Preston Pysh  4:38  

So it’s interesting because I had a question that I was going to ask and then I removed it out of Stig’s and my list here. But it has to do with what you’re getting at is these guys that perform really well during bear markets. And so a few names that kind of come to mind is billionaire George Soros, Jim Rogers, Dali.  I mean, once you start looking into these guys, another one is Stanley Druckenmiller. And so when I think about who are the people I want to follow, who are the people I really want to track, it’s really kind of those guys when you get into an overvalued market condition to see what are the moves that those guys are making, because when I look at like Warren Buffett, he’s much better at the bull market, if you will, instead of the bear market. These other guys though, they’re the experts at the bear. So are those the guys that you’re tracking right now? Do you you see those guys as being kind of your guiding light as far as ideas and how to look at things?

Raoul Pal  5:29  

Yeah, I tell you because I think in bull markets, anybody can look smart. So yes, some people are smarter than others. And people like Warren Buffett understand how to buy companies and they have a trade construction that’s very interesting. 

But in the overall market, you need to look like people like Stan Druckenmiller. I mean, Stan Druckenmiller has never had a down here and Duquesne funds in 1982. I mean, people talk about Warren Buffett being a great investment. Stan Druckenmiller is one of the greatest we’ve ever known and there’s a whole load of those guys out there. They understand bull markets, bear markets and multi-asset classes because investors tend to talk too much about equities. We’re there to make money with bear to make investments and things that make us money or protect ourselves. And that is a much wider remit than equity markets. So you know, looking at bull markets and equities is probably not the way *board is looking at.

Preston Pysh  6:16  

So it’s really funny that you’re saying that because this has been a theme that Stig and I have been talking about on our show for quite a while is, we think if you’re going to do well and have good returns in the coming year, two years, you’ve really got to step out of the equity space and look more into commodities, currencies and things like that. Would you agree with that approach? Is that where people really need to start focusing their attention to learn more?

Raoul Pal  6:40  

Yes, and also the interconnectedness and interplay between those asset classes. You know, yes, it gets more complicated because there’s longs and shorts and the average guy can’t do some of that. But just understanding the relative attractiveness of certain asset classes and certain points in the cycle is the key to making and holding the money that you’ve made.

Stig Brodersen  6:59  

Could you provide some examples when you’re talking about how the asset classes, the relationship between a commodity and currency, for instance? Could you come up with some examples? Because I think most people probably have a good understanding of how stocks and bonds interact with each other. But I’m curious to hear some of the more rare examples that you might come up with.

Raoul Pal  7:18  

Yeah and I think this is something people really don’t understand. Right now, we’re in a situation where we have underway what I think is a large dollar bull market up about 37% from its low. Usually *gullible markets go, the last one was up 50% back in the late 90s. The previous one in the early 80s was up 100%. I think we’ve got a long, long way to go for people to understand what that means. 

A *gullible market is inversely correlated to commodity prices in general, not always, but most of the time. It also tends to drive global economies global trade. So the interconnectedness of trading the US dollar right now, is very interesting. It also means that developed markets outperform emerging markets in equities. So there’s a whole string of trades that come up with one understanding and that’s one of things I spend a lot of time talking about and writing about is the knock on effects of things. That’s where the real value is to be made in investing.

Preston Pysh  8:09  

So what you’re really saying is that you’re a bear on oil. Is that right?

Raoul Pal  8:13  

Yeah, you’re dead right because interestingly enough, you can talk all day about supply and demand of oil. Just overlay the charts of oil against the DXY inverted, they are same chart because dollar is the denominator of all commodity prices, that the dollar goes up, oil goes down.

Preston Pysh  8:28  

So just so you know, Stig and I have this ongoing play of show. I’ve been a bear on oil for quite some time and he always tries to argue the bull case, but I think he’s slowly coming around to the idea that it’s not going to rebound here quickly. 

Stig Brodersen  8:45  

I think that oil might still go higher, even though some people might say that oil have seen the rebound. We’re still talking almost a double of the recent oil price. So definitely, that has been really bull lately. But I think since I know all the good arguments for why it should be a bull market, I’m just really interested in hearing why I’m wrong. That’s just how… I want to know why is it that I’m wrong and I’m really hoping that Raoul and all the other guests will hopefully tell them I’m wrong.

