[00:02:32] Clay Finck: Since you’ve been sharing these great charts, I figured it would make a ton of sense to pull some of these charts for those watching on video on YouTube. But for those listening on the audio, we’ll be sure to chat through sort of what’s happening on the screen here and tie it into the questions. So, to help set the stage for our conversation, let’s start with what you called the most important macro chart of this decade.

[00:03:03] Clay Finck: For those listening, the commodities to equity ratio has been in decline since the great financial crisis, and it’s well below its historical average. It looks to potentially be on the upswing and may have a shift in momentum here to the upside. What’s amazing to me is just how far commodities have fallen on this chart relative to equities, given how much commodities seem to have been underinvested in.

[00:03:31] Clay Finck: So maybe Tavi, we can start with your thesis on why you believe we’re just at the beginning of this uptrend for the commodity to equity ratio.

[00:03:42] Tavi Costa: Well, to start with, I would say that this chart will flex. I would think most of, at least my views in the macro environment, and it’s a reflection as well of how cheap tangible assets are relative to financial assets.

[00:03:58] Tavi Costa: For many reasons, we’ve had 30 years or so of declining interest rates. Discount rates have been declining as a result, cost of capital has been declining as well over the last 20 to 30 years, and therefore that all had an impact on inflating prices of financial assets. So you have equity markets near record levels in terms of price relative to fundamentals.

[00:04:24] Tavi Costa: The same thing is happening with the bond market, despite the fact that in 2022, we’ve had a decline in both asset classes. And the other side of this, which is absolutely important and critical for investors, has to do with the tangible asset side. We’re seeing how commodities have been underallocated by investors.

[00:04:46] Tavi Costa: Also, we’ve had a chronic period of underinvestment in the space. And so a lot of those commodities need new reserves, they need new discoveries. They have been lacking the level of capital expenditure that we’ve had over other times in history, especially when you are really looking at that data relative to GDP levels because 10 million spent on the ground today certainly isn’t the same as we saw during the global financial crisis period or so.

[00:05:17] Tavi Costa: And so this chart showing how the precious commodity to equity ratios are, it is a reflection of those views, and it’s also a reflection of the views about inflation. Inflation is something that we’ve had in other decades, the 1910s, the 1940s, and the 1970s. Although in this chart, it only goes back 50 years.

[00:05:39] Tavi Costa: So we’re not seeing the forties in the 1910s, but you can see clearly that in the seventies, the fact that we did have inflation, in other words, the cost of consumer prices, or I should say the price of consumer goods and services was rising during that period. And also we’ve had the break of the gold standard and other issues that caused this.

[00:06:05] Tavi Costa: Most investors flocked into most of the tangible assets, housing markets did well better than the stock market. I would say the tangible assets in general, including commodities, mostly from copper to gold to silver to energy, in general, agriculture, all perform better than stocks and bonds. And I think that correlation shift is a little bit understated today by most investors that believe that we’re always going to see equity markets outperforming other asset classes, but also bonds will serve as a haven asset for most portfolios. And all that is again indicated in this chart as what I think that is going to be a paradigm shift for investing, where commodities are going to go back and become a larger allocation of investors.

[00:06:55] Tavi Costa: And also, it’s not only commodities, it’s commodity businesses that are part of this as well. And so I think this chart is just simplistically telling us how cheap those assets are relative to financial assets, but there are a lot of ways to express that view in the markets. Some folks will think a certain commodity will do better than others.

[00:07:20] Tavi Costa: Let’s say myself, I have a very strong focus on gold and precious metals. Some others have the same view on energy and so forth. I happen to think there is a way to express that view today, similar to how people capitalized in the early nineties with the creation of private equities and venture capital approach of investing in many startups back in the nineties of the technology sector, which was the beginning of the internet and so forth and did very well.

[00:07:54] Tavi Costa: The difference here is that this space of natural resource industries is perhaps one of the oldest industries in history. And another thing that is related to this is a lack of folks that understand this space very well. I mean, we have not only an issue of price imbalances between equities and commodities, but also a problem of labor markets that are not able to fulfill the interests from companies that need geologists, for instance.

[00:08:24] Tavi Costa: So, geosciences undergrads and graduate students, in terms of the number of folks that are graduating in those fields, has also been in a secular decline. All of those trends shown in this chart are secular trends. They are long-term trends that tend to occur over a decade or so, and I think that we’re entering another one of those.

[00:08:48] Tavi Costa: We’ve had the beginning of that recently. It’s the gray rotation, the value to growth transition, the beginning of folks really understanding profitability, higher cost of capital. So, there’s a lot to unpack on this chart. I can talk about this chart for hours, perhaps, but I think it’s right at the core of why I believe commodities are undervalued.

[00:09:12] Tavi Costa: And why I think that financial assets are yet to suffer a lot further from what we’ve seen so far, especially between multiples and prices relative to fundamentals that I think need to compress significantly from here.

[00:09:27] Clay Finck: Let’s touch on the inflation piece. I know you’re a student of history, and history tells us that when inflation strikes, oftentimes it comes in waves. So after inflation may appear to be tamed, it can come back with a vengeance, you know, and at some point in time later.

[00:09:47] Clay Finck: So, the recent inflation started in early 2021 and peaked out in mid-2022, around 9.1% CPI here in the US. And then the most recent reading was 5.0% as of March 2023. Could you talk about what history tells us about when that second wave of inflation might be coming?

[00:10:07] Tavi Costa: Well, I think we’re getting very close to that for many reasons. First of all, we’ve had a liquidity issue recently with the banking situation, which was immediately mapped by a Federal Reserve intervention, which is, in a way, a liquidity injection in the system to avoid a liquidity gap otherwise. And so that goes to show how the Federal Reserve and specialty policymakers of developed economies have one job, which is to maintain the stability of the financial system.

[00:10:39] Tavi Costa: And that requires liquidity injections, and liquidity injections in an environment that requires as well financial repression ultimately. And so it is hard to believe that we’re not entering, just from that perspective, a period of inflation running higher than historical standards. And then you add to the fact something that I’ve been talking a lot about, which is what I call the four pillars of inflation.

[00:11:06] Tavi Costa: To me, that’s one of the most important ways of explaining how history has not only played out different roles in terms of the drivers of inflationary forces but also how today this is so pronounced, meaning today we have the wages and salaries growth, the wage prices spiral that is very similar to what we saw in the 1970s.

[00:11:30] Tavi Costa: And it starts with, you know, first of all, the cost of living rising, which is an important aspect here, which we’ve seen in rents and other services and consumer goods. Prices have not only increased since the pandemic, but we’re also not seeing a deflationary aspect of them. They’re not coming down. Prices are actually staying elevated, which causes people to require higher wages and salaries.

[00:11:56] Tavi Costa: To another point here that is important to elaborate regarding wages and salaries, it has to do with the fact that we’re seeing the share of labor costs relative to profits of corporations being historically low. So there is a secular trend as well, just there, that we think that corporations are not going to be able to get away with paying such low levels of wages and salaries relative to what they make. And so that pressure is coming, and I think we’re just at the beginning of that.

[00:12:32] Tavi Costa: And it fits into this wealth gap issue that we’re seeing, where most of the jobs that are likely to get higher wages are probably going to be the less skilled types of jobs for folks that don’t have a high school degree and so forth. And if you really explore that, we’re probably going to see, and we’re seeing that right now, the employment ratio across that part of the population in the US has never seen such a strong labor market throughout history.

