Crescat Capital: Shorting China And Hong Kong Currencies

ValueWalk’s Raul Panganiban interviews Kevin Smith, CFA, Founder, CEO, and CIO and Tavi Costa, Partner and Portfolio Manager at Crescat Capital. In this part, Tavi and Kevin discuss the opportunity for investing in precious metals, taking an activist approach, shorting China and Hong Kong currencies. Check out the full interview on ValueWalk Premium.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q2 2020 hedge fund letters, conferences and more

Raul Panganiban: Yeah, yeah. Can you tell me about the opportunity for precious metals and the room for growth there?

Kevin Smith: Tavi, do you want to talk about the kind of the macro factors set setting that up? And then I can go more into some of the specific micro things we're doing?

Seth Klarman Tells His Investors: Central Banks Are Treating Investors Like “Foolish Children”

Volatility"Surreal doesn't even begin to describe this moment," Seth Klarman noted in his second-quarter letter to the Baupost Group investors.  Commenting on the market developments over the past six months, the value investor stated that events, which would typically occur over an extended time frame, had been compressed into just a few months. He noted Read More


Tavi Costa: Yes, I'll just go back to the similar thesis I was referring to which we call is a supercharged environment, with the government highly indebted, and the Federal Reserve being forced to step in and buy treasuries. And, you know, Treasury, in our view of the Treasury market remains perhaps the most important market out there with no demand for treasuries and rates moving higher. Well, obviously, the game is over. So we're heading towards we think it's a dead end road. And, you know, I think that it's that dynamic that we refer to the suppresses long term rates and expensive monetary base that will lead to perhaps higher precious metals prices in general, and this is not a problem only in the US. I think we're in the race to the bottom for fiat currencies in general. And we think that the reserve currency, the dollar here in the case of is in better position than any other currency in the world. So it goes that thesis of buying gold and especially relative to the most overvalued currencies in the world, which would be Chinese currency or, or the Hong Kong dollar. So not to mention also the negative yielding bonds that, you know makes it very difficult now to for a lot of pension funds and other larger investors in allocators they're looking for alternatives to actually have a better expected returns in other assets and I think gold and precious metals will serve that purpose a lot more than probably equity markets. And another thing I think it's interesting is is a four year from from having Robinhood traders recently on on bankrupt companies and other types of investments that make no sense for a normal investor. I think that wait until this the traders to start hearing about those golden Silver, you know, Penny stocks that there are out there. And I think those are it's the only the mining industry is the only industry in the world that I know of that would still, you know, it would benefit tremendously from this macro environment of money printing everywhere. And when you look at cross the globe of the total market cap of equities versus what the industry now is worth the precious metals industry, it's somewhere close to less than 1%. So, you know, it makes it makes a tonne of sense to us to, it doesn't need a lot of money to move the needle here to to much higher valuate valuations. And when you look at the tech companies, for instance, trading at you know, 50 6070 times sales when you can find companies in the gold space producers today trading at 10, five, three times for cash flow, you know, that's where we see the opportunity. It's not 60 times sales, it's five to three times free cash flow and I think that's a big difference. So I'm stealing this from Kevin, this is actually Kevin's point about the miners. And I love that because it's so true. That relative, you know, value between the two, the two sectors or industries. So, but anyways, I think we're very excited to a lot of the opportunity. And I think Kevin can elaborate more on this, some of the things that we're starting to work here going forward at Crescat, that I think, just alternatives for for the weight, we're implementing these traits in our portfolio. Kevin, why don't you share a little bit of that?