Preston Pysh  9:15  

I really like pulling the thread on this idea because I think a lot of the people in our audience are really wanting to know more of this idea. So I know that Ray Dalio has this white paper on economic principles. For me, it was really kind of a game changer of how I understood how commodities and currencies are really kind of tied to each other because fiat currencies can be completely manipulated by the money supply and the credit that goes into the system. 

So once that starts contracting, that contraction of credit is actually adjusting the supply of money and it’s making the value of the commodities which are somewhat fixed. Oil is not maybe the best example but gold and other ones that are really hard to adjust the supply are fixed and so it’s really easy. It was easy for me to wrap my head around the idea of why that would contract and why that would go down. 

So do you have any other points or any other way that you would describe that to help people kind of understand it from a fundamental level? 

Raoul Pal  10:11  

I can’t break it down to simple things, but some things you can understand. You see that World Trade has fallen. So World Trade is now year-on-year yet the second lowest level since 1958. And people will argue, “Oh, that’s just because the dollar has shifted. So you know, the amount of exports in dollars has fallen.”

Okay that is basically correct. But when you dig beneath the surface and look on the knock on effects, we realized that something like $5 trillion alone got taken out of the global economy just from miners, oil miners, commodity miners, and the agricultural guys. That’s all the value chain, all the knock on effects of everybody else. 

So what you’ve done is you’ve sucked out a huge amount of dollars from the system, because the dollar has gone up. And commodities, the price of dollars, these come from countries, for example, Saudi Arabia, who doesn’t have enough dollar revenue anymore. That creates problems. So there’s a shortage of dollars. 

So as the dollar goes up, it creates a short squeeze. And the BIS explained this the best way, because they talked about the $10 trillion global carry trade, which is that everybody borrowed dollars to invest in commodities and other things. And that’s all around the world, whether it’s South Korea, whether it’s China, where the biggest position is, whether it’s Japan, whether it’s Europe. It’s there, and it’s the biggest position the world has ever known. 

So for me, I only deal in probabilities and you just say, if there is the largest short position the world has ever seen in the biggest asset class the world knows, then that is a big deal. I think it’s gonna destroy global revenues as people need dollars, and it’s not enough for them around.

Preston Pysh  11:42  

I think it’s really important with what you just described, and what you just laid out of understanding what is the direction that the Fed is basically saying they’re going to go because that’s what kind of keeps that trend persisting in that direction. And so right now, it’s May 23 2016 and the Fed is now signaling that they want to do another potential rate hike in June. I think that it’s all… I don’t know if they’re actually going to do it, but just them talking about it continues to push that trend in that direction where the dollar is going to get stronger just because they’re talking about it. They could delay it like they did last time for another six months. But if they keep saying, “Yeah, we’re interested in raising rates,” that keeps that pressure on that the dollar is going to at least stay where it’s at at a minimum, if not, maybe get a little bit stronger. I think that that is such an important thing. 

I know Stan Druckenmiller I mean, this is his big thing. Watch the Fed, watch the Fed, what are they doing? If they’re saying they’re gonna tighten more, that’s gonna keep the dollar strong that’s going to keep all these pressures at play. Once that reverses and once they start signaling something different, like, “Hey, we’re gonna do a bunch of QE and negative interest rates or whatever,” then all of a sudden, you might want to look at your strategy and maybe reconsider. Would you agree with what I’m saying there?

Raoul Pal  12:56  

Well, I think the consensus group think is that if the Fed are weakening the dollar weakens. Historically, that’s generally not the case. Sometimes it works. Sometimes it doesn’t. And it’s all about, you know how far you are in the cycle of people needing dollars. Secondly, it’s the relative performance is what drives asset classes. So if the US is cutting interest rates, but Japan is doing more and China’s doing more, Europe’s doing more, then the relative rate differential still applies, but that still drives the currencies and then you have the positioning problems. 