[00:13:06] Tavi Costa: Which means that even inside of the job openings and availability of jobs in general, we’re seeing the need for those non-skilled jobs to be fulfilled. And so that is going to create, in my view, a higher demand for salaries to increase. And in a sense, it will play into this where the bottom 50% of the population in financially speaking will probably be earning more money over time.

[00:13:34] Tavi Costa: And you know, like it or not, there’s a reason why folks that stay at the bottom 50% is because they tend to spend and allocate their capital when they earn it in ways that are less disciplinary than folks that are in the top 90% or so, in terms of financially speaking within the population of the United States and other developed economies as well.

[00:14:01] Tavi Costa: So that is one pillar, very important one that is happening today and has a lot of room for growth, especially if you look at the percentage of capital costs relative to profits from corporations. Number two, it has to do with what I just touched on initially in your first question, the chronic under investments in natural resource businesses.

[00:14:25] Tavi Costa: If there’s anything that triggers a commodity bull market that is looking at the aggregate capex of most of the commodity companies. And when you see that at the pressed levels, that tends to cause commodity prices to rise. And most of the reasons for that has to do with supply side being so constrained.

[00:14:47] Tavi Costa: I think we’re in that environment today, and I know that for a fact, just because of what’s happening in terms of the need for those things to be developed over time. In other words, the need for metals and availability for resources in order to make the green revolution happen. Even how oil has become such a strategic geopolitical asset over time.

[00:15:12] Tavi Costa: So all of this is playing an important aspect in the need for those materials to be more available. But we don’t have that, and it will take a long time for us to see the comeback of those investments into the natural resource industries to then translate into higher supply. I’m in the industry of investing in those things, so I’m very much aware of the time and effort that it takes to go from exploration to development phase and then producing phase of an asset within this space.

[00:15:48] Tavi Costa: And so, I think that’s also a very secular trend. We’ve seen this throughout history as well in other decades, but I think it’s again, very pronounced in today’s environment. Number three, and I think it’s important too, is the reckless or irresponsible amount of fiscal spending that we’re seeing currently.

[00:16:08] Tavi Costa: Partially, that has to do with the cost of debt. The cost of debt is increasing, creating a need for budgets to be, or I should say, deficits to be larger than historical standards. And this is going to get worse over time, but the interest payment on the debt only explains about 50% of the deficit today.

[00:16:32] Tavi Costa: If you look at the deficit currently relative to history, in the seventies and sixties, there was at least a notion from policymakers that government spending creates inflation. I’m not sure today that you can apply the same idea. In fact, we just passed recently, not too long ago, the inflation act part of the budget, which was something that goes to show how, why in the world would you be spending more when you have an inflationary problem.

[00:17:03] Tavi Costa: In the first place, and it’s something that we’re seeing to a large degree. If you actually adjust for inflationary numbers today, in terms of the fiscal spending throughout history, you’re going to find that today, by far, we’re seeing something that is quite scary. From that sense, it’s almost like the government is undoing what the Fed is attempting to do in terms of raising rates and tightening monetary conditions.

[00:17:32] Tavi Costa: And I am not sure this is the end of it. I think that the agenda on the fiscal side has never been so extensive. Why? Because you have this inequality issue that forces governments to run a larger social program. Number two, you have, again, this issue with developed economies having to become more industrialized and go back to reinvesting in their manufacturing plants.

[00:17:58] Tavi Costa: And that is a problem that I think is quite large in terms of the level of spending from the fiscal side. And so those things are very important. The Green Revolution is another one that will fit into the agenda more and more over time, and it’ll also be a large percentage of deficits, in my opinion, for the next decade or so.

[00:18:23] Tavi Costa: Military spending, it’s hard to make a case that military spending is going to be falling, not rising in the following years, especially given what’s happening with Russia and Ukraine, China and the US, Middle East and the US, and there are a lot of issues unfolding all at once, and I find it hard to believe that military spending is not going to be a much larger percentage of GDP.

[00:18:52] Tavi Costa: And just to give people a sense, the percentage of military spending or defense spending back in the sixties was about 9% of GDP. Today, it is less than 3%. So there’s a lot of room for that to grow over time here. So those are three pillars. The fourth pillar has to do with deglobalization. Deglobalization is, to me, one of the most significant trends. Maybe it started back in 2016 when we had Trump initiating the narrative to fight China, and we’ve had his discussions, which took a while until even the Democratic party began to really understand or maybe even buy into that idea in general.

[00:19:35] Tavi Costa: And today, I would say the bo it’s a very bipartisan idea in terms of having very different policies than we’ve had over the last decade or so. And so, deglobalization is a trend that tends to be something that magnifies over time, exacerbates this inflationary problem. It creates changes in terms of logistics and also the need, again, for developed economies to reinvest in what are called revitalization of their industrial parts in different places of the world.

[00:20:07] Tavi Costa: It will create different partnerships. I think Brazil, South America will play a big role in providing natural resources to some parts of the economy rather than Africa and other parts that have been playing a role and have a bigger connection with places like China. I think it will create separations of countries that will do well because of their own natural resources and other countries that don’t.

[00:20:34] Tavi Costa: So all those things are playing a role in creating some sort of issues related to deglobalization. I think that the war between Ukraine and Russia is perhaps more of a consequence of all those issues that we’re seeing growing over time, and again, it’s not like we’re probably going to go to World War III, although everything is from a probability perspective.

[00:21:00] Tavi Costa: I do think that the need for folks to rethink how their dependencies with other countries lie ahead and perhaps internally try to reduce those dependencies and improve their domestic economy over time to not have to rely on other countries like China. And so this is all playing a big role in inflation.

[00:21:21] Tavi Costa: Those are the four pillars of inflation: wages and salaries, natural resources under investments, the reckless amount of fiscal spending, and deglobalization. These four things are called the four pillars of inflation that will probably continue to play a role in creating what I think will be a secular inflationary period for the US and other developed economies.

[00:21:44] Clay Finck: So many great points here. I mean, so many to go through. It seems like all four pillars of inflation are working against us at this point in terms of trying to prevent it from happening. And this ties into company profitability and earnings, as you alluded to there. And you just recently published this chart here on the screen showing the basic and diluted earnings per share for the S&P 500 dating back to the 1950s.

[00:22:15] Clay Finck: And you can see this secular uptrend in the basic earnings per share. And it looks like we’ve hit sort of that extended point, probably in 2021, and it’s starting to roll over. I’m curious about your take on this chart, and you know, it seems to play into this inflationary thesis and, you know, wage growth hurting company profitability.

[00:22:39] Tavi Costa: Essentially, we’ve been in a 70-year channel in earnings per share on an aggregate basis in the S&P 500. This means there is an upper band and a lower band in this chart that you can see very clearly, which I pointed out with two lines. Basically, every time we hit the upper side of this band, we see a critical juncture in terms of earnings that tend to be in a contraction mode for the next few months or years, depending on the situation.

[00:23:13] Tavi Costa: It’s important to go back through our history again and analyze by decades because it’s a long-term analysis to reduce noise from different macro events that may have occurred. You can see more clearly macro regimes and different parts of history that played a role in the views that we have today.

[00:23:34] Tavi Costa: In my opinion, there are two things that are important here. Firstly, the 2010s, which was the prior decade we had, was by far the strongest real earnings growth that we’ve had in history. That is the first thing to point out. The question is, can we see two decades of that in a row? And the answer for that is we’ve never seen this in history.

