Preston Pysh  06:33

So it’s funny because we got all these questions. We’re not even close to getting near them, and we’re already having an awesome dialogue with you. I’ve got one more question before we even hit the list.

So I’m really curious because I’ve been talking on the show about how I really think there are issues over in Japan. I think that they’ve got a lot to be concerned about, even though they’re still executing this massive QE program. Do you see the China thing impacting Japan? Do you see that there’s trouble around the corner there? I mean, when we look at their GDP growth and their inflation numbers, it’s dismal at best. Do you see it getting worse from here over there?

Cullen Roche  07:09

Everything is impacted by the Chinese slowdown. Anything in the regional area there. I mean, even as far as Australia, and I mean, anything in Southeast Asia really is pretty interconnected into China.

Japan is a lot more independent than a lot of the other economies are over there just because they have such a massive entrepreneurial base of their own. I mean, they have, in terms of where a lot of the biggest, most important companies in Asia come from… Japan has always sort of been the central hub there. So, they have sort of an inherent hub of production that underlies all of their economic output that, at the end of the day, that’s one of the most important things that any economy can have, as long as you have an economic base that is really nice, diverse and innovative.

Most importantly, they are really innovative. You can overcome a lot of problems over the long term. And that’s   one of the big things that we’ve seen out of Japan is that, at the end of the day, they are still a huge innovator in the global economy. And that’s been the thing that’s, I think, kept that boat afloat for a long time, although they have what is ultimately really just a big demographic problem inside of their economies.

So they’re a little more autonomous than I think a lot of the economies that are really close to China, but they’re still impacted to a huge degree just because they rely on China increasingly for so much of what they export.

Stig Brodersen  08:39

Cullen, the thing is really interesting that you bring up this demographic problem in Japan, and personally, I’ve read quite a few books recently about valuation and the psychology and how the market is pricing these equities. And one of the things that are repeated is how we tend to overvalue the importance of these internal factors. An internal factor would be something like demographic, something that I guess most people know. And then a lot of people would emphasize that. That’s just like an overall observation, I guess, of five academic papers and some books.

How do you see that in the Japanese equities market right now? Do you think there’s a general skepticism that is perhaps exaggerated in the Japanese market because of the problem that they’re having not only the monetary policy, as Preston is talking about but also with the demographic problem?

Cullen Roche  09:31

yeah, I mean, to use a really crude model of the economy is to include population growth in the model. You don’t need population growth over the long term. But ideally, you have an economy that not only has productivity growth increasing over time, but also has growing population growth because it’s sort of a double whammy.

Theoretically, you can overcome population growth. And actually, if you look at the total return of the Nikkei since the early 90s when they had sort of their big bubble and even their GDP, they’ve seen a pretty actually impressive rate of growth over time in both even though they’ve had this huge demographic problem. It all   started to boil over with the big bubble that they had in real estate in the stock market there. But then it’s really been exacerbated by the demographic problem they’ve had.

I wouldn’t say that the demographic issue is something that it has to put negative pressure on either valuations or the stock market in general. But it depends because you have to have that underlying productivity base. And really, as I said before, the base of innovation and innovation can overcome so many things: government regulations, demographic problems. I mean, we see a great example is in the USA, where we see what looks increasingly like overregulated or just highly regulated industries, where the innovators in the USA, they keep going to other places.

I mean, the financial industry sort of the best example because the financial industry is a place where we keep seeing, basically big banks and financial innovation, sort of financial engineering skirt regulatory overreach to some degree and the regulators are trying to keep up. But innovation keeps sort of circumventing it all.

And obviously, the internet and the technology space are even better examples of that. But so the bottom line is innovation can overcome a lot of big problems. And that is something that the Japanese still have. I mean, they are the closest thing to true capitalism in Asia that we really have.

Preston Pysh  11:41

All right, Cullen, so let’s go ahead and get to the actual questions we had. That was a fantastic discussion.

