Transcripts

Erik:    Joining me now is Mike Alkin, CIO and fund manager for Sachem Cove Partners. Mike has prepared a slide deck to accompany today's interview. Registered users will find the download link in your Research Roundup email. If you don't have a Research Roundup email, just go to our homepage. macrovoices.com, look for the red button above Mike's picture that says, looking for the downloads.

Mike, I can't believe it's been four years since I've talked to you. I want to just let our listeners know that because of my travel plans to the World Nuclear Association conference in London, we recorded this interview fully eight days before you'll hear it, way back on August 28^th. So please excuse us if we don't have the latest market news. Mike, I want to start with the structure of this market, because I think, frankly, a lot of people other than yourself and a couple of other real pros don't really understand it. So let's start with the simplest question. You know, if I'm running a trucking company, I don't have to buy crude oil and hire somebody, contract with a refiner to refine it. For me, I just buy diesel fuel, if that's what I need to run my trucks. Why do utilities have to buy unrefined U308 yellow cake uranium and then contract with a conversion and enrichment? Why don't they just sell nuclear reactor fuel in a finished product market?

Mike:   That's a great question. Well, first, thanks for having me again. It's a pleasure to catch up again. So, historically, the fuel buyer, and let's understand what a fuel buyer is, right there. Most fuel buyers are nuclear engineers. And if you think about this, the market is defined by one where about 80%, 85% of the pounds that are purchased in a year go through a long term contract market from three years forward from the date signed. And it could last 5 years,7 years, 10 years. That's what a term market is. That's the vast majority of the pounds sold. And on occasion, the spot market comes into play, which is 15%, 20% of the pounds, depending on the year, sometimes a little bit more. Post Fukushima, there happen to be some pounds backed up. That one went away at the spot market. But if you're running a nuclear reactor, you can't switch to natural gas or coal, it is what it is. So, security of supply is paramount.

So the folks running these are very smart people, but they're infrequently discovering price. They're not in there, they're not coal traders or natural gas traders or oil traders. They're in there very infrequently. And what they do is they want to control the process, right? If you think about the nuclear fuel cycle, if you're buying coal or gas, you're not talking about the coal cycle, the gas cycle. You buy it, and pretty soon it's at your plant gate. Here, you're talking, it could be upwards of two years, right? U308 is mined, it gets converted to UF6. UF6 then goes to the enrichment plant. That gets enriched, then it goes off to fabrication. And you're saying, like, why don't they just buy EUP? Sometimes they do just buy EUP. They can go into the market and buy enriched uranium product, but most of the time, they want to control the process. They want to be in charge of what shows up and where, and they want to know they have that capacity, so they contract at each step along the way. And to know the fuel cycle, there's a product in the fuel cycle that's U308, that's the uranium that comes out of the ground, and then from that point forward, their services. So, conversion is a surface converting U308 to, ultimately, U308 becomes UF6, and then UF6 becomes enriched, and then it goes to fabrication. Those are services that take the natural uranium and convert it in.

And so, the utilities want to control each step of that plan, sometimes they might, they'll do a little horse trading. They might take in some enriched uranium product, some EUP, and in that, there might be some conversion, there may be some enrichment, there's other things that they could strip out and they could sell to others. And you know, that's getting deeper into a route. I don't want to go down a rabbit hole, but they want to control all portions of that. And so, like I said, their number one job is security of supply, because there is no substitute for what they do. So they want to carry it. And prices of these will move at different times, because at each stage of the fuel cycle, Erik, there are different market shares, and there are different players. For instance, in enrichment portion of the fuel cycle, which is where uranium, U308, by itself is nothing. UF6 needs to be enriched up to 3% to 5% levels to be able to be fissionable and create a reaction. When you're looking about those, enrichment is controlled. Up 40% of the market is Russia, then the West has Urenco and Orano, and so you can get some, you'll have market share there. China has some enrichment capabilities, and so it's very controlled by state owned players in enrichment. So their capacity is tighter, and now, after Fukushima, it was looser. But buyers, in a market where prices are rising and capacity is tightening, they tend to flock to it. To put some context around that, about five or six years ago, the price of enrichment, which is priced in a unit of work called a Separative Work Unit, was about $35 per SWU would be the acronym. Today, a unit of SWU is $176, right? So, it's gone up multiples. If you look at conversion, the act of converting U308 into UF6, that was back in 2016, ‘17, $4. Today in the spot market, it's $68. Why? Because a lot of capacity had to be taken out of the market during the downturn, and the commitments haven't come back in full swing for the converters to not only just bring back the capacity, but add new capacity that is needed. And so, if you're a fuel buyer, it needs to be enriched, so you focus on enrichment. With the Ukraine war, people are self-sanctioning away from Russia. There's a Russian ban in place in the US, so they got to scramble to go get enrichment capacity. And remember, just like there was a massive investment, which we could talk about, in the mine, under investment in capital expenditures in the miners for a decade post the 2011 event in Fukushima, same thing happened in enrichment and conversion. So, scramble goes to get the enrichment services. It goes to get the conversion services. There's a few more uranium miners than there are enrichers or converters. So it's a pecking order. Where do they go? Where's the biggest pinch point first? Now, even with that, the price of uranium has gone from $16, $17 at the low, to $80 right? So it still had a big move. It's just that's how, that's the nature of the business. The fuel buyers control it, and I don't see that changing.