So it’s not very clear cut but one thing that is obvious to me, it seems to be Stan Druckenmiller as well, maybe we’re both wrong, but it is when we get to that situation where the Fed are cutting interest rates, you get a situation where potentially the dollar can go up and gold can go up because gold is essentially a positive carry trade in a negative interest rate world and I think that’s an interesting dynamic because people don’t believe dollar and gold can govern the same time but I think they will.

Preston Pysh  13:56  

Just because of the demand that you’re going to have on those dollars, because of all the dollar denominated debt in the world, is that really kind of your opinion on that?

Raoul Pal  14:04  

Exactly right. Not everybody can own gold or wants to own gold. So what is the second best asset for them to own will be dollars. Right now, dollars are the best assets to own, potentially. But that gold situation, that we saw the first quarter in gold, there’s a lot of pent up demand. I’ve just had a roundtable here for global macro investor in the Cayman Islands. And a big theme for people was that how do we own gold for an extended period?

Preston Pysh  14:27  

Well, I think the thing that a lot of people don’t realize is that real interest rates in the US are negative right now. I don’t think people realize that. I think that they’re still looking at the 10 year Treasury and saying, “Oh, it’s at 1.7% or wherever it’s at.” And they’re thinking it’s still positive, but it’s not because after you account for the inflation that’s existing, and especially if you consider the energy prices into that inflation number of the last few months. I mean, you’re into negative territory with real interest rates in the US. So if we have negative interest rates, we had Jim Rickards on our show, and he really kind of did a good job describing how gold is zero yield asset, zero yield. But if interest rates are negative, that’s worse than your zero yield that you’re getting on gold. So gold makes more sense at that point. And I think that’s where you’re at right now in the first quarter and into the second quarter of 2016. And that’s why you’re seeing it go the way it’s going.

Raoul Pal  15:16  

Exactly right. It’s early days yet, we’ve had a decent sized correction in gold. Let’s see how it develops over time. But it feels like if you really want to own gold, if you really want a strong case to own gold, and this is probably the most likely outcome.

Stig Brodersen  15:29  

Raoul, like Presto and I, we don’t like to speak about certainties. But we do like to speak about probabilities and we think that the US stock market might face problems ahead. When I look at the stock market, one could argue that the current situation might be a lot worse. So the New York Stock Exchange margin debt is contracting for an all time high level, the central banks doesn’t have the same flexibility as they had back then. And when I look at the US and the world economy to support all this have trouble identifying where the growth should come from, say within the next three to five years. 

So where do you see the differences and similarities in the stock market today, perhaps both compared to 2000 and 2008?

Raoul Pal  16:08  

Yeah. Okay. Good question. So when I wrote about this in my last publication, when I talk about the similarities between 2000, it’s only a contextual pattern terms, like how the stock markets go up and down in 10to 15% increments and going nowhere. You wouldn’t really realize that it’s been a huge struggle, and everyone’s lost money, bulls and bears. So that’s how I see the similarity right now. It’s a similar situation, we know how that one was resolved. There are situations where it’s been resolved positively to the upside. But as you point out, the probability of that is low considering the valuation, the debt, the global slowdown, the dollar strength, and all of the other things in the background. 

Then we talk about magnitude. Now, I’ve gotten a mistake before trying to ascertain magnitude of events, particularly downside events. And I think it’s difficult to do because you don’t know the external factors that come to play over the course of a bear market. What you know is there’s a lot of banana skins to slip on. There’s Japan, China,a nd Europe, there’s geopolitics, you know, Russia, Turkey, situations within the US, including elections. So there’s so many things that we can slip on. And it’s all encapsulated by the global debt bubble. But you know, the probability is that if we start hitting towards global recessions, that there is an acceleration point that could be larger than people expect. 

So I totally agree with you. I totally agree with why the probability is the market doesn’t go much higher. I think it’s difficult to and the downside is potentially bigger than we expect, but we just don’t know. I mean, what does what does quantitative easing and spending on infrastructure do for the economy? Can that stop a recession? Well, it has done in Japan periodically, so we just don’t know.

