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  • Mercenary Daily: Why Vladimir Putin Might Be Toast (And The Oil Price Could Be Cut In Half)

    Some big picture thoughts on oil and gas today…

    In case you haven't noticed, we've seen some volatility lately (sarcasm). Crude oil in particular has been volatile to the extreme, making us wonder aloud if markets are temporarily broken (in the sense of going haywire under various push-and-pull pressures, not functioning correctly as a rational arbiter of price discovery). The next big "stress test" for structural market integrity could come with exchange-traded funds (ETFs). Indeed we are already seeing some stress and strain there.

    On the other hand, oil is also extremely volatile because the future price of oil is very much unknown. We thought this article from Stratechery was fascinating, specifically in respect to the oil question: Uber 2.0: Human Self-Driving Cars. Here are some takeaways (our paraphrasing):

    There are two types of driving, "trunk" and "branch." The first is more important, representing the long work commute endured by most Americans. The second is what happens in major urban areas.

    Uber has built a foundation replacing taxis and handling "branch" driving in part because the economic costs for driving in urban areas is so much higher. The rides within the city are short, the cost of parking is high, and taxis are generally a lousy experience, making it very economical to grab a ride-share. (On our upcoming trip to San Francisco, for example, we won't bother with renting a car.)

    "Trunk" driving, however, has far more impact in the big picture, in terms of all the millions of miles Americans burn up commuting to and from their homes to work each day. Think of the 40 minutes spent in the car, much of it in traffic, as you fight the rest of the city to get to an office by 8 or 9 am.

    Uber could technically have "self-driving cars" within two years, not in respect to replacing the human driver, but utilizing "trunk" car pools - long-commute car pools - in which the driver would have been taking the route regardless. The car is "self-driving" in respect to the fact that the person driving the car already would have been on the commute - and it is thus far less of a stretch for them to decide to become an Uber driver, even while being full-time employed by someone else! Think of picking up a friend or two who was already on the way to the same place where you work - or the same general office park - and they chip in for gas and a little more besides. That's a far, far lower barrier to participation than deciding to become a private taxi, spending a few hours a day acting like a taxi driver, and so on. And Uber would have a very strong case that such long-commute drivers are not "employees" in any sense of the word, but just people who were already making the trip, choosing to incrementally utilize the open seats in their vehicles.

    The average American commutes 5,645 miles per year. We burn insane amounts of miles, and oceans of gasoline, on our long commutes. The next frontier for Uber is using technology to pool "trunk" commuters… which would mean reducing the number of cars on the road substantially, and reducing the amount of gasoline burned on work commutes by substantial amounts.

    And this could happen not a long ways off (waiting for robotic self-driving cars to pass all the tests), but soon, as the logistical problem is fairly solvable: How to make it super-easy for work commuters to pool together, via smart phone technology, where a human is already behind the wheel.

    And so guess what mass ride-sharing by hundreds of millions of long-commuting workers on a daily basis, greatly reducing engine use and total car mileage on the road, would do to gasoline demand and thus the price of oil?

    There is a hedge fund manager making big bets that oil will go back to $25 per barrel. Maybe he is on to something… Via the Financial Times:

    Pierre Andurand, the hedge fund manager who returned 51 per cent before fees last year by betting against the oil price, told the Financial Times that the market had overreacted to signs of slowing US crude production and comments by Opec. He believes prices will head lower again, possibly dropping below $30 a barrel.

    "The market will remain oversupplied in 2016 and 2017," said Mr Andurand, who predicted the 2008 oil spike and subsequent crash. "We need low prices for longer to rebalance the market. There are no quick fixes."

    Oh and how about natural gas? We're looking at a mega-glut in natty supply on the way too… think of what the shale boys did to oil, and then scope this via Bloomberg:

    Cheniere Energy, based in Houston, has spent more than a decade, and upwards of $20 billion, turning 1,000 acres of swamp into the first LNG export terminal in the continental U.S. When the terminal goes live later this year, it will change the dynamics of the energy market in North America. The U.S. will be on its way to becoming a net exporter of natural gas. About 700 million cubic feet of the stuff will begin arriving each day from all over the country-from Texas, Pennsylvania, Ohio, and as far away as North Dakota-to this spot at the end of America's natural gas pipeline network.

