The "Global Macro Investor" - An Interview With Raoul Pal

Submitted by Erico Matias Tavares of Sinclair & Co

Raoul Pal has previously co-managed the GLG Global Macro Fund in London for GLG Partners, one of the largest hedge fund groups in the world. He came to GLG from Goldman Sachs where he co-managed the hedge fund sales business in Equities and Equity Derivatives in Europe. Other stop-off points on the way were Natwest Markets and HSBC. He started his career training traders in technical analysis.

Raoul retired from managing client money in 2004 at the age of 36 and now writes for The Global Macro Investor, his flagship publication on global markets, and is a cofounder of Real Vision TV, the worlds first video on demand service for investors.

Erico Tavares: Raoul, thanks for being with us today. You have been a successful hedge fund manager, you now publish a highly sought after global macro economic and investment strategy research service (www.globalmacroinvestor.com) on the global markets from sunny Little Cayman… Why leave your comfort zone and start Real Vision TV (www.realvisiontv.com), a financial video on demand channel, from scratch?

Raoul Pal: Back in 2008 I became very uncomfortable with the fact that friends of mine, family and people I knew came to me and said “Raoul, we did not know this was going to happen”. And I said a lot of us have been writing about it, to which the reply was that they just don’t get access to this type of information. It’s just not on the mainstream media. “We don’t see or hear any of these things. We don’t get real analysis and if we can we can’t afford it”; at least not in the format that people like myself produce it.

I thought about this a lot. The world is a messed up place – particularly in economics and investing right now. We had almost a duty to try to reveal to people what is really going on. People need more truth in finance.

One night I happened to have dinner in Spain with Grant Williams who ended up co-founding Real Vision TV with me. We talked it over and thought that the way to do this is to create a video channel and curate the best and brightest minds in the entire world of finance and pick their brains not in a 3-minute soundbite format but sit down and open their minds up and see what we can learn from them. 

So viewers themselves can make their own minds up about what risks are out there and what opportunities. Our idea is not to bias anybody but to provide building blocks with which to grow our knowledge base. That’s the idea behind Real Vision. 

You know, the whole media business is up for disruption. You don’t need a broadcasting license anymore to show video content, and this makes it very easy for new entrants to come in. We knew finance was a different world, but we also knew finance better than most other people. So we thought about offering a product that is subscription based, with a the worlds most beautiful video platform built from scratch – something that had never existed before, nobody has done what we did with the technology before. And that’s where we got to.

ET: So what makes Real Vision TV different from mainstream financial channels like CNBC? Is it because the interviewees, many well-known analysts and fund managers, have more latitude to present their thinking?

RP: Let’s look at what’s available right now. At one end you have Bloomberg and CNBC, where you have 3-minute soundbites at best. I have done several interviews in those channels and you never get any information across to the viewer at all, you are talked over by the hosts, you don’t really have anything in detail of your thoughts out there. And it’s all biased by sponsorships and advertising and promotions. We don’t like that. We believe there should be truth in finance.

On the other side you have Youtube. This is a phenomenal thing but it is non-curated, so you have no idea of what is good and what is bad out of thousands and thousands of videos, who has credibility and who doesn’t.

So we thought about creating something new, that is curated, ultra high-quality and with the best quality guests that our rolodexes could find in our network of friends. We ended up finding famous people like Jeff Gundlach and also unknown people like Mike Hart, who is one of the most successful investors in the period from 2000 to 2010. An incredible guy but nobody had ever heard of him. He is a friend of mine and we sat down one day and he opened his mind up.

What you are going to get is quality of the interviewee and the presentation, in a format that you have probably not seen before, in a level of depth that you have not had before, in a way that treats the audience as intelligent and lets them make their own minds up, so we don’t bias or filter the content. All we say is “look, here’s someone interesting”. Bullish, bearish, we don’t care, but he has a good analysis framework and he has thought about this in great detail.

And then we curate things. That’s why we charge a subscription because in the end people will pay for the very best content in the world, that is high quality, no bias, the best guests, in a beautiful format that makes it easy to use. 

ET: You have been broadcasting since September 2014. How has the public reception been thus far? What is the typical profile of your subscribers in terms of nationality, profession, stage in life and so forth?

RP: The reception has been phenomenal! We did the analysis recently and found that we have subscribers in over 120 countries. We have viewers from gold miners in Kazakhstan to tar sands workers in northern Canada, and from wealthy investors in Russia, to investors in Indonesia, India, South America, all over Europe, Australia, South Africa, New Zealand, Japan, Singapore, China and obviously in America. Probably 60% of our viewership is in America because that’s the highest percentage of investing public who are used to paying for services.

