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Q2/H1 Hedge Fund Letters – Letters, Conferences, Calls, And More

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With the Fed tightening credit late in the economic cycle, asset bubbles are poised to burst. Crescat is positioned to capitalize. We know how to capitalize on a credit bust. In 2007, when the US housing bubble burst, Crescat Global Macro Fund was up 79% net for the year based largely on our US housing bubble macro theme and our positioning around it. We were ahead of the curve and it paid off nicely. Back then, we were short homebuilders, mortgage originators, banks, and brokerage firms all supported by our fundamental equity model. We were short Bear Stearns and Lehman Brothers. We were long precious metals. That is how one makes money in a credit bust. It is ten years later today, and we believe we are again at the top of a global credit cycle. Based on our macro work, China today is home to the largest credit bubble in history, and it is past due to burst.

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In our analysis, China is a $33 trillion bank-credit Ponzi scheme that is destined to implode. In terms of on-balance-sheet banking assets compared to GDP, it is more than three times larger than the US banking bubble prior to the global financial crisis. It is even larger when one considers an additional $9 trillion of off-balance-sheet shadow bank credit. There are also credit and housing bubbles today in Australia and Canada. These are linked to the credit bubble in China. The chart below shows these three credit bubbles today and compares them to select past bubbles that led to severe financial crises:

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Being ahead of the crowd on getting short a bubble that is poised to burst means there may be some short term pain until the bust kicks in. We have to be positioned now because the imbalances are simply too extreme. We have great positions and we are confident that these bubbles will burst soon and that we will reap the rewards, particularly in our hedge funds. We encourage investors to get in before it happens, before our next big run up. Until it does, we have some long hedges in our hedge funds and we follow strict risk controls, but based on our macro and fundamental equity models, we are simply finding that there are substantially more prudent opportunities on the short side of the market today than on the long side. Therefore, we remain net short global equities in our hedge funds and positioned for the bust.

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June preliminary performance for Crescat’s three strategies is below. Our defensive-oriented long health care positions were a bright spot in June. Shorts in auto parts retailers, technology stocks, and oil producers also generated gains for us our hedge funds last month. Unfortunately, our short positons in China, Canada, and Australia in our hedge funds worked against us for the month. Our precious metals longs also worked against us in June. We remain long precious metals because they are extremely undervalued today relative to the global fiat monetary base. We believe they will shine again as an important haven when the China bubble bursts. We strongly believe our short-term drawdown is temporary and unsustainable. In July to date, China, Canada, and Australia short themes are working positively for us and our hedge funds are up month to date.

Our Q2 Quarterly Investor Letter will be out soon discussing our forward looking macro themes and analysis and last quarter’s performance attribution in more detail.
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Sincerely,

Crescat Capital

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