    Remember, America is an energy superpower (in terms of proven resources) AND a technology superpower (in terms of new ability to innovate and extract those resources) AND a financing powerhouse (in terms of ability to put capital and investment together causing productive assets to find their way into "strong hands," even if the initial hands prove weak). Put those three things together and… the USA dominates global energy supply, like it dominates many other things…

    Even without big innovations (like Uber cracking the nut of long-commute ride share), we've seen growing signs that "peak oil" is actually becoming "peak demand" - via Medium:

    Most importantly, their demand is going away - not incrementally but fundamentally. Like whale oil in the 1850s, oil is becoming uncompetitive even at low prices before it becomes unavailable even at high prices. U.S. gasoline (and electricity) demand has been falling since 2007 as more people drive thriftier vehicles fewer miles; the same is true in rich countries as a whole. Now major developing countries like China are shifting their energy strategy so quickly toward efficiency and renewables that global "peak oil" - in demand, not supply - could occur in this decade, not many decades in the future as the industry assumes.

    Imagine a future, just a few years from now, where America is exporting crude oil and natural gas like crazy, in part because of majorly increased supply (via extraction technologies) and also in part because of reduced North American demand (via innovations like Uber's long-commute ride-share pooling, Tesla's electric cars, and so on). You know who is stone cold smoked in that future? This guy - Vladimir Putin… and any other petro state players highly reliant on high energy prices.

    The outlook for oil service and the oil majors doesn't look too thrilling either… America on the whole might benefit hugely from a new cheap energy boom, but this is one of those setups where the economics of the industry itself cause poorly positioned players to see their value propositions implode. Unless, of course, Jeremy Grantham is correct in swearing up and down that the frackers are just a multi-year flash in the pan. Fossil fuel energy bulls had better hope Grantham is right… because his Malthusian US production tail-off forecast is about the only hope they've got…

    bullish on technology (if not valuations),

    JL (

    Sep 03 1:34 PM | Link | Comment!
  • Our Approach: Global Systematic Discretionary Hybrid

    We continue to develop the macro links.

    It will be excellent getting these up in the forum (among other things):

    But now I want to tell you more about the Mercenary vision, and how it relates to routines, deliberate practice, and other things. We can understand a lot of this through the evolved trading style that MT deploys.

    To understand the Mercenary approach to markets, it makes sense to start by considering the deep influences - the traders and investors we have studied and reverse engineered over a multi-decade period. These influences can be grouped into four broad categories:

    Global Macro Practitioners. From the very beginning, the global macro titans loomed large - guys like Soros and Druckenmiller and Bacon and Kovner and Jones. I remember reading "The Alchemy of Finance" in college. I underscored so many passages, my girlfriend at that time suggested it would be easier to underline the stuff I didn't think was important.

    Trend Followers. Early in my career I did a deep study of trend followers. I wound up making contributions to the book "Trend Following: How Great Traders Make Millions in Up or Down Markets" - you can find my name in the recognition credits. And I had some interesting experiences with Ed Seykota, during an overlap of years when we both lived in Lake Tahoe. Trend Followers were a strong influence from the earliest days.

    Value Investors. In the mid-2000′s commodities had expanded to fully encompass equities, which in turn led to an expansive study of value investors and value investing. This included the well known practitioners - Buffett, Munger, Klarman, Graham, Whitman, etc - and also lesser known guys and personal friends who were excellent value investors in their own right. Growth investing and activist investing were natural extensions.

    Quants. Finally there was the study of quantitative approaches… computerized modeling… broad classifications of fundamental factors, systematized rule sets and so on. Quant approaches lent new efficiency to market approaches and the possibility of increased scale and scope of trades within a portfolio.

