Gold, Ghost Cities, and the Great Credit Cycle: Mike Kao on Global Economic Shifts
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On the Tape.

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Welcome to the Risk Reversal Podcast, and this is a special one. The last time this gentleman was on was September 15th, 2023. Long overdue. If you don't follow Mike Cowell on Twitter, you're doing it wrong. He is the man from Akathos Capital Management. It's hard for me to say. It's a Greek peninsula, I believe.

Cal Family Office. Mike, how are you doing? All right. Thank you for having me back. It's always a pleasure to reunite with an old J. Aaron alum. That's exactly right. You know, the Aaron people are sort of wired a little bit differently. And all the stuff that's been going on, specifically over the last few months, I mean, it's almost like we were made to sort of live in this environment. So let's sort of start there because...

I think you would submit, and I know that I've been watching this, some of the moves we've seen in currencies, in commodities, in the bond market are unprecedented. So let's just take it from 30,000 feet and sort of tell me what you think has been going on over the last couple of months.

Well, I think that, you know, the prevailing narrative that's been, you know, driving the weakening dollar and weakening bond market, especially at longer durations at the same time, is this narrative that, you know, the U.S. has damaged its brand. The U.S. is...

flight out of everything US related, etc. And I think that's definitely driving the technicals. But there are, I noted a couple of weeks ago in my tweets and my sub stack, I said, look, every couple of years, whenever you see this bout of US dollar weakening,

the whole panoply of Reasons that I hear about how the dollar is in structural decline is the end of the dollar the end of the US Treasury market it always heats up and When you when you really back out and look at the really big picture and look at what the dollar has done It goes through these cyclical bouts of weakness and you know two years ago I

co-wrote and presented this paper to West Point that examined basically the roots of dollar hegemony. The paper was actually called U.S. Dollar Primacy in an Era of Economic Warfare.

It just talks about how, you know, at its roots, first of all, do not conflate currency strength or weakness with currency adoption. The two are very, very different, right? And we present, in fact, in our paper, we presented this strength versus adoption matrix where, you know, in one quadrant, you have...

you know, weak currencies and weak adoption currencies, which tend to be the EM currencies. And I would say that actually the, you know, the Chinese Yuan actually is in that category. You have, you have currencies that are weak adoption,

but have strong adoption. And up until recently, that would have been, for instance, the euro and the yen. OK, both of those have strengthened somewhat recently. And you have currencies that are that are strong, but low adoption. That would be something like the Swiss franc.

US dollar is unusual and that basically for for up until very very recently, right? It was both strong and strong adoption and it's the adoption metric that I think people are missing because you know There's a lot of talk right now about how you know The liberal world order is shifting from you know a post Cold War to this more multipolar world and while that is true

It's very useful. I think it's very, very important to remember that in the last shift, like when Sterling basically gave up its role as a global reserve, you had this upstart in the United States that basically dominated all the pillars of national power on all fronts, from resources, military, economic strength, you name it. It dominated across all fronts.

And so the euro-dollar market evolved and came about because of all of those factors. Now here, yes, it is that post-World War II liberal world order as defined by Pax Americana and the strength of the U.S. It's fracturing somewhat, but the difference this time is that there is no upstart in

China included, there is no upstart that dominates all those pillars of national power. So there really is not an alternative, I argue, to the U.S. dollar or to the U.S. Treasury as its central underlying reserve asset.

You're seeing you are seeing this flight to gold, you know, but but in the world of fiat, see, I also maintain there's a whole can of worms that we can open or not. But but I maintain that, you know, if you I wrote a thread a couple of years ago talking about this, how.

Now, ever since before the Nixon shock, really the rise of the euro dollar market and the untethering of the dollar to the gold standard happened even before the 1971 Nixon shock. But if you really look at what's happened since, right, GDP growth around the world has gone exponential because it's been fueled by this credit-driven nature of fiat money, right? Right.

Now, if this flight to gold is truly heralding doomsday of the current liberal world order and that we are moving to a new hard money standard, what people don't seem to understand is that that basically takes us back to a world of austerity. That hockey stick in GDP growth will grind to a halt.

So I don't think – I think this fight to gold obviously has a lot to do with, again, animus against the US, animus against Trump, et cetera. But I don't think it heralds the complete shifting of –

you know, the gold replacing dollars or US Treasury bonds as the reserve asset of the world. Now, all fair. And listen, I think you make excellent points. I'll say this as well. You know, we've gone from what used to be economic cycles. Now we're theoretically just in credit cycles. And those credit cycles are

have lasted a lot longer than I probably thought they would have. But if we're sort of at the end of one, your point about the hockey stick growth, I mean, there's going to be a period of austerity without question. And I think that's probably manifesting it in some of the earnings revisions to the downside in terms of the S&P 500. But let's just talk about the dollar a little bit more because I agree with you. I don't think the dollar is going to lose its reserve status politically.