[00:24:01] Tavi Costa: The other two times we’ve had such a robust growth in earnings of corporations happened in the 1920s, the Roaring Twenties, which was a time when we had different inventions, such as the television. The television created a communication piece for the world at that time. It created marketing in a different way, commercials, movies, and different things that you can extrapolate as a thought of how the global economy was transformed by just that invention itself. Other things happened during that period. Supposedly, the Roaring Twenties was a time when we had consumer spending to a degree that we haven’t seen in the past.

[00:24:43] Tavi Costa: And the macro environment was very different than today, but it’s important to see how that period was a time when the economy really prospered and corporations did very well despite the differences that we have with the current environment. The second decade that we did very well was in the 1990s, which was the time when technology was during the revolutionary period when we had the beginnings of the internet.

[00:25:11] Tavi Costa: And a lot of businesses were created during that phase and it was a period where, actually, believe it or not, corporations also did very well in terms of their earnings. Their bottom line was growing at a pace that we’ve only seen during those three decades, the 2010s and the 1920s. And if you think about those two decades specifically, the subsequent period or the subsequent decade after those two were times when corporations struggled significantly to earn capital.

[00:25:43] Tavi Costa: Meaning this was the 1930s, which was the Great Depression. And I would say the 1930s was a very, very difficult period as well in corporations. They had a significant contraction in their earnings. The same happened in the nineties. After the late nineties, we’ve had the tech bust, corporations struggled to make money again, and then right after that, at the end of the decade, we had the ’08 experience as well, which was a decade.

[00:26:14] Tavi Costa: That was one of the worst periods for growth in terms of corporate earnings that we’ve had in history. So, that never happened throughout, but we’ve never seen two straight decades of strong earnings, especially when we have such a strong period like we’ve had recently. What would make that change? I mean, some folks believe that the changes that we’re seeing today, technologically speaking, will create an environment that justifies the multiples that we have currently in equity markets and maybe justifies the growth that we’re seeing in corporate earnings to maintain that over the next decade.

[00:26:53] Tavi Costa: I don’t think that will be the case. I think despite the fact that we’re seeing those breakthroughs through AI and other incredible things that are being created recently, even in the biotechnology space as well, it’s just hard to believe that the pillars of inflation are not going to play an important role in squeezing the margins of those companies at a time when the cost of capital specifically is, I think, at a structural increase, meaning it’s not going to be cyclical, it’s going to be, we’re going to see the cost of capital, and specifically the cost of debt, being higher than historical standards, and at a time when what I said about wages and salaries is a real problem.

[00:27:42] Tavi Costa: Operating expenses are likely to go much higher and cause operating margins to be squeezed significantly. This is the main reason why we’ve had such a, you know, a period in terms of the times when corporations have been able to spend less capital paying for their wages and salaries relative to how much money they’ve been making.

[00:28:06] Tavi Costa: And I think that with the political agenda that we have currently, on top of the need for most of the population to start making more money to afford such a high cost of living environment that we have today, it will force those margins to be squeezed over time. I also have a strong view about material costs because of this underinvestment that we’ve had over commodities and really into the natural resource industries. It is very unlikely that the availability for raw materials will be here in the next three to five years.

[00:28:44] Tavi Costa: So the cost of those things, depending on what business you were related to, are likely to be pressuring those margins to be squeezed. Margins are starting to decline currently. So we’re now looking at earnings in this chart. But if you look at margins themselves, first of all, they increase to all-time highs. We’ve never seen margins this high recently with the Covid situation. And then after that, margins have declined to prior peaks. Prior peaks that we’ve had before the global financial crisis, before the tech bust. Look, I think we’re going to see a period where there is an earnings recession. I don’t think we’re immune to those issues.

[00:29:28] Tavi Costa: I do think there is a business cycle after all, and I do think we’re likely to be experiencing right now the beginning of a downturn in terms of earnings of most corporations. And we have to extrapolate that thought again and think, well, if we do see a decline in earnings, if earnings are inflated, and despite the fact that earnings are inflated, multiples are at record levels, meaning prices are high relative to inflated fundamentals, what happens if fundamentals fall 20%, 30% or so?

[00:30:03] Tavi Costa: What does that do to the current multiple that we have? And it’s such an important question. I do think we’re going to see multiples get compressed. And again, when I go back to history and I see, alright, well I have a view about inflation. I think this is going to be secular despite the fact that we may see deceleration and acceleration, like you said, through waves like we saw in the seventies, in the 1910s and 1940s, all had their waves as well. But what is important to go back in history is to see that multiples of equity markets during inflationary periods in average compressed significantly over 30% during those periods. And so, I do think we’re at the beginning of another era like that, but never throughout history have we started an inflationary decade with such a large degree of valuations that we have today.

[00:31:03] Tavi Costa: The valuations we have currently resemble periods like we’ve had in the tech bust or prior to the tech bust and during the tech bubble and prior to the Great Depression. So the late 1920s. Again, those are the two times that we also had strong earnings in the prior decade, and it’s just normal to see this because we have strong growth in earnings and then analysts, especially Wall Street analysts and other investors, begin to extrapolate that we will continue to see that and therefore you get those large multiples that we’re seeing today, but it’s very, very difficult to maintain that same growth rate that we’ve had in the last decade. So I think this chart is important. I think it tells us that we’re, again, at this critical juncture that we’re probably going to see a decline in earnings for all the reasons I mentioned here. And if that’s the case, you know, it really questions again, the valuation of financial assets, which we all tend to have a positive and more bullish view, especially the younger generations that have only lived through periods where the “buy the dip” mentality has worked. And I think it will work again at some point.

[00:32:25] Tavi Costa: But we do need to see the dip. We haven’t seen the real dip in markets yet. And so, I think we’re overdue for that. And it’s just hard for me to think that this excessive allocation of most large portfolios will continue to be excessive in equity markets and bond markets. I think we’re going to see a much more diversified portfolio in 10 years from now, where gold and commodities will play a role. And all this is linked to the idea that earnings are probably going to be compressing as well. So, I started to go along on this, but that’s really what’s in my mind when I think about this chart.. 

[00:33:11] Clay Finck: I just cannot get outta my head.

[00:33:14] Clay Finck: The Howard Marks kind of line, the sea change that has come upon us. And Trey Lockerbie just had Howard Marks on our show. And you know, he talks all about interest rates aren’t at zero anymore, and you can’t just assume that great times are going to continue, and that what worked in the previous decade is going to work in this decade.

[00:33:40] Clay Finck: And I wanted to transition to an asset that you definitely specialize in, which is gold, and have another chart pulled up here. It outlines the performance of gold relative to stocks, specifically after yield curve inversions. As those watching on YouTube can see, gold tends to outperform stocks over the 24 months after a yield curve inversion.

[00:34:03] Clay Finck: And on a relative basis, it actually outperformed the S&P 500 by 147% after the 1973-74 inversion. And on average, on a relative basis, it’s increased by 72% after other inversions here as shown on the chart. So could you walk us through why yield curve inversions are such a key indicator to watch for gold?

[00:34:25] Clay Finck: Specifically, maybe expand on why it, it leads to this relative outperformance. I’m sure a lot of it ties into what we’ve been talking about so far.

[00:34:35] Tavi Costa: To be frank, I think this is almost like a different topic that, at the end of it, will relate to what we’ve been talking about. But it’s back in. Just to give some history.

