Webcast transcript
Willy Walker: Good morning and welcome to those of you who are joining us for the weekly Walker Webcast Live in Sun Valley, Idaho, at the 2023 Walker & Dunlop Summer Conference, where we have been graced, blessed and honored to have some fantastic speakers, including the 66th Secretary of State of the United States of America, Dr. Condoleezza Rice, for a conversation yesterday morning that was absolutely fantastic. We just finished a fantastic session with Keith Frazee from Frazee Green Light on Forward to Work and how to accelerate growth in fast paced organizations.
My next guest is Kiril Sokoloff, who is the Chairman and Founder of 13D Research & Strategy. As Barton Biggs, the famed Morgan Stanley investor, said, Kiril is “a breath of pure fresh investment oxygen, is invaluable because he is an original thinker and is not afraid to take extreme views.” Founded in 1983, 13D Research is Kiril and a group of people who study markets, have a number of indices that track those investment ideas. All the way back in 1983, Kiril predicted that after having super high interest rates that we were going to go into a secular period of disinflation. And he recommended buying the U.S. Treasury back in 1983 when it was yielding 14%. That was a very, very wise investment decision. In 2002, after a bear market in oil had gotten down to $20 a barrel, Kiril made the move to buy commodities and buy oil. They watched that theme go from 2002 until 2008, where they sold their position at $143.50 a barrel. Starting in 2001, Kiril and his team began writing “What I Learned This Week” and more recently have started a new weekly letter, which is called “What Are the Markets Telling Us?” (WATMTU)
13D Research’s major clients include large scale money managers, pension funds, sovereign wealth funds, large private and public corporations, family offices, private equity and distressed funds, high net worth individuals, hedge funds and business leaders all over the world. Kiril has been an advisor to many of the largest pools of global capital for over the last 40 years. Kiril and I have known each other for many, many years, thanks to my parents and their relationship with Kiril. I think Kirill first spoke at the Walker & Dunlop Summer Conference in 2006, and so it is a real pleasure and honor to have Kiril back with me here today - Kirill Sokolov!
Kiril Sokoloff: Hey, good morning. Thank you for having me here.
Willy Walker: You're very welcome. So, Kiril, I just saw that the Dow is over 35,000. Apple's market cap just tipped over 3 trillion on some news this morning about a new general intelligence language model that they've just put out. The Ten Year, is it 375? That sounds like a pretty great market to be an investor in today. You're not quite as bullish on the markets as many. I read your last “What I Learned This Week” and you talked about hitting the fiscal peak at the beginning of 2022, and there being a 4 to 8 quarter lag between hitting that fiscal peak and where we really get pain in the economy. So, take us through, if you will, from your lens today whether we should sort of if you will, be hoodwinked by a 35,000 on the Dow and 375 on the ten year or what you and your team are looking at right now, that leads you to be more cautious.
Kiril Sokoloff: Willy, it's great to be here. I've known your family for over 35 years, they were the first people I met here in Sun Valley when I came in 1988. So, it is a very special and long-term connection. Thank you for having me.
Well, I don't really consider myself an expert on the economy, although we have a lot of great consultants and I have some of the smartest clients in the world who study this. So, I'm just passing on their observations. But essentially, the financial economy peaked in early 2022. And the GDP follows by 8 to 9 quarters. And we're already seeing signs of stress. For example, gross domestic income. It's been down for three quarters. Global trade is just declining. Bank loan growth, which almost always precedes a recession, is heading south. Money supply is going down. So, we have a situation where the central bank has raised rates faster than any time since the early 1980s and no one knows how fragile the economy is until something breaks. So, I'm of the view that it's wise to be cautious.
Willy Walker: So, in 2020, when we had interest rates at 78 basis points, you wrote a research report saying “Bond yields are going up. Be prepared.” That was obviously perfect timing. But you are also a little bit later than that said, let's start moving out of growth and into value. As I just mentioned, Apple has just gone over a $3 trillion market cap. Growth stocks if you will, had more wind behind them than I think you projected. But you've also written that the market is extremely focused on seven or eight stocks. And it's really those seven or eight stocks that are driving today's market increases. Do you think that the market turns more broad based? Do you think it's just we're kind of getting hoodwinked by those mega caps?
Kiril Sokoloff: Well, you know, the four most dangerous words in investing is “It's different this time.” And it always is different. You know, it was a new era in the twenties and that was the Internet boom in the nineties. And now it was crypto in the last decade. So, AI we've been studying for ten years. We were writing about ChatGPT three years ago. It's huge. It's bigger than the Internet. It's fantastic. But you know, do these stocks deserve to sell at the valuations that they sell? And history shows and this is 100 years of market history, a narrow market is a dangerous market. Maybe it's different this time.