The first question I really wanted to ask this to get to know you a little bit better, was how did you get your start in investing? And more importantly, why did you focus so much on understanding how central banks and credit cycles work?

Cullen Roche  11:59

I   came into the markets in really the late 90s or in the early 2000s,   during the big tech boom in Boston. So, I think I always had a sort of inherent skepticism about the markets just because my first experience was sort of being thrown into the fire of the tech bubble and seeing a market where everything just seems to go down all the time.

But I basically sort of developed almost a self-taught sort of economic perspective where I probably learned a lot more towards almost a sort of free-market or Austrian economics perspective, to some degree, because I was a market practitioner. It just seemed so obvious to me that the markets have operated better when people weren’t constantly intervening in them.

12:46

The financial crisis   changed a lot of my model. I had been really trying to figure out why correlations all went to one, back in 2008-2009. I don’t know if you remember but back in that period, the correlations of almost all financial markets went to one basically. And it didn’t almost matter if you were a value investor, or if you were a growth investor, or where you were regionally or what asset class you were even in.

When the central banks all started to get so involved, and the government started all to get so involved in the economy back then, everything sort of started to trend together. And that really changed my perspective on things because it made me realize that these entities increasingly were probably going to be involved in everything that much more going forward.

13:40

And the big one was quantitative easing, which was this completely new program that really, I don’t think anybody really understood it. But although I’m not a trained economist, because I’m a market practitioner, I’ve sort of relied to a large degree on my contacts on Wall Street. So, I ran a limited partnership for seven years, basically through the financial crisis. And one of the things I constantly relied on was to understand the world better by talking to people who were   on the ground and understanding things. So, bankers, investment bankers, traders on Wall Street. These are just lots of either friends or colleagues that I have in the industry.

And it was funny when the financial crisis broke out and quantitative easing was initiated, a lot of the people that I was speaking to on the ground were telling me very different things about the way this would unfold than what you were reading in the mainstream media or even what a lot of the actual academic economists were saying. And I had this sort of juxtaposition there where I was sort of had my ear to what was an operational reality relative to what looked like almost an academic or theoretical perspective, which was more the money printing sort of idea that you got from the mainstream media and whatnot, in the sort of the driving hyperinflationary view.

Preston Pysh  15:05

Fantastic and I just want to highlight to our audience, this paper that Colin had written. You should definitely read this because Cullen lays out is just fantastic. And it really debunks a lot of myths that I think a lot of people have.

Stig Brodersen  15:18

So I would actually like to talk about this paper because one of the things that you bring up is the provenance with fiat currencies. And I think it’s really interesting and it’s also something that Preston and I brought up on the earlier show. You talk about the value of any form of fiat money that is also made derived from three key linkages. And the first one you mentioned is output production. The second one is money supply management. And the third one is law and regulation. Cullen, could you please elaborate on that?

Cullen Roche  15:47

Yeah, so money is a really strange thing when you think about it. I love   going back to the origin of the word credit, because the word credit has traditionally been used as being synonymous with money, basically. And the word credit is derived from the Latin word crēdere, which means to believe, basically. And that’s ultimately what money really is.

Money is this sort of trust-based system of accounting, really. For all practical purposes, the money is just a tool. It’s a medium that we use as a record of account to basically account for the way that we interact in a monetary economy. So, the reason why I really highlight these three linkages is that I think that these are the three things that really make the monetary system viable over time.

So for instance, output and production are by far… they’re the base of all of this. If you don’t have output in production, there’s no reason for money to exist in the first place. I mean, the only reason that a monetary economy even exists is that we have an output that we want to trade with one another. So, in a barter type system, you wouldn’t need money. You would just trade this good for that good and you know, sort of a “you scratch my back, I scratch yours” type of economy.

17:11

But money changes the whole dynamic. Money allows me to get a back scratch from you. And then I take the money and I can go and I have basically some sort of monetary item that is worth that quantity of back scratches, but I can use it on anything. So, it basically is sort of a trust-based system that provides us with flexibility.