[00:34:49] Tavi Costa: In 2018, 2019, I was really trying to analyze the yield curve signals because we manage a macro fund, and yield curve inversions were beginning to emerge. At the time, there was a risk of a recession, and we wanted to understand portfolio positioning when you have yield curve inversions. And at that time, what I was able to understand was that there were a few popular spreads that were, you know, people like to look at, like the two-year versus a 10-year yield or looking at the three-month versus the 10-year yield as well.

[00:35:27] Tavi Costa: Some folks, Professor Campbell, actually got a Nobel Prize for the research on this, and you know, there’s a lot of talk on how to really analyze a yield curve, but I do think that the signals that you receive from that are very different. And for portfolio positioning purposes, it’s not very helpful, because the two versus ten inverted about two years before the downturn during the global financial crisis. If you look back in the tech bust, that spread specifically inverted right at the time when you’re supposed to be positioning to the downturn. So while the majority of people like to look at yield curve inversions, fighting the last war, meaning just looking at ’08 and claiming that that’s really what happens throughout history, that’s not true. In the seventies, we’ve had times when yield curve inversions coincided with declines and others that preceded the decline.

[00:36:26] Tavi Costa: And so, to me, this research needed more meat to understand how to really invest in periods when you have that. So that was the beginning of something I call the percentage of yield curve inversions. I created this metric recently, actually did a presentation at the IMF explaining why this metric is so relevant for markets.

[00:36:49] Tavi Costa: The idea of it is, instead of looking at one or two yield curve spreads, let’s look at all the possible spreads in the Treasury curve. Meaning, there are about 45 or really 45 mathematical spreads, possible spreads in the yield curve and the entire yield curve. And what you find is, rather than looking at one or two specifically, let’s see how many of those inversions are happening throughout the curve.

[00:37:18] Tavi Costa: So, how many of those spreads are actually inverting, are actually negative? And what I figured out is that every time you go above the 70% handle, so when 70% of the yield spreads are inverted, there’s a recession. And a recession meaning there’s a downturn in a business cycle where a lot of things can happen.

[00:37:41] Tavi Costa: And so that also is not very helpful because recessions, when you signal a recession itself, usually that tends to be the case that you’re actually at the bottom of the market when people are talking about the recession, that everything, I mean, especially the government, the downturn already occurred.

[00:38:01] Tavi Costa: And for portfolio positioning, what I found is, okay, so every time we got to 70%, we have a hard landing. There are even some periods where equity markets rally during the after the 70% handle. So how do I manage money after this? Well, I backtested a lot of asset classes: treasuries, oil, gold, the S&P 500, and they all have different performances, especially in different macro regimes.

[00:38:28] Tavi Costa: But what you find is that the gold-to-S&P 500 ratio is by far the best portfolio position after the 70% handle is triggered. To be fair, we’ve had this indicator going above 70% in November of 2022, and the gold-to-S&P 500 ratio has been going up. In fact, it has been tracking almost perfectly. Its average performance of all the way back to 50 years of history.

[00:38:55] Tavi Costa: In other words, the gold-S&P 500 ratio has been rising recently about 20% or so in average after two years from that 70% inversion. You go to the average performance is about 72%, which is what is shown in the chart. But again, there are times when gold goes up and S&P 500 actually goes up as well.

[00:39:18] Tavi Costa: There are times when gold declines, but the equity markets decline further, and so the ratio rises. And there are times in history when both legs of the trade work together, meaning gold rises with equity markets falling. This is such an important point because if you, again, go back and study which ones are those periods where both legs of this trade work very well, guess what?

[00:39:46] Tavi Costa: One of them was during the Stagflationary period in 1973, 74, and the other one was during the tech bust. Both periods, if you go back to the commodities-to-equity ratio chart, you’re going to see that both periods also align with the times when commodities are depressed relative to overall equities.

[00:40:06] Tavi Costa: Does that sound familiar? And so I do think there is a very, very strong case to be made of why precious metals in general could perform very well relative to equity markets. And those two cases specifically, it wasn’t just gold, silver did well, the miners did very well, and other commodity producers did very well.

[00:40:29] Tavi Costa: So we, I think as investors, need to stop looking at ’08 as the only time in history that will replicate what likely will happen here because of the potential for a recession or a downturn in the economy, and need to go back further and see what asset correlations we may have given the structural changes that we’re seeing in the macro drivers, especially during inflationary periods like the seventies, and seeing what those market correlations look like during those downturns.

[00:41:02] Tavi Costa: Treasuries did not serve as a haven asset. Gold did very well. And so if that’s the case and institutions begin to really understand that gold is going to play a role as a defensive asset for most portfolios, and we’re at the beginning of those institutions realizing that, and they will be allocating capital towards this.

[00:41:24] Tavi Costa: And remember, central banks lead the way on what institutions are likely to do. Central banks are already in the process of what I call this period of improving the quality of their international reserves. I don’t want to digress, and we can probably talk about this in the next questions, but really what’s happening is that central banks are buying gold.

[00:41:49] Tavi Costa: And so, I do think that the 60/40 portfolios that we have today, the most popular portfolio positioning that we’ve had over the last 20-30 years, are not going to be popular 10 years from now. And it doesn’t mean that equity and bonds are not going to play a big role in portfolios, but it means that they need to make room for things like gold and other commodities to be part of those portfolios.

[00:42:20] Tavi Costa: And if you just look at the downside volatility of the Treasury market today relative to the downside volatility of owning gold, especially in the last 20 months or so, what you’re going to find is that by far, Treasuries, throughout history, we’ve never seen the spread between the two where Treasuries are much riskier than gold from a downside perspective than we’ve seen in the last 30 years or so.

[00:42:48] Tavi Costa: Which in my view, as people will start to see those types of research pieces going around, we’ll start realizing that gold does play a role as a defensive asset for most portfolios. I think the biggest pushback you get across this is when you see Treasury yields rising because Treasuries are falling over time. At some point, you start seeing the fact that you are actually able to get some yield, and gold doesn’t yield anything. And so why would you own gold when Treasury yields are higher?

[00:43:24] Tavi Costa: Well, the reason for that is because the risk perceived in the markets by owning Treasuries starts to change. Today, we haven’t, you know, you can separate the risk of owning Treasuries by three things. There’s a default risk, there’s inflation risk, and there’s interest rate risk. In the last 30 years, we didn’t have any of those factors really playing an important aspect here of pricing those instruments. In the seventies, we did see that we had the interest rate risk rising. We’ve had the fact that we had inflation rising and the default risk wasn’t really high. Today we kind of have the three kind of working, as I would say, strong counterarguments for owning US Treasuries as a defensive asset.

[00:44:13] Tavi Costa: And so, I do think that there’s going to be some pressure on US treasuries in the following years, and this is going to be driven by the large amount of supply of treasuries that we may see, given the fact that we’re running large deficits. And we’re also seeing less demand from large central banks and institutions, given what I just said, of this shift towards making more room for gold and commodities relative to what they currently have of fixed income and equity allocation.

[00:44:47] Tavi Costa: And all that is going to play a role in driving gold prices higher. So, you know, we can touch on this later, but to me, when I saw this research, it made me such a bull in gold prices for the next, you know, five to 10 years that I wanted to understand how do I find the most asymmetric ways to express that view, that gold prices are going to go higher, not lower 10 years from now?

[00:45:19] Tavi Costa: And I don’t think the answer to me was to own gold. Gold is sort of a boring asset and it’s not news for anyone. Gold is not something you’re going to get rich by buying that. It is truly a defensive asset. It’s truly something that has a history and credibility in terms of being, having that track record of being a defensive asset during periods when you need that protection. And so, especially at times during inflation, secular inflationary forces, you know, higher cost of capital, and things like the nature that we’re seeing today.