Our average subscriber is probably a mix of professionals – the RIAs and those sorts of people – and a lot of home investors, the kind of 401k retirees or soon-to-be-retired crowd, who just want to know what is going on in the world, and what the risks are for their pension pot.

But in all honesty, it is the incredible feedback that we get that has blown us away. The single most frequents comments are “This video alone has been worth the subscription cost many times over” and “Real vision has changed our investing lives” We are immensely proud of that.

ET: That also resonates with what you were trying to do back in 2008, to get as many people informed as possible…

RP: The other target audience for us is students. I have spoken at Cambridge University and Warwick University about the need for broader schools of economic thought, because economics has been dumbed down to basically Keynesianism and some form of monetarism, and that’s it. 

And so the broader schools of thought are not given any airing. Things like Austrian economics, behavioral economics or business cycle theory just don’t get any airplay amongst students. So if they don’t learn about it how will we ever change policymakers?

So I have been going around universities talking about the need for a broader economic understanding of the real world and not theoretical economics, which have failed us. Real Vision is part of this.

ET: We certainly agree with that. When we studied economics we did not learn anything about how high levels of leverage can risk economic development and financial stability. That is just astonishing. 

RP: Right. And you probably used words like “ceteris paribus”, meaning “all things remaining equal”, which basically means that it does not work in the real world. 

So the whole school of economics does not work because it does not take into account human psychology. I think that is the biggest flaw actually. And they don’t take into account that markets are not rational, that they can trend instead of just being some random walk. Economies also trend up and down, in cycles, and the people are not able to be put into a model. 

Hence why behavioral economics can provide such an incredible change to our understanding to what is happening in the world, you know, the incentives of the individual.

ET: That’s right. The problem is that because they come up with those fancy models, statistics and econometrics, people start believing in them as if it was an exact science, when in fact it is based on assumptions that are incredibly oversimplified.

RP: That is exactly the problem. People believe economics is a science and it is not. At best it is a social science, otherwise it’s like a dark art. 

ET: With the dark arts in mind, let’s switch gears to the markets. A few months ago you made a great call predicting the US dollar would rally strongly, which it did. However, in recent weeks we have been stuck in a range, with some of that momentum being lost. Is the US dollar rally over or are we just pausing for a continuation?

RP: I think we are pausing for a continuation. 

Much like we look at market breadth in stock markets, you can look at market breadth in almost everything. In the currency markets, you can look at the number of currencies making new lows against the US dollar versus the usual ones that we watch. Just because the Euro and the Pound, maybe the Aussie and the Canadian, aren’t making new lows right now, if you look at other currencies like the Turkish Lira and the New Zealand dollar those continue to go down strongly. 

That makes me think that the broad strength of the dollar is still there. It also has to pause because it gets overpositioned and then you get big washouts like you did yesterday in the dollar-yen for example. But then you get back up so fast that you don’t get a chance to buy in.

I looked at the history of dollar bull markets. There are only two big ones in the US dollar, and there was never any correction larger than 10%. So there were times when it traded sideways or had a 10% correction, but it never fell more than that. Usually, the buybacks are short, sharp, and are over and done with and before you know it everyone is panicking back in.

The reason why that happens in currencies, why they trend so strongly, is because it is just not financial market participants in the picture. It’s all the corporations, the pension funds and everybody who realize that they need to hedge every product that they sell, all their US dollar exposure. Think about this. Every pension fund that is considering making an allocation into emerging markets right now are likely figuring out how they will hedge the currency risk back to US dollars. So you got this constant flow of currency always going through. This is why when commodities trend, they really trend. 

The next phase of this, I think, is because people are confusing the rise of interest rates in the US as the reason for the dollar bull market. That’s not the reason, it was just one of many catalysts. It’s going on because the rest of the world is slowing down. The US might also go into recession at some point over the next 18 months, essentially this year, and the likelihood of the US in recession and the Fed out of the picture means that money rushes back to the US dollar.

Now, considering that there is a US$9.5 trillion carry trade of short dollars / long emerging markets and other currencies, chances for an accident on what is the biggest ever position in world markets are very high. And the IMF have been warning about this and nobody is listening. And I was even warning about it even before the IMF were. 

ET: It makes you wonder what has really changed since 2008. For one debt levels are even higher. Perhaps the thing that has changed is that governments are willing to step in, although their ability to do so has become much more limited because of their own debt levels, but certainly the central banks are much more active now – basically willing to underwrite huge portions of the financial markets. 

