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Q1 2022 hedge fund letters, conferences and more

In an environment where it feels like everything is falling apart, you don’t need more negative news. I wanted to break the cycle. Sometimes in the darkness there’s a glimmer of light. In other words, when things look black, there’s always a silver lining.

I want to shift your attention away from what appears to be an ongoing crisis to the silver lining. Basically an advantage that comes from a difficult or unpleasant situation.

We have been in some bad spots in the past. We have shown in the past that we can overcome challenges with hard work and ingenuity.

I’m going to pick on some hot topics and look at the silver lining. Here’s are some quick take on

Energy, Blockchain/crypto, housing, inflation, and Europe.

Energy

We are living in a great energy shock. Despite the short-term pain inflicted, I believe in the longer term it will transform the energy industry. Where we are today is the result of decisions made in the past. Governments have failed to deal with the demand side of the equation when coordinating a transition away from fossil fuels. By restricting fossil fuel supply before developing adequate alternative solutions, policymakers have stunted oil and gas investment. Nevertheless, the “cure to high oil prices is high oil prices.”

We all hate expensive oil (except for producers and Alberta). But the conditions for cheap oil are not there. We don’t want to drill more, we don’t want to build more infrastructure to move it, we don’t want to build more refineries, we don’t want unethical oil, we don’t want Russian oil, and we don’t want dirty Canadian oil. Unless demand drops, oil is staying high.

There are no perfect solutions here, only trade-offs. The world is realizing you can’t go to carbon-neutral policies overnight; it will take a while. Society has to recognize the need for more sources of energy, and especially the need for more sources of clean energy.

I’m not talking about greenwashing or ESGing the problem away. We need a serious credible energy security strategy. Not a feel-good measure to get through the next election.

The silver lining is this backdrop could accelerate the clean-energy transition. We are in a transition from a fossil fuel economy to a clean energy economy. We are at a moment when better government policy triggers the investment needed to resolve the conflict between a safer supply of energy and that is climate friendly.

We need all hands on deck. We need smart resilient grids. We need hydrogen. We need nuclear power. We need renewables to be more dependable. We need LNG. We need nuclear fission. We need storage. We need better technology.

The wind and the sun are free abundant energy sources that are not controlled by petro-dictators.It takes about 18 months to get a solar project to scale. Much faster than a gas plant.

We really need to embrace nuclear power. Nuclear is clean energy. It does not emit carbon. It’s steady. Nuclear can keep the lights on when the sun doesn’t shine and the wind doesn’t blow.

The invasion of Ukraine underscores the energy argument that they afford their owners a security of electricity supply. Having more nuclear plants means Europe would have less reliance on Russian gas, which is boosting Russia’s income.

The Arab embargo of the 1970s caused short-term pain for the West, but also spurred a drive for fuel efficiency that ultimately reduced its reliance on oil. I think we are at a similar moment today. We may find ourselves hoping that the short-term pain similarly gives way to the long gain of energy security.

Blockchain, Crypto, Web3, Metaverse

I’ve been both an admirer and critic of the blockchain crypto space. I admire the innovation. I criticize the scammer aspect of it.

In the last few months we have seen the bubble pop and it was loud. The speculative mania of the last two years has ended. The mania touched a lot of assets: tech stocks, cryptos, pokemon cards, housing, wine fine etc…Right now a lot of things are crashing back to earth. And like any crashes, there’s pain, there’s damage and there are losses. The “why” is a convergence of many reasons, but mainly it’s because of inflation. If you want to point your finger at something, it’s at the Federal Reserve. By aggressively hiking rates, the Federal Reserve removed the punch bowl in the middle of a party that degenerated for way too long. Now there’s a massive hangover.

One area that received an old school beating, it’s crypto. The blockchain/crypto universe presented itself as revolutionary. As the next big thing. There was a lot of hype. Like promising new exciting space, you get a lot of scams and b.s. And then comes the meltdown. When you get a good beating, the scams, the phonies, the weaks, all get washed away. My point is whatever emerges from the beating will be better and stronger.

We have seen this story before. It’s reminiscent of the dotcom bubble. It was the same thing. The Internet presented itself as the new emerging space that will revolutionize everything. We knew it was here to stay. But it was impossible to pick the winner. With hindsight, it’s easy to say that Google won search. But it was impossible to tell in 1999. The dotcom party lasted a couple years and crashed hard in 2000. A lot of young promising startups disappeared.

Just like the dotcom bubble, the crypto universe suffered from too much hype and risk relative to the actual use cases being created.

Despite all of that. The metaverse, whatever exactly it is or whatever form it takes, is a thing. Defi is here to stay. Web3 is here to stay. That means more digital assets. More digital assets means more tokenization. The ecosystem being designed will be better (more contribution and less extraction).

It’s hard to imagine a world, maybe years or decades from now, in which web3 doesn’t play a role. Eventually you will see better ownership, better governance, and a better economic model. We are in the early innings of this stuff. It’s going to take a long time. But whatever comes out will be better.

Home (Un)affordability

The surge in prices from the last two years is cooling. Sure home prices are expensive, and mortgage rates are roaring. Are there any good news for prospective home buyers?

The answer is yes. Home inventories are on the rise, increasing an annualized 18.7% in June. This is driven by both sellers entering the market and by moderating demand.

Bringing supply and demand to an equilibrium will take time. High prices incentivize constructions which led to an increase in supply. We are also seeing a drop in the cost of material like lumber.

This is not a quick fix. The good news is that we are building more.

Inflation

I don’t need to tell you that higher prices sucks and if inflation doesn’t get under control we could be in serious trouble. So what’s the good news?

Well we are doing something about it. We rediscovered an old truth: That is inflation is a monetary phenomenon. Now that we recognize the problem, we can address it.

For the last decade or so we had the luxury of living in a low inflation world (1.7% on average for 2010-2020). During that period some crazy ideas have emerged like the modern monetary theory (MMT) which states that you can print and spend as much money as you want without causing inflation. It’s hard to wrap your head around but that view was being pushed by certain academians, economists and politicians. The most interesting thing about the current inflation wave is how quiet the hype MMT ringleaders are right now.

Inflation is influencing behavior, including mine. Companies are reining in the pizzazz. People are being more careful. For example, because of high gas prices, people will buy more electric cars, carpool more, take the smaller car, walk or bike more. Basically less driving. All these decisions have an impact.

Going after inflation means more short-term pain. It won’t be easy. It could mean a recession. But if we get inflation under control, it could set the conditions in place for lower long-term interest rates and a prolonged economic boom. A situation similar to the 80s, when the Federal Reserve crushed inflation with a hammer.

Inflation isn’t great but it has a silver lining: It favors debtors by letting them repay their loans with cheaper money. A few years of moderate inflation might have helped everyone reduce their leverage.

European Unity

Concerns over European disunity are overdone – for now.

The silver lining is that Russia’s invasion of Ukraine jolted Europe into unity. Yes some diplomats wonder whether the whole thing was worth whipping up in the first place. Yes there’s intra-European squabbling. That won’t go away. But continental unity is holding up rather well. A united Europe is better than a not united Europe. Because history suggests that a not-united Europe is a dangerous Europe.

The EU agreed to stiffer sanctions against Russia, which included an embargo on most imports (with some exceptions).

The EU is a union of 27 democracies. It’s supposed to look fractious. Democracy is a messy process. European unity will always be tested. So far it seems to be holding.

On that note, I want to wish everyone a great summer.