Stig Brodersen  17:45  

Interesting response, Raoul, and now I mentioned margin debt. And we also talked about central banks. I guess that we are all looking for this one key ratio that could tell us everything but which is not there, but I know that you place a lot of emphasis on ISM. Can you please explain that indicates and what that tells us right now?

Raoul Pal  18:03  

Yes, so as a student, I kind of throw out all schools of economics because most of them are theoretical and they failed. I, however, a much more sanguine and say, You know what, all we need to understand is the economy goes up and down the business cycle, it’s been going forever. You know, if we even look at Egyptians talking about stuff, they had the seven, you know, linear seven fat years. The business cycle is always there. 

What’s also great about it, I use the ISM to predict the business cycle or as my indicator of the business cycle, because it maps GDP very closely. And what we know is it goes from peak to trough and trough to peak. We also know because we’ve got data going back to 1947 in the ISM, and 1870 using the Treasury survey beforehand. We can look at the number of months between a peak and a trough. So it’ll give us a probability of when we should be seeing a peak or a trough. We also know what happens at various points in the cycle, how many months after it crosses 50 does it lead to recession? We also know how many times it leads to recession when it does certain things or leads to a boom. So we can calculate probabilities. And that means that you end up being a better forecaster, the most economists are with a very simple thing, which is the *inaudible advisor. So that’s how I find it useful. 

Also ISM correlates very closely to asset prices for the year and year rate of change of the S&P 500 is yet the ISM, almost identical. Generally speaking, the year on year rates of change, bond yield is the same, it’s got more skewed now with quantitative easing, commodity prices are the same. So all asset prices, obviously, are related to the business cycle. So ignore everything else that people look at in terms of trying to judge GDP. Use the business cycle, it’s a much easier way of doing it. As long as you understand that nothing is a science, everything is an art and a probability.

Stig Brodersen  19:46  

And just to put it in the context of this, so if we have a higher ISM index, that means that we can expect higher corporate profits, and that would usually also have a positive spillover on the stock market. So I just wanted to add that to the response.

Raoul Pal  20:00  

Absolutely right and in that environment, you generally see CPI rising a little bit as well, because inflation comes up because a bit more money around, you know, it’s not rocket science. It’s a very obvious linkage.

Preston Pysh  20:11  

So it’s interesting when you talk about the the business cycle, what you’re really talking about is credit growth and contraction that’s occurring during that period. And so that makes total sense when you think about GDP, because GDP is simply your top line revenue is at least how I think of it in my head is the top line revenue for the United States. And so if you’re seeing that top line, expand and get bigger, and then you start to see that slowly start to contract, that’s a representation of your actual money that’s in the system, the monetary baseline plus your credit, which represents the overall currency that’s being circulated in the economy. Would you agree with that idea, as far as the way that you’re looking at it?

Raoul Pal  20:49  

I try not to overthink it because we all try and be smart to try and understand what drives the business cycle. The fact is, nobody really knows. We know it’s a function of credit. We know it’s a function of the manufacturing cycle. We know it’s a function of inventory cycle. All of these things we know. But let’s not concern ourselves with what does it, just that it is? That’s that makes it much clearer. I mean, you know, we’re talking about GDP. 

One of the interesting things about GDP is GDP is kind of exports minus imports. Okay, that’s a weird old world, because right now, exports and imports in almost every country is falling. Now, if that’s your own personal economy, if you’re selling less stuff and buying less stuff, your economy is shrinking, But in GDP accounting, it’s not shrinking, which is why people kind of misunderstand what’s going on in the world right now when we see these kind of things. So I try to keep it… I try to uncomplicate things.

Preston Pysh  21:35  

I like that. One of the other points that you had made in that previous response, you said that the market hasn’t moved anywhere since 2014. And when you look at that, and you look at the time that you’re talking, and I imagine that if you go back to call it like November of 2014. And this is, you know, I don’t know for sure, but that’s what I would guess. Right now, the Dow Jones is at 17,500 at the end of May of 2016 and I think if you’d go back to November of 2014, you’d probably see a similar spot on the Dow. 