But what’s interesting here is that a lot of people think of money as something that maybe should be unregulated or something that the supply of should is sort of managed or massaged. Of you read a lot of academic work, they focus on really managing the money supply and the whole idea of monetarism is really based on the idea of the central bank managing the money supply.

And, interestingly, what we’ve sort of built-in a modern credit-based system where banks are the primary issuers of money is really a market-based system. The monetary supply really expands and contracts in an elastic way, which means that basically, the market chooses how much money should exist at times by making new loans and by repaying loans. Money supply can literally expand and contract, but there’s a linkage there between the money supply and output ultimately, so we can demand more money.

18:38

But ultimately, one of the key linkages that make the system viable is how well that money is actually used. So, are we borrowing money and going out and speculating on the stock market? Or are we borrowing money and we’re actually building things? Are we building things that add real value to the economy? And they make that base of the whole financial system broader.

That’s why I kept going back to innovation earlier. Innovation is such a key portion of all of this because it is the thing that drives ultimately output in production and makes all of this sustainable. I sort of think of laws and regulations as being able, to use a bad sports analogy… If we think of all of this as sort of being something like a soccer game, we’re all basically trying to obtain the balls, which would be synonymous with something like the money to try to score goals, and goals would be synonymous with basically creating more output or production. And the government is just sort of there to set the boundaries and make sure that people aren’t committing fouls and doing things that could harm the process of trying to get the ball into the goal basically.

So the government has an important process to play in terms of how a system adheres to those laws. And that’s really the crucial part that government plays in all this is that government can come in and sort of being an independent party that oversees everything that says okay, the system is creditworthy, because if you need to go to court because somebody isn’t good on their monetary promise, the court can   come in and intervene and they can literally, they can give credit to the money that we utilize because people realize that they have some sort of independent party that’s going to regulate and actually make this viable to some degree in the long term and uphold contracts, which is such an important part of all of this.

Preston Pysh  20:39

So Cullen, one of the things that I’m most impressed with this white paper and some of the other talking points that you have on your website is that you really debunk this money multiplier or reserve ratio piece of what they teach in any economics course across the country. And you suggest that after the US came off the gold standard that the banks have been really driving this supply of money or credit that’s being created into the system.

So can you walk our audience through this idea so that we can understand this more clearly? And just so everyone knows Cullen is effectively saying that the money multiplier used to have an impact, up until this point where we really   came off this backed monetary baseline. And once we didn’t have anything that was backed, really it was   the banks were taking control at that point. So, Cullen, if you could describe this in a little bit more detail so people can   understand your vantage point? We’d appreciate it.

Cullen Roche  21:29

Yeah. So, this is actually a lot simpler than it probably seems. I think the crucial part of all of this is getting the causation right. So, a lot of people tend to work from the idea that the government controls the monetary system, basically, that the government prints money, that the government   oversees and either the central bank prints the money or the Treasury prints the money. And that’s not really an accurate way to think of all of this.

I think of the government more as a facilitating entity. Whereas the current financial system has really come to be dominated by private sector entities. I mean, the banks are for all practical purposes, they are the real money printers because they’re the ones that when they create loans, loans create deposits, but you have to get the causation there right.

A lot of people, especially if you’ve taken a course on economics, you think that the deposit base or what economists call the broad money supply, which is basically the supply of money that banks control, they think of that as some sort of a ratio. And so you might have $1 of reserves in the reserve market, which is the market that the central bank controls, which would allow banks to create $10 worth of broad money. That’s not really how any of this works, though.