Kevin Smith: So what what, you know, we've had really in the last business cycle, the expansion phase of the last decade is, is that people have have it because gold did have a pretty big bull market from the early 2000s until about 2010 11. On You know, we've had a bear market for gold and that's gone along with that bull market for financial assets and And you know over that you know app but after a 10 year bear market there's actually been some incredible value that that has been created or that exists today in the precious metals mining industry, whether you look at the bigger companies that are actually producing and generating free cash flow with a low multiples like Tavi's talking about or you go down into the the junior the junior explorer type companies that are just developing gold deposits in the ground in the ground, these companies have been left for dead and in the last cycle and there's some incredible opportunities. So one thing that Prescott is is doing is worried we are getting activist in the gold exploration part of the of the gold mining industry and we're working with with a renowned exploration geologist His name is Quinton Hennigh, and he's acting as a technical advisor to Crescat and he is helping As to identify some of the best gold deposits all over the world that are newer deposits. They're not the same old picked over carcasses from the last cycle for gold. They are exciting new deposits and Quinton is chairman of Nova resources, which is one company we have talked about before, that has developed one such enormously potentially enormous gold deposit in the, in the western region of Australia called the Pilbara to non conventional type of cold field. That is because it's it's it's aggregate gold it's actually very, very shallow and easily accessible, but it's highly dispersed and nuggety. So it's a non conventional type of gold deposit, but it actually can be highly economic and it's fast. But there's there's all kinds of other gold exploration stories out there. Quinton was instrumental, for instance, in in helping to realise the potential of the foster Ville goldmine in Australia in eastern Australia that and he was a key advocate for Kirkland lake to come in and buy that. That mine after he analysed their first drilling results from drilling deeper into what they call the swan zone of that, of that deposit. And, and they discovered what was the, you know, by using newer techniques and going and going deeper with Quinton's guidance, they discovered, you know, what his was the perhaps the richest, you know, highest grade gold mine and most successful mine during the bear market for Kirkland lake. So I'm quite glad he's also been credited with with other big discoveries and so we've aligned with him because people just for some reason People are not interested in the space. And so we're like, let's just go find the best, the best exploration geologists out there and let's go create some value like like what Quinton did with foster Ville on ourselves. And and we've identified with his help, probably a dozen companies, maybe close closer to 15 or 20, actually that that Prescott has been building activist positions in and we're actually by doing private placements in these companies. We're actually able to the public companies that but we're getting them actual money that they can use to put in the ground to develop these deposits and with coatings help we're bringing other technical expertise either either to the board, some cases quoting himself is coming in and going on the board and, and other other technical people that that Quint knows from his extensive experience. In the industry, he started with homestake. Mining 25 years ago after getting his double PhD from Colorado School of Mines. And then he worked for new crest and Newmont and before he started branching off into the into the smaller Junior exploration companies that he's been involved with for the past 10 plus years on, so he's helped us really identify some exciting opportunities. We are taking activist stakes in these companies getting them the money that they need to advance these deposits, and we're trying to recreate the magic like like, happened with that, that foster ville deposit. We'll have a number of exciting stories that we'll be talking about here in some live YouTube broadcast that Tavi and I will be doing along with Quinton in the coming weeks.

Raul Panganiban: Very nice. And I want to know why you have to take an activist approach or are these companies not wanting to do it?

Kevin Smith: Well, the opportunity to get to become activists really has risen. Because of the of the deep value opportunity that there is in a number of of these companies because they've literally been left for dead for and for the past several years and you know, as called, you know, gold mining stocks in general have been in a bear market and it takes a lot of money to develop a successful goldmine and, and there's a lot of, of, of, you know, we know we I call them the picked over carcasses from the last cycle that's what Quinton calls him beat, because there's a lot of ore deposits that have been developed, that that are, you know, people keep keep shopping around as if when the gold price gets gets, you know, back above whatever, you know, 2000 or whatever, again, these mines will be profitable. But the idea is let's, you know, you know, why not, you know, find the mindset that can be like the foster village of the of the of the world that can be profitable, extremely profitable at today's gold prices. And then when coal prices go higher, they'll be even more profitable. I mean, know what we don't we don't need to, you know, we need to find the exciting new stuff based upon the the new geology, that that that will be the winners in the cycle and because the whole industry has been left for dead there actually happens to be a number of these potential gold and silver deposits out there that and Quinton is the one certainly who's identified them already. So by getting activists we can actually bring the capital that these companies need to infuse into the into the companies to to actually develop these deposits and improve them out because it is a capital intensive industry, no doubt. And you know when we can also be an activist also means brain The technical expertise and and we are friendly activists. So we are working in coordination with with the management of these companies. We're not taking an adversarial position we, you know, we want to help them by adding new new technical people to the to the, to the advisory team and even the board on both, but we're doing it in a friendly way. So that's what we mean by activist.