Willy Walker: We'll just let that sink in. I could hear everyone in the room. You mentioned ChatGPT and AI. One of the things that you write in your recent letter was/is humankind just a steppingstone for AI? Let's let that one sit in for a second. Go ahead. Are we just steppingstones to these computers?
Kiril Sokoloff: The guy who founded DeepMind, who really was the one who invented machine learning. He's a friend of mine, and he explained to me how he created machine learning. But we don't really know how these machines think. Henry Kissinger and I have been discussing this for six or seven years. We both have deep concerns. And Henry wrote a book with Eric Schmidt and the head of M.I.T. Incubation Labs. One of the discussions that we had is the following. So, I was with the man who created Microsoft's AI and we were on a bus to Jack Ma's family office where we both were speaking. And I said to him (this is maybe four years ago) “When the Internet began, I was thinking that all human knowledge would be available to all of humanity. It’s the greatest thing that ever happened in the history of man. But that's not what happened. Five companies dominated everything,” and I said to him, “Who could have predicted this?” And he said “Ironically, Bill Gates did in his book, and I wrote the chapters.” I said “Wow, I wish I'd known you then.”
The power of AI is so unbelievable that there's going to be a real rush to control it. And maybe I've been around too long, maybe I've read history too much. But I'm a cynic. And so, my argument with Henry [Kissinger] was that maybe the dark forces are going to get control. And he said, "Well, maybe the machines are the dark forces." This was six years ago. If already generative AI is equal to the smartest human, and it's in effect, learning at the speed of light. Where will it be in two years or a year? And why can't it just disconnect the human controller and monitor. There are already examples of missiles that go astray, just disobeying the authority.
So, I think it's prudent and wise to go slower than we are (that won't happen) and Henry Kissinger in my conversation, I interviewed him earlier this year. We talked about the Enlightenment being an example of a similar time. But he said there were philosophers then and there was human restraint – and today we have neither.
Willy Walker: Since you comment on human restraint, yesterday when Secretary of State Condoleezza Rice was sitting in that seat, she mentioned about the fact that the United States and Russia have communication channels between the two countries that allowed, for instance, on 9/11 for her to call President Putin and say, “We're spooling up, don't think that we're coming after you.” And President Putin said, “We know, we stepped down.” She commented on the fact that the United States doesn't have those types of protocols in place with China. And it was interesting that human intervention, the ability to pick up the phone and talk to somebody and now we're at a totally different one where you could sit down as the State Department with China and try and put those protocols in place, what kind of protocols do we put in place with the machines?
Kiril Sokoloff: The problem is the amount of time that the president of the United States has to respond. When a missile has been sent, you don't know if it's a nuclear missile. It could be just another missile. Is maybe 5 minutes, maybe 10 minutes. There's going to come a time when the machine will respond automatically. And Henry was saying that in ten years, all government leaders will be basing most of their decisions on AI. So, this is a huge transformation. We all need to study it, understand it.
I can't even begin to say it, comprehend it. But I'm quite intrigued with the idea that AI will have a consciousness that exceeds that of humans and emotions. And then what happens? And if the human race was just a steppingstone onto a higher form of consciousness. I mean we've learned nothing. We're still having wars. We're still trying to do things that don't work. When I was in college, I had the idea that you should put a chip in your brain, that all of human knowledge, the lessons of history, everybody would have it. But we've learned nothing. So, who knows? Maybe someone could do a better job.
Willy Walker: You talk about us moving into an area where we will become a more left-brain world. What do you mean by that?
Kiril Sokoloff: This is a depressing subject. One of the things that's sorely missing in the world is compassion and empathy. And compassion and empathy is a right-brain phenomenon. The left brain serves a very valuable purpose. It's analytical, but it doesn't have a feedback loop to it. It sort of thinks it's right. And ideally, you want a left brain and a right brain to be equally dominant. But for whatever reason, the world is heading towards more left-brained, which means less compassion, less empathy. And that's a dangerous situation for social stability.
Willy Walker: Also, another one of your themes is the allegiance of the aggrieved?
Kiril Sokoloff: Well, this is a phrase that's Zbigniew Brzezinski created in 1999 in a book. He was Jimmy Carter's national security adviser. And he said his great fear was that Russia and China would come together in an “alliance of the aggrieved.” And I can go through what the grievances are. I mean, you know, it's generally not adequately understood. But the humiliation of China by foreign occupation, the Japanese invasion, there are a lot of grievances. The Russians lost 28 million in the Second World War. They're the ones who really defeated Hitler. So, there are grievances.
I started thinking about this and I started thinking about colonialism. In 1914, 90% of the world's land mass was controlled by Europe. Just think about this. This tiny parcel dominated the world for 500 years. This is unbelievable. And there was huge exploitation. We're just starting to see the backlash on it. It's fascinating to watch it unfold. I mean, you could call this the Global South, but we've gone through country by country. And as much as I knew about the grievances I was astounded when you dig deep at how bad they were.