22:48

The way that it really works, for all practical purposes, is that banks create broad money, and then if they need reserves, they tend to borrow them after the fact. So, loans are actually made before the reserves are even needed. And if the reserves are needed, the central bank actually has to respond to what the banking systems’ needs are. A central bank is basically just a clearinghouse that operates with government leverage, which basically keeps wheels going during scary times. And this is exactly what we saw during 2008 is that the Federal Reserve kept operating even when JP Morgan wouldn’t lend in the overnight market to Bank of America. The Federal Reserve stepped in and they said we’ll make a market here, we will lend to whoever needs it to keep the wheels greased here or to keep the engine greased here.

Stig Brodersen  23:42

I think it’s really interesting that you’re talking about this, Cullen, because I would really like to keep talking about the Federal Reserve. If I have a normal household, I can run out of money. But as you were talking about the Federal Reserve, they don’t have the same constraints. One of the things you talked about in your work is also how the risk with the Central Bank is not solvency issues, but rather an inflation and the foreign currency risk. So, could you explain those concepts and why it’s a risk for the central bank?

Cullen Roche  24:10

Yeah. So, again, to   use a really simple analogy: a central bank operates in a lot of ways like the government bank. It’s   been strange, to think about over the course of the last seven years, one of the things we keep hearing about, the debt ceiling, for instance, is coming up again, and we’re hearing about how the US government can’t afford all the things that it has to pay for these days.

This always   makes me laugh because the US government has a bank that it can borrow from at zero percent. And whether that’s good or bad, I don’t know. I mean, I’m not making a political statement about all this. I’m coming from an operational perspective. There is literally no way that the US government can run out of money right now. They are an entity that can sell at zero percent interest rates. So, literally, their credit line right now is bottomless. Completely bottomless.

In addition to being able to tax 22% of all world output, issuing the world’s real safe-haven asset, which is the US government bond as sort of the reserve currency issuer were inherently the entity that issues the world’s safest assets. There’s no real solvency constraint there like there is for a household. So, you might be able to run out of money. But if you had an infinite credit line, if you had basically a credit line at a bank where you could go in and you could borrow at zero percent, you would never worry about running out of money. That’s the exact situation that the US government is in.

And yet, we continually hear about how the US government has some sort of solvency risk, just like a household does, and it’s just not true. What the government really has to worry about is creating so much liquidity or incentivizing people in such a way that you basically dilute that output base, to the point where you have so much liquidity chasing so few goods and services that then we start to see sort of a South American problem.

26:21

South America has been just a great example of mismanagement of basically fiscal and monetary policy over the course of the last 30 years because what they’ve really tried to do is time and time again, they’ve tried to basically create money as an alternative for output. And they’ve never really had the output base from which to be able to leverage their governments. So, you’ve had a lot of cases of hyperinflation and high inflation and then in a lot of cases, really nasty currency situations. That’s the big risk that you have to worry about is if you have an economy that has a fragile output base where the government then is being involved in such a way that they’re trying to almost print output.

You can’t print output really. You can incentivize people to create output in certain ways. But you can’t print innovation and things like that. And that’s the problem that a lot of governments run into.

But with regards to the United States, it’s a very, very unique situation. There’s a certain exorbitant privilege, as economists would phrase it because we’re such a uniquely innovative and diverse economy with diverse resource access and a really mature and diverse economy in so many ways. So, there’s a lot of specifics. I hate to generalize about this because I don’t want to give people the impression that the US government because it has to access to basically a credit card that has an infinite amount of money on it, that is not necessarily a good thing. But I think that coming from an operational perspective and understanding that the government doesn’t necessarily have the same solvency issue as a household is really crucial for keeping things in the proper perspective.

Stig Brodersen  28:06

Yeah and Cullen, it is so interesting that you bring up the uniqueness and complexity of the American monetary system. So, I teach macroeconomics here in Denmark, and I wouldn’t use American textbooks, because America is so different, really, for everything else.

Cullen Roche  28:20

Yeah,   and the financial systems are all different. So, I wrote my paper, for instance, from the American perspective, obviously, and you wouldn’t believe how many international emails I get, and people asking me, “How does this apply to Europe?”