Yeah.

When you have $37 trillion in debt, whether you want to admit it or not, a weak dollar actually works to your advantage. So speak to that. Well, yeah, look, so I think this is one of the things that I talked about on our paper, right? So the debt situation is...

Needs to be fixed right so we have this ridiculous 7% wartime non non wartime Deficit that's led to this gigantic amount of debt now that debt to GDP Sounds untenable, you know a debt to GDP at 120 130 percent or something like that until you realize that number Whoa, what's Japan's Oh close to three up close to 300 and then and then the other thing is that

You know, I spent most of my hedge fund career looking at corporate credits. OK. And when you look at corporate credits, you look at things like, you know, you look at you look at stock to flow metrics like that, like the debt to GDP equivalent in the corporate world would be, you know, debt to EBITDA, for instance. Right.

But what else do you look at? You also look at the strength of the balance sheet. You look at basically stock to stock metrics. You look at the assets that the company has. You look at the cash. You look at not just debt to GDP. You look at a whole bunch of other things. And in the world of

Sovereign credit you also have to look at the intangibles like the strength of the military the strength show the strength of US cultural persuasion this the the the the fact that we have oceanic buffers that mean that we don't need to spend money on defending those those oceanic buffers the fact that we have the largest number of deep water ports in the world all of these things right and

So one thing one thing that I found really, really interesting in one of the podcasts that I believe was Howard Letnick gave it where they were talking about this notion of using this sovereign wealth fund, which has historically only been with countries running big, you know, surpluses.

But using the sovereign wealth fund, not just to address industrial policy for the country, but to try to marshal and monetize the left side of the economy.

of the U.S. balance sheet because everybody just focuses on the right side of the U.S. balance sheet. So when you think out of the box like that, I think that the debt to GDP metric doesn't look as scary.

It's it's I still think, though, that it needs to be addressed. But but, you know, it's not it doesn't mean my point is that it doesn't mean that the the imminent demise of the U.S. is around the corner. Far from it.

No, I'm with you on that without question. I mean, historically, though, that 130% threshold is something to be concerned about. But you bring up the points that there are other things working in the US's favor. And obviously, Japan is more than twice of what we're seeing. But they have their own issues without question. But I'll also mention, if you look at China, right? China's PBOC balance sheet, I believe its debt to GDP is something only like 80% or something like that, right?

But it's a farce of a balance sheet because all of its debt, all of its debt, as you know, is basically at the local level. And all of the LGFVs, the local government financing vehicles, are basically bankrupt. So if you actually had to consolidate its debt—and by the way, you know, China is going to—right now is being forced into a position where it needs to do exactly that because if they need to—

bail out at state banks or if they need to basically do a debt jubilee to stimulate consumers because that's their fundamental problem, the lack of a consumer driven economy, that that off balance sheet debt eventually makes its way on balance sheet. And if you fully consolidate it, China's China's debt to GDP is something like 350 percent.

But to your point, it's all sort of housed, you know, domiciled in places that people don't pay attention to until they do. And I think we all agree. I mean, there are obviously some there's a confluence of events right now that are going on that puts at least our equity market on somewhat tenuous ground. And you're seeing it manifesting itself.

in the volatility index. But let me just take you to commodities real quick, because this is important to point out. When you were last with us, and again, I said it was September 15, 2023, people can go back and look, but I do actually remember this. Crude oil had spent the summer rallying. And I think by the fall of that year, when you came on with us, was trading about $91 or thereabouts, probably the highest level we had seen in quite some time. But you came on

And you were sort of counter trend. You're like, you know what? This is unsustainable. And you gave a number of reasons why you thought crude oil was going to actually start to turn lower. By the way, that was the ball's high. I want to point out to people. It was that September of 2023, probably within a week or so of you coming on with us. So here we are at the other end of the spectrum. Nobody seemingly likes crude oil here. But there is a price that if crude oil gets below, it starts to hurt people.

domestic producers. So what's your sense now, two and a half years later or two years later in terms of the crude market?

Yeah. So I, okay. So I have a very nuanced view of oil. I've been focused on oil very much because, you know, one of the last deals that I did before I retired from active hedge fund management was basically play in the distressed oil sector. And I have a oversized, you know, post equity, post reorg equity from one of the restructurings that I did in 2018. So, so with that as a backdrop,

Um, in, I began in early, early 2021.