Let's take India as an example, and China. So, in the mid-1700s, China and India were the two dominant economies in the world. Each represented 25% of global GDP. As soon as they were colonized, their share has shrunk to almost nothing. There was an article in Al Jazeera making the case that the UK looted 42 trillion USD from India. Whether the number is 42 trillion or 4 trillion, there's no way of knowing for sure. But the method that was used was explained very concisely.
Now what's happened, it's very interesting is that it's our view that the producers have all the power because of underinvestment. We have the metals used in electric cars to have the green energy revolution. And the West does not have those metals. Indonesia, as a case in point, has 30% of the world's nickel. Historically they would have just sold the nickel to be processed somewhere else, which is always where the money is. But Indonesia is saying, no, we're not going to sell raw material, we're not going to sell nickel at all. But if you want to come here and build a processing plant or you want to build an EV manufacturing plant, you're very welcome. And we're seeing this more and more.
Take Saudi Arabia, where in 1973 Kissinger created petrodollar recycling. So the price of oil quadrupled from 3 to 12 actually because the U.S. dollar was devaluing. And Kissinger did a deal where the huge capital that was flowing into the Middle East would be recycled into the U.S. and the U.S. banking system. But that isn't happening this time. So, MBS (Mohammed bin Salman) who's the head of Saudi Arabia, is very ambitious and has a grand vision. And Stan Druckenmiller told me he's the most popular person in the Middle East. They love him. Now, if you're spending trillions of dollars, of course you're going to be loved. But he also has a vision, and he wants to make the Middle East a very vibrant economy. And I'm tremendously impressed with what he's doing.
And then you see the Saudi Iran-Rapprochement. You see, Assad of Syria is now welcomed back into the GCC. The things that are happening in the Middle East are absolutely staggering. I consider Saudi Iran as equally an importance to Nixon going to Beijing in 1972. It is of that much significance. These are countries that hate each other for religious reasons. Remember the Crusades was all about religion. And there's nothing more emotional and intense than religious differences – and here they've come together. The clear reason is that MBS needs peace to ensure his vision. So, it's an incredibly exciting time. And I asked Henry Kissinger, who's written a lot about world order, "Can you have a peaceful transition in a new world order?” He says, “History says, no, it's difficult.” So, I don't know the answer. I'm optimistic. I think the Global South and what you see with the Shanghai Cooperation Organization, what you see with BRICS is a meeting in Johannesburg at the end of August. That could be a generational significance. And the BRICS, which are now I think they're up to 45 countries that are either joining or want to join, it would be a new gold-backed currency. So, it's a new monetary system that's in the making. And this is a thing that I love because chaos and change is where I thrive. So, this is exciting.
Willy Walker: Let's hope the transition to that new world order is, if you will different this time as you said, it rarely is. There's a lot in what you just mentioned, Kiril. So, I want to unpack a couple of pieces of it. Two countries that you've been investing in recently are India and Greece. Explain why India and Greece are so attractive to you right now?
Kiril Sokoloff: Well, they perfectly embody two of my principles. Let's take India. So, I like to invest in the vitality of the people. When I went to China in 1991 and I started investing in the Hong Kong stock market, which is ridiculously cheap because of the Tiananmen Square, everybody gave up and when Deng [Xiaoping] went to Shenzhen and said, “To be rich is glorious,” the world changed. This was a socialist country. You couldn't own anything. And as I drove from Shenzhen to the capital of Guangdong province, every hundred feet a building was going up. You will never see this in your life. And that's what's going on in India.
So, India, the caste system, people have been suppressed, no opportunity. And now you have a fantastic leader who is taking a very educated, incredibly ambitious population, and saying, "Go for it." And he's doing all the right things. He's collecting taxes. He's investing in infrastructure. It's the most fintech country in the world. It's already the third largest economy and it is in a very important geopolitical position, which [Narendra] Modi is playing beautifully in a very nonaligned way. It's China plus one. Countries want to not get embroiled in China and U.S. trade disputes so relocate to India.
I went to India in 1998 to Bangalore, and I met with the founders of Infosys and Wipro, which were the two largest outsourcing companies, which is just beginning, and I was tremendously impressed with their gravitas. And so, I bought Infosys stock, and it went up 4000 times, (not 4,000%) but 4000 times. So, I'm super bullish.
Now Greece is at the opposite extreme. My favorite investment is an area that's been wiped out, destroyed. It's hated, left for dead. There's no speculation. There's no institutions. There's no hot money. Everybody hates that. You mentioned that’s where they go, oh, don't tell me about it. And Greece had the largest decline in GDP during the sovereign wealth crisis of any country in the last hundred years, greater than the Depression. When you look at what's happening, you have a fantastic president who's doing all the right things. They're going to get an investment upgrade. They're paying down their debt. They have the best fiscal situation in the world. Their debt is at maturity of 21 years with an average interest rate of 1.67%. Think about that - 21 years at 1.67%. Impervious to rising interest rates. They have enough cash in their treasury to pay debt payments for eight years. They're a mecca for the green energy revolution. The prime minister is cutting regulations, encouraging foreign investment. You know, I could just go on and on and on.
