Podcast: Frans Pettinga on metals markets and tariff tensions

This transcript has been automatically generated and may contain errors or inaccuracies. It is provided for reference only and should not be considered a fully accurate record of the conversation.

Nicky

Hello! Welcome everyone to another edition of the EA Forum podcast. I'm delighted to be sitting here today with Frans Bettinger to discuss some of the really interesting developments in the metals industry. I think it's a super interesting environment at the moment. There's a lot going on from tariffs, safe haven flows, inflation flows. We're seeing commodity trading shops really scale up their businesses in this space around some of the longer-term demand themes.

And who better to unpack some of the themes with us than Frans. So, thank you very much for coming, Frans.

Frans

Thank you. And a pleasure to be here.

Nicky

So, Frans, you're a seasoned executive in the commodity trading business with particular expertise in metals. Do you want to just talk us through some of your career highlights? And maybe what you've been up to.

Frans

Yeah. I started in the metal space when I first started my career in trading, which was at Cargill in the mid 80s. Cargill was a very fundamentally oriented shop, very focused on process over short term now. I think that gave me a good grounding in trying to remain objective in trading markets.

I was at Cargill in the mid 80s, and it was mainly a physical business. I found myself attracted to the futures markets during that time. We were running a hedging book and, in the physical markets at that time, there was a fairly significant lack of volatility that was driving the growth story, post in crisis.

Eventually, I moved to the LME brokerage futures side, with a couple of shops there, including Billiton and Lehman Brothers, and then eventually ended up going to Koch Industries in 1997 to start with the metals business, which was originally just in, now has expanded into, precious as well.

That business has now been in existence for just over 25 years. I actually haven't been at Koch since the end of 2018. I retired from there. So I'm really just managing my own capital with a few partners. I'm still obviously, as a trader, never lose interest in the markets, but doing a job that's a little bit less intensive than running a global trading business.

Nicky

Fantastic. And obviously a lot of those themes over the years, with different trading cycles, are super relevant to today with what's going on. We're seeing traders get hit with every kind of macro and micro theme all at the same time. Some of those micro themes are quite specific to the contracts in the metals industry and how it actually operates.

Given most of our clients are predominantly from the energy side of things, I think it's worth highlighting some of the key differences between the contracts, the specs, how storage really operates in the metal space, and the differences between some of the major exchanges so that we can link it to some of our discussions as we go through.

Frans

Yeah. I'll try and talk a little bit about the qualitative differences in the metal space, which I think make a difference to how price setting mechanisms work. This goes back to my experience of looking at metals first and then having some involvement with the energy space when I ran the overall business at Koch and seeing the contrast between which trades worked, which trades had different processing mechanisms or clearing mechanisms.

Looking at metals generally, a couple of things are important: the durability of metals, the general homogeneity of metals—meaning that qualitative differences between regions are relatively limited compared to a lot of the energy markets. Cost of storage and transportation being relatively low compared to the value of the commodity is also quite important for how high prices and connectivity between global markets work.

Up until recently, I would have said that in energy markets, politics played a greater role in terms of understanding risk. Of course, recently with the whole tariff story, that's coming into the metal space as well. It's clearly a new phenomenon that people in that market are trying to deal with and quantify.

In terms of how those dynamics affect pricing, the opportunities in metals around quality, location, and timing trades are impacted by those differences to the energy space. What we've seen in recent months, for example, is dislocation between Comex copper and LME copper and CME gold and London gold—a little bit unusual and probably unlikely to be continued for very long times.

Nicky

That was one of the interesting things when I came to the metals space—dealing with even just on a contract basis, the difference between LME forwards or futures, Comex futures, the different timing periods, the different settlement processes between the two, and the differences in the actual storage of the two exchanges. Those seem to be playing out today and why we're seeing such volatility between the two sets of prices.

Frans

Yeah. Between Comex and LME, there's always been this difference between the LME not being a cash-settled and cash-cleared market in the same way that the CME is. In fact, you could argue that LME futures might have been considered in the past to be forward contracts rather than futures contracts because they're not settled on a net present value basis in the same way that, say, Comex contracts are.

That's always created a different participant stack between those markets. Some of the arbitrage in the past wasn't necessarily due to qualitative differences between the two markets in terms of copper in Europe and the States being different, but more about the fact that, for example, the market in the US, the domestic market with customs-cleared metal, the LME was a global market where all the storage is in bonded facilities, meaning that even though it's a global network, the metals were actually not cleared for customs purposes into the countries in which they're located.

