Raoul Pal on Off The Chain

Raoul Pal Calls for a Potential Depression | Off the Chain with Anthony Pompliano

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Key Takeaways

  • Investing at major turning points yields best returns 
  • Raoul believes we could be going into an economic depression
    • Your job as an investor is to think about the future and double up before the panic
  • Cash is king in a recession
  • Bitcoin is probably the best performing asset of all time and it has a massive return: risk ratio
  • Gold is insurance in a bad situation, Bitcoin will probably behave similarly
    • “Bitcoin is a parachute that’s masked as an adrenaline rush” – Anthony Pompliano
  • Digital currencies are being issued by everyone (including banks), they all have similar monetary policies and that’s missing the point: This is not a tech problem, the competition is in the monetary policy
    • We will see people choose the new monetary policy, slowly then all at once
  • Currencies are evolving, you can now have a programmable money and smart contracts
    • This is a new financial system being built in parallel to the current system. One day, you can just turn the lights off on the old system
  • Thanks to the digital revolution, companies are global from day one, servicing users all over the world, this was never possible in the old world
  • Think of tokens as a replacement to equity markets, not as currencies
    • “We are building a new equity market from scratch based on tokens” – Raoul Pal
    • Example: Tokenize a corporation like Exxon into different income streams and asset prices and own whatever part of it you choose
  • Most important book: The Bonfire of the Vanities   Because it shows the humility we should have when we think we are geniuses
  • Most important advice: Cash is king, don’t over complicate it
    • If you can, pay off your mortgage before anything else

Intro

Making Big Money Investing

  • Big money is made at inflection points – most of it during down cycles 
    • Up-cycle can take 10 years but the down usually occurs over 18 months (Compressed amounts of return in this period is extraordinary)
  • Investing top tip: cut your losers fast, push your winners hard
    • Raoul counters: the top investors have an innate understanding of outcomes and can stomach more draw-downs than most
  • Raoul recounts the story of the greatest macro-trader he ever saw
    • In 2001, with similar economic conditions to today, this trader made a heavy bet that the Fed will massively cut interest rates
      • He opened his trade in January, closed it in November, and then retired with $200 million

Current Economic Conditions

  • Raoul believes we could be going into an economic depression – Here is how he sees it unfolding:
    • The slowdown started when the fed went too far raising rates in 2017
    • Tariffs and trade wars kindled the recession
    • Crises hit with the Coronavirus
  • Crises are about human behavior, when people panic, everything moves fast
    • Recall Asian crises (1997), Bond market (1994), Dot-com bust, banking crisis
    • Your job as an investor is to think about the future and double up before the panic
      • A major sign was China shutting down

Effects of the Coronavirus on the Economy

  • World Health Organization reports COVID-19 mortality rate at 3.5%
    • Assume it has the same reach as the Spanish flu (27% of humanity) – It translates to 2 billion people infected – 68 million will not survive
    • Western nations are more affected by COVID-19 because of its older population. Further: It’s undetectable for 2-4 weeks
      • “It’s very clear that the Coronavirus has been spreading undetected and unabated in the United States for at least 3 weeks” – Raoul Pal
  • Raoul foresaw the US travel suspension and expects many cities to go into quarantine – this could be the worst economic event of our lifetimes – why?
    • “I do not see a world in which there is not an outcome in which they have to shut down whole parts of economies, whether that’s travel, tourism, conferences, businesses, wait till they quarantine people at home!” – Raoul Pal
      • “The clear thing is we are going into a recession, this [Coronavirus] just pressed the nuclear button for depression”
  • So what do investors do?
    • There will be job losses and governments will try to support companies
    • Your takeaway: Cash is king in a recession

Bonds

  • Interest rates are going to zero and probably negative (especially with stock market and other assets falling)
    • “The Fed isn’t going to raise rates, so bonds aren’t going to move against you, if all hell breaks loose you will get your money back in bonds” – Raoul Pal
      • “But if all hell breaks loose and bond price rallies, which it will do, you will make a shit ton of money”
  • The US is about to start testing for Coronavirus on a massive scale, combine this with potential depression, it means the Fed will cut rates
    • Add an election year when everyone is incentivized to panic