    After many years of experience gathering, tinkering and seasoning, all these elements came together in what one might call a "Global Systematic Discretionary Hybrid" approach. That's a mouthful, but the traditional style boxes don't really apply. Let's break down the words in that description as to what they mean:

    Global. Willingness to go anywhere on the planet and trade any asset class, long or short. Stocks, bonds, currencies, commodities, up or down, you name it. No restrictions here - which turns out to be important for reasons of selectivity and a focus on best-in-class opportunities. The more beaches you can monitor, the better your chances of finding a great wave to surf…

    Systematic. This means logical rules and evolved best practices for trade parameters, pattern recognition, setup requirements and other things. Large aspects of the vetting process are systematized in the sense that very clear rules apply, and the rulesets are precise enough that a computer could understand and execute them. This systematic approach also allows for a "shared language" between traders, in the sense that our parameters are so well defined that other traders can learn to recognize and apply them. This also means a rule-based and somewhat computerized approach to position management, which allows for a larger portfolio of positions.

    Discretionary. This factors in the human element and the ability to vary position size by multiple orders of magnitude. The positions we take can be anywhere from tiny (less than 10 basis points of planned risk) to absolutely gargantuan (e.g. planned risk of half the open profits in the portfolio, with full position size representing high triple-digit leverage, properly safeguarded through limited risk options structures). True opportunities are outlier and fat tail oriented, which requires "courage to be a pig" when the time is right (and only when it is right). Discretion means ability to crank up the conviction dial and deploy capital aggressively, even super-aggressively, as conditions dictate.

    Hybrid. This means our style doesn't fit the traditional boxes. We have elements of all the components mentioned - global macro, trend following, value investing, quantitative - and also elements that are systematized (some things a computer should handle) and elements that are discretionary (it takes a human to know when to bet big). The synthesis of all these elements creates the Mercenary way of trading. We also think it is an approach Jesse Livermore would recognize - Livermore being, we would argue, one of the original go-anywhere macro guys. He would've traded currencies too along with everything else, if there had been liquid currencies to trade back then.

    The other factor here is community-based output. Mercenary has long had community in its blood - "a community of ruthless profiteers."

    When the world is your hunting ground there is great value in having extra eyes and ears. The ultimate would be having a sort of market "God's Eye" - the hypothetical technology in a recent action movie (Furious 7) that allowed the user to "see" through the lens of any smart phone or surveillance cam. With global scanning technology and the right flagging signatures, you could spot far-flung opportunities as they develop anywhere.

    The Mercenary approach - Global Systematic Discretionary Hybrid - is well suited to this "God's Eye" overlay. We trade liquid instruments, and prefer trends of weeks to months if not longer. This allows for community-based awareness of good trading ideas, with time to vet or research or a trade before the window of opportunity closes. Shorter term time frames would be harder to share or replicate in a timely manner. (And as Ed Seykota has observed, short-term trading can bear unfortunate resemblance to short-term flying - traveling coast-to-coast is much easier with one or zero stopovers than with ten, and so on.)

    Our "God's Eye" view of all the worthwhile trends that are developing, and potentially exciting trades that are happening, is first leveraged with the creation of highly efficient monitoring tools. We have begun this legwork with our early "Trend Tracker" tools, now covering dozens of ETFs as well as various major equity, commodity and currency groupings. The Trend Trackers will soon evolve into GATS - our Global Alerts Targeting System which acts as a monitoring overlay for all potential trading vehicles.

    Then, too, it will be important for the community to have a standardized "language" - especially in the forums - as such that a common body of knowledge and best practices are shared. The reason poker players who just met each other can have engaging conversations immediately, much of the time, is because they speak the language of a shared pursuit. Certain terms or ideas, or even advanced versions of the same, are simply implied and understood. This greatly enhances the ef efficiency of communication.

    Within the MT community (and the upcoming Forum) we can do the same thing - create a shared language through the widespread teaching of the Mercenary methodology, along with basic guidelines as to what to look for in attractive trade setups. There can also be feedback ranking of trade submission quality and even reward systems or recognition for excellent idea submissions.