What I find interesting is when you go back to November 2014, that’s whenever the Fed had stopped quantitative easing. They haven’t done it since, in fact, they had one small 25 point basis point move, where they tightened. They really haven’t done anything ever since that point in time. Is there a correlation? Do you believe that there’s a correlation there?

Raoul Pal  22:30  

We claimed the same thing with commodity prices, but then it didn’t work. I think there’s a Pavlovian response that creates this bias right now within the marketplace. I don’t believe there’s an actual mechanism because if we look at the positioning, we look at the flow into equities. It does not correlate with the amount of quantitative easing. What we’ve seen is volumes declining in equities, but the all of the trillions of QE. 

So I think yes,  at the margin, prime brokerage units within banks will lend more money to hedge funds, but hedge fund positioning is not going up at the same rate. I don’t think the flow through I think it’s a Pavlovian response, but doesn’t really have a direct linkage because they don’t see it elsewhere in the world. So the footsie, when the UK bought astonishing amounts of *guilds. We just didn’t see the same linkage. We didn’t see it in Europe. We don’t see it in Japan. So is the US different from some mechanism? I don’t think so. I just think it’s slightly more speculative.

Preston Pysh  23:30  

Very interesting. So well, when I listened to George Soros talk about the issues in China, it seems like their country might be repeating some of the mistakes that we made here in the US back in 2008. The only difference is that they are even more leverage than we were back then. Do you agree with Soros and Kyle Bass and all these other guys that are saying that China is the number one risk that we’re facing with the global economy? And if not, what would what would you say is that number one risk whether it’s Japan or European banks? What do you think that is? Do you agree with them? And then what do you think is the major risk? 

Raoul Pal  24:04  

The China thing is something I was probably one of the first people in the world on. I mean, I back in 2008. I went and ran a shot video of empty buildings in China. I think it was before Hugh Hendry did it, before everybody else did it. So I’ve been very concerned about China and the debt story. I think I wrote an article back in 2004, when I was still running a hedge fund for GLD. And I think Stanley Druckenmiller got 11 copies of it various people, as it got circulated around the world because people weren’t skeptical about China. They just wanted to believe.

And that China story I’ve been following it from then on and seeing the whole issue grow and grow and grow. And it’s kind of the Chinese situation is more has been spent on infrastructure and capital expenditure than any other nation at any time in history. And the amounts of money are vast, and the amounts of credit is astonishing. And it’s so opaque we don’t know what to do data. We don’t know how they can manipulate the data. Yes, they need to devalue their currency. But it’s gonna take time and maybe they’ll draw it out, they won’t let anybody win in this game, and that we’re kind of fighting them blind and no way speculating is going to win the game. The other side, not much more of okay these are the numbers, they cannot last any longer, this will have to blow at some point. So I kind of a remark sside but I understand downside too.

Preston Pysh  25:19  

So it’s funny because last summer, we saw that their equity market was really just having tremendous problems. It was having a huge pull backs. It had a crash, not a 60% downturn, but it had a tremendous downturn last summer. And I think a lot of people are looking at it now saying, “Hey, it’s been mitigated. It’s been stopped.” But do you think that it has more to fall from here? Do you think that they have a lot more deleveraging occur?

Raoul Pal  25:44  

So I tend to be a student of history. So I try to take snapshots of where we are now and say that’s where we are. We have to live in the future in the global macro world, we have to look in the future and extrapolate backwards. Also, we need to live in the past and understand how the past worked.

So if I look back at any time, similar situation, there is a very low probability chance that China gets out of this without a really big issue. You know, however much of shifting around of taking it from state owned enterprises, put it in the government balance sheet, hiding it amongst the banks. that’s a whole game. Nobody’s ever really gotten away with it in the past. Will China? Well, my view is probably not. My view is generally there tends to be some bundled fundamental economic laws, which are once you get to0 overstretched, there’s nothing you can do about it. It eventually implodes.

Stig Brodersen  26:29  

So if we keep talking about China, and if we compare that to the US, the thing I find really interesting is that in 2009, in the States, the American Recovery and Reinvestment Act was approved. And, as far as I remember, it was approximately 5% of US GDP. Now, if you compare that to China, what they did with fiscal policy, it was 17% of their GDP. So what do you think China should do because this path of key pouring in money into the society with *inaudible, that’s not a sustainable solution?