Tavi Costa: Well, aside from the the part of, you know, helping the company to tell the story better, and helping them to set that up in a way that that can help their image in using Quinton's expertise to really help the geologists team of those companies in a friendly way to focus on the right targets of exploration. But like Kevin said, it's a truly is a deep value opportunity. A lot of those companies traded very low market cap valuations today and we're excited I think this is this is a very interesting setup. For the following years for gold and silver, and if that's correct, I think that the whole entire mining space will be value in a much higher multiples. And I think that the whole exploration, Junior exploration space is still to rise significantly here, if that's going to be playing out in the following years.

Raul Panganiban: And for for the other investment opportunities. What else are you seeing globally?

Tavi Costa: I would say that the dollar situation is still is a big part of our thesis and the recent weakness in the dollar is also poses a window of opportunity for us. We're so short that Chinese renminbi and and the Hong Kong dollar, we still have this dollar shortage problem. You know, when you calculate the amount of dollar denominated liabilities minus the us money supply, which includes also the the foreign reserves of other countries and I still In a significant imbalance. And now we have this issue with the savings rate spiking up here in the US. Well, that's also provides less dollars outside of the US and US imports have dropped significantly. You know, it's limiting the situation's limiting central banks from printing money in general in a few places relative to the Fed. They're still printing money, but relative to the Fed is interesting how they have been sort of limited in a way. I'll give an example when you look at the Fed's balance sheet relative to the pboc balance sheet. It's the first time in 16 years, the Federal Reserve has a higher amount of assets then then the pboc. And, you know, at the same time when you have dx y or the dollar just $1 index, so weak recently, no CNH has, you know, can't even rally in can't even appreciate versus $1. In a scenario like this, when you look at the last five years, I know we've been talking about this issue with China for some time now. And a lot of things have been unfolding and people forget when you look at the last five years in among major economies, regardless if it is England or, you know, the whole euros region, or Japan and Australia or Canada, when you put those currencies together and you look at for the last five years, you know, the one is the second currency that devalued the most relative to all of those very few people know that. And so I do believe that with this, especially in emerging markets, space to have rally, you know, there, those currencies have rally significantly versus the Dollar recently. I believe that that's a, an incredible window of opportunity on, you know, especially for the one for shorting the one and shorting the Hong Kong dollar, which in our view are two of the largest credit bubbles we've seen in history as we have elaborated before. And that's still the case.

Raul Panganiban: Yeah. For any new listeners. Can you quickly go over the China and Hong Kong case for shorting their currencies?