    To further clarify:

    The purpose of the MT "machine" is to generate excellent trading ideas at scale. We want excellent, timely ideas, checking the boxes on all key parameters, with the capability of handling large amounts of capital. This scalability factor is key, and is one of the reasons we show less interest in short-term trading. We want ideas that can "move the needle" on tens to hundreds of millions without running into highly restrictive capacity.

    The secondary purpose of the MT machine is to matriculate Master Traders, and future hedge fund managers, to deploy the excellent trading ideas generated (while adding value themselves). The community aspect of the Mercenary model also has a very strong "core team" emphasis - indeed, it is our plan to expand our roster of Mercenary analysts, and traders and portfolio managers, possibly into the dozens as we rapidly expand. This means a precise vetting process in which potential hires progress through various levels, with the highest level being full-fledged hedge fund manager, backed with MT's blessing, capital and full operational support.

    The purpose of deep dive fundamental research and discussion of general conditions is knowing when to bet big. Again, as we have emphasized over and over, market opportunity is fat tail oriented and follows a power law distribution. The biggest and best trades are not evenly distributed throughout time frames or market environments. They come in clusters and bunches, or sometimes come one at a time in isolated fashion. As such, the ability to bet big at the right time is crucial - and deep awareness of suitability as to general conditions, coupled with knowledge of the trade on all fronts, is what enables this.

    The MT community can act as a collective "God's Eye" - an extension of the Mercenary Mind - by fully understanding the mechanics and subtleties of the Global Systematic Discretionary Hybrid approach and generating idea flow, for all to make potential use of within the community itself. The problem with so many collaborative environments, especially in respect to trading or investing, is lack of well distributed knowledge or even time frames and methodologies working at cross purposes. If one trader is looking for trends that can be exploited for weeks or months, or investment ideas that can absorb large amounts of capital, and other traders are focused on taking 30 cents out of an options trade or two handles off the mini S&P, there will simply be a disconnect. Shared purpose, focus and vision are required, with shared educational levels and knowledge access tremendously helpful.

    This is where ideas come into play like:

    • standardized parameters for trade idea submission
    • social ranking of excellent ideas or contributions
    • creating an environment of open discussion and mental enrichment

    This also helps us see the deeper purpose of the MT Driver's Manual:

    The core purpose of the DM is to help facilitate "Deliberate Practice." We wrote fairly extensively about the different areas of deliberate practice and the importance of engaging those. Proper engagement of Deliberate Practice in the areas of behavior modification, routine proficiency, pattern recognition and mental model building will require access to countless "workbook examples" - possibly hundreds of them - along with valuable in-depth materials that do far more than just present information on a surface level (the thing that most trading books do). The DM is the vehicle for this: A means of adding greatly to breadth and depth of knowledge in all core areas on the path to trading mastery.

    With proper execution, and the inherent leverage of the Mercenary community, our "God's Eye" factor becomes real as the Global Systematic Discretionary Hybrid approach goes truly global. We will hunt for groundbreaking new ways - through technology and tools and social structures and other things - to build collaborative value, in result creating a "whole more than the sum of its parts" with a power and scope never seen before.

    Aug 21 9:30 AM | Link | Comment!
  • Google (Or Rather Alphabet) Is The Future; Berkshire Hathaway Is The Past; And Berkshire's Core Model May Be Doomed

    Google has undergone a major restructuring. There is a new parent company, Alphabet, which splits out all of Larry and Sergey's various moonshot ventures - Google X, Nest, Calico, and so on - which focus on crazy big bets like self-driving cars and human life extension. Google is now a subsidiary of Alphabet.

    The most amusing perspective on this came via @tsrandall on Twitter: "The new parent company will be able to pursue new areas of interest that had previously been off-limits to Google."

    Joking aside, there are multiple reasons why the split-out makes sense. The new structure allows for more CEO spots, rewarding talented executives. Google itself (now a subsidiary) can get back to focusing solely on search under its new CEO (Sundar Pichai) and protecting the company's near-insurmountable lead in search. Google's original founders, Larry and Sergey, can now focus more on the crazy stuff that holds their attention. And it will now become easier to spin off any subsidiary into its own entity (including the original Google) fairly quickly if need be.