RP: We have a problem with this, and that is central bank hubris. 

They now think that they are omnipotent, because, essentially the government has said we are going to pass over all control of the economy to the central banks, they say to everybody else including financial market participants that “you don’t know, you don’t understand, we have our models and they are right”. And that kind of hubristic approach is when you sow the seeds of your own destruction.

The central bankers do not listen to financial markets. They are not listening to all of us. One of the reasons we set up Real Vision was to get across to people “look, this is not a good situation. The answer to more leverage cannot be more leverage”. And yet this is what we are doing. You know, at risk here is the whole fallacy of central banking. 

ET: Well, it never ceases to amaze us how when we think they are at the end of the rope, central banks always seem to pull one more rabbit out of the hat.

RP: This is what is so dangerous about it. Because the financial markets believe that they will always pull a rabbit out of the hat. 

If you remember the times of the Greenspan put, the market can never go down because Alan Greenspan put a put on it... Then we had a 48% correction beginning in 2001 and that was the end of that. We then had the Bernanke put, that he will look after the markets and helicopter Ben will not let a big correction happen... Guess what? We ended up having deflation and the biggest recession since the Great Depression. 

And yet people still want to believe that Yellen won’t allow this to happen, that the central banks will magically buy all assets so nothing bad can ever go wrong again. It’s a fallacy and it’s dangerous.

ET: Last year there had been a lot of talk of how the Fed tapering last year would unravel US equity markets. Actually, it looks like crude oil was the victim this time around given the collapse in prices shortly after QE3 ended. 

In your view, what is the transmission mechanism that juices up the markets from quantitative easing: the resulting increase in liquidity (although it has ended largely in bank reserves, much to the chagrin of central bankers) or the fact that interest rates are at near zero levels and therefore speculation is the only way to generate a yield?

RP: There’s part of that. If you look at the portfolio of the average 401k investor, in fact someone asked me to have a look at their portfolio today, people think they need to have some exposure to equities because there are no yields to be had and so they can’t retire otherwise. 

The entire US pension system in particular is driven by equity investment because they have huge black holes created by the low bond yields. And so the only way to overcome that is to be overlong equities. Now the problem with that is the inherent risk of equities. If it all goes wrong and you have a 50% bear market just when a large part of the population is over 65 years old, that’s the big risk that is out there today. 

So speculation is a big thing. If you are close to the money system you get leverage. This is why the London property market has done well, this is why the art markets have done well, this is why there have been a lot of private businesses for sale, this is why the private equity markets have done well. It’s because people who are close to the money can borrow money. 

But the average guy can’t borrow money at all. And you can see that particularly well in Spain and Portugal and Italy and Greece and everywhere else. But if you are a big corporation you can. So that has driven big speculation. Think of the hedge fund business that has been able to borrow money and invest in equity markets, chasing beta essentially. 

So speculation is a big thing. The other part of this – and a very dangerous one – is psychology. Again if people think that because central banks are trying to keep money easy, therefore equities must go up because they are not testing the assumption that they can also go down. You hang on to that blind faith that they always go up. 

So what you are doing, usually suppressed volatility leads to hyper volatility. People always forget that, which is why they always pay too much for insurance in bad times and never enough in good times. Just basic psychology – again, behavioral economics.

ET: One of the largest share buyers has been the corporations themselves, who have been levering up to fund massive buybacks. Is this why equities remain so elevated when assets like commodities and gold remain in the doldrums? 

RP: Commodities don’t have cash flow, unless you own the mining businesses themselves. So it’s a different game. With equities, the two biggest buyers in the world have been sovereign wealth funds and, as you said, corporations. 

So you have the Norwegian sovereign wealth fund buying into equities. Even the Swiss central bank has been an enormous buyer of global equities. But guess what? Norway now has to start giving money back out of its sovereign wealth fund to cushion the downside of the commodities cycle. That’s why you need a sovereign wealth fund in fact. So they are expected to be net sellers now.

Therefore, you are left with one big buyer now, the corporate buyback. And that is based on three things: accounting tricks, the fact that interest rates are very low, and finally because managers get awarded stock options and they can inflate their own share prices through buybacks, thus making them rich. Again, behavioral economics tells us that you will always pursue the options that will make you rich, make your earnings per share look higher and make your accounting look good. 

The reality is that you are hollowing out whole companies by transferring equity to debt. And that is not a good thing, having a world awash with debt. So basically that’s another accident waiting to happen.