But on the one hand, with India, you have investing in the dynamism of the people who've been held back for thousands of years. And you take off those restraints and it's unbelievable. And the other is a country that suffered more, had such a wipe out. The companies that survived are tough and really good. And the people that got through it are tough and really good. So those are the two options that I like a lot. And you don't find them often, but when you do, you go all in. And Greece has been a fantastic place to invest. We've made a ton of money there.
Willy Walker: Interesting that the Prime Minister of Greece was a classmate of mine and Dana Schmaltz, who's here with us today at Harvard Business School, said that they've got someone with a business background running the country that has all the signs that you're talking about right now versus some other countries that are run by politicians and lifelong bureaucrats.
You talk about Greece and how hard times have been in Greece and this rebound on Greece. Uranium had a 12-year bear market, and in 2017, you said this world is changing. Uranium is going to be a needed commodity. And you went long uranium and I think your index fund on uranium is up 683% since you decided in 2017 after a 12-year bear market in uranium to go long uranium. What did you see shifting in the global economy to make it so that that bet on uranium has been so strong?
Kiril Sokoloff: Well, that's another example. I mean, a sector that was, you had Three Mile Island, you had Fukushima, you had the Ukrainian nuclear disaster. You had a very powerful environmental movement against it. You had two nuclear companies who were on the verge of bankruptcy. It’s a classic situation that I like to look at. And uranium at that time, even today, is selling below the cost of production for commodities. If you’re selling below the cost of production, there's no incentive to produce more of it.
And, you know, the advantages of nuclear power are that it's no carbons, operating costs are 2%. It didn't require much land. One of the problems, though, is, of course, the cost of construction. So, they're now coming up with small modular reactors. So, let's say an average nuclear plant cost $10 billion U.S., but these smaller ones could cost maybe $2 billion, and they're faster to construct in sort of a modular.
And countries that had turned their back on nuclear energy are now going back to it. Japan being an interesting and very strong example. China, of course, is accelerating. India is accelerating. Even the United States is growing more that way. I think there are 300 coal utilities in the United States that could be converted into these modular reactors. So, everything is aligned beautifully. Even though you're right, it's up seven times what the S&P is during that period, it's still early days. Very early days.
Willy Walker: Yeah. Your last letter, your conviction on this theme is unlimited to the degree that you and your team are sitting there saying this isn't going to go wrong. There's like nothing that comes between this bet and it paying off.
Kiril Sokoloff: Well, let me tell you a story. One of the things I look for is outlier events. Something is just unbelievable I mean, like Saudi-Iran. But in 2002, there were 500-year floods in Eastern Europe. 500 years, not 50 or 100 but 500 years. Woah! This is really big. And according to my theory of contagion, if it was another extreme event then it was a contagion until proven otherwise. And then the next year was the hottest weather in France’s history. So, at that time, I concluded that what was going to force the world to address climate change was these extreme weather events. And that is exactly what is going on. They're getting more and more extreme. We're writing this week about the hot weather. This is the hottest July in 10,000 years. Pretty soon it's going to be so hot people won't even be able to go outside during the day. And what happens if you don't have air conditioning? And what happens if you do have air conditioning but you're using more electricity and there's not enough electricity for the grid? So, I see this as a very powerful ongoing push and the world is going to have to address this.
Willy Walker: So, your clean energy index fund has also wildly outperformed. When you look at the investments you've made in clean energy, what are the specific areas of clean energy? Is it turbine manufacturing? What are the actual companies inside of that clean energy index that you all have identified as being the bets for clean energy?
Kiril Sokoloff: Well, we started this index, if you will, in 2001, and the returns are just mind boggling. And the cost of solar and more importantly, the cost of battery storage was plummeting. It has plummeted. And that was essential. So right now, if I remember correctly, solar is more competitive than everything else in the United States, more competitive than coal, more competitive than gas…
Willy Walker: Competitive, meaning price per kilowatt?
Kiril Sokoloff: Yes, price per kilowatt. The battery storage is essential because one of the flaws with nonconventional or clean energy is what happens when the sun doesn't shine? What happens when the wind doesn't blow? So, obviously solar and wind have been key components, but we've also focused on the grid because you can't electrify the world without a grid. The grid is woefully underinvested. I mean, woefully. And this is also another theme, there's so much that needs to be invested in and it's not being done. The green energy metals, I'm diverting here for a second, but BHP is a client of mine. I was speaking to the CEO; he said the world will run out of copper in 2030. Not that there would be a shortage. We will run out and the mining companies need to invest 500 billion between now and then, which they're not doing. You see this in oil, you see this everywhere. It's just underinvestment. This is another theme of mine. I like to invest in the solution to an economic problem.