Raoul Pal  27:04  

When the problem is with a fiscal stimulus, much like monetary stimulus is there is a law of diminishing returns. So you can build more empty cities, more roads, but the stimulus effect is very limited. It’s just the construction spend goes in construction spending goes out, and that’s the effects. So the US could get a better stimulus because it leads to infrastructure spending, for example, but China really doesn’t at this point. So, you know, I don’t really know how this plays out. But I think the only way countries really play this out is they have to end up becoming economically attractive for external investment and for selling their own goods. And I know the world doesn’t like the idea of a cheaper Chinese currency. But we need China to be one of the legs of the global economy that is working. Currently, we have no legs. US is the strongest leg and it’s pretty weak.

Preston Pysh  27:53  

So let’s expand on this idea. So let’s just say that we go into the third quarter of this year and we really start to see deflationary force is starting to take over. And this is all hypothetical. And things get a lot worse. And now the Fed is in a position where they can drop interest rates a quarter of a percent and that’s what they’ve got. That’s what they have in the hopper. You know you got Ray Dalio, you got other people all saying helicopter money, helicopter money. But the the issue that I see potentially with this is that is relying on the fiscal arm of policy versus monetary policy, which was what the Fed actually controls in order to stimulate and to put more dollars into the system. I see the fiscal side of it dealing with the House and Senate and everybody else passing this kind of stuff is being a very slow process. Would that potentially cause more problems because the Fed doesn’t have their tools available? So now we’re relying on the fiscal side. You see what I’m getting at?

Raoul Pal  28:49  

Okay, so I’ve talked about this in the past. We have a policy gap between the Fed being on tightening bias to an actual implementation of something useful. Now, quantitative easing In his previous format is almost politically impossible to do right now, because it pushed too much money in the hands of too few. And with the political cycle where it is, it’s almost impossible to do. So then that then we have to go to money for the people.

Preston Pysh  29:15  

I’m thinking about in the past, the Fed, as much as we’d like to beat up the Fed, they do understand that something has to be done. And then they had the power to do something very quickly. But all their tools are gone. They don’t have any tools left. And so now you’re really kind of looking at the fiscal side to solve the problem. And the fiscal side is not going to get this quickly, if at all.

Raoul Pal  29:37  

No, I mean, we know the fiscal side has worked in recessions in the past. Will it work this time around? Well, probably a bit, you know, can it save us at the bottom of the next recession? It probably can. Is it an ongoing thing because we have no monetary policy? Well, the next time around, we won’t have much fiscal policy either, because what you’re doing is you’re essentially monetizing fiscal policy. It becomes problematic and all of these things leads us to believe at the end of it, something has to be done about the global debt pile, which is causing this problem, and potentially something to do with their currency. And my view is at some point, whether it’s the bottom of this cycle or the bottom of the next cycle, is going to have to be a debt Jubilee of some sort. That’s the way the world has always dealt with these things.

Preston Pysh  30:21  

Raoul, going back to what we were talking about earlier, as far as China, do you see China as that number one threat? Or do you see Japan or European banks, which would you say is the number one risk facing the global economy at this point?

Raoul Pal  30:32  

I think, again, this is a mistake people make is they try to assign probabilities to these things and we really don’t know. It’s usually the thing you weren’t looking at. All we do know is all of these things are part of the domino effect. So once the first domino goes, then there’s things that we can do. We can trade along that domino effect, look for the knock on effects and look to protect ourselves or make money out of a situation like that. The hard thing, I think the wrong thing we’ve seen people repeatedly do this was trying to pick up the one: it’s Europe. It’s Japan. It’s China. I don’t know what’s what. I’m past indifference. Once it starts, we know what to do.

Preston Pysh  31:07  

I love that. I’m serious. I love that response because I fall victim to that all the time. That is a great response. I’m going to start using that. I’ll let people know where I got it from.