ET: Yes, in fact it is often when equities are at their highest that by definition risk is at the highest as well.

RP: Yes, Howard Marks just wrote a piece about this. If you have a good understanding of risk right now, you know that the upside opportunity versus the downside risk is so wildly out of kilter that it really does not incentivize you now to own equities. 

Now, we could have said this much throughout this rally, and there were many of us who have said that and chose another market to be long and make money from, but it has been true much of the way through. If Spain hadn’t been bailed out in 2012 it would have been another Armageddon in the equity markets. And we have had several of these where by luck, I think, we had the right cards dealt to us. I don’t bet on flipping heads every time. It just doesn’t make sense. 

ET: Actually, let’s talk about Europe. It seems to us that the mood there is not that bad. There’s a lot of tourists coming in to take advantage of the collapse in the Euro. The correction in oil prices, where Europe is a clear net consumer, has also given people more money to spend on other things. Aren’t these supportive of a more dynamic Europe, at least until the end of the year, putting aside all the Greek problems out there?

RP: I don’t think so. I think that the European business cycle lags the US by some 9 months or so, generally, over the last two decades. So Europe was due to pick up after the US spurt last year and if I look at the PMIs across Europe many are rolling over now. 

And I fear that Germany may be the economy that leads to the downside. It is not getting enough competitive advantage still. Japan is eating its dinner by devaluing its currency much harder than anybody else. 

So everyone now is doing the same trick by extrapolating forward and not looking at the cycle. I think the balance of probability says yes, it might do better through to the end of the year still, but I think there’s a chance that Europe weakens again later in the year and going into next year. And that’s against the backdrop of China that’s already in a recession, India borderline recession, Brazil in a recession so there’s not many areas in the world that have a leg to stand on right now. 

ET: We visited Lisbon last week and it was interesting to note the vibe. The upper class seems to be doing fine: new Mercedes and BMWs in many places, high end real estate values increasing to the point where net rental yields are minimal, trendy new restaurants, and so forth. But the average citizen continues to struggle with low wages, austerity and chronic unemployment. Is this symptomatic of how skewed monetary policy has become?

RP: You see it in Spain too. The upper end of the property market did not really have a correction, except perhaps in Mallorca. The middle tier got murdered. And yet on balance it is still way below where it was, down over 40%. So again, the people closer to the money are still pilling money into assets, whether it’s property in Lisbon or London or Spain. That’s still going on. The rich are buying businesses like you would not believe it, sweeping up anything they can find that looks like an opportunity. All because they can borrow money. But if you ask the average worker what their life is like, they will tell you that their backs are still up against the wall and they don’t know what to do.

ET: That’s an interesting situation indeed. Either the rich are right and the future is indeed rosy or we might all be in trouble. Now, we talked about the importance of having alternative schools of economic thought. One that should be getting more attention is demographics. There aren’t many things you can predict with some accuracy going forward, but we can get a good sense of how ageing populations will look like per country. When you look at a number of European countries the demographics picture is downright scary with populations that are ageing very fast. How do you factor that in your economic thinking?

RP: Demographics is a big part of my framework. It’s the big part of the secular trends that I look at and there are certain observations that come out of that. 

One is that everyone needs to own bonds when they retire. With falling bond yields you need to have even higher savings otherwise you can’t retire because you have no income. And so the more interest rates fall via the mechanisms of quantitative easing or disinflation, the less people spend, the more disinflationary things are and the more bond yields fall and the harder it is to retire. That whole trend is out there, we have seen it before and that will keep on playing. I’ve seen my parents retire and what happens to income in those times. That’s not a good mechanism. 

Obviously there are whole areas of the economy where you can make money by anticipating those trends, whether it’s in managed healthcare for older people as they retire in Europe or in the pharmaceutical business. So there are a lot of opportunities there. And also just understanding the differences between how millennials spend their money versus baby boomers. This also creates opportunities. 

For me, the low hanging fruit is the opportunity to look for countries with the inverse of the problems we have. So I took a map of the world, crossed out the countries with too much debt, crossed out those with bad demographics and what I ended up with is a world that on the whole is centered around the Indian Ocean. I then realized that this is where the old spice trading routes were from thousands of years ago, and I call it the GMI Monsoon region as those  monsoon winds promoted those trading ties back then. 

The big population there is India and that diaspora of Indians spread across the Eastern coast of Africa, Indonesia, Singapore, up to Iran. All these countries have traded with each other for thousands of years and the people have also mixed their cultures. What’s amazing about them all now is that they all have very young populations, it’s like the biggest population in world history is in those regions right now and they are all under the age of 30. They have high savings ratios – 25-35% in many cases, virtually no household debt and the average government debt is something like 50% (10% in the case of Iran). 