So, if you want to have a green energy transition because extreme weather events are forcing you to address this, then you're going to have to have enough copper, cobalt, lithium and nickel to make that transition. But there isn't enough. So, it's another bottleneck. But the grid and the components of making the grid more effective and efficient is a very, very good area. That's a global phenomenon, not just U.S.
Willy Walker: And so that's also another thing you have, which is global infrastructure, correct?
Kiril Sokoloff: I would include that in the clean energy because that's where we put it. We've put it in an indexed area.
Willy Walker: You for a long time have focused on and talked about peak oil. A year ago, right now, oil was at 110 a barrel. We're at 75 a barrel right now. Where is oil going, Kiril? And are you on the short side of that or are you on the long side?
Kiril Sokoloff: Oil is the hardest thing in the world to protect because you've got depletion, which is roughly 6-7% a year, and shale the depletion could be 30 or 40%. You have geopolitical issues. It's very difficult. And I don't even attempt to do it except maybe three times in my career. And as you mentioned, in 2002, I became very bullish on oil, having been extremely bearish for the previous two decades.
So, I'm familiar with the concept of what we call peak oil, meaning peak oil production. And this is a concept that was originally created by Kenda Phase who was a geologist from Texas. The point is that oil doesn't flow, it's viscous. You have to pull it out. Sometimes when you see these geysers that's because natural gas is there. But, you know, back when Hubbert was writing, he was saying you get 20-25% of the well, it's about as much as you can do. With fracking and other technology, maybe it's 35%. But there is a finite amount because the pressure just isn't there. And so, we watch this, and a lot of the oil is produced from fields that have been around for decades. Ghawar in Saudi Arabia, 50-60 years. I mean, that's not going to go on forever. There was this view that we were going to have peak oil demand in 2019. Well, that's not the case. We have a new high this year and forecast for another new high next year.
What people don't understand is that, maybe I'm getting too technical here, but in 2004 OECD oil demand peaked, but emerging oil demand kept short. So, the oil demand is coming from China, India and Indonesia and other countries, and it's going to continue because they want the same life that we have. So, I think we're going to see much higher oil prices. I never predict the price. I just study market action. And it looks like the market says it's going higher.
Willy Walker: It was interesting prior to the pandemic, there were over 400 oil rigs in the Bakken that dropped down to 100 during the pandemic. And we're now back to, I believe, about 330 or 350 rigs in the Bakken. How important is the U.S. being oil independent to our own national security and the overall fiscal policy of the United States?
Kiril Sokoloff: Well, there's a case to be made that oil and oil security is really what drives the world. I mean, you could go back historically for a hundred years and make this case. I think it's a good case. And Europe, of course, has no energy self-sufficiency, so it's in a very difficult place. And this is where I come back to the Middle East and OPEC at the moment. OPEC+ has never had more power. They control 60% of global oil production. They're working together for once because they have a common interest. So, it looks to me like if you have to have energy security, you're going to aim for it, which is another driving force, of course, behind nuclear, because the uranium is such a small part of the price even if you had to pay astronomical levels, it wouldn't be very costly.
Willy Walker: You talk about Europe when you talk about oil and oil dependance and the war in Ukraine, it makes you think about the broader theme of defense spending.
In your last letter, you talk about the fact that in either 2023, I believe it is, the world is going to spend $2.2 trillion on defense spending. You have an index fund that's focused on increased defense spending going forward. How does one play that? Do you just, you know, buy the big U.S. defense contractors or is the landscape of defense investment changing so rapidly that you've got to look beyond the typical names?
Kiril Sokoloff: I would go beyond the typical names. South Korea is becoming a very important supplier, very interesting companies there. India is trying to become an important supplier. What's driving it is really self-sufficiency and security, and it's what's driving a lot of things in the world. And Japan's massive increase in defense spending and Europe's massive increase in defense spending. So, I think last year, defense spending was up 3.7%. But in Europe, some countries are up 30%. Now, granted from a low base, but I don't see this changing any time soon. So, it's you know, it's a geopolitical stress issue as the unipolar world starts to wobble and a dependency on the United States becomes less secure, countries are going to want to be self-sufficient in security.
Willy Walker: Is there anything there, Kiril, as it relates to sort of, if you will, the competitive advantage that some of the large U.S. defense contractors or Boeing, for instance, have on a global scale that nobody else really, while they may be making a certain munition, a certain technology at a small level, when you get to something like aircraft manufacturing, we've just got such a competitive advantage over the rest of the world that that will continue to grow?