Stig Brodersen  31:18  

So let me just shift gears a bit. You retired as a hedge fund manager back in 2004. And that was after an impressive career at Goldman Sachs and GLG Partners as Preston mentioned before. I’m personally very impressed by the performance investment approach of some managers and Ray Dalio from Bridgewater aAsociates might be the best example. 12 years since you retired and the industry has changed rapidly. And today there are more than 10,000 funds managing assets exceeding $3 trillion. 

So, I know that there are some investors out there, they’re under the impression that there would be better positioned for a potential recession in the hedge fund than other investment vehicles. What would your advise be for these investors? What should the look for aside say historical performance and fees, which is the typical things to look at?

Raoul Pal  32:09  

Okay, that’s a big question that first I think the death of the hedge fund industry is coming. I think it’s underway. I think it’s impossible to have 10,000 of the smartest people in the room because the risk reward in running a hedge fund is very good. You get paid a management fee and upside, no downside, unless you’ve got some of your money invested. It attracts a lot of people into that business, you can get rich if you get it right. 

But the fact is, most people don’t make money over time. You know, people bleed money and they give up in the business. There’s a reasonable turnover of funds, I think, as a way of protecting yourself. Yeah, you know, hedge funds overall with a broad enough portfolios, okay. But as the pension fund industry, started investing in the hedge fund business, they got rid of the high volatile, high return, long view. And what they do is they force people down to monthly returns. So then you’re a hedge fund manager and you have to perform monthly. And if you fail to make money in one month, you have to go to investors and say why you didn’t. That means your trade horizon has gone to two weeks. And this is the problem. 

*Paul Tudor Jones once told me that he said, “Raoul, the most common mistake people have is that their trade horizon doesn’t match that idea horizon.” So if you’re trading an 18 month view about what you think is going on, we might get to stimulus within the US economy, then don’t trade on a two week view because you’re trading two different things.

Stig Brodersen  33:34  

I remember the first time I heard about hedge funds. I think it was my first year in undergrad and we have people from hedge fund talking about how they could always make money. They could do that in bull markets, they can do that in bear markets. And I guess that’s how people usually see has funds because they can be market neutral. And then a crisis happened and almost all hedge funds got crushed. For me, that was very confusing because I read through some of these investment strategies, and almost all of them said we also make money if the market goes down. So what’s the due diligence approach for an investor to make sure that they actually do make money if the market is down?

Raoul Pal  34:15  

You know, it’s very difficult because people can get their view wrong. So you know, not everybody’s amazing. So the due diligence process, first portfolio construction, do have a balance of hedge funds, and give yourself the chance of smoothing out those returns because one or two guys will get it right, one or two guys will get it wrong. We need to make sure that the ones that get it wrong, they’ll get it spectacularly wrong. So they lose 10%, the other guys make 30% You’re all fine. I think that’s part of it. 

The other part is finding out when people started the career. Preston started this earlier in the conversation when we first started. It’s about when you started your career has a big influence on how you think about things. Anybody started their career trading bull markets and that’s what they understand, tend not to be able to handle downside. People who’ve been ups and downs cycles tend to better handle both because you’d become very humble after a while, because you’re gonna  screwed up somewhere down the line. And you’ll learn that you’re not great. Once you learn that, that’s the key lesson. And that allows you to be a little more flexible in how you think about things.

Preston Pysh  35:16  

So, Raoul, you’ve had access to all these amazing people that you’ve interviewed. And the thing that I really want to hear from you is who’s one of the smarter people or one of the people that I guess maybe smarter isn’t the best word, but who’s really impressed you when you sat down with them? And you’ve heard them respond to some of your answers. And you could just see their response was just extremely profound, very intelligent. What name would kind of stick out in your head? You can you can give more than one if you have multiple people.

Raoul Pal  35:47  

Well look, some of this, you know, you sit down with Kyle bass, he’s a smart guy. People the likes of this, the person I really, really like to talk to and really appreciate how he forms his view is John Burbank. John is really one of the better thinkers out there. It doesn’t have to be famous people. There’s hidden gems everywhere of incredibly smart people. It’s about keeping your mind open.