Europe has been a really interesting thing to talk about over the course of the last 15 years. Their whole Euro project is sort of unfolded because Europe is an incomplete version of the United States financial system in a lot of ways because what you have there is basically… The European Central Bank is not really controlled by a centralized government. So, you have basically a foreign central bank and then you don’t have a global Treasury for the entire euro system. So, what you have though is you have a system that is basically united through using the same currency. But you don’t have all of these other interlocking pieces that actually sort of complete the monetary union.

Preston Pysh  29:23

So it’s funny. Jim Rickards says that he feels that the Euro is actually a stronger currency than the dollar or currency that’s going to hold its value better than the dollar because of that structure. Would you agree with that?

Cullen Roche  29:35

the likelihood is that Europe’s economy will remain in a sort of depressed state until they resolve a lot of this because what’s happening basically, is that you have an inherent trade imbalance inside of Europe. So, a lot of people don’t realize this. But in the United States, for instance, we have trade imbalances here, we basically have 50 little countries. We all use the same currency. But a lot of these countries are a lot more productive than others. So, New York and Texas and California are the big ones. They’re the Germany of the euro system. So, they’re the biggest exporters of goods and services. And this naturally creates a trade imbalance inside of all of the states.

But what happens a lot of people don’t realize this is that you don’t get big Greek-like financial crises every once in a while inside of the United States, because you have a central government that offsets a lot of the imbalances that occur.

So for instance, a lot of the southeastern states like Alabama and Mississippi, are huge importers of these goods and services, which means they’re basically exporters of dollars. So, they’re just like Greece. And to offset the income outflow, they basically need some other source of income. It has to come from somewhere. Does it come from borrowing? Do they issue more municipal bonds? Or do they get money from the federal government?

31:09

In the case of the USA, they end up getting huge amounts. They’re the biggest beneficiaries of federal funding. So, the big states like California, Texas, and New York, they actually get as a percentage of their GDP, they get a lot less federal funding than a lot of the smaller, less productive states do.

And the situation though in for instance, with Greece is Greece doesn’t get federal funding from anywhere. They actually are being told that they have to deleverage that there’s no support mechanism for what they’re doing, basically. That they have to implement austerity. I mean, Greece is literally going through a depression right now. The closest thing to a modern-day depression that really any fairly substantial economy has gone through. It’s just not a good situation for Greece because they don’t have the political unity that’s required to make their stuff system viable.

But at the same time, Germany doesn’t want to let the smaller weaker countries out of the euro, because Germany is the biggest beneficiary of the weak euro. So, if you had all these weaker peripheral countries peel out of the euro, ultimately, that’s an inherent price hike for everything that’s produced inside of Germany because what happens is, for instance of Greece and Italy and Spain and Portugal all left the Euro, they bring back their old currencies. They would become just infinitely more competitive against what is essentially becoming a German currency, basically.

Preston Pysh  32:37

That’s phenomenal. I love that discussion.

Changing gears just a little bit, Cullen. So, when we look at the high yield bond market right now, it’s a really popular topic. You got guys like Carl Icahn out there basically saying that doom and gloom is coming. And a lot of this has to do with the fact that a lot of people are selling out of this bond market, which is raising the yield in the high yield bond market.

In general, are we seeing the credit cycle starting to contract? Regardless of whether the Fed raises rates here in the federal funds rate, in the near term, say they do it in the next six months? Are you seeing worldwide the credit cycle starting to contract? Is this starting to spin in the opposite direction? And if so, what ramifications or expectations that we have moving forward?

Cullen Roche  33:21

So we’re not technically in a deleveraging, especially in the United States, I think it’s important to be really specific about which sectors we’re talking about. So, when we look at, for instance, in the United States, what happened in the period from basically from 2002 up until fairly recently. Really 2013 was we had this huge boom and bust in credit and specifically, it was household credit. You had lots of people speculating on houses and doing sort of funny things with the housing ATM situation and buying cars they probably could not afford. So, household credit really boomed in the 2002 to 2007 period.

