WBD314 Audio Transcription
Sovereign Bonds & Bitcoin with Lyn Alden
Interview date: Friday 26th February
Note: the following is a transcription of my interview with Lyn Alden. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.
In this interview, I talk to Lyn Alden, a macroeconomist and investment strategist. We discuss Tesla buying bitcoin, MicroStrategy's billion-dollar raise, hitting a $1 trillion market cap and the sovereign bond market.
“Yield curve controls are like rocket fuel for all of these inflationary assets. If they try to suppress yields while inflation moves up this summer thats rocket fuel for all these scarce assets.”
— Lyn Alden
Interview Transcription
Peter McCormack: Lyn, how are you?
Lyn Alden: I'm good, thanks for having me back.
Peter McCormack: It's always a pleasure to have you back. We've got so much to discuss, I can't believe how much stuff has happened since we last spoke; the basics I've got written down here: $50K Bitcoin, $1 trillion Bitcoin, Michael Saylor borrowed another $1 billion, Tesla investing in Bitcoin, Stone Ridge. I mean there's so much to get through, it's been just weird. Just for me, because I only look at Bitcoin, it's been a weird month. I don't think I've ever experienced a month like this, but you look at everything else; is everything else crazy?
Lyn Alden: Yeah, probably the craziest thing outside of that is the bond market, the sovereign bond market. Have you been following that?
Peter McCormack: No, you tell me what's going on with the sovereign bond market?
Lyn Alden: So, yields are spiking in a way that is getting somewhat disorderly.
Peter McCormack: What?
Lyn Alden: Yeah, if you look at, for example, the ten-year treasury, that was pushing up nearly at 1.5% today. So, if you look back since where it was in August, it was back down at like 0.5% and over the past few weeks in particular we've seen a global increase in sovereign bond yields.
Peter McCormack: What's driving this?
Lyn Alden: It is kind of rational because for a while now, most of those sovereign bond yields were below the expected inflation rate, both the measured inflation rate and the inflation rate that a lot of those markets are pricing in; so now we're kind of getting this sharp meaner version where those yields are pushing up, and that is going to test central banks around the world to see if they want to try to control the long end of the curve more than they're already doing.
Because most of them have -- their major buyers are their central banks, but they're only willing to buy a certain amount, so they don't look like they're just outright monetising debt. So now, some of the private market participants are reasserting themselves and driving yields up, and so we are going to test a couple of things.
For example Australia, they have yield curve control on, I forget what duration it is; it might be their three-year or something like that, or their three-month, I forget which duration it is; but they have a specific target on one of their treasuries and so, because it broke above that, they announced a round of purchases to basically try to maintain that peg. So, there are eyes on what is the Fed going to do if their long end keeps pushing up. It's getting pretty interesting because that pushes down valuations of growth stocks, tech stocks, so we have seen that kind of sharp perversion where tech stocks are going down.
The reason I bring it up is because that has probably played a role in Bitcoin's correction, because when you get that sharp uptick in bond moves, you tend to get like a push down in a lot of these kind of duration assets. Bitcoin's overall correlation changes throughout the cycle; sometimes it's correlated to the S&P 500; sometimes it anti-correlated to the dollar; sometimes it's liquidity play.
But mainly it's correlated to its own halving cycle, so an adoption cycle, but it can have these shorter-term correlations, so it seems to have been caught up in some of these bond yields going up and growth stocks going down thing that's happening. It looks like it decoupled a little bit today but overall, that's certainly something I'm watching.
Peter McCormack: All right, so probably an easy question for you, but how are the bond rates set; does the central bank set them; is it a market force?
Lyn Alden: Well in theory, it's a market force. So basically, the way it works is that the central banks, they mostly set the short end of the curve. They use some of their operations to basically enforce the overnight lending rate and then theoretically, all the yields from there, as you get into a three-month and two-year and five-year and ten-year and 30-year, those should all be set by the private market supply and demand. So, the governments sell them and whatever the market thinks is prudent, they buy them.
Now in recent years ever since 2008, that's been not the case, because some of the biggest buyers of those sovereign bonds are central banks. So, central banks create new money and buy the bonds associated with government issuance. So basically, if you are the biggest buyer, you are obviously impacting price.
Now, it is not always the case where they push prices down, so for example if you look back in 2008 to 2014 it was an ironic case where whenever the Fed started buying more bonds, yields actually went up, so bond prices went down. That's kind of the inverse of what you'd think but basically, they're providing liquidity to the system. But if they really want to go all out, they can suppress yields; so that's why people are talking about yield curve control and things like that.
The last time the Fed did that was the 1940s and we're seeing it in a very minor way in Japan and Australia. We're seeing, for example, spread control in the ECB where it's kind of informal, they haven't really announced it, but they don't want Italian bond yields to get too much higher than German bund yields, basically for the sake of fairness; so they're targeting that like maybe 1% differential to avoid a repeat of what they had happen in the European Sovereign Bond Crisis back in like 2012.
So, it's really kind of a turning point for markets, because we're going to see how far central banks are willing to go to prevent their yields from rising too much and increasing their government funding costs. So for example, if you do yield curve control, like if you go back to the 1940s, the Federal Reserve said, "No, we're not going to let yields go above 2.5%; we're going to print money and buy any bond that try to go above that percent".
So, they can do that but then the release valve is the currency, so they basically lose control of their balance sheet size, the currency is taken out to the woodshed, and you have things like commodities scream higher because you go to deeper and deeper negative real yields. So, even gold in particular would be the legacy asset that does really well in that environment after its recent correction.
Bitcoin also should. If they were to enact that, that should be great for Bitcoin, but I'm kind of watching in the medium term because as yields go up, that can put pressure on a variety of these things.
Peter McCormack: What is going on here though; is there anything sinister? What's your most simple explanation for somebody who isn't an economist, who doesn't understand these things like you do? Like, is there something sinister going on here? I'm going lay that up with something else right and it might be not connected.