Was when was the last time I was truly bullish oil because I saw confluence of factors I saw the Biden administration turning very Vocally at least hostile against the oil oil and gas industry I saw Basically the Fed was basically pumping the economy and the Treasury was pumping the economy, right and

Um, so everything was in its favor. When did I, I actually started turning bearish in April of 2022. Um, it wasn't, uh, wasn't the total peak, but it was when oil was probably around like 120 at the time. And what I began to see was number one, those oil prices at that point were unsustainable, but I really began turning, uh, bearish when, when you and I started talking because it

Around that time, I can't believe exactly when Saudi Arabia started its unilateral cuts. But I said at the time, you know, while I appreciate it from the standpoint of my oil and gas private equity, that the Saudis are unilaterally supporting the market, this is an unsustainable situation because it's

They're number one. They were fighting the Fed at that time, right? The Fed had basically been late to the game in terms of Dealing with inflation and they finally found religion now at the same time the Saudis were basically trying to support the price of oil by unilaterally cutting 3 million barrels per day, you know withdrawing 3 million barrels per day what's untenable about that is twofold one

They were basically subsidizing U.S. shale, including my Permian Co., which I thanked them for. But they were also subsidizing the rest of their cheaters within OPEC+, namely Russia, Iran, and UAE. But thirdly, the biggest issue is that at that time, fighting the Fed, I wrote a piece saying that in this clash of titans—

the Fed is ultimately going to win. Because if you think about their respective tools, the Fed's tool and its tool chest, which is interest rates, is ultimately a demand destructive tool. But

OPEC's tool in supporting the oil price is ultimately also demand destructive, but has this additional pernicious effect of keeping the Fed even more vigilant on inflation. So it's a really double-edged sword that they were playing with. And so since that period of time, I've basically been selling every geopolitical rally. I've been saying that the real geopolitical risk is to the downside because

Saudi Arabia is now in this spot where they cannot, they have no exit strategy, right? And I even said over a year ago that should Trump win, expect a Q125 surprise where he will convince the Saudis, maybe it's in the form of a security guarantee, to basically start relaxing their

their their unilateral cuts. So when you saw oil a couple of weeks ago really collapsed, what happened there was OPEC plus finally said, you know what? They had already they had already signaled that they were going to start relaxing their cuts, but they wound up pulling forward three months worth of their cuts. It was very, very interesting timing, mind you, Guy, because it happened right at the same time that Trump unveiled his tariff strategy.

Right. So so that really collapsed the price of oil. So that brings us to today. So, look, I don't like shorting a commodity that's in the hole now. Right. But I don't I also don't think we're out of the woods yet, because, number one, what would make me turn bullish on oil now? A couple of things have to happen. I need to see Saudi Arabia fully exhaust its spare capacity. Right.

And they're still very, very far from that. I need to also see that, you know, post, you know, there are rumors that we're about to do another deal with Iran and there's potential, potentially a peace settlement between Russia, Ukraine. I mean, you know, the news flow is conflicting every day. But if that happens, that's going to put incremental barrels, OK, on the market.

And obviously the trade war matters. So the sustainable bull market ingredients are lack of OPEC plus spare capacity, the Permian peaking. Now that's the one thing that I will say is that with oil down here, you're getting very close to guys stacking rigs and basically delaying their completions, right? Pulling their frat crews, right?

But in talking to people in the industry, I also hear that, look, it's probably going to take about six months before you even really see that that pullback in production. But when it hits, it will hit pretty hard. So so, you know, so so so I'm looking at that. That's the one thing that I'll say is that that that could support the price of oil into the 50s.

But the demand, a lot rests upon demand too, right? Because the tariff situation, I think, ultimately is going to be net-net deflationary because depending on what survives, it's going to cause demand destruction of everything, not just commodities. Right.

And, you know, you had a tweet out, I think, within the last 24 hours or so. And you said basically with two charts, I'm watching oil and gold as in quotes, peace, black swans. So I think basically what you're saying is you just sort of addressed it. I mean, this is probably something that people are not watching, at least not through that lens.

Yeah, I mean, again, oil, we already talked about why I think the real geopolitical risk is to the downside of that's already somewhat played out. But, you know, with gold, it'll be really interesting, right? Because I think with especially with Trump at the helm, you have to just expand your mind to the possibility of very wide tail scenarios. And and, you know, I spoke on an interview a couple of weeks ago about how

you know, one black swan that would be a good thing for the world is the potential of peace breaking out in areas that have been war torn for a long time now, right? Russia, Ukraine being number one. And then, and then, um, the, um, you know, Iran, you know, uh, Hamas, Israel, um, entanglement. So, so if any of these things resolve themselves, uh,

it could be a black swan for certain assets, right? And it could, so I'm watching, right? I'm watching gold, watching oil. You gotta watch, you know, defense stocks. So who knows?