    Some have compared the new Google structure to Berkshire Hathaway, even suggesting this new entity is "molded after" Berkshire:

    The new structure takes a page from Buffett, 84, whose Berkshire Hathaway Inc. is a holding company for disparate businesses ranging from insurance and railroads to running shoes and ice cream. In the past five decades, he's built one of the largest businesses in the world by eschewing fads, buying when others sell, and taking a long-term approach to investing. Through 2014, Berkshire averaged annual returns of almost 22 percent, more than double the Standard & Poor's 500 Index.

    "They look at Warren as a hero and Berkshire as a template," said Steve Wallman, a Middleton, Wisconsin-based money manager who has invested in Berkshire since 1982 and bought stock in Apple Inc. in late 2003. He's not a Google shareholder, but says he wishes he were.

    Fellow executives in the technology industry also noted the similarities to Berkshire.

    "Google's Alphabet sounds like a 21st-century Berkshire Hathaway, but with a lot of very large venture bets," Jeff Weiner, CEO of LinkedIn Corp., said on Twitter.

    ~ BloombergBusiness, 'B Is for Buffett' in Page's Plan to Mold Google After Berkshire

    There were old references from Google's founders too:

    In a letter to potential shareholders in 2004 ahead of Google's initial public offering, Page and co-founder Sergey Brin quoted Buffett when outlining the company's long-term focus.

    "Much of this was inspired by Warren Buffett's essays in his annual reports and his 'An Owner's Manual' to Berkshire Hathaway shareholders," the letter said, in the lone footnote at the bottom of the statement…

    The comparison is amusing because the two entities could hardly be more opposite.

    Yes there are similarities in structure between Alphabet and Berkshire. But so what? Saying that decentralized conglomerates are similar just because of their organization chart is like talking about hedge funds as an asset class. It doesn't make sense. (Hedge funds come in countless shapes, sizes, and areas of focus - the only thing that unites them is performance based manager compensation.)

    We concede that it's possible the organizational structure of Alphabet was inspired by a Berkshire flowchart. But that's about as far as it goes in terms of useful comparisons. The interesting thing in our view is that Alphabet is the future; Berkshire is the past; and their core models are radically different. One has a future. The other may not.

    As the WSJ reports, Google had $66 billion in revenue in 2014, 89% of which came from advertising on YouTube and search. Alphabet is driven by a gigantic, hugely profitable advertising machine.

    This hugely profitable advertising machine supports what we would call a "Quantum Evolution" model:

    • Use cash flow from a central source to fund speculative projects on the periphery.
    • Let rapid evolution take place at the margins (small experiments all around the periphery).
    • Eventually, one or more of the experiments experiences quantum evolution…
    • And becomes a cash flow juggernaut in its own right, overwhelming the original center.

    If you imagine a giant circle, Google (the original Google) is at the center of that circle, throwing off huge amounts of cash. That cash is re-invested in all these speculative areas - self-driving cars, smart thermostats, life extension, and so on. Over time, some of these aggressive "quantum evolution" bets - attempts to fast-forward the future - could pay off to the tune of hundreds of billions, or even trillions.

    Doubters think huge innovation bets are a waste of effort. But when a quantum evolution bet pays off, the results can be incredible. Consider, which spent most of its life as a cash-burning e-commerce business. Now, thanks to the stunning profitability of Amazon Web Services (AWS), Amazon is viewed as a cloud computing business with a marginal breakeven e-commerce business attached. It's not inconceivable that, 10 or 15 years from now, Alphabet could be viewed as a self-driving car business or life extension medical technology business, with a modestly profitable search engine attached.

    This "quantum evolution" model (focused on accelerating the future) is robust to the degree that the central cash source is robust (and the Google search engine cash cow appears quite robust, mainly because Google's engineers maintain a pace of innovation and improvement faster than any competitor could realistically match). And the quantum evolution model is failure resistant due to the fact that such a model expects routine failure, and allows for routine disappointment, in exchange for cultivating that opportunity to ultimately score with a moonshot that works. The ability to fail is built into the system, as a form of flexibility and resiliency.