[00:45:58] Tavi Costa: So, I do think that, you know, it is one of the most important questions that I ask myself. I have a lot of potential answers of how to express that view in the markets. After 30 years thinking about this, we’ve created even a fund to invest in. You know, I think there’s a niche in the industry itself of the lack of discoveries, and I think there are a lot of inefficiencies. Not in the mining industry overall, but really, first and foremost in smaller businesses, which there is a lack of people that understand the space very well.

[00:46:38] Tavi Costa: Again, this is all linked to the idea of why commodities are so cheap and equities are so expensive, and why I think that we’re probably going to see a hard landing, a recession, and also a contraction of earnings over time. And one of the most important macro indicators to look at is the percentage of yield curing versions, in my opinion, and we’ve had that signal in November.

[00:47:00] Tavi Costa: So don’t be surprised if the gold s P 500 ratio rises for the next, call it 18 months or so 

[00:47:09] Clay Finck: Before we get to some of those asymmetric plays to discuss, I thought it was a really interesting dynamic how you posted this chart of China’s US Treasury holdings back in 2013. It was over 1.3 trillion in US Treasury holdings, and today it’s approaching 900 billion, so that’s about a 400 billion drop. And that’s interesting because rising interest rates, as you mentioned, lead to falling US Treasury values, meaning that if foreign entities want to strengthen their balance sheets, then they better look for something that potentially stores its value a bit better. So, how do foreign Treasury holdings play into this thesis and your research?

[00:47:52] Tavi Costa: I I think if we go back to the seventies again and understand what the composition of central bank assets looked like back then versus today, it may be very relevant. To answer your question, initially, when I looked at that, the first thing you find is that gold as a percentage of international reserves by central banks, well first of all, let’s understand what central banks do before we answer that question.

[00:48:21] Tavi Costa: Central banks usually run a monetary system. So, in this case, not a central bank but a currency system, the Euro in this case, or European currencies, you’ve got the US dollar, the Canadian dollar, the Japanese Yen, you know, the Euro really started in the nineties, so there are obviously changes in terms of that and those monetary systems.

[00:48:45] Tavi Costa: So, every monetary system requires high-quality assets to back those currencies. That topic became a thing recently because of Bitcoin, which was a, I would say, a normal argument across the gold community, but it became, I would say, a lot more popular of an argument of questioning what really backs the US dollar and other fiat currencies today after we’ve had this Bitcoin and crypto movement across the younger generations, first and foremost.

[00:49:14] Tavi Costa: What is important to note is that back in the seventies, gold was about 70% of those international reserves. Those were the quality assets that central banks used to own in order to support their own currency systems. Well, after the seventies, in the eighties or so, we peaked in that ratio of gold relative to other international reserves, and we’ve been in a decline, which has been almost a 30-year decline really, and the most credible central banks in the world were the ones that bought treasuries, were the ones that actually accumulated US treasuries over time.

[00:49:54] Tavi Costa: And it’s very, you know, like it or not, like it, this was certainly what occurred. And on top of it, we’ve had also the 60/40 portfolios happening at the same time, which also helped to fulfill that demand that was required to create such a bull market that we’ve had in treasuries over the last 30 years.

[00:50:17] Tavi Costa: More recently, given the fact of the de-globalization trends, the inflation issue, the default issues starting to rise, questions about interest rates, do cost of capital needs to be higher over time? Can they maintain those interest rates to be as low as they were back in 20-30 years ago? Do we need to see higher historical standards for cost of capital?

[00:50:42] Tavi Costa: All those questions are becoming more, I would say, relevant over time. And I think what’s happening is clearly with the de-globalization trends, most central banks now thinking about should I own debt from another indebted economy like owning US treasuries, or should I own a neutral asset like gold that has a very long history of a track record of being that asset that creates that quality of international reserves that a central bank requires in order to not completely lose value of their fee currencies and create some level of credibility. So we’re at the beginning of this process of central banks having to improve the quality of their international reserves.

[00:51:27] Tavi Costa: This is why we’re seeing gold being purchased by most central banks recently, record levels, really, and it’s something that drives the entire gold cycle at the end of the day. And so I think, you know, it’s important to go back to the forties because today, despite the fact that we like to go back to decades that we had inflation, like the 1970s, that debt problem today is a lot more severe than what we’ve had during that decade.

[00:51:59] Tavi Costa: And the 1940s is a good example of a time when leverage was an issue as well. It was a different reason back then. The reason back then had to do with the war. The war drove leverage on the government side to levels that we have currently and who financed it? Well, there’s a lot of things that happened during that period.

[00:52:24] Tavi Costa: Number one, we’ve had, and I think that was one of the most important things, was really the individuals buying war bonds. So individuals in the US were actually financing the war, number one, but financing that debt that we’ve had during that period, that buildup of that debt. And that was a significant portion of the demand driven by treasuries at that time.

[00:52:50] Tavi Costa: The second thing that happened was that the Fed instructed the banks to buy US treasuries too. And so that created another demand for treasuries that it’s not the case as much today. And then we also reinstituted this yield curve control that is also a really popular topic today. The potential for that happening, and I think it will happen at some point inevitably, but it’s important to go back that the need for financial repression, given the fact that you have such high levels of debt, also will play into this inflationary problem.

[00:53:28] Tavi Costa: But ultimately yields had to move higher. And we’ve had a move up in yields all the way to the seventies and eighties that then peaked in the eighties. And then we’ve had a 30-year period of declining interest rates. So I don’t know how bad things are going to be, but today I would say that those issues with treasuries are probably one of the worst we’ve seen in history. Number one, we haven’t even seen the same degree of or the same need for deficits to be running as high as it was in the forties. It was a war happening. You know, World War happening unfolding at that time today. That could happen, and we would start that war already at very record leverage ratios.

[00:54:19] Tavi Costa: In terms of the government side, which is very scary in general, but this is the case with every developed economy, including China, which you may say it’s not a developed market, it’s more an emerging market, or maybe it’s in between and so forth. But the biggest issue with treasuries today, to your question, has to do with the amount of treasury issuances that are happening in the market.

[00:54:47] Tavi Costa: Recently, we’ve had something called the debt ceiling. That ceiling has been basically irrelevant for markets. Every time someone claims that this is going to be relevant, it’s not relevant, and the markets don’t care about it, markets go higher on the back of the debt ceiling situation. This time, however, it’s not the debt ceiling itself that matters.

[00:55:11] Tavi Costa: It’s not the agreement between the Republicans and Democrats if they need to extend the debt situation or not. That has to happen. Like it or not like it, we may see a technical default or something like that, but that’s not really relevant because they will ultimately extend the debt limit because otherwise everything is going to be collapsing and imploding in the US.

[00:55:37] Tavi Costa: So assuming that’s going to happen at some point, the question now is how can the market absorb a large amount of treasury issuances once we do have that agreement in place? So the treasury cash balance today is running at one of its lowest levels in history. Today it’s at about 200 billion. Just to give you some perspective, in March, the amount of fiscal deficit that we were running was over 300 billion.

[00:56:07] Tavi Costa: So in one month, we could dry up the entire cash balance. That cash balance is basically used for day-to-day operations, is basically what funds the treasury deficit that we have currently. So, once the agreement happens, and every time we’ve had a debt ceiling, basically, if you look at the amount of debt outstanding in the US, if you look at a chart of debt outstanding, you see a straight line which is caused by the debt ceiling.