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one of the most anticipated alternative investment events of the year where deals happen. Thousands of curated one-on-one meetings, cutting-edge thought leadership, and unmatched networking opportunities all in one place. To explore more about iConnections events and gain access to its members-only platform, visit iConnections.io.

Talk about gold real quick because, listen, you know, I've been on this gold wagon for a while and for some reason it's working out and I've gotten something right over the last couple of years. But with all that said,

Is this just as simple as, again, concern around some policies here, obviously. Central Bank's been buying gold now in record amounts for the last four years. But maybe as equally important, just the weakness in the dollar. And if somehow those things abate, could we see the gold trade end as quickly as it started? Well, so the problem I have with gold is that

is that I've never really understood what it is. Is it an inflation hedge? Is it a deflation hedge? Is it a safety trade? Is it all the above? Is it none of the above? So this is the problem I have with it. I fundamentally think it's kind of a chameleon trade. Bitcoin is kind of like that as well. I mean, it's kind of a chameleon trade. And

What's what's your exit condition? How do you determine when to get off that train? I mean if you've been on the train congratulations, but how do you how do you know when to get off and

I, I'm, I'm not sure how to answer that question. I don't, I don't know. It's, it's hard. Nor do I, but this takes us to, you know, you do something called musings of the day. And again, if you're not following Mike on Twitter, it's at urban cowboy and it's spelled K A O B O Y. Everybody should be following. I've been following you for, no, it's, it's one of those things that I look forward to.

But one of the things was tips on how to survive the Trump 2.0. Yes. Get into them. But, you know, one of the ones is really interesting. Make linear extrapolations off of Oval Office tweets and the vituor per tiv hyperventilation that follows at your own peril. First of all, words I don't use, but, you know.

But this one, number three specifically, and this goes back to a couple of things. Now, without question, I think over the weekend or maybe I don't know what it was, but President Trump put out a tweet about Jerome Powell. And at the end of it, I'm paraphrasing to a point, but it said,

I can't wait until his termination. Now, that's a chosen word, termination. He didn't say, I can't wait until his tenure is up in May of 2026. No, he said termination. And that scared the bejesus out of the market, and the market acted in kind. But to your point, if you're making bets on the back of this, do it to your own peril because...

Earlier this week, he walked the entire thing back. So how do you make heads or tails of all of this? Well, but see, I feel like memories are so short. Have people forgotten the volatility during Trump 1.0? I mean, I feel like, why is this a surprise to anybody, right? Because like he, I call him the long gamma president because like you need to effectively be long gamma during his presidency because of this factor, right? So like just the simple mental model with respect to the linear extrapolations, right?

If you think that like basically his rhetoric at least follows kind of like a sine wave, right? So what? Are you going to basically try to make linear extrapolations here? Because like you're going to basically get chopped to bits if you try to do that. So I think what's much more important here is this concept of

just understanding what the underlying economic statecraft goals are, because I'm definitely of the school of thought that it's actually, it's not so much that Trump is shaping the real politic of the day, it's the other way around. These big forces that have been in play for over 10 years now in terms of the shifting of this liberal world order,

That's basically what has brought a persona, a cult of personality like a Trump to the fore, you know, to basically as a response to the shifting real politic of the day. And at its core is this, right? So for decades now, you've had China essentially –

run its top-down GDP targeting economy based upon real estate now now they But it's not big based on supply demand of real estate It's based upon the fact that they needed to urbanize a largely peasantry peasant population from the 60s and 70s and

And they did a great job with that and they kept people gainfully employed. But what they also did was build tons of ghost cities. There are now 100 million unoccupied housing units with another 100 million in process that'll probably never get finished. So that real estate jig is up. So what do they turn to? The CCPI of Sauron has now trained itself on industrial capacity.

So that results in this runaway assembly line, I call it, right, where it's just churning out goods regardless of economic profit or loss. So, you know, gone are the days of what globalization was meant to do in a true globalized economy guy.

It's based upon comparative advantage. If you're a fisherman and I'm a peanut farmer, we do our respective trades and then we trade with one another and one plus one equals three. We have the benefits of free trade. That is not what we have today. What we have is we've got this runaway assembly line based upon a hostile industrial policy, number one, from China, but it's also based upon their need to keep the runaway assembly line churning.