Preston Pysh  36:10  

And I think that that’s what’s really important that we wanted to kind of highlight with that question, Raoul, was because we always talk about a lot of the same billionaires and things like that. But you know, there’s these other people out there that are high net worth people that have really kind of earned their stripes, if you will, in the industry, but we don’t talk about them or they might have like a treasure trove of information that they’ve written about. I want to find those people and I want to highlight them.

Raoul Pal  36:32  

Also, the media has a tendency to follow certain people. So everyone’s following Ray Dalio, he’s a guy I’d like  to follow. The guy I like to follow is people like Louis Bacon of Moore Capital Management. When I used to be trading with them when I was at Goldman, that trade construction of how these people do things is beyond my comprehension. So smart.

Stig Brodersen  36:52  

I’m curious to hear how you think about all the amazing conversations you have with these intelligent people because how do we make sure that you are 100% objective and avoid your own confirmation bias?

Raoul Pal  37:05  

Confirmation bias is fine, as long as you’re always doing your homework. What I find that people don’t know and I noticed this from the comments within Real Vision, people don’t know how to… when somebody tells them apply to their own framework. There is no replacement for doing your own homework, listen to somebody else do their trade. You have Stan Druckenmiller likes *gold. You don’t know what other trades he does, how he implements the trade, when he’s in the trade, when he’s out the trade. So it’s ridiculous to assume we can piggyback people. What we should do is learn from people. When you learn from people, that’s when you get all of the value.

Preston Pysh  37:34  

I like that too. Learn the essence of how they’re making decisions, not the actual decision itself.

Stig Brodersen  37:42  

And I just want to highlight if you thinking after this interview, that Raoul Pal is a bear on oil, so I should start shorting oil. That’s not what he’s saying. He’s not talking about what Saudi Arabia will do or oil risks in America. That’s not what he’s saying neither. What he is saying is that he think that the dollar will go up, and therefore, oil we go down. It’s two very, very different things.

Raoul Pal  38:05  

Correct. But that is absolutely correct. Right. So you could say, I agree with, with your view about the dollar. But I think the linkage between dollar and oil is different because here’s my research, right? That’s a very valid view. It’s what’s not valid is just say, “Well, I had an argument from so and so they said, the dollars go, oil is going up.” That’s not valid. What’s valid is what you’ve just done, “Is that okay? I can understand that. It doesn’t fit in my framework, but I understand that maybe the risk to my equation.”

Stig Brodersen  38:31  

This is my final question. As a macro guy, what would be one of the best books a person could read to better understand currencies and commodities and how they interact?

Raoul Pal  38:41  

I think that any of the source books originally the “Crisis of Global Capitalism,” which is about the emerging market crisis for Soros and Soros. Obviously as ever, *it’s the market was in  books. Once you read Druckenmiller’s writing about the German unification, understand how currencies work and how complex a world that is. In terms of understanding macro, I think one of the things you have to do is understand history. You cannot approach macro by not knowing that. So I would use “Manias, Panics, and Crashes” lby Kindleberger because it gives you a full history of how things evolve. And they’re basically the cycles of markets. Those kind of things, I think will put you in a good stead to understand that A.) you can’t extrapolate a trend forever and B.)  you can understand the interplay of the asset classes.

Preston Pysh  39:23  

Great recommendation. Thank you. That’s awesome. I’m gonna pick up that last one you just said.

Raoul Pal  39:28  

That’s brilliant.

Preston Pysh  39:29  

So Raoul, thank you so much for coming on our show and spending this last hour with you. I know our audience is going to get a ton out of it, but we really appreciate everything that you’re doing. So thank you very much.

Raoul Pal  39:38  

I love that. Thanks, guys. Really enjoyed it.

Stig Brodersen  39:40  

Alright guys, that was all that we have for this episode. We will see each other next week.

Preston Pysh  39:46  

So one of the things that Stig and I are very strict about is not endorsing any kind of service or product that we don’t personally use ourselves. So with that said, we give our full endorsement of our sponsors’ content realvisionTV.com. Real Vision is a site that Stig and I personally use ourselves and it has had a profound impact on the way that we view the financial markets. 

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Outro  41:39  

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