I've noticed recently over the last two weeks on Twitter, a lot of people are sharing passages from the book, When Money Dies; there's a lot of that going on. It's a book I haven't read, I have got it on my audible, I'm preparing because I've basically started walking every day for an hour and I'm going to go out later and I'm going to start listening to it. Is this anything to do with whereby, I seem to remember some of the passages people were sharing are things about, as a currency is about to collapse, everything starts to get weird?
Lyn Alden: I think it depends on what you define as sinister, but basically what we're seeing with this bond move is theoretically rational. Bonds should pay a yield that is above the inflation rate; that's how it's worked for most of history. So, if it's not working like that, that means that bondholders and especially cash holders, because they have low yields too, are just getting killed on a real basis. So, it's natural for long duration bond yields to try to push up above the inflation rate, so that part's not sinister; that is totally normal. The problem is that if you have governments with a 100% that's GDP or in some cases much higher, they can't afford to pay 2%, 3%, 4% interest on their debt; they basically would have a fiscal crisis.
Generally, we have talked about this before in these long-term debt cycles, they often end with a currency de-valuation; because any country that is a monetary sovereign, meaning that it issues its own currency, there are virtually no cases of them defaulting in nominal terms on their government debt, because they also issue their currency; so instead, what they do is they'll default in real terms, so they'll have inflation run higher than bond yields for quite a while in something called "financial repression", and it's really bad for bondholders and cash holders. So that's the general path that we seem to be headed towards where the central banks will basically prevent that from ever kind of reflecting positive real yields.
Now, this is the period where we're seeing that tested, especially depending on what central bank you look at. I mean, the Federal Reserve as the operator of the global reserve currency, they don't want to come out and say, "We're monetising federal deficits; we want to totally override the market". They're using language, "Keep arm's length", and so the market's calling their bluff and says, "Okay, we're going to jack yields up and see what you do"; so we're going to get kind of tested I think, yeah, later this year.
I mean it's happening a lot quicker than people thought but basically, as we progress through months and this year, it's kind of going to be an interesting test. It's the opposite of last year because last year we had this big deflationary shock, we had all this money thrown it and now we're kind of on the opposite side of that; we're getting the rebound; we're looking, hopefully later this year, more and more re-openings and people getting past this virus; and uptick in commodity prices; more of these stimulus effects kind of increasing money velocity and things like that; and that's where we test.
Okay, we can look at the governments to say, "How are you feeling about 2% or 3% bond yields on your 120% debt to GDP?" So, we'll see what happens.
Peter McCormack: It's interesting, I was interviewing Balaji the other day and we were discussing the nation's state case for Bitcoin adoption. I'm not sure if you've read his article about his case for India to adopt Bitcoin; it's brilliant. If you haven't, I'll send it to you. But, as part of the conversation, he talked about the fact that he actually thinks we're approaching the stage of currency wars now. Increasingly, some countries are perhaps wanting to get off the dollar as its reserve. Certainly, we're going to see pressure from China but also, we've got Bitcoin in the mix now. Is this something you're expecting?
Lyn Alden: Yes, and I covered that with the article from a while ago called, The Fraying of the US Global Reserve System. That went into Triffin's dilemma and this whole issue, and it's a topic that I've been covering even before then; but that was kind of my complete thoughts on the matter. So, what we're seeing is a couple of things.
One is, for the past almost 50 years, we've been in the petrodollar system. The way that works is that pretty much anywhere in the world the only currency you can use to buy oil from oil producing nations is the dollar. So, if France buys oil from Saudi Arabia, they have to pay in dollars, even though neither of them have the dollar as their currency. That was because of deals that the US made with OPEC back in the 1970s and they've been able to enforce that with trade deals and military protection, things like that. It's basically like a global gangster thing.
Peter McCormack: That's what Balaji said, it was more about the military protection.
Lyn Alden: Yeah, pretty much. So, we basically said, "Okay Saudi Arabia, you will basically be under the umbrella of US protection, we will protect the supply lines like the shipping lanes and things like that, but you have to sell your oil in dollars; and then whenever you get those dollar surpluses, go ahead and reinvest them in the treasuries".
That worked for a while, because the US was the biggest importer of oil and commodities in general, and basically we were a very large force. But over time, as we have seen the rest of the world grow, the global percent of GDP that the United States makes up dropped from something like 35% down to like 20%, which is still big but it's hard to kind of have that global lock on oil when you're roughly half the size of the global GDP that you used to be.
Now, China's the biggest importer of commodities, and so it's kind of posing an issue. And so we've seen, for example, that's where you get into kind of military stuff, where we've had some smaller nations try to price oil in dollars in the past and it hasn't really worked out for them; they tend to get invaded and then they quickly go back to pricing in dollars.
But starting a couple of years ago, Russia made the move where they said, "Okay, we're going to sell all of our treasuries, so we're going to de-dollarize", and so their central bank invests heavily in gold and euro-denominated assets. Then they also said, "We're going to start selling oil predominantly in euros", so they have been increasing their sales to Europe in euros and also to China in euros, as well as some of their local currency as well.
Going back to India, they have been having oil and arms deals where they actually managed to sell some of that in rubles. So, we're basically seeing Russia lead that trend and now, of course, we're seeing China accelerate their digital currency initiative. They're now the world's largest trading partner with most countries around the world, and so of course when you have nations like that that can't be attacked, that can't really be physically threatened, do that; that's a much more credible change to the system than we've seen in the past.
So that is where you get trade wars, you get sanctions, you get things like that; but there's really not a ton that can be done about it. And actually, I've argued in my piece that the United States eventually needs to turn away from the system too, because even though some people in the United States are benefitting from the current system, many people in the United States have actually been harmed by the system; because in some ways, we've had another type of currency war for a long time, which is basically that most countries try to devalue their currencies so they can keep running export, like trade surpluses, to the United States, and the United States has had a 50-year trade deficit.
Basically, this could revert and balance that structural imbalance out as the global monetary system shiftsg but of course it's going to be interesting changes along the path; it's never going to be a smooth ride.
Peter McCormack: Has oil ever been settled in gold?