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Erik:      Joining me now is Victor Shvets, global head of desk strategy for Macquarie Capital. Viktor, it's great to get you back on the show. So much we've got to talk about. Let's start with the Federal Reserve and for that matter, we can expand the conversation to central banks generally. Have they become political? Heavens no, it could never happen in the United States, and have they committed a policy error?

Viktor:    Well, thank you very much for having me. It's always an interesting question, are central banks political? It's like asking, is any human institution political or not? For the answer, they’re all political in some form. It's all about the degree of independence that you get, but nobody is truly non-political. So, I don't think Federal Reserve or any other central banks are purely technocratic institutions. However, in terms of whether they made a policy error or not, that's an interesting question. Because, to my mind, the inflation, or the problem of inflation was over and done with probably sometime in earlier 2023. That's when I published that team transitory has won, and team transitory was right all along, any inflation after that, pretty much globally, was really anomalies, either statistical anomalies or methodological anomalies, but the underlying inflationary pulse arising out of COVID was pretty much over in 2023. So, the question is, by waiting all the way into ’24, whether central banks have committed a policy error by keeping interest rates above neutral rates. To my mind, they have committed a policy error, but the consequences are not as significant as they used to be.

One of the things I keep emphasizing is that we live in the world of excess surplus capital. We've got abundance of capital, not a constraint shortage of capital. Now, that's quite unique. It only occurred in the last 15, 20 years, and it's been increasing ever since, primarily because money supply has been growing so much faster than nominal GDP. And the difference between the two is this excess capital we have, it's very hard to compute, but on a global basis, I think we have at least $500 to $800 trillion of capital, which means anywhere from 5 to 10 times GDP. So, when you have excess capital, prices don't work as well because there is excess of that commodity, rather than a shortage. Now that helps if you commit a policy error, if you keep rates too high, but there is too much capital moving around, that cushions the real economy.

The second thing we have that we never had before is really instantaneous risk repricing. You know, Federal Reserve makes one announcement, the answer is automatically on a screen within a split second, so you immediately know where there is a problem. And the third thing we have, once again, we didn't have it before, really, is ability of central banks to roll out new policies on a whim incredibly fast. Think of it this way. Federal Reserve, it took them almost a year to become comfortable with QE. It took them at least a month to understand that we need an emergency repo facility back in 2019, but in 2023 it just took 72 hours in order to create a brand new facility to rescue Silicon Valley Bank and essentially end the regional banking crisis. So, if you have too much capital, which we do, in other words, there is no shortage of capital if you have instantaneous repricing of risk, and if you have policies that are designed for specific problems and can't be rolled out incredibly fast, how can you commit a policy error? And more importantly, if you have committed a policy error, you can unwind it incredibly fast, pretty much in a split second, without really damaging the underlying economy so much. Now, I'm not saying that if you decided that inflation is a real problem, and you want to keep, say, policy rates at 5.5%, when neutral rates in the US are closer to 3%- 3.5%, if you keep basis points up for a long period of time, eventually you're going to crash the economy. But why would you do that? If inflation is not really a problem and is unlikely to be a problem as you go forward?