[00:56:38] Tavi Costa: In other words, the government’s not allowed to issue treasuries. Once that gets resolved, you see a jump in treasuries or a Trump in treasuries, outstanding. That means that they’re issuing treasuries. We don’t know if it’s going to happen in, you know, long duration, short duration, meaning is that going to be two year yield? Treasuries going to be issued 10 year, 30 years? I don’t know. I don’t have an answer for that. I have a feeling it’s going to be a mix, but I don’t think we all have an answer for that just yet. But it will happen. It has to happen. And so what does that mean? How will the market absorb? This is a very, very important question because we just went through 2022, which was a total collapse of the 60 40 belief. Despite the fact there was a big decline in prices too, it was really a collapse or a break of belief in this portfolio allocation, which it’s interesting that in the first quarter of 2023, we’ve had this sort of comeback with mega caps doing well, treasuries rallying, and that portfolio actually did very well.

[00:57:56] Tavi Costa: But to me, this is almost like a bear market rally of their portfolio positioning. We’ll see if I’m right here in years from now, but I do think that the age of the 60 forties is over. And if that’s the case, and you have on top of all this the banking problem, which think about this, well, the banking problem was not caused, was really caused by collateral prices falling that caused a mismarking of those assets in their balance sheets, and then the unintended consequences of the treasury market decline. What happens if we have a 500 billion to a trillion issuance of treasuries at a time when 60 40 portfolios belief is somewhat broken? You have central banks not buying those treasuries and who is going to be the buyer individuals, or they’re going to create, I don’t know, green energy bonds and people would be buying them at record levels? I don’t know. I don’t think so. If I look at probabilities, I think there’s a high chance that we may see some big issues in the treasury markets sometime, like similar to what we saw in the BOE in the Bank of England last year. And the Fed is going to have to step in. It’s the Fed’s responsibility to try to avoid.

[00:59:24] Tavi Costa: The instability of the financial system. And so, if the Treasury market is linked to everything in the financial markets and causes that turmoil, then the Fed is going to have to step in. And it’s not something we haven’t seen. What QE is, is exactly that. It’s buying those bonds, creating the demand for those bonds, is essentially monetizing the debt.

[00:59:49] Tavi Costa: Now, just because I said that, some people may have issues with the technicality of that and say it’s not really monetizing the debt. Well, it is, at the end of the day, it will be monetizing the debt. And even if I were a policymaker, I get that question a lot. What would you do differently? I don’t think there’s a way to do anything different.

[01:00:16] Tavi Costa: I mean, or I think they’re trapped. And so investors need to be thinking about that context and saying, how do I exploit those issues in order to capitalize on that? And I think there are a lot of trends that will be successful here. It probably won’t be the sexy technology space or the Treasury market or the 60/40 portfolios or the software companies or even maybe the overall crypto market.

[01:00:44] Tavi Costa: I don’t think it will be. I think there will be other things that maybe will look more attractive for the future. Natural resources is one example. Value companies going back to understanding fundamental analysis is going to be in demand. Understanding short sellers, how they do their craft, which will be very handy and in high demand to understand the downside risk of markets.

[01:01:10] Tavi Costa: So everything is interconnected in a way. And the Treasury market, to me, is fascinating and it basically holds the key for the entire stability of financial assets in general. And it’s something that I’m paying very, very close attention to.

[01:01:27] Clay Finck: Now, since you’re in the investment business, you mentioned you’re looking to make the most bang for your buck when you’re allocating capital and you have a thesis around gold. And then you have things like gold miners, which offer more upside potential because they’re a derivative of gold. So when gold moves up, say 10%, maybe these gold miners move up, call it 30% or something, depending on how well you choose your gold miners. So how do you think about allocating to gold miners and how that might apply to our audience as individual investors?

[01:02:06] Tavi Costa: Okay, so I think in order to understand the gold space, you need to have some historical context on the industry too. And recently, I talked to a lot of institutional investors who ask me questions about our strategy of investing in natural resource businesses and trying to exploit those inefficiencies.

[01:02:26] Tavi Costa: And what we find is the biggest question, most popular question we get is, “Why do you see gold prices making new highs, but you’re not seeing the miners following suit?” And it’s such an important question because the majority of the indices that track gold miners are indices that use the composition of those indices are really driven by larger mines, the Barricks, the Newmonts, the Kinrosses of the world.

[01:02:54] Tavi Costa: And in my view, that does not reflect the opportunity in this decade in the space, although they might, for other reasons, do very well. And if gold prices rise, I don’t think that’s ultimately where the large amounts of money will be made.

[01:03:12] Tavi Costa: So if you think about the biggest reason why we’re seeing this chronic underperformance across the majors, it has to do with the fact of how they’re running those businesses. If you looked at just a chart of gold prices relative to revenues of those companies, you’re going to find a major divergence where gold prices are rising and their revenues are not rising.

[01:03:38] Tavi Costa: Why? Well, you can’t even explain that by saying operating costs are higher because we’re looking at top line, we’re not even declining. They’re not even subtracting by operating costs whatsoever. So the main reason for that, it has to do with the fact that most of the major companies or all of the major companies have aging assets with deteriorating quality of those assets and also a total lack and vision for growth. There is no production growth happening across those firms.

[01:04:11] Tavi Costa: If you look at Barrick’s production for gold over the last decade, you are going to see a secular decline. If you look at Kinross, you’re going to see the same. AngloGold, the same idea. Newmont, same gold production since we’ve seen 16 years ago. So why would an institution buy those assets if all they’re doing is retiring those assets over time, their own projects that are producing assets, and then what they do with the capital because of the pressure from some investors and even their own board members on cost saving, is that what they do is they take that capital, that profitability they’re generating because gold prices are at record levels, and then they return that capital back to shareholders at record levels.

[01:05:02] Tavi Costa: Meaning they should be spending money on focusing on replenishing their existing reserves, improving the quality of those reserves, finding new discoveries, being bold at a time of the beginning of a gold cycle. Instead, they’re just letting those assets run their course and the average grades of those assets have been in a multi-year decline.

[01:05:24] Tavi Costa: So what’s the vision here? It’s creating, in my opinion, one of the best opportunities for an investor to be creative, to maybe build the next Newmont, the next Barrick of this cycle. That’s what I’m trying to do. So the way I think it’s going to happen is you have producers, developers, and explorers. The majority of people, when they talk about miners, they’re really talking about producers.

[01:05:52] Tavi Costa: If you’re looking at GDX, the ETF or the GDXJ, both ETFs are basically all producers. So you’re not seeing the real opportunity here. I’m not here to claim that what we are trying to accomplish is easy. We are investing in very small cap names. In the mining space, there are over 3000 companies in this part of the industry, and what I would say is that 90 or 95% of them will fail.

[01:06:22] Tavi Costa: So the thing is, the quality companies and the badly run companies are basically being priced at the same level today. So you can find a company that trades at a sub 20 million market cap that is very likely onto a major discovery of gold, and investors don’t care about it. In fact, they price it along with another company that most likely won’t have anything in the following years as they follow up on those projects.

[01:06:53] Tavi Costa: So what we found is that there is a plan. Oh, and by the way, the majority of the billionaires in this industry throughout history have made their money on discoveries. Remember, producing, development, and also the explorers. Most of the capital made in this industry was actually made on exploration. Basically, it was a property that some of those billionaires acquired or invested in a company that owned the property that then found a major discovery that became a company maker deposit. That’s what we call something that is very economically viable, scalable, high grade, and successful over time creates such a level of profitability during that speculation period of going from a very low value of owning a property or a mineral rights over that property to then finding a major discovery.