So what I fear is that, so I, from an economic statecraft perspective, I wholeheartedly support what the administration is doing. Now, their bedside manner could be a lot better because the worst outcome that could come out of this is that if the leaders of the EU, for instance, truly side with China versus the US in this trade war,

they would effectively be letting the proverbial

you know, wolf or, you know, or, you know, Fox into the hen house, right? A hundred percent. Right. Because, because the runaway assembly line, if it's shut off from the U S global consumer that consumes 35% of global consumption, if that is really cut off from them, where do you think all of those goods wind up? That's right. But you know, we were the ones that let that Fox into the hen house 50 years ago. Exactly. So that it's got to change. It's got to change.

And it's interesting, and I know you have views on this. I do as well. And by the way, politics aside for all this stuff, but I think the administration views things binary in terms of wins and losses. And if you have a trade deficit with another country, by definition, you have to be losing. Now, that can be true.

I don't think it's true by definition, though. I mean, to your point, there are trade deficits. That's just sort of the lay of the land. But I think what you're pointing out is in the case of our biggest trade partner, well, one of our biggest trade partners in the form of China, I mean, there are problems. My problem is, and maybe it's a negotiating tactic, I have no idea, but to label every trade deficit as losing and therefore go on this sort of global stampede

To me, that's somewhat problematic, but maybe there's a method to madness. Well, so here's my take on that, right? So a lot of people obviously had pointed out the flawed math behind the tariff calculations. To me, that was basically a rationalization

to be able to come up with this ridiculous opening gambit, right? Because one thing, as you know, is the art of the deal tactics of this administration, which is if your desired goal is X and you open with something that's 5X, and then if you end up at something that's like 2X or X... You win. Yeah. Okay. You know what? People are going to say that you caved, but is that really a cave? I think of the tariffs as...

broadly in two big categories. And I've not heard of anybody really think about it this way, but this is my own interpretation. I think that there are certain tariffs and we're going to hear about some of these upcoming sectoral tariffs, right?

That are coming. I think that those are going to be what are what I call long-term incentive modifiers I think those tariffs are going to be sticky big and sticky for a good reason because I think those in Senate long-term incentive modifiers Have to be in critical path industries and for critical path industries. I'm thinking energy chips drugs the shipbuilding industry, although that's not really like a tariff issue it's more of like the port addressed by the port fees and

And then and then also rare earths, right? Those those five critical path industries. But then you have the punitive reciprocal tariffs, right? These are what I call short term negotiation tools. So so what I think is that the punitive tariffs, the reciprocal tariffs are going to be traded down to probably relax down to zero.

But but what are what's going to be sticky? At least I hope if I were advising the president, that's exactly what I would do. I would say that, you know what? I don't care if our tchotchkes and T-shirts and coffee mugs are made in China or Cambodia or wherever.

Those are going to go to zero. I really care where my chips are made. I really care where my rare earths are coming from. I really care where energy is coming from. So I expect those to have longer-term stickiness. At least that's my hope from an industrial policy standpoint.

Before we get out of here, I know trying to game out the stock market is not necessarily your thing, but we've obviously, the downdraft we've seen since the middle of February, I think it was around Valentine's Day, has been as dramatic a move to the downside we've seen. The market has recovered probably half of that move, but when you look at the stock market as sort of a monolith, what are your thoughts here?

Well, you know, I, I, I just expect more volatility. Um, I'm not a day trader. Um, um, you know, so, so I tried to, you know, my, my own PA is like a super concentrated, you know, amalgam of like a couple of event driven names, a couple of names that are like current pay. Um, and then, you know, I'll trade some, I'll, I'll do some macro hedges, you know, around the edges, but you know, I, I'm not a day trader. Um,

The market still seems kind of expensive to me. But I'm not one to own passive beta. So that's neither here nor there for me. So I don't pay that much attention to that. I pay attention to idiosyncratic. What I think is interesting in situations like this, Guy, is...

I like event-driven names that have some sort of catalyst to ultimate value realization. And when event-driven names get slammed because of beta factors but not because of its specific event, that's when I pounce. That's where I see tremendous opportunity in this type of volatility.

Makes a lot of sense. And again, folks, if you're not following Mike, it's at Urban Cowboy is his Twitter handle. You should follow him on UrbanCowboy.com. And again, cow is spelled K-A-O and Cowboy Musings. I mean, this is somebody that

you know, should be far more mainstream than you are. I know you keep things close to the vest. I am fortunate to know you and you are fortunate. Um, well not you, but we are fortunate to have you join us. I know the audience has enjoyed it and two years long. Hopefully we'll be back a lot sooner. Thank you, Michael. Very grateful. Thanks guy.