The fat tail idea right now

Monday, 24 January 2022 — Melbourne, Australia

[6 min read]

Dear Reader,

The market is under pressure right now. Friday’s market action was ugly.

The open today is mostly red too.

However, I don’t think there is any reason to panic here. Volatility is washing through the global markets as the outlook for interest rates rattle around.

Is inflation transitory? Is it more than that?

We don’t presume to predict the future here at The Daily Reckoning Australia. If we have a creed, it’s that we are never certain about anything.

Nor do we need to be. What we want to find in any market — or under any interest rate — are ‘fat tail’ investment ideas.

These are the only ones worth bothering with usually. They carry massive upside…if they work out.

But, by their nature, they must be either against the herd or massively misunderstood in some way.

Let me give you an example.

Most people treat Bitcoin [BTC] as if it’s some kind of strange asset they don’t understand. But they can also see people can make lots of money from it.

Therefore they don’t mind dabbling in it — say 1–2% of their total portfolio — but they wouldn’t dream of owning nothing else.

And yet that is exactly what one of my friends has done. His entire portfolio is bitcoin.

I’m not recommending you do this. The volatility and risk of such a holding are gigantic.

But think through the implications if bitcoin does hit US$100,000 or above in the next five years. He will make a small fortune.

Of course, if it doesn’t, he may very well see his portfolio cut in half or go to zero if he doesn’t get out in time.

Most of us couldn’t stomach this kind of bet. We’re too comfortable and sensible, and rightly fearful, to place our health, future, and sanity at such a risk.

So we accept the historical market return of 8–10% a year as acceptable. We will likely not get rich this way. But we can get by in a little more comfort than yesterday.

And yet occasionally, opportunities present to put a small stake down that can become an astonishing sum.

The beauty of these is you need not risk your entire portfolio to gain an outrageous return.

These ideas can only come from two areas, really…small-cap stocks and cryptos.

That’s because both sectors offer huge growth potential and are under-researched enough to offer an asymmetric risk versus reward.

I can offer a recent example. I tipped a little gold explorer in December 2018 at 12 cents per share. It was called Chalice Mining Ltd [ASX:CHN]. A subscriber placed $3,000 on it.

He never sold — even through the COVID collapse — and his stake was worth nearly $200,000 when he wrote to me last year.

Chalice is now $8.80 a share…despite spinning out an asset last year too into a separate IPO. A big mineral discovery…one of the best in decades…sent it into the stratosphere.

That was a fat tail investment idea that worked out. Many don’t. Those ones we try to forget…

But it’s astonishing to me how many people do not approach the stock market with this hunt in mind.

I have a wealthy friend that is happy to hold Woolies…BHP…Telstra…you know, the usual list.

When I suggested a small iron ore developer last year, after the iron ore price crash, he balked.

He tuned into the mainstream commentators forecasting its return to somewhere near $70–80 a tonne.

So far, they have been proven wrong. Iron ore is back at $130. And my little developer was up 50% from its recent low — until last week’s market sell down anyway. We’ll see what happens from here.

Every commodity or stock book tells you to buy after a price crash. But it’s never easy because whatever drove the crash in the first place seems so resonant.

Some in the market genuinely believed Chinese property would collapse last year. Buying iron ore stocks was a ‘crazy’ — or fat tail — idea.

And yet, in the last two months, some of the strongest stocks have been Fortescue, Rio Tinto, and BHP. They are set to pay monster dividends in February — again.

Will this continue? I have no idea. But I’m riding the train while it’s there.

Where else might we find a fat tail idea?

I’ve told you. Crypto is likely your best bet now. The market has been walloped recently. People seemed spooked by this, despite this being the very nature of crypto.

As the price goes lower, you should be getting more interested, instead of less.

Fat tail ideas never feel easy. That’s why they can be so damn profitable!

Search for them every day…and who knows…maybe one day you could turn $3,000 into a near $200,000 too.

Best Wishes,

Callum Newman,
Editor, The Daily Reckoning Australia

This week, we explored the pampas. That’s where the US is headed, we believe. Chaotic, divisive politics. Government that plays the public for a fool. Runaway spending. Mountains of unpayable debt. Persistent, and sometimes exorbitant, inflation.

Are we there yet?

We don’t know. But we must be close.

The US is now trapped between two very familiar features of the Argentine landscape: a rock and a hard place. ‘Inflate or Die’, is how the late sage, Richard Russell described it. You either keep the party going by printing more money…or you pull the plug and reckon with the consequences now rather than later.