The Corporate Debt Bubble

  • The biggest part of the current bubble is the corporate debt bubble, here is how it gets created:
    • American companies issue debt to buy back their own shares (They also buy shares for top management)
      • This drives share prices up, which pleases shareholders and enriches top management
      • But: Corporation is taking on more debt
  • Who buys this debt? The pension system – Here is why:
    • Corporate bonds have more yield than government bonds and it is deemed safe
    • Pensions are motivated by more returns and state pensions are putting tax money into buying corporate bonds

Enter: Recession

  • In a recession, company cash flows and earnings go negative, and tax receipts are lower – So:
    • Corporations can’t buy back their own shares
    • State pensions can’t buy equities
    • No baby boomers or millennials buying equity
  • In other words: When the business cycle goes negative, buyers of credit and buyers of equity both leave, right when you most need buyers 
    • Result: Share prices plummet, corporations issue more debt, further pushing share prices down – A doom loop
  • This is the reason many executives have been quitting recently
    • They made a lot of money in the bull cycle, better walking out with the championship trophy instead of waiting for a bad situation

What does it mean for pensions?

  • ­If you are young you can weather this storm and get more opportunities at investing
    • But for retirees, they can’t buy the dip and being bankrupt when you are old is not an option
  • The yield fall from 2% to 1% means you need twice as much money to live off the yield
    • Raoul expands: “When it goes to 0% you can never have enough money to live off the yield, you have to have capital gains, that completely screws up pension calculations”
      • And many countries are at zero rates, the U.S is an anomaly
  • Does this lead to pension blow-up?
    • “The pension is not what people think, they think it’s a promise or a guarantee – it’s not that”
    • Raoul adds “you will not get, even if you are a fireman or a teacher or somebody who has worked all their life and you have been told you will get two-thirds of your final salary, that will not happen”
  • Raoul is worried about the current confluence of events:
    • Going into a recession – fine
    • Massive corporate debt bubble – we could deal with that
    • Put the coronavirus on top to accelerate it all
    • Add the pension issue: Pensioners can’t afford to retire
    • Extrapolate: how do insurance companies survive medical insurance issues?

Two Sides to the Dollar Liquidity Crisis

  • There is $15Tr credit to foreign borrowers
    • In a slow economic cycle borrowers get less dollars to service their debts This drives the dollar higher in periods of stress
  • The European banking system is starved of dollars
    • Eurodollar and US dollars are not fungible (they are not the same) This has led to a shortage of dollars offshore
  • In short: The world runs on dollars, and there is not enough to make the world run – dollar liquidity crisis

Add – Oil Prices

  • In a slowdown, oil price falls (Oil-dependent economies now get less dollars)
    • Producers will pump more oil and watch the price fall (What Saudi Arabia and Shale are doing) – Why? They need to sell more oil in order to service their debts
    • Anthony sums it up: “It goes from a premium price play to a volume play” – A dollar at any cost

Central Banks

  • Central banks have only 2 tools at their disposal: Cutting rates and printing more money
    • Raoul doesn’t buy into the premise that central banks are evil – “They are a function of the demographics they have been presented”
      • However, the notion of Consumer Price Index used by central banks is mistaken; because different people have different inflation rates
  • What should a central bank do in the coming period?
    • First, whatever they do makes no difference now – With that said;
      • Raoul thinks central banks will have to support the pension system
      • We will see a lot of monetary printing as a natural consequence of promises given to an aging population
  • Hong Kong recently announced a $200Bn stimulus plan for the economy that includes $1200 “Cash giveaways” to each citizen
    • Raoul doesn’t think stimulus packages have much effect – the solution? Building new projects, rebuild economies and systems
      • “When you say: we have got a depression on our hands, the emotional impact on our population has been enormous, and how do we create a future? The only way is to rebuild economies and systems.” – Raoul Pal