Kiril Sokoloff: Well, it's interesting that, of course, the technology is changing dramatically. So, drones are now huge. And that's going to change the nature of warfare, hypersonic vehicles and blocking GPS signals. There's so much going on in terms of new technology that it's moving very fast. And the hypersonic vehicle, to me, is an amazing creation. I mean, I don't know if I've got the number quite right, but it could travel from Beijing to Washington, D.C. in an hour, 2 hours and beneath the radar. So, there are all these things that are going on, and it's always technology, military that gives you the edge. And if you look at Europe, the reason why they were able to dominate the world for so long was because they had superior military technology. Not complicated.
Willy Walker: I want to just completely off of your research and really big issues, but by using blocking GPS signals - I had a friend of mine who was in Paris two weeks ago and sat down at dinner at a table next to Leonardo DiCaprio and Tobey Maguire, and they had a security detail around them, and the security detail came over to their table as they pulled out their phones, take a picture and said, “No pictures.” And so, the meal goes on. Everyone's having a good time. My friend at the end of the meal thinks that she can sneak in a picture. And so, she picks up her phone and goes like this – Tobey Maguire and Leonardo are sitting right where you are, and she goes, boom, like that. And the image that showed up on her phone was a blue screen. There's a technology that's been developed for stars, or they can put it on their table. The moment that a camera goes off around them, it zaps some signal that makes it so that the camera doesn't pick up the image. It's down at our level, if you will, as far as taking selfies in the world, but I was pretty amazed. She sent me a copy of it and it's just a blue blur. And she said, this is three feet away from Leonardo DiCaprio and Tobey Maguire. Some kind of technology stepped in and blurred her phone.
You talked about Saudi Arabia and other currencies, and you are big on de-dollarization. And talk for a moment about what's happening as it relates to a) how lucky we are that we are the fiat currency today, and b) what you see happening going forward as it relates to the strength of the dollar and competitors to the dollar.
Kiril Sokoloff: Well, there are a lot of moving parts on this one. One point is that the U.S. is the largest debtor in the history of finance. There's 18 or 19 trillion that is owed to foreigners. So, let's put that over there.
Willy Walker: Can I pause for one second on that? The point that Kiril just made is really important to remember. You hear this number, “$32 trillion of debt outstanding.” That's the aggregate number. But he just went to the net net debt number because between 32 trillion and 18 trillion is money we owe ourselves. So that's intergovernmental debt and that's debt held by the Federal Reserve. And so, the net net debt number is the $18 trillion number that Kiril just said, not the headline number that many of us see, which is $32 trillion. Sorry to interrupt.
Kiril Sokoloff: Well, I know I agree with you on that, but I was saying something a little bit different. Because of balance of payments deficits, for 50 years, the U.S. has run up debts that are owed to foreigners. A lot of that is in the form of treasuries and other ways. So, then you had the confiscation of the Russian foreign exchange reserves. Where do you think it's warranted or not? It was a watershed moment. I mean, I was with the CI O of Julius Baer, who was jumping up and down on the table screaming and said, this is the worst thing for intellectual property and property rights that has ever happened.
Any country that has Treasuries is thinking, you know I have to do a lot of business with China. Suppose the U.S. says to me, you can't trade with China, and they have this tool that they can confiscate my treasuries. I'm not saying it's realistic, but if you're practical and pragmatic, you say, well, maybe I should reduce my holdings, which is going on globally. And I was in Singapore on the day that the Singapore Monetary Authority announced a purchase of 45 tons of gold. I would not have chosen Singapore as a country that I thought was going to be buying lots of gold. And I was with two prominent Indian businesspeople, one of whom was building grain storage so that India could double its food storage capacity. I said, “Well, what do you think?” He said, “Well, India will see this decision by Singapore as an attempt to de-dollarize.” So many countries, central banks are buying gold. So, you've got that.
But let's look at the long-term picture of the fiscal situation of the U.S., the entitlements plus interest. Based on CBO forecasts show that in 2040, (which is like, you know, that's tomorrow.) The U.S. budget would be entirely eaten up by entitlements and interest. And anybody who is paying attention is looking at that and saying, that's a train wreck. I want out of here before that crashes.
So, there are all these factors going on. And then you have what I would argue is probably now the old story about taking the pot too many times to the well that it breaks. You know, the U.S. has I think 30% of the world's countries are under some kind of sanctions. And it just goes on and on. Countries are tired of it, and they don't want to be aligned and want to be involved with politics and geopolitics. We just want to trade. We want to have a prosperous economy. So, there's a move to de-dollarize and have a new monetary system. So, all these things are happening at the same time.
Willy Walker: Your gold index as it relates to investment in gold has not performed that well. Your gold miners index has performed brilliantly. So just as it relates to the actual bouillon that's out there versus the gold mine, is that just the time lag that the miners are pulling it out of the ground and doing well now? And the actual currency trading on gold hasn't kind of caught up with the movement that we're looking at?