There are not many métiers where age is a benefit. Finance is the only one we can think of. Richard Russell. Charlie Munger. Paul Volcker. Henry Kaufman. The young investor can imagine anything he wants. But the old timers are sceptical and suspicious. They’ve seen too many great businesses that went broke, too many political promises that weren’t kept…and too many innovations that later flopped.

Henry Kaufman, born 1927, is among the small group of analysts who are still among the quick and still paying attention. Back in the 1970s, as chief economist for Salomon Bros, he became known as Dr Doom for criticising government policies.

But then, in 1980, Paul Volcker, the US’s last honest central banker, got way ahead of inflation. Prices were rising at a 14% rate. Volcker pulled the plug. He put the Fed’s key lending rate at 20%. Within months, the inflation figures turned around. And in 1982, Kaufman saw that the trend of the last 30 years (towards higher inflation and higher bond yields) had reversed; he told investors that the worst was over. He was right then. He’s probably right again now.

As we’ve shown in previous Diaries…if you’re going to stop inflation you must also stop inflation expectations. And that means getting ahead of the inflation rate, not trailing along behind as it goes higher and higher.

Today, to get ahead of a 7% inflation rate, the Fed should put its key lending rate at 10% — or about 1,000% higher than it is today. That would shock the financial world…and stop inflation in its tracks. It would certainly shock us, too!

Will the Fed do it? Kaufman:

‘I don’t think this Federal Reserve and this leadership has the stamina to act decisively. They’ll act incrementally. In order to turn the market around to a more non-inflationary attitude, you have to shock the market. You can’t raise interest rates bit-by-bit.’

On this point, the Fed has already expressed itself.

The Fed will be ‘data dependent’, said Fed Chief Jerome Powell. It will not lead; it will follow where the ‘data’ leads it.

But why? Do Fed jefes lack cojones? Do their hundreds of PhDs lack brainpower? Or is there something else going on? Let’s see if we can connect some dots.

Beer guzzlers versus wine snobs

As we saw the other day, traditionally, beer drinkers are more likely to pay their debts than wine aficionados. The US is a country split between the two. Beer drinkers in flyover country. Wine drinkers on the coasts. Not to pretend to any precision, but you’re not likely to find a good Saint Émilion at a roadside trucker restaurant in Oklahoma. You find it in the fashionable precincts…where the decision makers live and work.

In the US, wine drinkers make the rules. Beer drinkers follow them.

Puzzling? Irrelevant? Is this just a joke?

Here’s the punchline: the most obvious downside of printing extra money is inflation. Inflation is a tax…and it falls most heavily on the beer drinkers, not on the deciders. It’s an extremely ‘regressive’ tax, in other words.

If you earn a million dollars, you may spend only $100,000 of your annual income on inflation-sensitive consumer items — including an occasional ‘grand cru’ from Bordeaux. If they go up 10%, therefore, you pay an inflation tax of $10,000…or 1% of your income. Trivial. Barely worth noticing.

But if you earn $50,000, you probably spend all your income on consumer items — food, fuel, beer, rent, etc. A 10% increase in prices cuts your purchasing power by $5,000…equivalent to a 10% tax rate. As a percentage of income, that’s 10 times as high as the rich fellow. And you feel it; you are noticeably poorer as a result.

And it’s not the fellow with a can of Bud Light in his hand who is going to answer the ‘Inflate or Die’ question. It’s the people who control and influence the government — people in the media…in Congress…in the universities…and most important, people on Wall Street.

For these people, inflation will not bruise their daily lives…neither will it dent their balance sheets. By contrast, a real economic contraction would hit them hard. They are the ones who have gained the most from the Fed’s money-printing lollapaloozas. They stand to be the big losers when the bubble pops.

The entire stock market has a value of US$48 trillion. The top 10% own about 80% of it. Since 2009, they’ve made about US$32 trillion in stock market gains alone.

A real bear market would erase at least half of it. By our reckoning, that’s approximately a US$3 million loss for every family in the top 10%. And if the Fed refuses to come to the rescue with more printing press money, the loss will likely be permanent, not ‘transitory’.

‘Inflate or Die?’ A 1% annual inflation tax? Or a US$3 million loss in a matter of weeks? Which way do you think that will go?

Regards,

Bill Bonner,
For The Daily Reckoning Australia