So to answer your question, are central banks political? I think every human institution in some form is political. Number two, have they kept the interest rates, whether Federal Reserve or ECB, too high? The answer is yes, they have. Have they committed a policy error? Yes. Is it going to lead to recession or extremely negative outcomes, either in terms of bankruptcies or bad debts or consumer spending? The answer, no, we're going to end up with a slower growth. We're going to end 3%-3.5%. In the case of eurozone, it's going to be a more like 1.5%-2% lower rates. And we're going to get more liquidity. And if you think of liquidity, if you look at federal reserve balance sheet, they're down to about $3.2- $3.3 trillion in Treasury securities. If you think of reverse repo, they're down to only about $300 billion. They need to continue to unwind the idea of QT, and, in fact, go beyond that and start injecting liquidity. So, my view in the next 18 months, slow growth, but no recession, lower rates and more liquidity. So from an asset classes point of view, and asset prices point of view, what is there not to like? It's almost like a goldilock.

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Erik:   Joining me now is Saxo Bank’s commodity chief Ole Hansen. Ole prepared a slide deck to accompany this week's interview. You'll find the download link in your Research Roundup email. If you don't have a Research Roundup email, just go to our homepage, macrovoices.com, click the red button above Ole’s picture that says, looking for the downloads. Ole, I love this picture of the 747 on the opening page here. Let's dive into the slide deck and talk about the next page, which, of course, is the table of commodities, lot of things in the green this year. But give us the rundown.

Ole:   Well, hello Erik and thank you very much for inviting me back. We passed the halfway mark. And I think the first observation is that if we look at the commodity sector as a whole, we're back to square one. The Bloomberg commodity index, which tracks 24 major commodity futures, is especially unchanged on the year, following a relatively strong rally during the later part of the first quarter and into the second. And then since then, the rally has deflated, and questions are clearly being asked right now, whether that whether rally is done, or what's going on in the market. But as we can also see, it's as per usual, some big movements are unfolding. I think those that has really attracted a lot of attention this year are also the ones that we can see on this performance, where we have precious metals out in front. From a sector perspective, we continue to see gold making new record high. Silver is struggling a little bit recently because of the weakness in the industrial metals, but that seems to be returning as well, as we speak. And then this big divergence in the agricultural space between soft commodities like coffee, cocoa and orange juice and sugar as well. And then grains on the other side, which is really struggling, another bumper crop year across the northern hemisphere, leaving bread prices hopefully relatively subdued into the coming winter. And then in the middle, we got the energy sector, where, basically we are in the Big Three scheme of things. We are trading unchanged almost in crude oil for the past year and a half and the range there is getting increasingly narrow, so obviously something is going to happen eventually.

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Erik:   Joining me now is Diego Parilla, CIO at Quadriga Asset Management. Diego, it's great to get you back on the show. It's been quite a while. Needless to say, I think what's on everybody's mind these days is okay, what exactly just happened? It was a yen carry trade unwind because of a BOJ policy decision. Oh, wait a minute. They changed their mind. They took it back. Does that mean it's all over? Is this just a correction now? Are we headed higher, or is this just the beginning of a bear market? What should we think about this big risk event that's just happened in the market, and Is it over yet?

Diego:   Yeah, thanks Erik for having me back. And for sure, I think what happened is the result of a number of drivers. I mean, first of all, we've had a period of what I would consider to be artificially low levels of volatility, and that has contributed to a number of dynamics, including very successful in crowded carry trades across the board, where the Japanese yen happened to be one of the preferred but not the only funding currency. The other major factor, obviously, is what I would consider the bluff on Japan's idea that you can actually print and borrow your way out of problems at infinite and that bluff has been called. Japan's been leading the monitoring fiscal abuse for the past few decades with zero and negative nominal yields and extraordinarily high levels of government debt, basically driven by this view that the enemy is deflation, and you can literally print and borrow as much as you want without any severe consequences. And so, what's been playing out for the last couple of years, is a reversal of some of those dynamics, with effectively inflation post-COVID being obviously a clear problem. Countries and economies like the US aggressively hiking at a pace in size that had literally no precedents, and people like Japan lagging behind big time, totally unable and unwilling, but mostly unable to do something about it. And that widening rate differential that you know, inflation, that all these factors contributed to pretty much a one-way depreciating yen in a low vol. So, if you add the low volatility trend, wide carry and this spiral of the valuation that leads to dynamics that are effectively very difficult to revert. I think they got into a position that got to a bit of an extreme.