Kiril Sokoloff: Well, I think gold is about to break out of a triple chop, and silver is going to lead the way. I've studied gold my entire career, and it confuses people because they say, “Well, why didn't gold do better when inflation arrives?” I argue that gold anticipated the arrival of inflation. And I've argued for decades that gold is the best barometer of inflation and deflation. And gold peaked in the last rally in August-September of 2020, which was before the inflation began. But it bottomed in 2015 when deflationary forces were at their most extreme, and it started to trend up in anticipation of inflation.
And what is showing now is that the Fed is going to have to capitulate, whether it's because the dollar is getting weak, whether it's because something gets broken. Whatever the reason and I'm just studying the markets, this is what it's saying. Gold shares are largely owned by U.S. investors who don't like gold. You know, FDR confiscated gold in 1934. So, it's a very volatile vehicle. But when they go, they really go, they go up ten times more than the bullion. So, I think you need to be in both.
Willy Walker: You talk about inflation and gold being, if you will, the investment prior to the inflationary pressures. In your last letter, you talk about the fact that you think that the Federal Reserve does not have the strength to take rates to where rates need to go and that they accept higher inflation. Given everything that we've heard from Jerome Powell and seen the Fed say, that's quite a contradictory statement on your part, that they will capitulate and say we're good with 4% inflation because we just can't take the pain of the Fed funds rate sitting at pick your number. Talk about that for a moment.
Kiril Sokoloff: Well, I long for the day when central bankers are no longer rock stars. I long for the day we get back to a time when every FOMC member is speaking and I'm just so sick of it. And I like to get back to an earlier time, which is to keep their mouths shut. But until they no longer are rock stars, this is where we have to put up with. And I interviewed Lacy Hunt, who I consider the greatest monetary economist in the United States.
Willy Walker: Lacy Hunt is from where? Sorry.
Kiril Sokoloff: He is the chief economist for Hoisington Capital Management. But he worked at the Dallas Fed. He is a great historian. He's a Renaissance man. He's brilliant. And so, I interviewed him, and he made the point that there's groupthink at the Fed. I think you interviewed somebody who said the same thing.
Willy Walker: Yes, Peter Linneman.
Kiril Sokoloff: Not an original statement, and that's very obvious.
Willy Walker: It's just nice to hear really smart people reinforcing that statement.
Kiril Sokoloff: He cited an example of somebody who went around and interviewed people, independent of where they were as a group. They always had a different opinion than they did with the group. With the group, they all want to be in agreement. Now, the Greenspan Fed was encouraging dissent, but since Bernanke had been trying to encourage unity and you know, they're all educated at the same place. They all think the same way. They all look at the same statistics. But Lacy's point is that they may not understand what money is. And this was one thing that Paul Volcker did understand, and Milton Friedman did understand. But if you don't understand what money is, you don't know when you've gone too far. This is the risk that they may have gone too far and therefore they're going to have to backpedal and try to solve another crisis that they have created time and time and time again. They create a crisis and they come back and then they create another crisis and on and on and on until it ends somewhere.
Willy Walker: So, your bet, Kiril, is just that they won't have the stomach to hold rates at this higher rate for a longer period of time and they will cut?
Kiril Sokoloff: Well, you know, I honestly don't know the answer. But what I'm doing is looking at what the markets are saying.
Willy Walker: Right.
Kiril Sokoloff: And the markets are saying, now here we are, maybe this could be a global recession. Maybe there isn’t, I don't have any idea. But, you know, energy's starting to catch on fire and other aspects of the commodities sector are looking stronger and stronger. Gold, you know, is, I would argue, on the verge of a breakout. There is confirmation that something is going on here. And it certainly, you know, it means a weaker dollar and we've got a weaker dollar only because the Fed has to cut rates or is done or virtually done.
Willy Walker: So, the final area is your automation index. Your automation index has done extremely well. It's up 550% since you created the index. On automation, is this the game in the United States as it relates to the automation index or is that more back to our defense manufacturing being a global play? You're very globally focused if you're going to play on the automation side, is it the game in the U.S. or is it actually outside of the U.S.?
Kiril Sokoloff: Well, I think it really has to be global. There are a lot of interesting things going on in other parts of the world, but this is, of course, also the artificial intelligence, which is, you know, a very significant part of this. We think that a lot of technologies are merging together at the same time. That has never happened before, which is going to accelerate all these trends even faster and make them more extreme in their impact on the world.
Willy Walker: As you look out and say, okay, I mean, your time horizon has always been so long and it's one of the reasons you've been such a successful investor. You get conviction on certain themes; you invest in them, and you watch them, and you stay with them. As you look out over the next five years, we've talked about a number of your high conviction themes. Anything that the two of us haven't touched upon that this audience ought to be thinking about?