[01:07:46] Tavi Costa: That increase of speculation, that creation of value that you build during that phase of the mining industry is what makes most of the billionaires in this industry. And when thinking about this, we thought, well, you know, isn’t this very similar to the technology space? Most of the billionaires made their money in startup companies that then became multibillion-dollar businesses, and that’s how they made most of their capital at that initial phase. The growth came from that startup-faced part of the industry.

[01:08:20] Tavi Costa: What if we replicate the success of venture capital and the success of private equity in general, which includes venture capital of investing in what I think is the beginning of a trend, meaning natural resources, in this case, specifically metals and mining, because that’s where I would say our niche is, and our knowledge is across the team and working with geologists and so forth.

[01:08:46] Tavi Costa: What we’ve built is in metals and mining. What if we create a place where we can invest in maybe a hundred companies or so, where all we need is one or two of those businesses to be very successful, meaning becoming unicorns or multi-billion dollar companies on the back of major discoveries, knowing that the value of those businesses are today priced for failure already, there’s a lack of understanding of that industry overall.

[01:09:16] Tavi Costa: What if I come in with the more intellectual and institutional approach towards this, rather than the current participants in this market and really exploit those inefficiencies and own the best quality assets I can find in exploration side of it, and really build a business on top of that. Just to be fair, this is the model that Newmont became.

[01:09:41] Tavi Costa: Newmont is the largest gold, one of the largest gold companies in the world, and they started as a fund. They own a bunch of early stage projects that then became major discoveries or major, or a company maker types of projects. That on the back of that was the beginning of Newmont. That started really in 1920s.

[01:10:04] Tavi Costa: So, Esau, we were trying to replicate that specifically the same way. It’s not like we were trying to turn Crest into a mining company or anything like that, although, you know, we like to keep the optionality open. The fact that no one is spending time and effort to go deep intellectually into this space and understand the level of opportunity we have.

[01:10:30] Tavi Costa: It’s kind of funny how you have either I’m very wrong or I’m going to be very right, because why would you see gold prices at record levels and a property that has very likely a major discovery of that metal? And we have statistically very good ways to give us conviction that they are onto major discoveries.

[01:10:53] Tavi Costa: One of the main reasons is because they drilled and they found gold, very high-grade gold, and not just once. They drilled, in some cases, several hundred meters of those deposits have been drilled. And so what you find there is that, “Wow, then, you know, why would they be priced at such a depressed level when gold prices are higher?”

[01:11:17] Tavi Costa: And to me, it’s sort of like a no-brainer. And so that’s why I, you know, after going deep into this and knowing that the major companies are in desperate need at some point, we’ll have pressure from investors to improve, again, the quality of their own reserves. Not central banks, just the miners. They need to improve their own reserves, their existing reserves, the quality of those.

[01:11:44] Tavi Costa: If I am now the largest investor of a lot of those major discoveries that are high-grade, scalable, and economically viable, and I can provide that to the majors at some point, and maybe we don’t want to do that. I don’t know. Those are all options that are, I think, one of the most important things for investors to be successful is to have optionality.

[01:12:11] Tavi Costa: I can’t think of a time when I can find more optionality than this. I think this is one of the best ways I find to really create wealth, generational wealth in an environment that not a lot of people care about. I don’t go to a restaurant or a bar and hear people talking about acquiring, you know, gold properties or copper-related properties or a silver discovery or anything like that. I do hear people talking about technology and crypto. So to me, this is one of the most contrarian and interesting ways of asymmetrically tackling an opportunity that I have. Very high conviction given my macro views. And I think it requires a lot of understanding.

[01:12:58] Tavi Costa: I mean, I’ve been in this industry now for three to four years, and I would say that the level of understanding of this, in terms of the learning curve, continues to be steeper and steeper. I continue to learn about this, and our portfolio, I think, looks much better than it looked three years ago, and I hope that’s the case.

[01:13:23] Tavi Costa: Five years from now, we’ll continue to improve that way. So, I think that we’ll be in demand as well, this level of knowledge of this space, especially across institutions, and at some point, they will realize, in my opinion, that that’s really the opportunity. And so that’s why we did what we did, and that’s why I am so excited about, you know, I’ve been talking about silvers for so long, right? Or gold. And, you know, guess what I did recently? We purchased the seventh-largest silver mine in the world. Is there a better way to leverage up your trade than that without? Well, we actually, this was a leverage buyout and so it’s literally leveraging up a trade. I don’t know of anything. Every dollar that silver goes higher, the free cash flow of this mine goes up by 15 to $20 million. So what if we see gold or silver prices in triple digits one day? I don’t think that’s out of reality. I mean, that’s probably going to go higher than $50, which was a prior peak. And then, and then we’re off to the races and probably going to go much higher than that and make new highs and historical highs. And probably head towards triple digits at some point. And so I am trying to think ahead of time here. I know that this is speaking out of terms and maybe difficult for people to see this opportunity. And I love that factor, how contrarian this is. And you know, we’ll see if this is going to be proven right or wrong, but hedge funds are paid to take risks, and I think this is a high conviction risk that I like to take.

[01:15:19] Clay Finck: Another highly contrarian play, I think you’ve been talking about is getting exposure to Brazil.

[01:15:27] Clay Finck: I believe your fund is invested in Brazil and also shared a chart here of the Brazilian to US equity ratio. Is this thesis of Brazil, is it highly in line with this commodity and gold thesis, or are there more factors at play here with Brazil specifically? 

[01:15:47] Tavi Costa: It is. I would say the biggest thing that really brought to our attention this opportunity to invest in Brazil has to do with the fact of, as we learn about this natural resource space better and better, and as we really research this through all history, what we found is the market is very small.

[01:16:10] Tavi Costa: It’s a very thin market to spread your wings around, especially if you’re a large institution looking to find significant exposure. So let’s just say I’m right about 60 forties and now we’re going to have a 20% allocation or 15% allocation towards commodities. One day you can only go so far. If you’re a pension fund, managing billions and billions of dollars into that space, you can buy the companies that are in developed economies.

[01:16:40] Tavi Costa: You can buy energy companies, is probably the easiest way to start getting to the metals and mining space and. Now, very rarely you’re going to see someone trying to play where we are playing in terms of the microcap names in the space, and even companies that are not even public cap. And as you dive into the potential ways of expressing that long commodity view in the markets, what you find is at some point they’re going to find, look for countries that are likely to benefit from that environment.

[01:17:17] Tavi Costa: And when I thought about that, I thought about emerging markets, and I think emerging markets, we immediately think about bricks and bricks could not be, that’s probably one of the worst ways to think about this as an opportunity because the bricks are so different from each other. It’s not a block of economy.

[01:17:39] Tavi Costa: It’s actually very segregated and very different in the nature of those countries of how they’re run. You got China, that is an authoritarian regime, that is a net importer of commodities, not an exporter. You’ve got Russia, which is a net exporter of commodities, but a total geopolitical mass that I don’t think any institutional large institutional capital will ever chase that in the next five to 10 years.