How Raoul Allocates his Personal Portfolio

  • Raoul currently allocates his personal portfolio to Bonds, Dollars, Gold and Bitcoin (Cash heavy, Under 10% Gold & Bitcoin, uses leverage on bonds) – His reasoning;
    • Interest rates have to fall
    • Dollar rising in value will create a global wrecking ball
    • Gold appreciates against fiat currencies because of printing money
      • And everyone will stimulate and print money to bail out pension systems
    • Add: Corona and baby boomers retiring, this could break the financial system
      • Outcome: move to something different (maybe Bitcoin?)
  • In 2013, Raoul changed his life and savings to USD, flew over to the US and bought a property in Miami to keep his assets in the dollar, he still keeps this position today

Bitcoin as an Investment

  • Raoul doesn’t see Bitcoin as a good investment fit for pensions – Reason: The future risk-return isn’t adequate for a baby boomer
    • The time to take risk is when you are young
  • Bitcoin is probably the best performing asset of all time and it has a massive return: risk ratio
    • Raoul believes bitcoin is worth $1 million
    • Expected return on a 10% allocation is life changing
      • It could be worth much more in 20 years and we will be talking in terms of satoshis and not bitcoins

Gold & Bitcoin

  • Both Gold bugs and Bitcoiners agree that printing money creates bubbles, you can’t keep printing forever
  • Gold is insurance in a bad situation, Bitcoin will probably behave similarly
    • But in a disaster: Gold will be base protection while Bitcoin will likely surge massively as a digital neutral asset
    • Think of Bitcoin and Gold as “call options” on the outcome
  • Bitcoin is “A parachute that’s masked as an adrenaline rush” – Anthony Pompliano
  • Digital currencies are being issued by everyone (including banks), they all have similar monetary policies and that’s missing the point:
    • This is not a tech problem, the competition is in the monetary policy
      • There is Bitcoin: Fixed monetary policy, fixed issuance rate, etc.
      • Then there is everything else…
  • We will see people choose the new monetary policy, slowly then all at once

Digital Finance

  • Governments are burning physical cash in fear of the coronavirus (Shows an advantage of moving to a cashless society)
  • But it is still painful to open bank accounts, transfer money and use the financial system
    • Luckily, there is a brain drain of people from the traditional financial system to create a new, easy to use and efficient financial system
  • Currencies are evolving, you can now have programmable money and smart contracts
    • This is a new financial system being built in parallel to the current system. One day, you can just turn the lights off on the old system
  • Raoul thinks of Ethereum as silver to Bitcoin’s gold – It has industrial use
    • “Everybody I know is building on Ethereum” – Raoul Pal

There are Enormous Opportunities in the Digital Revolution

  • Beyond money, we are seeing the digitization of everything – Example: Creating a supercomputer out of distributed computer networks
    • Imagine researchers having access to super-computing power they could never afford before
  • Thanks to the digital revolution, companies now don’t start locally then expand internationally
    • Companies are global from day one, servicing users all over the world, this was never possible in the old world
    • Example: Binance cryptocurrency exchange – Achieving $2Bn valuation in 6 months from inception
  • India’s supreme court recently overruled a ban on using cryptocurrencies – allowing the entire Indian population to use digital currency and services
    • Combined with IndiaStack, this provides enormous opportunities
  • Digital Tokens will change investing – Here is how:
    • The notion of investing in corporations as a single entity is about to end
      • Instead: Tokenize a corporation like Exxon into different income streams and asset prices and owning whatever part of it you choose
    • Think of tokens as a replacement to equity markets, not as currencies
    • Investing in SP 500? This could become tokenized as “Coinbase 500 token”
      • “We are building a new equity market from scratch based on tokens” – Raoul Pal

Other Notes

  • Most important book: The  Bonfire of the Vanities   Because it shows the humility we should have when we think we are geniuses
  • If Raoul could give you one advice: Cash is king, don’t over complicate it
    • If you can, pay off your mortgage before anything else
      • You have a house, your life is protected and you can work from a position of strength
      • The ability to have money when nobody else has it is extremely powerful even at a small micro level
  • Raoul worst investment ever was buying and trying to rent real-estate on a golf course in Spain in 2006
    • He later sold them at 50% loss just to get rid of them (Raoul hates golf)
  • The entire financial world is moving to video Everything is moving to video
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Notes By Mostafa Khaled

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