    This is the exact opposite of the Berkshire Hathaway model, which can roughly be summed up as "Leverage insurance float and buy stuff that stays the same." To point out more differences:

    Berkshire says "never lose money." Alphabet is willing to lose significant sums via calculated risks.

    Berkshire focuses on businesses that stay static and don't change. Alphabet drives change.

    Berkshire focuses on past stability. Alphabet focuses on future possibility.

    Berkshire intrinsically fears uncertainty and change. Alphabet embraces uncertainty and change.

    Here is an interesting thought experiment. If you had to put your net worth in a blind trust 100% invested in one of these two conglomerates - Berkshire Hathaway or Alphabet - for the next 20 years, which would you choose?

    Alphabet seems the no-brainer choice. Alphabet has dozens of ways to invent the future, and only needs one or two moonshots to pay off. Berkshire, meanwhile, faces peril at every turn. Some of Berkshire's core drivers, in fact, are under direct assault from Alphabet itself. For example:

    Car insurance. Berkshire derives huge revenue, and "float," from its various insurance businesses, with GEICO the crown jewel. It is not implausible that self-driving cars could completely gut the car insurance business.

    Soft drinks, fast food, and unhealthy consumer goods. Coca-cola, Dairy Queen, Kraft macaroni and cheese… Berkshire is heavily invested in food that can barely be considered food. Tastes are changing here as nutritional science reveals just how awful most of this stuff is, and technology better enables production of healthy stuff (with consumer tastes shifting).

    Railroads. The health of the railroads is tied to physical transport, and especially the transport of energy resources like oil and coal. 3D printing and localized manufacturing are a big threat here. And solar phasing out fossil fuel use.

    Utilities and related "old school" energy bets. Big, hulking, heavily regulated status quo players are subject to the threat of alternative energy inroads. Investments in old established cash flow generators like Exxon and Suncor (oil sands) are further exposed to pressure from alternative upstarts (whose valuations are too speculative for Berkshire to touch) and major transition away from traditional energy sources.

    Gigantic financial institutions. Silicon Valley is coming for the megabanks. Many of their services will be undercut by rapidly improving technology. Mortgages, life insurance, basic services - all ripe for technology upgrades that hammer legacy players by squeezing profit margins, giving greater benefit to consumers at lower cost.

    Antiquated technology. In one of his classic worldly wisdom speeches some years ago, Charlie Munger specifically referenced IBM as a good example of a company Berkshire would not buy because they don't understand the vagaries of the technology landscape and don't want to mess with it. Many years on, what does Berkshire do? They buy $10 billion worth of IBM… and wander into the middle of the cloud wars (which IBM is losing badly). Say what?

    Generational preference shifts. How many millennials give a rip about American Express?

    Broadly speaking, we would argue that Berkshire Hathaway was a brilliant creation, ideal for its time - a conglomerate vehicle leveraged to the powerhouse growth of the United States economy all throughout the 20th century. Buffett's central insight was being a value investor when value investors hardly existed… with willingness to make huge bets when the time and price was right… while brilliantly leveraging the power of insurance "float" through exposure to the longest and strongest economic tailwind (the growth of the US economy) that the world had ever experienced.

    But now Berkshire's core philosophy is deeply exposed. If your game plan is to buy into safe, stable businesses that don't change… then what happens when the whole landscape is rapidly shifting?

    Everything about Berky seems to make a virtue of sameness and stagnation. That's great when you truly have the "moats" to defend your franchises, and when the pace of technological change is a friendly dawdle. But happens when your moats are breached, your whales are beached, and you don't know what to do?

    Berkshire Hathaway, like Saudi Arabia, will be around for quite a long time. But the aversion to innovation, and embrace of stagnation and sameness as antidote to risk, could become huge liabilities in the not too distant future. Google - or rather Alphabet - is working hard to make the self-driving car revolution happen in five to ten years time. Wall Street houses are already talking about it.

    Maybe a multi-decade spread trade is in order: Long Alphabet, short Berkshire…

    Tags: short-ideas
    Aug 11 1:35 PM | Link | 1 Comment
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