Lyn Alden: I'm not sure, but you can go back to, for example, Luke Gromen would make the argument that Russia has basically been selling oil for gold for years now, because what they do is as soon as they get the dollars or the euros, they just plough that into gold on their central bank balance sheet. So, you can have countries that certainly settle in things that are other than dollars to treasuries.
Prior to this current system we had the Bretton Woods system where the dollar was backed by gold, and that was a different way of settling trade; and so indirectly, yes, you had oil settled in gold back then.
Peter McCormack: So, I guess some people are looking forward and thinking, "Well, will we ever settle oil in Bitcoin?" I guess it's too volatile right now, which is probably one of the reasons why. Am I thinking the reason that Russia settled in the euro is because it's still a stable currency and still a widely accepted currency?
Lyn Alden: A couple of reasons: one is it's a really big trading partner for Russia. I mean, Russia provides something like 40% of Europe's natural gas. I forget the exact number, but it's a very significant percentage, and so that is a very big trading partner for them. It is the second largest currency in terms of global reserves around the world, and so basically they said, "We don't want to do the dollar, but we'll do euros".
The tricky thing with Europe is that there's no euro bond, right, so basically countries never hold their reserves in cash or at least mostly they don't. Russia actually did, they held some of their reserves in physical cash, because they were concerned about sanctions; but for the most part, they hold it in sovereign bonds. They take the surpluses they get, and they reinvest in sovereign bonds.
So, reserves consist of treasuries, they consist of all these different sovereign bonds, but Europe has no central bond issuance. You have to invest in German bund, you have to invest France's sovereign bond, and then they generally don't want to invest particularly in Italy's sovereign bonds; and so that kind of limits, to some extent, how far Europe can go as a global reserve currency, but especially for Russia, it's been appealing for them along with gold.
Peter McCormack: Right. Is that because essentially, the euro, am I correct in this, I heard this before, it's a monetary union but not fiscal union?
Lyn Alden: Exactly, yes.
Peter McCormack: Yeah. So in terms of -- sorry, this is just some stuff that I'm learning about. For example, these French bonds, how do they actually handle that situation because if they don't actually manage their own currency, are they in a slightly different position; because in the US, where you've talked about, they can pay back in nominal terms but they can also drive-up inflation, so the purchasing power is lost, but they can still pay it back, what do countries in Europe do, because they don't actually control the money printer?
Lyn Alden: This has been a critical issue for Europe because the United States, Japan, UK, they're all monetary sovereign whereas Europe they're not; and so, that's one of the reasons we've seen, if you look at fiscal spending as percentage of GDP around the world during this Pandemic, Europe has not been able to do as much, because they have to agree with each other.
Italy can't just say, "We're going to do what the United States did and come out with a 15% of GDP fiscal stimulus, and then we're going to do it again next year, and we're going to basically have our central bank buy a lot of it as needed", because Italy is not monetary sovereign and neither is Germany, neither is France. So of course, some of the countries that have lower debts or better fiscal positions, they don't want to accommodate some of the things that some of, say, the Southern European Countries need.
It's been a tricky environment because the monetary union, in some ways, has hurt Italy more because if they had like a weaker currency, their exports would be stronger, and so it has really kind of benefitted the export powerhouse of Germany at kind of the expense of some of the Southern European countries. It is kind of just a flawed union at the current time; it's a pretty tricky thing for them to do, because it's one of those things where it's based more on politics than on sound policy.
Peter McCormack: So because of that, has the euro essentially strengthened against the dollar, because I'm just trying to look it up now; I'm trying to imagine that the euro has probably strengthened against the dollar at this time, because they haven't had the money printer go brrr as the dollar has.
Lyn Alden: Over the past year, yes. We've had the dollar weaken versus many currencies, including the euro; and the euro runs very large current account surpluses, and so it kind of has that floor that keeps it pretty strong, but you kind of get that trade-off. So, if they do less fiscal stimulus, you should get a stronger currency; but then also if, due to less physical stimuluses, if their economy kind of stagnates, that can make people maybe not want to invest too heavily into them, and that can kind of weaken the currency. So, you kind of get that middle of the road currency strength where it's neither weakening nor is it strengthening too much.
Peter McCormack: Okay, it's interesting here. So, we've kind of got our exit plan for coming out of the COVID crisis from our government. Thankfully the kids go back to school in 11 daysm which I can't wait for. I love my kids, but home schooling isn't the most fun. Then we've got this gradual opening up of the economy, non-essential shops, so hairdressers, gyms and stores will be opening up; I think 10 April, I think it is. And then in May, we've got entertainment venues; and then I think by June, they're looking to have most of the economy opened up, and they're even talking about you won't have to wear masks indoors by June/July.
There's a big festival in the UK called the Reading Festival end of August; we have Reading and Leeds. They said they're going ahead; they said these festivals are happening. So, it feels like over the next six months, we're going to get back to some level of normality, with any hope. There's this general kind of, even though we're still in lockdown, Lyn, there's this general glow of happiness around people.
I had to pop in and see a friend earlier and just drop something off at her store, both of us we're like, "It feels like the end of the road here". Are you expecting like a bounce back to the economies? A lot of businesses that I know have struggled, a lot have gone under, some are going to need finance and loans, some of the ones that have gone under are going to be replaced by new businesses; but are you expecting some kind of economic boost?
Lyn Alden: Yeah, my overall base case is for pretty high nominal GDP in 2021, because you're coming off really weak base effects; so when you do year-on-year comparisons, it can be pretty high. Then also, yeah, you have that surge of certain types of demand that are pent-up demand and certain ones that are not. So for example, restaurant demand is an example where, for the most part, it is not pent-up, because you can't go back and replace all the meals you missed, right. You can go and you can have a couple of extra meals for a few weeks and people get that out of their system, but some of that economic activity was lost forever.
Whereas travel, for example, you might have people want to say, "I'm going to take two trips instead of one trip this year", or you might have more travel like that. So, overall, I do think that we're likely to see it spike up and that's when it gets interesting, because countries around the world did these massive fiscal stimulus packages, that bonds were in large part bought by the central banks, and so that directly increased the broad money supply; but it's been offset by a reduction in economic activity, a reduction in velocity of that money.