So what you have is a group of people who are highly educated, young, moving into the workforce, high savings, low government debts, low corporate debts – all of which make for a perfect investment environment. That’s like the baby boom generation back in the early 60s for anyone who was around then to start investing. So I am very enchanted with some of those markets.

ET: So, on the whole you are bearish on the equity markets, bullish on bonds…

RP: Yes, I have been bullish on bonds for twelve or fourteen years now, and remain so because I think bold yields go to zero pretty much everywhere. I am generally bearish on equities and I am bearish on commodities. I am very bullish on countries with strong demographics and that’s with a combined population of two billion people, so we are not talking about small fry here. And I’m interested in bitcoin…

ET: Can you summarize your views on bitcoin? Can this offer a transactional alternative in case governments decide to abolish cash?

RP: I don’t see bitcoin as being an alternative in case governments ban cash, which I think will likely happen because it is the same financial repression happening bit by bit by bit everywhere around the world. 

We saw what happened in Cyprus when they took savings and called it a bail-in, sounded nice but it was basically theft of their savings. Why should a saver be penalized for your country being in debt? But that’s what happened. So there are a number of things in the financial repression spectrum that concern me. The cash thing is one of them and stops you from being able to move money around the world. 

Bitcoin does give you the ability to move money around the world quickly and efficiently but I don’t think of it like a currency. It’s much more revolutionary than that. 

Bitcoin’s block chain is essentially the world’s biggest ledger. It’s unique because ledges work like you record the buy, I record the sell, that’s how it works; but with bitcoin you record the buy, I record the sell and he records both transactions. So it’s a tri-party ledger and that means that it’s a much more robust system. If you go bankrupt there’s somebody else who can prove what has happened. 

So it’s a proof of ownership system and it’s enormous. It is by far the largest thing since the development of the internet in terms of the amount of computing power used. And we can put anything on the block chain, like house documents, insurance documents, whether there’s need to be proof of that contract’s existence. 

But the real value by far is going to be the global securities and custody industry, because that is where the rotting heart of the leverage lies – where collateral is reused 20-30 times without you even realizing. If you own some US government bonds, you don’t realize that they get used 40 times by everybody else in the system. Your bonds that you own and that you bought.

But with the block chain we can move the entire securities industry onto this ledger system where it will be monitored and kept and stored in real time. So you will never get into a situation like Lehman where nobody knew who owned what assets. And to own a part of the block chain you have to pay in bitcoins and that’s why it has a real value, ignoring the transactional elements, which are also interesting. This is the big deal, it is revolutionary to the world of finance.

ET: Well, as victims of the MF Global debacle we could not be more supportive of that! Lastly, some prominent money managers and analysts – including yourself – are predicting not just a stock market correction, but another shock to our entire financial system, even bigger than 2008. A big deflationary reset if you like. Is this indicative of bearish sentiment in the markets or is this is something that could actually happen?

RP: I remember this well back in the late 1990s, early 2000s where people I knew as the world’s greatest investors, one after the other, and I was speaking to a lot at the time when I was running hedge fund sales at Goldman, were coming to me and saying that this was going to end badly. And whether it was Julian Robertson, Paul Tudor Jones, Stan Druckenmiller, George Soros… all of these guys, one after the other, were saying “I’m out. This is very dangerous”. 

And now I am hearing the smartest investors in the world, whether it’s Icahn or Druckenmiller or Robertson, they are all telling you to be careful, that this is really, really dangerous. And the people aren’t listening because the party is still going. And nobody is telling you that you are the party, that you are drunk and that the police are about the break up the party. Well, they are telling you but you don’t want to listen because you are having such a good time. 

None of us are saying that we have an ability to see the future with anything more than assessing probability. What we are saying is that the probability of something bad happening is increasing dramatically. The magnitude of that downside is also probably very large. The odds are stacking up for something very bad.

ET: Raoul, this has been fantastic. We wish we had more time today. For people wanting to get more of your views, where should they go to?

RP: Everyone is welcome to subscribe to Real Vision at www.realvisiontv.com. You will find a treasure trove of information on the markets there.

Actually, if anyone reading this article wants to subscribe, they can use the code MILTON4 for a discount of 25% (the maximum we offer) in the first annual subscription.

ET: We could not recommend it more. Thanks Raoul, all the best!

RP: Thank you very much.