[01:18:07] Tavi Costa: You’ve got India, which is less of a geopolitical mass than the other two, doesn’t have an authoritarian regime, but it’s a net commodity importer, and a very large one at that. And then you have Brazil, in this kind of different environment, which has exposure to every commodity I can think of, large exposure to agriculture, metals, and mining energy, even water. Most of the Brazilian economy is related to natural resources. And so, at the same time, it is almost like the Switzerland of the BRICs in terms of geopolitically speaking. It’s very neutral. It will sell things to China, will also sell things to the US, even sell things to Russia really, and it is very interesting that today because of the political leadership in Brazil, and to be fair, I am from Brazil. I could not have been more skeptical about the political environment, but also the corruption scandals and corruption history of the country over the last 30 years. I’m not even talking about the last year or so; I’m talking about the last 30 years. So it was very difficult for me to sort of put away those biases and become bullish in the space. So just so you understand the context a little bit of how it was difficult for me to become bullish on the whole country, but understanding the commodity markets and the likelihood of the beginning of a commodity cycle. Which, by the way, triggers in different ways. Sometimes it starts, in this case, it started with energy, and then it’s sort of a domino effect, and then it triggers agricultural commodities rise. And then we’ve had a pause in gold prices over the last two years. And now gold prices begin to rise all of a sudden. And so every time it’s going to be one section of the commodity market. And you have to be, I think, diversified into the space. And the Brazilian market attracts me not only for this backdrop that is positive for tangible assets, specifically commodities, but also because of how cheap and historically undervalued those assets are in Brazil.

[01:20:29] Tavi Costa: Give an example: If you look at the banks, which are not necessarily tied directly to the natural resource industries, although we all know that if an economy is a commodity-led economy, you should think that indirectly a bank that is operating in Brazil should be impacted by a commodity bull market.

[01:20:50] Tavi Costa: And it is. If you look through all of history, the banking industry does very well during those periods as well, where commodities perform better than other periods. And what you’re going to find there is that they’re trading at one of the lowest multiples in terms of prices relative to fundamentals that we’ve seen throughout history.

[01:21:13] Tavi Costa: And so I think it’s an opportunity. I think the political risk is real. So it requires a change in terms of allocation of how you allocate those assets into your portfolio. I don’t think it requires a very large percentage of your portfolio because if you are right, those things are so cheap that the potential for return could be exponential.

[01:21:38] Tavi Costa: And look, everything has a price. You don’t just avoid risk at all costs. I mean, you’re just. There’s risk reward in everything. And in this case, the reward is very mispriced relative to the risk. I think the risk is completely priced into most of those equities, and I find that a very interesting opportunity.

[01:22:00] Tavi Costa: Then I looked at the commodity producers’ chart of the index of looking at world commodity producers relative to the Brazilian equity market. What you’re going to find is that there is a very strong correlation between the two positive correlation, and recently we’re seeing a gap on that. Since elections and so forth, Brazil has been sort of sideways recently, while commodity equity markets have been basically moving a lot higher, especially driven by energy, which is a huge part of exposure in the Brazilian economy as well.

[01:22:36] Tavi Costa: So I think there are some really interesting opportunities in the Brazilian market. I think you can also again, extrapolate that as well into South America. Not every South American country is a place we invest now. We recently increased exposure to Bolivia, which I think is in the process of opening up their economy, very similar to what we saw with Peru back in the nineties, where it became a very hot market in the mining space, specifically driven by this openness to foreign investors to invest in the space.

[01:23:12] Tavi Costa: And I think Bolivia is basically not priced for that, right. I understand the risks of Brazil, believe in all that, or at least I appreciate the fact that there are risks that may be impacting how cheap those assets are. Now I think those assets, in general, are not, broadly speaking, considering any improvements whatsoever on the political environment. And people think a lot about the political side of it rather than the economic side of it. And the economic side usually leads the way, meaning what happened with Venezuela, for instance, just to use it as an example here, was exacerbated by the fact that energy was in a collapse, and meaning the energy space was collapsing, oil prices were collapsing.

[01:24:01] Tavi Costa: That really created the narrative that you needed for the populism that you saw in Venezuela to create that situation. And then the political environment worsened. You’ll have the inflationary pressure because their currency devalues. Everything is related. Then you have social unrest, and then you have a populist that comes in, you know, and brings up this authoritarian agenda.

[01:24:25] Tavi Costa: I think we’re not going to see that again in South America, given the fact that commodities are unlikely to go to a bust of another 10 years, like we saw from the 1910s to now. In fact, go back just for an idea quickly to that, the whole thought about how we’ve had the best earning season in the 2010s was also a time when all commodities are basically falling during a period.

[01:24:55] Tavi Costa: That’s not my view today, right. So I think Brazil is likely to benefit tremendously from those commodity trends. I think you have to also consider commodity-led economies versus commodity importers. China, on the other hand, if commodity prices rise drastically different than what everyone thinks, they have the upper hand in the commodity markets. I don’t think so at all.

[01:25:19] Tavi Costa: I think that could potentially see social unrest, that could potentially see a major devaluation of the currency that could potentially see a shift in the political environment. You know, those things are not priced in the Chinese market today, in my opinion. So I’d much rather own Brazilian assets, South American assets.

[01:25:40] Tavi Costa: And it’s a portion of a portfolio. It’s not a huge portion of it, but it’s a growing portion of a portfolio, and I can see it growing over time. And I’m very bullish about Brazil, and I love the fact that its opportunity has been masked by the political leadership right now, which a lot of people are bearish on.

[01:26:05] Tavi Costa: But it’s important to remember that in the early 2000s, when we had a commodity bull market, in fact, it happened when Lula, the same president as today, became the leader at that time. And so I think there are a lot of similarities with that period, especially given how cheap they are relative to equity markets, which is the chart that you brought in today.

[01:26:31] Tavi Costa: So I like to own Brazilian assets, and I think there are also asymmetric opportunities in that space as well.

[01:26:39] Clay Finck: Well, Tavi, I do not want to take too much of your time. I really, really appreciate you joining me. I know I really enjoyed this discussion. Before we close out the episode, as always, I want to give you the opportunity to give a handoff to where people can get connected with you and Crescat Capital.

[01:26:57] Tavi Costa: Well, thanks for having me on your show, and my apologies for the long answers. I get really caught up in my views, and I love sharing some of those as well. You can find my work on Twitter @TaviCosta. I’ve been doing a new version of my posts recently, which I’ve been trying to elaborate a little more on my views.

[01:27:21] Tavi Costa: Let me know if you guys like that, but that’s sort of a new thing that I’ve been working on as well. And you can also find our work, if you like, more in-depth research. There are long letters and ideas about how to maybe assess this macro environment – my views, at least. You can find it at Crescat.net 

[01:27:45] Tavi Costa: The fund or the company that I’m a partner in runs three funds: a global macro fund, a long-short fund, and a precious metals-focused fund. We’ll be launching a commodity institutional fund here soon, along with a macro institutional fund as well. It’s actually one of the longest macro funds that have been successful over the years in the space, and we’re very proud of it.

[01:28:12] Tavi Costa: And I think there are a lot of opportunities to be a macro investor today, especially given all those big macro trends being unleashed in this environment. So I’m really excited about the future, and I hope I provided some good ideas for investors in general. Thanks for having me.

[01:28:32] Clay Finck: Lots of great ideas, really amazing work.

[01:28:34] Clay Finck: I enjoy all the stuff you put out, especially, you know, all the free stuff. You’re a great follow on Twitter and I’ve enjoyed following you the past couple years. So thanks again for joining me, Tavi. 

[01:28:43] Tavi Costa: Thank you. 

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