So, if you have an uptick in economic activity and velocity, with that increased monetary amount of money in the system, that's when you can get an inflationary spike. Of course, countries did it at different rates. So the UK increased their money supply by something like 10% year over year, whereas over in the States we boosted our money supply by 25% year over year; we've been like the cowboys of the money printing. So, yeah, we'll probably see it at different rates around the world, but it's going to be fun to watch.
Peter McCormack: So, with that, what kind of things, measures, are you going to be looking at in the economy? What is going to be the impact on the markets; what do you think? The strange thing is you still track the S&P and it's still performing very well. Are we expecting that to continue; or is there going to be this really weird thing that the economy is going to come out of a glut, and then we're going to see the S&P drop or something?
Lyn Alden: That's actually quite possible and so, one of the things we're watching now over the past week is, we're seeing a rotation. So the overall index is sagging a little bit, but under the surface you're actually seeing really big moves, which is you're seeing some of the unprofitable, extremely highly-valued tech stocks that have done extraordinarily well in 2020, and a lot of them were up 100%, 200%, 300% year on year, a lot of those are sagging really hard; whereas you have things like bank stocks or energy stocks surging. And of course energy is surging because energy prices are going up, because we have reduced supply and demand is starting to return a little bit, and so they're liking that.
With bank stocks, they benefit from a steeper yield curve, so when the ten-year treasury, the third-year treasury, when they go up, banks like that because their business model is based on borrowing at the short-end of the curve and lending at the long-end of the curve; and because also, higher 10-year, 30-year bonds, that should keep up mortgage rates and things like that. So, you're seeing that rotation from basically growth to value, in things like banks and energy. If you were to get higher and higher yields, that should continue that rotation.
One of the things about the United States market is that our S&P 500 is very kind of tilted towards those growth tech names, and so it tends to be kind of worse for us if we have that rotation; whereas UK, if you look at the top, it's energy companies and commodity companies and some financials and things like that. It's a little bit more value oriented.
That is generally a rotation we're seeing and so it's going to be interesting to see Bitcoin is traded more like these growth stocks, and so it will really throw people off if it continues its post having a bull run, because all these bears are thinking, "Okay now the Bitcoin trades done, it's going to roll over like the growth stocks", but if it starts trading like a commodity and keeps going up, that is going to throw a lot of them off.
Peter McCormack: Wow, okay, so we should get into Bitcoin because it's been wild, Lyn. Let's start with the $1 trillion market cap and there's something I want to ask you. A while back I spoke to Travis Kling and he said to me, "The thing about Bitcoin is, there's a lot of people who can't invest in it because the market cap's too small, it's too risky. Once you get over $1 trillion this actually opens it up to more investors". How much can you tell me about that?
Lyn Alden: I mean, there are a couple of things. One is, some of them, for a while until we're getting these kind of institutional custody solutions, they couldn't invest in it even for regulatory reasons, regardless of size. So, I talked to investment managers, they were like, "Yeah we looked about self-custodying, but we can't self-custody investments". For example, they were used GBTC the Grayscale Bitcoin Trust as their way to do it.
But we now we have the build out of Fidelity, we have some of these other like NYDIG or SkyBridge, some of these other institutions that are coming out with institutional grade products. It's basically, the onramps for institutions to put it in are much easier, and so we've basically have been in a situation where liquidity has been an issue. Even if you were going to invest and if you are running $100 billion fund and you want to put a 1% position in, they are worried that that $1 billion purchase is going to move the market. Back when Bitcoin was $100 billion and then the percentage of that that was actually liquid was lower, that would move the market.
Now we are seeing that, for example, Michael Saylor can do $1 billion purchases and it probably moves the market a little bit, but you're not really sure. You're kind of watching it and you're assuming he's probably in there buying, but as long as they do it smart and they spread their purchases out, it's basically a liquid enough market that you can absorb $1 billion purchases now. So, basically that $1 trillion threshold and that liquidity threshold, that really kind of does make it a macro asset.
So, it's basically somewhat normalised I think now over the past year for some of these institutions to have a non-zero Bitcoin position. It doesn't sound like they're whacky, they're not going to get fired for even recommending it.
Peter McCormack: Well, it could be the opposite now. I was listening to a really interesting interview with Hamish Baillie from Ruffer and he was talking about their Bitcoin allocation and he said, "Obviously, we went into the market and a lot of people were surprised that we were investing in Bitcoin; but we did, and we agreed to a 2.5% allocation. But then the price appreciated, so we actually decreased our allocation because we wanted to maintain…", I think it was around 2.5%; which leads me to another question.
If more institutions are creating this allocation percentage that forces them to buy or sell depending on the current price, do you think that's going to lead to a little bit more stability in the pricing, or do you still think we are still going to suffer from the volatility?
Lyn Alden: My base case over time is that as it becomes a bigger and more widely held asset, that its volatility should go down. We haven't really seen that too much so far with the post-halving cycle drawdowns, but if you look at things like market cap versus realised cap, each cycle has been by that measure less volatile than the one before it. So, my base case is that that would continue and that if you see more dispersion, including these institutional holdings, that you're likely to get a little bit more stability there.
As an example, I hold Bitcoin in multiple different ways. For example, I have the cold storage holding, but I also have portfolios that some of my members and clients look at it and use for their own inspiration. And so, for example, in those brokerage accounts, all have something like GBTC as my Bitcoin allocation, just because that's the options available on that sort of account.
I have done occasional trimmings to basically maintain that below a certain threshold because it's not like -- there are people that actually follow that and have to maintain the volatility at a certain level. So, there are certainly other portfolio managers like that that are doing a similar thing where they might have had a 5% Bitcoin allocation, and then it bloomed to 20% and they have to reduce it a little bit. But then on the same token, if you were to get a big selloff, you might get some of them come in and say, "Okay, we got to boost up our Bitcoin allocation because we're going to rebalance". So, if it becomes that more widely held asset, it benefits from that rebalancing cycle.
Peter McCormack: Okay, you can explain something to me that nobody's done in a way that I've been able to understand yet. Can you explain the GBTC premium to me?