Kevin Smith: Sure, and I'll just say, you know, first people might be saying, Well, wait a second, you guys were just talking about how bullish from for gold you are. And now you're saying how bullish for the dollar you are. And it actually makes makes a tonne of sense. And one of the reasons like Tommy just said is that some of the biggest credit bubbles in the world and debt bubbles in the world are not just here in the US but, uh, globally. And you know, in the developed market world, whether it's Europe and Japan with with their debt imbalances or in the emerging market world and China, first and foremost, we think is the largest credit bubble on the planet right now. They've created over $40 trillion of, of credit in their banking system. And that just dwarfs anything in any other country in history in terms of just the sheer magnitude of, of debt that they Have have have placed in their economy. It's been through their banking system. So it's somewhat veiled and hidden from a lot of the other traditional metrics we look at when we look at government debt, but the banks are government owned entities. And, and what they have is a debt in the form of of deposits to the, to their own, to their own people. And, and so $42 trillion is something like three times the size of the US banking system are at least twice. And so, Hong Kong, the Hong Kong dollar has a similar situation and now with with Beijing, you know, coming in with this new national security law, they've effectively for Hong Kong, they've effectively taken away this one country two systems' stance on Hong Kong for one country. One system sent stance and that and that that system is is that that Hong Kong is now going to fall under totalitarianism and democracy is essentially gone. Well Hong Kong's been this this banking centre of Asia for years under under British control and, and and that and you know how much assets that Hong Kong have in its banking system alone amid something like over 3 trillion you look at how the banks have been performing in Hong Kong since the protests have started and money is fleeing that country so that the you know, the property bubble the the the the banking and debt bubble in China and Hong Kong is is another big macro factor and, and, and that's, you know, just want one reason among other emerging market countries And imbalances? Well, we think the dollar actually can can be strong but we like we like gold relative to global fiat currencies in general. That's why our gold thesis for years we've called it the global Fiat debasement thesis. It's not just $1 it it's all currencies that we expect gold to, to rise in.

Tavi Costa: I'm just going to add to a lot of the China and Hong Kong parts, if you allow me, but, it's, you know, it's also part of that the citadis trap idea of Graham Allison, the book that he wrote, in which he looks at the rising power that challenges established power. And he points out 16 scenarios of those that happened throughout history and 12 of those actually led to a physical war between those two powers. It's quite interesting book and, and, and goes back to the thesis of the situation between US and China. Now, when you look at the Chinese economy, aside from the credit bubble that Kevin was elaborating on, you know, There's a lot of other issues that could become more problematic here soon. I mean, disposable income just plunged to the worst level ever in China. More recently, and we have, you know, there's not a lot of pickup and growth recently that we're seeing a personal mortgage is not picking up either. I mean, we've got freight traffic that is still negative in a year over year basis imports, number of imports in a year over year basis actually dropping like almost 20%. And, you know, what we pay attention to is as is the cost of capital as we know, you know, when you have a credit bubble, what really bursts the credit bubble usually is as cost of capital rises, regardless if it is through inflation or, or just defaults, that causes debt to become more expensive to raise and still have you know, even pork prices are still up 80% year over year, the last sprint, you know, they haven't really returned back. I mean, it's been coming down but it's still significantly high. You know, which China is still dominant. factory plant of the world. And I think that after this Coronavirus or virus outbreak that we had and showing how fragile This is relations between US and China in China versus the world have been, I think it's going to be very difficult to see investments going back to China in time soon. When we go back to that macro trade of the century, when you have a credit bubble, and it bursts, usually, especially in emerging markets, what we see is that gold prices in local currency terms tends to rise significantly. And that's the whole play that we're doing in Hong Kong and China, issues are heating up again. And Hong Kong has its own own bubble credit bubble. And you know, like Kevin said that Hong Kong banks have been performing terribly in the last few years and provision for loan losses relative to sales that we point out a few years ago which used to be a record low is even lower than the Asian before the Asian crisis. Now it's uh, you know, approaching double digits and starting to squeeze their their profit I was looking at total deposits for licenced Hong Kong banks, it's contracting again. You know, it's very interesting. And something I pointed out a few days ago yesterday, actually an office, property values are plunging, like 25%, which is just as bad as it was in the global financial crisis. The only difference is that this time we have, you know, their financial system and the banking assets is close to nine times the size of their economy. So, I think there's a lot of issues in those two places and still to unfold and the currency seems to be one of the ways to play it and being long gold in short, those currencies makes you being long gold in those local currency terms. And I think that that's, that's the way we're implementing. That's exactly the way we're implementing a Crescat.

Transcript continues.