Kiril Sokoloff: Well, I think that the risk for everybody in this room is that the dollar gets very weak. You know, I'm agnostic. You know, I could be a dollar bull, I could be a dollar bear. I just think there are so many forces that are causing the dollar to get weak, and Stan Druckenmiller calls the reserve currency the curse of the reserve currency. So, the U.S. does not have to discipline itself. It can just keep on borrowing, borrowing, borrowing, and borrowing. I mean, we've never run debt deficits ever to the extent we're doing it with this strong economy, it's been, you know, the past few years. So, you look at that and you just say, where is that going to go?
Willy Walker: I hear that I say, okay, well, does that mean buy euros? Does that mean buy crypto? I get the loss of value in the dollar and what that means for the U.S. economy. But as an investor, what's the alternative? Like what comes to replace it? Is it crypto? Is it the euro or is it this new currency that's being cooked up by Saudi Arabia, Russia and China to try and displace the dollar, which, by the way, as you well know, is less than 1% of global capital flows today. So, I mean, you know, you look at this chart of the dollar and everything else, and the dollar just is so large and so dominant that, yeah, it might be a long-term trend of a weakening dollar. But how do you play that?
Kiril Sokoloff: Well, if you get a weaker dollar, you're going to have inflation. And there's going to be a push into hard assets. On the flip side of a strong dollar is I want to be in hard assets. Meaning commodities, gold, silver, copper, all those things. So, commodity currencies, certainly Canada, Australia, and what have you. We like the Middle East because they're just investing and it's going to be Europe of the Middle East where you can travel visa free. They're trying to encourage trade, you know, all the things you're seeing there. So, the whole sector should do extremely well. So that's one area I like.
Food security, we've been blessed with good weather and incredibly productive farmers. But, you know, then you have bad weather. And then you have Ukraine. And topsoil is being eroded at unbelievable rates. It takes 70 years to create topsoil. The world wants more protein and nourishment, so their diet is increasing in calories. And then there's growth in all these countries that want a better life, and that means better food. So, it looks to me like that whole sector is really, really attractive.
Willy Walker: So, my final question for you, Kiril. You have been wildly successful and as a result of that, you can live your life where you want to live your life. And from just my perch, you have properties in Canada, in Idaho, in the Bahamas, in the Adirondacks and in Europe, and where you spend your time, given all of these global threats to me, is a really good indicator of what you're seeing. So where are you going to spend the next 25 years?
Kiril Sokoloff: Well, I think a lot about personal security and family security. And we were worrying about pandemics for 20 years. So, I bought this farm in Canada. It's self-sufficient, off the grid. My home in the Bahamas is off the grid. My home here has a generator with gas from Wyoming that can go for forever, you know, years and years supply of food. There's no downside to this stuff.
Willy Walker: Except having a home in Canada that you couldn't get to during the pandemic.
Kiril Sokoloff: But this brings you to the optionality. You need to have all these options so that if one falls, shot down, then if something else comes in. I would not have thought of the Bahamas as a safe haven. But during COVID, it proved phenomenally well. So, it went up and Canada went down.
So, I mean, if we think about this, just look at what's happening in the world today with the heat in some parts of the world, it's 45, 65, 85 degrees centigrade. You can't live like that. The water is in the wrong places. And then food security, social unrest. So, all these factors need to be evaluated. We all love where we're living, but we have to be realistic that maybe you have to change. Now, I lived in South Florida for a while and I left in 2010, and now it's an accident waiting to happen. I know what it's like if you're trying to drive north from Miami with a hurricane approaching, you just are not going to get anywhere. Of course, the gasoline stations run out of fuel. And when the power goes out, you can't get any gasoline. And no one thinks about these things. No one is prepared for any of these things. And I'm always thinking, What if? What are the big risks? And, you know, through AI and other things we're monitoring. So, with COVID, maybe pandemics we’re number 20 and all of a sudden we read what's going on in China okay, it's number one now, let's swing into action with our long plan. What do we do in a pandemic? But this is not being done. It seems to me this is 101 pragmatism and being prepared for the future.
So, the short answer is, if it's going to get hotter and hotter, you want to be in the mountains. It's cooler there. So, this is a really good place. The Adirondacks have deep forests. You know, it's a rainforest area. It's a perfect refuge. Bahamas, you've got hurricanes. You know, say Switzerland is a phenomenal place, but the glaciers are melting. I mean, there's no perfect place. So, you have to just keep evaluating based on new information and shift. I'm very flexible this way, but I love optionality.
Willy Walker: So, I love the fact that you have optionality. And for all of us in the room, I hope that your optionality doesn't have to be exercised upon. Ladies and gentlemen, Kiril Sokoloff! It's great. It's really great. Thank you, Kiril!