Lyn Alden: So GBTC is not an ETF; it's a closed-end fund. So, basically, they don't quickly issue more shares as needed in order to maintain their premium above NAV around zero, like an EFT would. So, basically if you look at a closed end fund --
Peter McCormack: I think even that, I'm thinking about other people who don't know this. Can we explain what happens with an ETF then?
Lyn Alden: Sure. It's probably simpler first to explain closed-end funds that don't do that. And so, closed-end funds, they've been around for decades. What they'll say is, "Okay, this manager is going to go ahead and buy like 20 stocks and they're going to an initial public offering and they're going to take in $1 billion. And they're going to use that $1 billion, and they're going to build a portfolio of stocks". Then basically, that portfolio now trades publicly. It is basically organised as a company and so, you can buy shares in that company and all that company does is hold these stocks.
What's interesting about that is that company is not necessarily issuing more shares. There are a certain number of shares outstanding and they hold investments in their account. At the end of the day, you can look at all their investments and calculate what their portfolio's worth. If you just kind of add it up, that's their net asset value or NAV.
Then the market can then price those shares or whatever it wants, and sometimes it might say, "Okay, even though we've done the calculations and if you add up all the investments that that company holds per share, it's $25 a share; but we want to get in on the action so much, we really like that manager, so we're going to pay $28 a share". So, you are basically paying a premium over NAV.
On the other hand, most closed-end funds trade at a discount to NAV, because that fund charges a fee on the investments and so if you basically trade at a discount to NAV, you are basically factoring out the fee, essentially.
Peter McCormack: Right, I think I know what's going on. So with GBTC, the fact is it's very hard for some of these people to -- there's no ETF, it's very hard for people to buy Bitcoin, so the premium exists, but just because these people want exposure?
Lyn Alden: Exactly, they're saying, "I'm willing to buy Bitcoin at a 10% premium, because otherwise I can't have Bitcoin, because in my brokerage that's the only option available to me", for example. That happens with some popular funds but yeah, it's been particularly happening with Bitcoin fund.
So, then, of course, you get arbitraged people come in because when Grayscale issues new shares to basically buy more Bitcoin, the people that they credited investors, like high net worth or institutional investors that buy into that kind of launch, they get to buy in at NAV; they don't have to pay the premium. But then they have a lock up period where they can't sell the shares for six months and then six months later, they can sell them at whatever the market price is, which is normally a premium.
So, there's been arbitrage opportunity where someone can buy into a Grayscale share issuance and then on the side, they can also short Bitcoin. So, basically what they're doing is that over that six months, at the end of that trade, they want to take that trade off and they'll capture that premium spread with Grayscale. So that seems to be going away now because we've had a number of other -- there's more competition basically. We now have a Canadian ETF.
Peter McCormack: We have Michael Saylor's shares; MicroStrategy shares.
Lyn Alden: Exactly, that's why MicroStrategy was trading at a premium for long, and still is. I made this argument before; if you're running a mutual fund, you can only invest in stocks, but you happen to be privately a bitcoiner, you're bullish on Bitcoin but your job is to run this fund that can only buy stocks, what do you do? You allocate to MicroStrategy, because that's one of your ways that you can express bullishness on Bitcoin within that portfolio. And so MicroStrategy also basically would trade it at essentially a premium to what it logically should.
Peter McCormack: Yeah, but as more of those become available, I guess we have Tesla now, we have Square, we have this Canadian ETF as you say. I think there's even a Swedish one; I'm not sure on that. I guess that is the competition then, but I've also seen the note that the GBTC premium, did it go negative for a moment briefly?
Lyn Alden: Very briefly, yes. It briefly did when we had that big selloff, it went negative. And so for the past couple of months, it's been decreasing, and that's just because of competition; but then when you have that decreased premium and then you get a sharp selloff, yeah, it went briefly into negative territory, which is interesting.
Peter McCormack: Is it risky; are there any risks associated with that?
Lyn Alden: I would say not many. The biggest risk is not your keys not your coins problem.
Peter McCormack: Of course.
Lyn Alden: So you have counterparty risk. I mean I think they use Coinbase as their custodians, so you're basically hoping that there's not going to be an utterly massive hack or fraud, or something like that, and you're basically trusting the security of that custodian. Other than that, there's not really risk. But that's kind of a tail risk, because they have something like $20 billion of Bitcoin that if they were to screw up that custody, I mean that would be a headline.
Peter McCormack: It would be good for the rest of us, though.
Lyn Alden: Yeah, pretty much.
Peter McCormack: It would push up the value of our Bitcoin. So, do you think there's an ETF coming; do you think this is also like a signal an ETF is coming, because the SEC is pretty good; I know Hester Peirce is, I think she's pretty keen on an ETF. Jay Clayton wasn't so keen, but the fact that there is now an ETF in Canada, that does put the US slightly behind. Do you think that's like pushing and giving the SEC an incentive to reconsider this?
Lyn Alden: I think so. I think the bigger Bitcoin gets and the more that other ETFs exist, the harder it is for them to justify no ETF. They can't really use the volatility, because there are some crazy ETFs out there that are triple leveraged or triple bearish ETFs. There are absolutely crazy products out there, and so a Bitcoin ETF would by no means be the most volatile ETF on the market. So basically, it's just ETF that gives people exposure to a $1 trillion asset, a macro asset. So, it's really hard to justify not having one the bigger it gets.
I think Cathie Woods of Ark argued that $2 trillion is a threshold, but those are all estimates. Maybe $1 trillion definitely puts it on the radar and then as you get Canada with their ETF, basically it looks increasingly silly if the US isn't allowing one.
Peter McCormack: Does the Gemini Trust then become an ETF; does it convert into an ETF; or does it just carry on as it is?
Lyn Alden: You mean the GBTC the Grayscale Bitcoin Trust?
Peter McCormack: Yeah, sorry, yes not Gemini; Grayscale.
Lyn Alden: Yeah, they might. I don't know the full history; in the past they were one of the ones that filed to become an ETF and it didn't really work out. I was speaking of Gemini; I think they a while ago filed for an ETF. You have VanEck Vectors, they're a popular ETF provider. They filed for an ETF, so it would make sense for some of these either to launch an ETF or to convert to an ETF.