Those dynamics have an impact on relative value between those markets. In the case of financial players, a lot have struggled in the past to get comfortable with a couple of different dynamics. One is the non-cash settlement/cash clearing element, which meant that everything had to be looked at on how you could adjust it to NPV. That's an extra step you don't have to take when dealing with the CME. Also, the fact that you have this date system, not the monthly delivery contracts. Those have been idiosyncrasies unique to the LME. I'm not sure if they're necessarily giving the benefits they used to in the past.

In the past, the reason the forward market existed was that it gave the ability for producers and consumers who were hedging to match their cash flows to the hedges, and credit lines would be provided by brokers in the meantime to allow for people to carry positions as hedges without having to necessarily put a lot of upfront cash to work.

That system worked pretty well. But since the financial crisis in 2008–10, regulators have been increasingly focused on making sure people had enough cash collateral to support positions. I would argue now that the benefits that existed in the past have been a little bit eroded. For example, today, if you're a brokerage firm and you deal with a producer or a consumer, you're not allowed to aggregate those positions with your own in the same way that you used to be able to. The netting effect amongst positions is a lot less than it used to be. So the benefit of having the deferred cash flows goes away with the fact that you have to produce cash collateral upfront on day one today, just given the way the clearinghouse administers positions.

That's an important change to the underlying dynamics. Maybe that's something the LME might look upon, because I do think having those sort of special qualities for the LME contracts and looking at them—whether they're still providing the benefit—is a worthwhile exercise.

On the warehousing side, we have a date system, which in theory allows people to fine-tune their deliveries. But the reality is that we also have a warehousing system where most of the markets with significant inventories have significant queues. So you have this mismatch between what is a daily contract and a day delivery system, but not really having the ability to execute on that in a physical way. That has undermined the convergence between, for example, the LME and the physical market, and that's created some of the dislocation between futures prices and physical prices over the last few years.

Nicky

Do you think those inefficiencies are really driving some of the volatility? That has been, let's say, tariffs-driven, but a lot of it seems dislocations between the two markets, is coming from maybe the different systems within those markets.

Frans

Yeah. With the recent tariff speculation, if you compare base metals to gold, I think it's one reason that gold has seen the focus for those moves. Out of all the commodities globally, the absolute lowest transportation cost relative to value is in gold and silver—mainly gold. So, it's not surprising for me to see, if you've got a potential tariff coming in the country where you can shift your metal reasonably quickly, gold is by far the quickest and least expensive to move. That's where the focus of the activity is going to be. We've seen some moves like that in copper.

My sense is, talking to participants in the market, that most people who are trading physical in that space are being very cautious about taking too many assumptions around what might happen. I think that's fair because physical trading houses are not particularly competitively advantaged in predicting outcomes on what happens in tariff policy.

At this stage, there is obviously a very wide and volatile arbitrage, which is unusual. But if you look at the liquidity in that space, in terms of being able to physically transfer units across with copper compared to, say, gold, there's a good deal more time involved. At the moment, given the fact that things are changing daily in tariffs, that means the connection in gold is working much more efficiently than, say, in copper.

Nicky

Okay. Yeah. It seems that way. We've definitely seen a huge increase in Comex gold stocks, right? The arbitrage kind of makes sense with limited transport costs, and a heavily contango market on the CME, encouraging people to store there. The contango is giving a double yield and, you know, the cost of money at the moment.

Frans

Yeah. If you look at social media these days and what's going on around the gold market, there's lots of speculation about the increase in CME stocks and lots of people talking about the US demanding metal. I look at it slightly differently.

The CME has had an influx of metal because it's a relatively cheap option to ship metal across on the basis that, worst case, you ship it back. But at the same time, if a 20% tariff comes in, you've got huge upside. That's something that makes a lot of sense.

Where you see CME see these big inflows, obviously it needs to incentivise people to finance that metal because it's now moved all to one location. The wide contango is actually a reaction to the fact that there's excess availability of material. In order to get people to step in and take delivery of notices, for example, you've seen contango widen to implied interest rates, which are very significant relative to cost of money.