What happened was that it created a very fragile sort of situation where we had basically built a credit boom based on a very fragile pricing mechanism, which was the real estate market. We had such a huge increase in real estate prices that the value of the assets that were underlying so much of this debt, it made everything very unsustainable. And when the price of houses began to basically contract, you got this domino effect.

34:38

The business sector in the United States has been actually really healthy over the course of the last 15 years. And it’s interesting that what we’ve seen over the course of the last, really the last five to 10 years is the credit crisis has played out to some degree as households have deleveraged in the United States.

Businesses have actually leveraged up. We’ve had a big boom in corporate borrowing in the last five years. And obviously, the biggest player in all of this was the government. The government became a huge borrower in the post-crisis period. And this offset what was happening at the household level to a large degree.

So you have to   get a little bit more granular. We’re not having a broad deleveraging in the United States. But we’re still in a situation where relative to historical norms, the household sector, in particular, is still borrowing far less than they have historically. And so this is a sign of still very tepid balance sheet strength because this is one of the main drivers of the economy.

Ironically, you want the money supply to be expanding through loans over time because that’s a sign that things are actually healthy when businesses are borrowing and people are borrowing and utilizing that money for good productive purposes. That’s a sign that things are actually good. You want to see that happening.

Stig Brodersen  36:03

Really good answer, Cullen. I have a question about exchange rates that I’ve been thinking of quite a while since I’ve read Jim Rickards’ paper. And he’s talking about the advantages of the American dollar impact to something and the pros and cons of doing it.

So, first of all, he might be talking about paying Delta gold, like they used t. The other one would be pegged to another currency. And he also explores the opportunities of being pegged to a basket of currencies. Could you imagine a situation from your point of view where it would be beneficial for Americans?

Cullen Roche  36:39

I don’t really understand the rationale for doing this because I think this tends to be a function of the view that the government controls the exchange rate necessarily, or that the government controls the money supply. More importantly, and historically, there have been times where governments have directly controlled the money supply. But in today’s monetary system, for all practical purposes, the money supply is really controlled by the private sector.

The private sector plays the most important role as the issuers of money through primary loans. And so, I don’t see what the benefit would be to pegging the dollar to either a hard commodity or even another currency. The general goal is to basically to tie the hands of the government to some degree to make it more difficult for them to issue money.

But we’ve sort of seen this. I mean, quantitative easing is the best example that I like to use. The government is a facilitator of the monetary system. And so they use a really simple example of what quantitative easing is. Quantitative easing is basically changing the composition of private sector financial assets. What the government does is when they implement quantitative easing, the central bank basically prints reserves, or you can think of them as printing deposits into the financial system and exchanging them with some other type of financial asset. So, for instance, if I hold a treasury bond, maybe the central bank comes to me and they give me a deposit and I give them the bond. I’m not wealthier, I don’t have more money, my net worth hasn’t increased. In fact, the private sector’s net worth is exactly the same after quantitative easing has been implemented.

Preston Pysh  38:26

All right, Cullen, this is our last question. What book do you recommend? And specifically, what investment text has drastically shaped your thinking?

Cullen Roche  38:34

So this might actually surprise a lot of people. But I’m actually a huge advocate of simplicity. So, although I   work from what’s is a seemingly complex perspective of the world, my goal with all of this is vastly simplify everything, to sort of condensing all of this into very simple forms of understandings.

The book that I love that I think is just the most direct, simplistic way of understanding what is generally the best way of allocating assets for people is John Bogle’s “Little Book of Common Sense Investing.” I think that he just does a masterful way of explaining how simple this whole process should be. At the end of the day, although a lot of this get bogged down in the complexities of all this stuff endlessly if you can really simplify all of this as best you can, I’ve always been a huge advocate of simplicity and I think that Bogle just is sort of the master of it.