Basically, GBTC without the premium, they do have an incentive to basically convert to an ETF, and it's also going to put increasing fee pressure on them because Grayscale, I think, charges something like 2%. Whereas if you look at SkyBridge, Mooch's fund, they charge lower and so over time you should get more and more competition to basically push down these fees.
Peter McCormack: Funny you say that because while we were talking the Mooch just texted me; what does he want? He's telling me there's some huge news. Stone Ridge filed with the SEC to become the first open-ended mutual fund to buy Bitcoin.
Lyn Alden: There you go.
Peter McCormack: There you go.
Lyn Alden: The bigger this asset is, the more that these normal products should exist.
Peter McCormack: So, let me ask you about this. Stone Ridge have filed with the SEC to become the first open-ended mutual fund. What does that mean; what's an open-ended mutual fund?
Lyn Alden: So, those are actually in some ways if you were looking at what Vanguard was doing for a long time, you'd have these open-ended mutual funds. When you think of a classic mutual fund, you could put money into this kind of actively managed, or in Vanguard's case, passively managed fund. Before you had the emergence of ETFs in the 1990s, that was the classic fund. So, you had mutual funds and you had hedge funds for credit investors.
So over time, because ETFs are -- I mean, one is they're publicly traded; and two is they're more tax efficient. So, we have seen a shift from mutual funds to ETFs, although mutual funds are still a much bigger market. It's just that it's like a giant melting ice cube that's kind of moving more towards ETFs.
There are actually even funny cases where there are mutual funds that under the surface just hold an ETF because it's more tax efficient. It's funny how that works but basically that's another kind of traditional vehicle that 401(k)s and all these big investment pools of money can invest into. So, yeah if they can get an open-ended mutual fund that's powerful. That's more brokerage access for people that don't want to hold Bitcoin that still want to have allocations to Bitcoin, but don't want to have like a Trezor or something?
Peter McCormack: Does the ETF have to hold Bitcoin, physically hold it?
Lyn Alden: Not necessarily. There are ETFs for commodities and all they hold is futures. They need to have an allocation in some way; how they go about that allocation will depend on how they file, what their prospectus says, and then what regulators allow.
Peter McCormack: It's got here, I've got the SEC filing, it says, "Seeks to generate returns by gaining exposure to the price of Bitcoin by selling put options on Bitcoin futures contracts. Its strategy may also invest in pooled investment vehicles such as registered or private funds that themselves invest in Bitcoin". They are here now; Stone Ridge are part of the game.
Lyn Alden: Yeah, I'm not surprised.
Peter McCormack: Okay. The next thing I want to ask you about is, how the hell can Michael Saylor borrow $1.05 billion at 0% interest; and how can I do the same, because I would like to?
Lyn Alden: I would like too as well. The main reason he's able to is actually kind of the same problem. Let's say you're running a bond fund and you want to have Bitcoin; you happen to be bullish on Bitcoin, be running a bond fund, right. So, Michael Saylor, what he did was basically those are convertible notes. So, if MicroStrategy stock price moons because it's holding Bitcoin and Bitcoin goes up to six figures, whatever the case may be, those bonds in several years' time can be converted to MicroStrategy stock, so they can participate in some of the upside above a certain price threshold.
So, that's basically a way of saying that for those bonds they have virtually no downside risk other than if MicroStrategy defaults, right. So, say if some tail risk happens and Bitcoin goes to zero and their cash -- I mean, they still have cash flow so even then, they should be able to pay those bonds. But let's say for some reason they can't repay the bonds, that's basically the tail risk that those bond holders have; but on the other hand, if Bitcoin goes up a ton, they participate in some of that exposure.
So for them, it's a slightly more conservative way to invest in Bitcoin where they don't get all the upside, but they also have some volatility downside protection, except for like the tail risk. So for them, if you're running a bond fund and you happen to be bullish on Bitcoin but the only thing you can invest in is bonds, you say, "Well, I'll take some of these convertible MicroStrategy notes and I'll just have that as like 2% of my portfolio sitting over there; and if Bitcoin moons, then I'll opt out from all other bond funds. If it doesn't, then it doesn't matter; it's a small percentage".
Peter McCormack: Preston Pysh tweeted about this. He said, "This is what you can do when your balance sheet is doubling every few months".
Lyn Alden: Yeah, pretty much. He went into this with virtually no debt and tons of cash, and so the first steps were to turn the cash into Bitcoin, and then to issue debt against it; and so because he's hardcore bullish on it, he's willing to take that risk. So far, he's not had regulators seemingly have an issue with it, he's not really kind of run into issue, and so it's worked out great for him because he's been able to buy Bitcoin. In some ways, he's dollar cost averaging into it in chunks; he's putting cash flow into it and also doing these occasional bond issuances.
Peter McCormack: He's million-dollar cost averaging now; what a baller! Okay, another thing I want to talk to you about is obviously Tesla. I did not really see it coming. Obviously, we've memed Elon Musk continually and everyone's harassed him, and he's finally done it. I was still surprised, and I was still surprised how much. You look at someone like Square run by Jack Dorsey that has invested $50 million and now another $170 million; Tesla just comes straight with $1.5 billion. What did you make of this?
Lyn Alden: It's interesting because it's kind of the middle of the road play, because it's not all in like Michael Saylor; but it was something like 10% of their cash. The reason that some investors weren't really expecting it is because Tesla doesn't really produce free cash flow. They don't really make money from selling cars; they make money from selling equity.
Peter McCormack: They make money from Bitcoin now!
Lyn Alden: Yeah, they have actually made more money from Bitcoin than their entire history of selling cars ever. Until this past year, they never really made an accounting profit; and then they finally made an accounting profit, but it's very small and it's really only based on tax credits and stuff. So, cars are like a loss leader for them and then what they really do is issue new shares, because there's always investors happy to buy in and then so that's how they got all their cash; and then they put some of that cash into Bitcoin, and so it's kind of funny to see.