So the BOJ, I think Central Bank of Japan, they're back against the wall. They effectively took the decision to unwind yield curve control. For me, that was really a pretty major point in the fate of Japan, because effectively, with the level of debt that they have, to pretend they can let long term yields to go up somewhat freely is science fiction. It leads to a situation where, as these long-term yields, or yields in general, go up, and you have too much debt, they could result into what I call an LDI². I mean, you might remember the crisis in the UK, where we had higher yields, weaker Sterling. And this situation got Japan to extreme levels in Dollar/Yen, which effectively forced intervention for the nth time, and were potentially opening the door to force repatriation, or the more extreme measures. I think, once you go into the hikes and the market starts pricing them out, and those actually materialize, I've seen some of these skeletons in the close that come out. Volatility increases, and there's a clear bubble, anti-bubble relationship here between volatility and prices and the CTAs. I think trend followers are big drivers of both moves on the way up and down, and the move in the Nikkei, it's somewhat a bit of a zero sum game in total return terms, because a lot of the strength that we saw in the Nikkei, that everybody felt very happy about, effectively reversing multi decade cycle and making new all-time highs was largely driven by Yen weakness, and so it shouldn't be a surprise that as the yen unwinds and strengthens, then you have this dynamic in the Nikkei.

So, to keep things equal, 20% down move in Dollar/Yen and a 20% up move in the Nikkei, or vice versa, lead to effectively neutral total return game. So I think that all that went to expose that, obviously, the central bank had to step in refrain, or control a little bit some of those expectations with hikes. Because I think what we're seeing is the reaffirmation of the big thesis of the anti-bubble. You know, if you abuse monitoring fiscal policies, eventually the degree of freedom is inflation and the currency. And in some ways, what we've seen is, as Mike Tyson would say, everybody has a plan until they punch you in the face. And I think once you see your currency moving, but worse than that, you see your equity market collapsing and doing 12.5% in a day, worst day since ‘87 and a 20% drawdown in a few days, then obviously forces people to react. So my sense is, implied volatility is picked up. It's still at reasonably high levels. We're off the highs, but still high. But if you look at the VIX and other markets, that's already easing fast. So, my sense is that the carry trade is very much alive. The position has been cleaned significantly. Depending on who you ask, you might hear that that's been reduced to about by 75% and so my sense is Dollar/Yen is going to go back up with a weaker Yen as volatility consolidates in some of these dynamics that we've discussed with rate differentials and others, and inflation and continue to play out. So, I think this is a bit of a canary in a coal mine, you get, again, every time you have artificially low volatility in artificially high prices, or vice versa, they can last for a while. They create a lot of complacency, but when they unwind, they can do it in a very fast and vicious way, which is what we've witnessed. And you know, I think whilst the position is now much cleaner, and probably will see that some of these moves going back to where we were before. There's a bit more caution and perhaps a few people licking their wounds. But yeah, I think the fundamental picture hasn't changed. The big framework has been reinforced. And yeah, there are a lot of structural issues in the system that we need to be mindful about.

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Erik:   Joining me now is Gavekal co-founder, Louis-Vincent Gave. Louis, any other guest but you, it's so easy to do an August interview. You talk to the guest off the air. It's like, okay, dog days of summer. Nothing happened in the market, nothing to talk about. Let's make something up. We don't have to do that this week, do we? And you know, when the VIX hit 60 on Monday, my first reaction was to look at the calendar, and I thought to myself, wait a minute, I'd have thought we didn't have Louis Gave until tomorrow, because it seems like every time you and I talk, something crazy happens in the market.

Louis:   That's right. Thanks for having me on. It's always a pleasure to chat. You probably remember this, but you and I were taping an interview the day the WTI went negative. So with that in mind, I think what I'm going to start doing now is, each time I do a MacroVoices interview, maybe I'll start buying calls on the VIX and, you know, way, way, way out of the money calls and puts on a bunch of asset classes the week or two before we’re slated to talk, because it does seem that there's an uncanny coincidence where each time we're talking, things seem to be melting down.

Erik:   Dude, I've already got plans to launch an ETF where basically the strategy is, we know we have inside information. Our producer knows when Louis Gave is on the schedule. We're buying structured, you know, hedge instruments, the Friday before we get you on the show, dude. Anyway…

Louis:   It’s the only rational thing to do.

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