Preston Pysh  39:33

All right, Cullen, just fantastic information. We want to make sure that everyone in our audience has a handoff back to your different sites and all the things that you have on the internet, so please tell them where they can learn more about you.

Cullen Roche  39:45

Yeah, so the best place to go to is pragcap.com. That’s PR, AGCAP. The website is Pragmatic Capitalism, and that’s just it’s my personal blog. But I’ve posted so much sort of educational material. I think there’s so much misinformation out there about the way that the financial markets work and just the way that the monetary system works because of real people’s behavioral biases, and more importantly, their political biases. There’s just so much misinformation out there about the way things work. And I like to view these all of these things, sort of through the perspective of an engineer. If we can understand how the monetary vehicle works, we can understand what certain pedals do and gears do and how they operate in certain ways. So, a lot of my stuff is just very operational and educational. I don’t know if it’s all right, or applies to every monetary system out there. But I think a refreshing sort of perspective because it’s operational.

Preston Pysh  40:48

Fantastic. Stig, did you have anything else?

Stig Brodersen  40:51

No, not all. Cullen always has a standing invitation to join us on a podcast. I mean, this was amazing. Right up our alley. Awesome.

Cullen Roche  40:59

Thanks. So, much, guys. It was really a blast. I hope I wasn’t too all over the place. I know we’ve covered a lot of ground.

Preston Pysh  41:06

No, it was fantastic. Thank you so much for coming on the show, Cullen, and I’m sure we’ll probably send you another invite here soon. So, thank you so much.

Cullen Roche  41:14

That would be awesome. Thank you.

Preston Pysh  41:17

All right, so this is the point in the show where we take a question from the audience. And this question comes from Matthew Wong.

Matthew  41:23

Hi, Preston and Stig. My name is Matthew, I’m calling from Ireland. I’m a huge fan of the show. And my question is just related to the low oil prices, which I’m hoping to get some exposure to. Our reluctance to buy into oil ETS… I think that the 12-month future contracts that would have been locked in by some oil companies around this time last year at the decent prices or whatever, around $200 a barrel, those will be expiring soon. And I can see multiple companies going bankrupt in the next six to 12 months, as long as the Saudis continue to keep the oil prices down. So, I’m reluctant to buy ETFs just because obviously that portfolio will include some of these companies that are more likely to go bankrupt. And I guess that leaves the individual companies. I’ve been considering maybe Phillips 66. Buffett invested in them, gives them a stamp of approval. But yeah, my question really is just are you guys investing in oil ETFs? Thanks a lot, guys appreciate it.

Preston Pysh  42:23

So, Matthew, this question is really a good question. And I think that this is one that a lot of people in our audience have. So, I am not right now. I am not investing in anything that’s oil-related. That doesn’t mean that that’s right. That just means that I’m a little scared and timid to dive in at this point without really knowing how everything’s going to shake out.

Something that I can say that I’m surprised by and I know we had Tres Knippa on the show. He said he was surprised by the price action in the oil commodity where it really went down. It was down into the $39 level for basically a couple days and then it came back out and it’s now up to 45 to $50. And it’s been bouncing around that 45 to $50 range.

What I find really amazing is our friend Morgan Downey, he told Stig and me, specifically said, “If oil drops down into the $30 range, it will only be there for a couple of days.” He was dead right. I mean, dead right.

43:18

Now going to where do we go from this point forward and into the future? So my opinion is that the Saudis and some of the other countries that produce oil at a very cheap level like they can pull it out of the ground at $10 a barrel and still be profitable. I really think that they have this approach that they’re going to try to keep oil at the 50 to $60 range. I really think that that’s going to persist until they shake out a lot of these companies that are like the frackers up in Canada, the oil sands. I think they are trying to demolish that business so that they can gain their market share back in the long run. I think this is a long term strategy. That’s what I really think’s happening.