It takes a while for people to understand what's involved with trading that. My own sense is that will eventually get arbitraged because if you have the ability to convert your cash to gold and sell for futures, the secondary consequence of moving gold across from Europe to the States is the fact that you've got this cash and carry.

Nicky

It's a really interesting dynamic in gold at the moment where you have this physical, underlying dislocation movement going on, but you've also got some of the biggest ever speculative positions in gold. We've seen a lot of hedging from the inflation aspects in the last few years. But we've also seen huge safe haven demand, and gold is back to trading with things like Japanese yen and Swiss franc, as increased risks from either a recession or global risk-off arise.

But we've also had it trading with Bitcoin, and things like that again. We're actually seeing now traders, given the inventories in the Comex, putting on loads of hedges with puts. Every time you see gold rise now, there is a level of nervousness as gold prices hit record highs and things like that.

Do you think eventually the inventories on the Comex side could actually lead to a bit more downside skew arising on that contract?

Frans

We've seen a few unusual things in gold. Generally speaking, gold has been affected by the value of the dollar. As the dollar has gone down relative to other currencies, gold is generally supported, and the other way around. Clearly, in the last year or so, gold has been strong along with the dollar. That's an unusual phenomenon.

The general shape of the gold market is an important consideration for those holding long-term investment positions because there's an opportunity cost element, which is the contango. If you look at the price of gold today and the shape of the curve, there's a very significant interest rate-related, but also now a premium to interest rate-related, contango. If you're financing or holding a long position, that's chopping away at your return. In the past, contango-shaped markets like that have found headwinds at some point.

One thing we haven't seen, as far as I can tell so far, has been that curve shape attracting a lot of forward hedging. That's kind of the irony of these situations. In a strong commodity price environment, you'd expect hedging to increase, but actually the opposite occurs. Producers feel like they owe it to their investors to give them the upside exposure. They also feel comfortable with their own cash flows, so they feel less incentive to hedge. The shape of the curve in gold right now means that, with relatively high interest rates and a high price, if you take a 4 or 5 year forward price and look at cost of production, mining stock share prices seem to be a pretty open arb, the further out you go.

Nicky

Yeah. That's really strange. Is there anything else behind the discount in some of the mining stocks shares relative to gold?

Frans

One thing people might be overlooking is that most of the gold production in the world is not in the US. The gold price people are looking at is the Comex price, which is in theory a price that might include some tariffs. To the extent that might happen, one of the reasons there's a bit of a discounting is that people are looking at those two separate parts and recognising that implicitly in the gold price right now is an element of tariffs.

To the extent that you're outside the US, that's not something you're going to realise as part of your return. There may be an element of that. There are lots of interesting idiosyncrasies going on where gold futures are behaving differently from where they might otherwise behave—relative to the share prices of mining companies, but also relative to things like the dollar.

There are some risks in that equation to liquidity events. I'm not surprised that people are concerned about hedging that because that can happen very quickly.

Nicky

Yeah. Particularly with the size of the relative positions. Even retail have been getting in again on gold. It's become very loved. I think I looked at my numbers this morning and, $5 billion of ETF inflows on the physical side this year, but in contrast, virtually silver looks a little bit unloved.

That's actually one of the only precious metals seeing retail outflows this year. Silver, given where a lot of its production is, in Mexico, should actually be more impacted by tariffs, to a certain extent. Do you have any thoughts on why silver is relatively stuck in the mud compared to gold?

Frans

I think it comes down in some ways to the fact that some of the big drivers to the increase in gold prices have been around concerns about the value of fiat money. When you look at the precious complex, gold is clearly considered to be the money alternative. Silver has this slight hybrid between being, on the one hand, the money alternative and on the other hand, the commodity.

Fundamentally, it looks like the silver market's got some pretty good tailwinds. In theory, you'd expect that to translate to a bigger price support. But perhaps it's explained a little bit by the fact that it's considered to be more of a commodity. If you look at the other metals—copper, aluminium, zinc, nickel—right now they're all kind of struggling a little bit. That, I think, is part of the reason why silver may be underperforming.

Nicky

That brings us perfectly into those other metals. Copper has been one of the most interesting stories this year. It's had tariff noise, and a lot of that's playing out in the differences in the price between the CME and the LME. Prices got over $1,000 a tonne on the ARB.

