Generational Wealth Will Be Made and Lost as the Carry Trades Unwind

Welcome to another Finance U!  This is one of my favorites, as I sit down again with Adam Rozencwajg of Goehring and Rozencwajg to discuss their incredibly well-thought-out investment theses.

Let me be blunt: I think commodities are going to be the “next big thing.”  The time to climb aboard the commodity train is right now.

In this episode, Adam walks us through the G&R investment thesis, which is that a long, stable era of fat-and-happy “carry trade” profits is about to end.

(Source)

This has happened several times throughout history, and every time it brings deep losses to the (over) leveraged carry-traders and rewards those who are invested in real things.

Even if you are not ready or able to invest in this manner, you need to know about the process of unwinding the many massive carry trades because it will create significant market volatility and much higher prices for the necessities of life.

That’s a lot of words to say, “Things are about to get even more expensive.”

We discussed:

• The Carry Trade: Defined as a “leveraged short-volatility strategy,” which means borrowing money and relying on stability to continue to persist.  Carry traders count on tomorrow resembling yesterday.
• Adam provided examples such as currency trades (e.g., borrowing in Japan, to invest in higher-yield assets), private equity, hedge funds, and stock buybacks, all enabled by central banks suppressing volatility.
• The result has been hyper-financialization, where financial assets (stocks and bonds) now exceed 200% of GDP.
• Anti-Carry Trade Shift: Carry regimes are unnatural and eventually unwind when central banks won’t or can’t suppress volatility.
• Carry trade regimes always result in underinvestment in real assets and value plays.
• Monetary debasement:  Gold’s current price reflects various counterparty risks as well as USD weakness (a.k.a. “the debasement trade”).
• The gold-oil ratio is at a historical extreme (77.8 barrels per ounce, 9.8 standard deviations from trend!), suggesting gold is overvalued relative to oil; gold leads commodity bull markets, with oil following.  So, oil’s next!
• Oil Markets: Profound underinvestment for 15 to 20 years due to carry trade is going to be followed by absolutely massive investments.  Meanwhile, shale production in the US is rolling over (the Permian is the last major play with some growth possible, all others have rolled over).
• IEA report highlights: 5.6% annual decline rates across all global conventional fields, requiring $500B+ annually to maintain supply (potentially $1T with demand growth).  Adam’s view is that the current IEA “oil glut” narrative is overstated.
• Natural Gas Outlook: U.S. production growth is now limited to the Permian as all other major basins are declining. Meanwhile, a huge demand surge from LNG exports, data centers, and petrochemicals (12-15 BCF/day extra needed) will have to be met from “somewhere,” the only problem is nobody is addressing this at the national level. This opens the U.S. to a potential price spike that will see natural gas prices rise by 3x to 4x to match global prices.
• Key Predictions: Inflation’s return ties the Fed’s hands leading to a sudden unwinding of the carry trades, huge increases in volatility and a sudden rush back into real assets and value stocks.

Timestamps
00:00 Understanding the Carry Trade
17:46 The Impact of Financialization on Real Assets
29:01 Gold as a Hedge Against Systemic Risks
37:02 Understanding Short Volatility and Systemic Risk
38:20 The Impact of Financialization on Commodities
39:18 Gold and Oil: Historical Trends and Future Predictions
40:33 The Role of Gold in Economic Cycles
42:42 The Malthusian Perspective on Resource Scarcity
44:14 The Energy Crisis: Power Generation and Resource Management
46:50 Investment Strategies in Energy and Commodities
53:14 The Decline of Oil and Gas Production
01:00:54 The Future of Oil Production and Investment Needs