end of the JGB market also had the tendency to rally (yield falls) when there was trouble in markets. The meant that the dollar returns to owning a long dated JGB were immense during crisis periods.

It is a fundamental truth in financial markets is that if an asset has behaved a certain way, then a narrative will be built that explains it, and markets will generally accept it and then expect it. However, this month neither JGBs or Treasuries have acted as a safe haven asset.

Why is this? To me the answer is obvious, mainly as I lived and traded through that period - but I am going to guess that most people will not grasp it. From 1990 onwards, the market was obsessed with carry trades. The carry trade came in many many guises. The convergence of European sovereign bond yields, was a carry trade. The convergence of Italian and German bonds began in the 1990s, and moved on to every other nation that joined the Eurozone. In this case, a long Italian bond, short German bond trade was the carry trade.

Emerging markets US bond spreads converged massively from 2002 onwards. In this case, owning lets say Brazilian USD bonds (C-bond) and short Treasuries was the carry trade.

In currency markets, you also had a huge carry trade in emerging markets. Long high yielding emerging market currencies, while short the Yen or the Swiss franc was extremely popular. This trade also leached into the banking system, where Yen and Swiss franc mortgages became extremely popular (you are long a Polish home, while borrowing Yen).

Subprime trade was also a carry trade. You have to remember is that while most fund managers and hedge fund strategies present themselves as complex and sophisticated, they are often at their heart, very simple. Carry trade is extremely popular, as it generates a positive carry, and from 2003 to 2006 also produced capital return. The point of this history lesson is that as we can see above, the carry trade worked until 2009 or so, and has been a failure more or less since. The reason assets like Treasuries, JGBs, Yen and Swiss Franc traded as safe havens was that they were the short legs of carry trades. When markets turned, fund managers were forced to buy them back. They were safe haven as the market was short of these assets.

So when markets are weak now, and the old “safe haven” trade don’t work - what does that tell us? It tells me, the market is long treasuries and long risky assets. Why is that? For me, the efforts of central banks, governments, regulators and clearinghouse reforms since the GFC has in effect mutualised risk - that is corporate risk and government risk are now one in the same. In simple terms, the US government has dedicated so much of itself to preserving and protecting corporate America, there is no real distinction anymore. Despite the market ructions this year, US high yield credit spreads are still close to all time lows..

That is the trade since COVID has been to basically assume government risk and corporate risk is the same. We can already see that when TLT is weak, US equities now tend to follow as in 2022 and this year.

This is actually not a new phenomenon. It was true of the US in the 1960s and 1970s, when government was much more directly active in the economy, and has been true in emerging markets, where foreign investors basically see corporates and governments being fused together. The only really novel thing is that the US government has protected the corporate sector, while asking for NOTHING in return. In the 1970s, federal guarantees where given in return for high tax takes. In the 2000s, the corporate sector has been protected, while also receiving tax breaks, the end result is sky high government debt.

What in essence I am saying is that in 1990s to 2010s, the dominant trade was long high yield or risky assets, short low yielding boring assets. Since the 2010s, the issuers of low yielding boring assets have extended guarantees to in effect make all assets low yielding (or expensive). There is essentially no short leg to this carry trade - hence there is so safe asset. Perhaps the only asset that could be argued to be under owned in gold. If sovereign bonds are not considered safe - then gold is under owned by central banks. The other asset I suspect might be under owned is cash. Of course a big exception to this is Warren Buffett. He has a lot of cash. But then again, he has been around a lot longer than most investors, and does not try and pretend his investing strategy is complicated or sophisticated.

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Its been a long time since we have had a real bear market in the US. For me, its looks like more of slope of hope, where rallies are there to be sold.

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Let be clear - I am not a “gold bug”. In fact I used to make fund of gold bugs all the time. Fred Hickey, who apparently was a “technology strategist” used to devote most of his newsletter to gold, and gold mining stocks, while missing the greatest bull run in tech stocks ever seen. Long gold miners, while recommending short Tesla and Nvidia is probably about as mentally deficient as it gets. I always had two big problems with gold bugs. First, why if fiat currencies are so bad did we get a bear market from 1980 to 2000, and then again 2011 to 2020? What changed in these periods?

Gold bugs often wave away bear markets in gold as some sort of government conspiracy, which may well be true. But in the fund management game, owning an asset in a 10 or even 20 year bear market is one way ticket to unemployment. As long time readers will probably guess, I see gold as a reflection of political attitudes to rising wages. And the recent surge in gold, in my view is inline with President Trumps use of tariffs to boost American wages.