I could be 100% wrong with that. I don’t have any insight source over in Saudi Arabia or anywhere else that would be telling me this, this is just from the different articles that I read. And what I think they’re really trying to do is get their market share back. And I think they’re trying to do that by supplying the amount of volume of oil that they’re producing until these defaults actually start to occur. So, that’s why I’m waiting. That’s why I don’t think that it’s going anywhere anytime soon. And I really don’t think that I’m missing the opportunity, because I think there’s more to come. I don’t think that we’re at the bottom here. I think that you’re going to see more of this play out as time goes on and things mature and develop. So, I don’t feel like I’m missing the boat here. I think that it’s going to be something that persists for a little bit longer.

do believe and I want people to understand this: I think there’s a huge opportunity here. A huge opportunity. But I think it really depends on when that oil price is going to start coming back up and start to go higher. Until you start to see that shift, that consistent shift, start to take place, I’m just going to hold tight and maybe get in a little too late. But I think that I’m going to mitigate potential risks, especially from a global standpoint by waiting for that. So, that’s my opinion. I’m really curious to hear what Stig has to say.

Stig Brodersen  45:13

first of all, Matthew, I think it’s a great question. And the reason why is that you’re seeing cheap oil and you’re thinking of opportunity. So, you’re not looking at cheap oil and thinking that’s a problem, I need to run away from that. That’s a question from a real value investor. So, first of all, immensely props for that one. Contrary to Preston, I am actually invested in oil. I’m not invested in an ETF. And it’s really not on purpose. I know it sounds strange, but I don’t have the same access. So, for instance, if I here in Denmark, try to invest from a 401k it’s not legal here in Denmark. The authorities have claimed that it’s too risky. We don’t know enough about American ETFs, so we cannot allow dangerous investors to hold American ETFs. So, if I was to answer your question, I’m not. But I would really like to. And I wrote a blog post about investing oil ETFs. And you can find that on theinvestorspodcast.com and it’s on the blog section.

Preston Pysh  46:15

So I want to comment on the oil ETF piece of this. So, I would think that investing in individual companies is going to end up being a little bit better for an individual. I think that the big large-cap companies that have strong balance sheets are going to be the ones that benefit the most from all of this simply because they’re going to be able to buy up the capital resources. When these companies do go bankrupt. And some of these aren’t able to produce and be profitable, they’re going to have fire-sale opportunities for large-cap companies that have managed their finances when they buy their capital assets. So, that’s why I think maybe going after individual picks and companies that have really strong balance sheets and that have been managed really well through the years. I think those are the companies that are going to benefit most from this after it does start turning around.

Stig Brodersen  47:02

Great point, Preston. And you might well be right. I’m investing individual stocks right now, actually, just a few weeks ago, I bought into them. And with the strong balance sheet, as you suggest, and could they go lower?   of course, they can. The reason why I do still invest in them is that I’m looking at a 3% yield right now. And basically, this is for companies I consider close to being risk-free. And I   feel like I’m waiting for a strong upside.

Now I want to say two things. I am looking to increase my exposure if I see a severe price drop again. The second part which is very, very important too is that I could very easily be wrong. And if I’m wrong, I still want to be exposed if you don’t see the drop, and I missed my shot to invest while the prices are low.

Preston Pysh  47:50

Okay, so that’s all we have. We’re going to go ahead and send Matthew a free signed copy of our book, the Warren Buffett Accounting Book, for asking that fantastic question. And if you’re like Matthew, and you want to get your question, please on our show, go to asktheinvestors.com, and you can record your question there.

So we’d really like to thank our guest Cullen for coming to the show. As you guys can see, Cullen is extremely smart. We highly recommend all of his white papers. We’re going to have a link to all those on our show notes. So, make sure you check that out. And we just want to thank our audience for joining us today. We really appreciate everything that you guys do for us. So, with that, we’ll see you guys next week.

Outro  50:18

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