Whereas Square, they now have something like 5% of their cash into Bitcoin. Square, in some ways, has been the expected model and so when people were talking about corporations putting Bitcoin on the balance sheet, most people envisioned it as a small percentage of their balance sheet and they would expect it. I mean, Square was a natural first mover, but it's funny because we had MicroStrategy come out of nowhere as the actual first mover, and they went all in.
Now that we're seeing things like Square and Tesla put a smaller percentage of their cash into Bitcoin, that's the model you can perhaps see more regularly, because few companies are going to go all in, but many companies might say, "Okay, we have cash yielding near zero with inflation expectations rising. Why would I not have a small Bitcoin hedge in case my cash gets impaired by inflation?" They can hold things like Bitcoin and say, "Okay, if Bitcoin goes to zero, our 5% Bitcoin position doesn't matter; but if Bitcoin goes up 10X, it's basically hedged the rest of our cash position".
Peter McCormack: Well Tesla's other risks, like you say it's not highly profitable, but also I was reading this morning that I think over the last year, they've done something like 13 discounts on prices reflecting they have a potential demand issue; not unsurprising as we're in a pandemic and potentially they've even got a supply issue, because I've been trying to buy my dad a car recently and you just can't get a car till August. So, I wonder if any of that's partly to do with it as well?
Lyn Alden: He's kind of a natural marketer, and so I personally think that Tesla stock is very overvalued compared to what it is worth, even taking into account future growth in some of their growth avenues. I think the current price is very high, so I personally will not invest in Tesla even though, for example, once MicroStrategy bought Bitcoin, I actually did invest in that in one of my portfolios; because I had the same problem in that in that account, I had no other way to hold Bitcoin and I wanted to have that performance in that portfolio.
So one of the ways I did was, I allocated to MicroStrategy; whereas I wouldn't do it for Tesla because one, their market cap is several hundred billion dollars and Bitcoin, they bought $1.5 billion of it, so it's a very small percentage of their market cap; and two, I don't like the fundamentals of Tesla compared to the valuation. Whereas, MicroStrategy even though I didn't like the valuation, I was like, "No, this is enough that I can put a small position in and let it moon", and it did.
Peter McCormack: But you're not going to short Tesla, are you?
Lyn Alden: Not now. Occasionally I would short it as like a hedge, but then take that short off if it went above a certain price point; and this is not a super attractive market for shorting, but I do think that a lot of these really highly valued tech stocks that are unprofitable, like the Ark funds and Tesla and some of these others, I do think that they could have a pretty significant price correction over the next couple of years.
Peter McCormack: I think the interesting thing to think about something like Tesla is how I think of my little business as a microcosm, but I've told you before that I've been holding Bitcoin on the balance sheet and my capital position now is quite interesting in that, if I want to grow, you know, we're a team of seven now; if I want to grow beyond that, if I really wanted to ramp up, I'd have a choice of always bootstrapping, taking on investment and losing equity, or I can actually use now the Bitcoin that I've got on the balance sheet.
My problem with that is I don't want to sell the Bitcoin ever. I did this interview recently with Jaime Leverton, the new CEO of Hut 8, where she was talking about they use their Bitcoin, they borrow money against the Bitcoin, because they don't want to sell the Bitcoin, it's more of a pristine asset. It'll be interesting in a company like Tesla in the future if they need more money, whether they would consider selling their Bitcoin or just borrow against it. It would be really interesting to see.
Lyn Alden: Yeah, it makes sense, and you should get pretty low rates for that sort of borrowing. I think that's an attractive model, because that is the role of Bitcoin as pristine collateral. For Tesla, I mean at their current time, because Bitcoin's a very small percentage of what they hold, I don't think they would borrow against that; but in the future, if you were to have Bitcoin to have like an extra zero on its price or something, then that would be a much bigger percentage of their assets, so they could use that certainly as a source of borrowing if they wanted to. The funny thing is, I haven't checked their credit rating recently, but I think they're still junk rated, Tesla.
Peter McCormack: Really?
Lyn Alden: Let me check it now, because until this year, they were actually a junk-rated company because if you looked at the numbers, they just weren't producing income and they had that and people were concerned about a lot of it; but because ironically the stock price did so well and they were able to issue so much equity, they got a ton of cash on their balance sheet.
It's been a funny thing where Elon Musk has basically memed Tesla into solvency, because the massive increase in the stock price allowed him to issue equity and get a ton of cash. So now actually, he's ironically improved the fundamentals of Tesla by being a really good marketer.
Peter McCormack: The strategy that Jim Cramer put out yesterday for GameStop, he said they should issue a bunch of stock and then spend the income on Bitcoin.
Lyn Alden: Yeah, I saw that and to follow up, Tesla is on the highend of junk rated.
Peter McCormack: Wow.
Lyn Alden: So, it's funny because that's just how this year has worked. That's 2020 in a nutshell and 2021.
Peter McCormack: 2021 has been a lot better than 2020 so far.
Lyn Alden: Yeah.
Peter McCormack: Okay, a couple of things to finish out on. I did want to talk to you about the borrow and lending market, the likes of BlockFi, etc, but I think I'm going to save that until next month because I'm going to do an interview with Zac Prince and cover that; so I think I'm going to save that for next month.
A couple of things I did want to talk to you about, going back to your report, which by the way I say to everyone every month, is brilliant; I love it, I've subscribed. Subscribe. It's in the show notes, Lyn crushes it. What did I pay; like $199 for the year?
Lyn Alden: Yeah.
Peter McCormack: It's so cheap, Lyn, that's too cheap. Go and subscribe it's in the show notes. But I've actually written something down here, with regards to the price of Bitcoin, you're saying, "The higher it gets, the less asymmetric it gets the opportunities in this cycle, and we may be in for some high volatility, lengthy consolidation. Can you talk me through that?
Lyn Alden: Yes, I mean I started covering Bitcoin back in 2017 like I have talked about before, back in November 2017, and so back then I expressed concerns about the price. I was also concerned about the Bitcoin fork and things like that, and so I sat on the sidelines. I wasn't one of the Bitcoin bears, but I also wasn't bullish on it.
So, as we had improving fundamentals in 2018/2019, the forks were sorted out, we had the improving network effect, we had institutional great custodians; in April 2020 is when I got quite bullish on Bitcoin. And then, I increased bullishness up through about June, and then just been super bullish since then.
My point was that as we go along this halving bull market, people started to buy in at these higher price points and especially, a lot of retail investors tend to get caught up in the motion, then they're more likely to go in at the top. So, there's smart money that buys in early or like leverages early, like MicroStrategy did and what you did; but then there's always these concerns where, if you look back in 2017, there were investors that bought Bitcoin with leverage at the top and then there was like stories of them getting crushed when Bitcoin falls, however much it falls.
So my point was that, as we go on this bull market just be cautious with the amount of risk you take on, because Bitcoin back when I went long at $6,900 was a no-brainer. I was like, "This thing could up 10X or more and so it's like the case for having it --"
Peter McCormack: It's already nearly done that! We've done 8X; we did an 8X over $58,000!
Lyn Alden: Yeah, exactly we've done 8X. And so, that was such an asymmetric move but then as you get kind of deeper into this halving cycle and the on-chain indicators start to get more heated, it's a bit more consensus; that's when it's like, "Okay, now coming in with your massive all-in purchase or leverage purchase", it's like, "Think this through".
Make sure you know what risk you are taking on, make sure you're willing to handle the volatility, because the last thing I want is someone coming in towards the later stages of a bull market and then getting hurt. It's not even that I necessarily think that this is the later stages; I think by most indicators, it looks kind of mid-cycle bull run. But basically, now I still think it's going higher, but it's less of a slam dunk than it was at like below $10,000.
Peter McCormack: Willy said to me the other day, he said, "It's middle of the cycle". I don't know if you get his email too, but he is saying, "Retail has arrived". He was seeing 20,000 new accounts a day or something, so that indicates retail has arrived which is a signal for middle of the bull market. Although it feels weird to say "middle", because a lot of people say the bull market will close out around November. Well, what's going to go on between then?
I have seen such a range of things. I have seen you saying it could get choppy at around $100,000, I've seen other people talking about it going through $200,000, $300,000, $400,000; other people talk about it going much higher.
Lyn Alden: I think that's all fair because it's only been three cycles, this is like the fourth cycle and so that's why I've been avoiding specific price targets. If anything, I give conservative price targets and so then it meets them and it keeps it -- instead of going for the high-end target and then maybe you're not hitting it, I like to put low hurdles and then step over them. It's the Buffet quote; he likes to invest by setting low hurdles and then stepping over them. So, that is how I have approached it.
Certainly, if you look at previous halving cycles, the peak compared to the prior peak, the last time was a twentyfold increase over the prior peak. And so if you were to get that, that's how you get to $400,000. Even a tenfold level over the previous one would be $200,000, but that's where I think you have to be careful about extrapolating too much, because the past is just a signpost. It gives you indicators and so it can overshoot, or it can undershoot either of those metrics by a pretty wide margin, based on what happens in macroland.
So, for example, if we get that yield curve control and if we get a greater institutional adoption, that's where you can get one of those, say, supercycles like some of the analysts are talking about, that's certainly on the table. On the other hand, let's say you get yields rise super far, that could put a dent in the bull run, and maybe the bull run tops at a little bit lower than people expect. There is a pretty big range of outcomes and it's mainly because supply is known and demand is not, so the best we can do is monitor those indicators and say, "Okay, where are the risks; where are the opportunities; How far are we in?" I think by most indicators, mid-cycle is a good way to describe it.
Peter McCormack: I have also noticed with your own work, there's an increasing amount of Bitcoin. There's a like a Bitcoin gravity into your own work. Have you noticed that yourself? You feel you're like looking at it a lot more and writing about it a lot more?
Lyn Alden: I think so because it's certainly been an area of interest that I want to address and it's also like, if you start from zero, you have to build up a knowledge base and build up a research base on it. And so for example, I have a long history with precious metals, I'm writing about those; and so I basically have to build up a foundation of reading for people that want to come in and learn about this asset.
It's also a case of where the money is. So for example, I was writing the precious metal bull market from 2018 to 2020 and then in my August 2020 newsletter, I wrote I could see gold being choppy for a little while and I'm more bullish on Bitcoin; and so it's natural that I've been emphasising more on Bitcoin, because that's the cycle that's been doing well over the past several months and the place has been a source of alpha.
It goes in cycles, like if you were to have a Bitcoin bear market at some point, I probably would write about it somewhat less even though, if there was a topic I wanted to discuss, I would. I was writing about gold back in the bear market and things like that.
Peter McCormack: When you report, when I get my email in, your latest report, I always scroll down to the bottom for the Bitcoin bit first, naturally!
Lyn Alden: There are certainly people that like those segments, yes.
Peter McCormack: All right, brilliant, listen always a pleasure to talk to you. I always learn so much with you Lyn, it's amazing. Anything else you are looking at, anything else you want to talk about before we go?
Lyn Alden: I think those are the main things. I guess the single key thing I am watching from a macro perspective is, what happens with some of these inflation numbers in the next several months as we gradually reopen, and then see how the bond market behaves; and then see how central banks respond to their bond markets misbehaving, because that can really set the tone and set the maths, I guess more specifically, of what happens.
So higher bond yields put pressure on tech stocks, it will potentially put pressure on gold, maybe Bitcoin, we'll see; whereas something like yield curve controls are like rocket fuel for all of these inflationary assets. If they try to suppress yields while inflation moves up this summer, that is rocket fuel for all these kind of scarce assets.
Peter McCormack: Amazing. Okay, tell people where to sign up to your newsletter, please?
Lyn Alden: So, I am at lynalden.com, most of my content's free, I also have a low-cost service; people can check that out. I'm also on Twitter @lynaldencontact.
Peter McCormack: Definitely check it out, I'll put it in the show notes, go and sign up it's well worth the $199 a year. Each report is like a book, so I highly recommend it. Lyn, I will see you in a month, you take care, and as I said I always love talking to you.
Lyn Alden: Yeah, you too.