There is a lot of relative value flow now, and the ARB seems to be attracting a new type of capital. When I speak to metals traders or brokers, they're seeing new participants on the ARB. You've also got differences in the systematic flows on the ARB. You've had a lot more buying from cars on the Comex side, which have been supporting that.

But it's also making it a lot more volatile, as a lot of those systematic flows between the two contracts exacerbate some of those moves. You mentioned early that this might be a little bit short-lived, kind of post tariffs. It already looks like there is some fading of tariff news on the Comex contract.

Do you think after these short-term noises, those two contracts will normalise?

Frans

The problem is that it depends on what the outcome is on the tariffs. One of the issues we're having to deal with, and one of the turbo boosts to the movement in the arbitrage more recently, was the fact that the administration in the US imposed commodity-based rather than country-based tariffs when it came to steel and aluminium.

Up until now, most people have been looking at which countries are going to be affected, what's their production, how much of the imports are they? But realistically, the market understands that if tariffs are imposed on a country basis in commodity markets, generally speaking, all that will happen is that the countries that haven't had tariffs imposed will see that metal flow into the country that doesn't have those tariffs.

That's one of the reasons, I think, the administration in the US probably chose to impose the tariffs as they did on the commodity, rather than on countries. It's going to be very interesting to see what happens in the next few weeks in relation to things like copper. Clearly there was an announcement last week about the administration looking very seriously at copper.

To my mind, if you go down the route of imposing a commodity-based tariff rather than a country-based tariff, then that's a pretty binary outcome in terms of what that means for the value of Comex metal relative to LME metal.

Nicky

That's really interesting. When you said a lot of governments are now looking at copper, we've got this thematic backdrop being the energy transition is going to take a lot more copper, there's not a lot of mines coming on. It seems that copper is the base of why a lot of commodity trading shops are now starting to really ramp up their exposure to metals.

We've seen many of our clients, core energy clients, getting into metals trading. At our conference last year, we had a trading panel, and all four of the panelists were senior trading leaders in energy. We actually asked them, if you put any trade on now, what would it be? Every single one of them actually said, long copper.

What do you think to this thematic backdrop of how trading firms are now shifting around the energy transition? Is this likely to be something that plays out in the short term, or do you think this is much more of a longer-term thing?

Frans

It's tough. As we talked about at the beginning, the qualitative differences between metals and energy give rise to different opportunities. If I look at the buckets of risk taking—the five main buckets I consider to be price, timing, location, quality, and volatility—then in my experience in the metal space, relative to the energy space, quality and location are generally less volatile because traditionally there's been greater interconnectivity between the markets.

To the extent that you introduce tariffs into that equation, that might change the formula. One challenge I would have is that it doesn't necessarily give any one player a particular competitive advantage unless, for example, you're an asset owner in the US and you're protected by those tariffs.

In terms of the energy space or the energy trading companies looking at the metal space, my own sense is that if you're seeking price exposure, the barriers to entry are fairly limited. Anybody can go in and create positions in that way if they wanted to, either through ownership of copper producing assets or through trades on the market.

As for building a trading business around that, my sense is that the marginal added value from doing that in metals might be a little bit more limited. If you look at the history of the last five years, what does merchandizing activity give you? It gives you a return on your bid-offer as you build a franchise. But generally, the history of trading will tell you that's very heavily competed. You get two things from merching: a degree of optionality, and information flow.

Again, my own sense is that the marginal value of information flow has probably been declining because the world is more interconnected. People have greater access to information which previously would have been considered proprietary. Then it goes back to the marginal value of optionality.

In the energy space we've seen in the last few years very significant dislocations between regions, very significant dislocations between the different qualities which have given people super returns from those activities. In the metal space, whilst we've seen some of these tariff-driven opportunities more recently, and whilst there are idiosyncratic differences between, for example, the LME and Comex and the Shanghai Exchange, which do give rise to occasional arbitrages, the underlying qualitative differences of the metals complex are going to make the upside in those types of plays less sustainable than you would see in maybe the energy space.

Nicky

Where do you think maybe physical optionality does lie in the metals space and where are we likely to see volatility perhaps in that supply chain?

Frans

That's to maybe think about the secondary consequences of tariffs. If you look at what's coming through right now, we're seeing tariffs as being a US issue. Who knows what happens in response from other countries. That's something people need to think about. Everybody's focused on the US being the imposer of tariffs, but there's obviously the possibility of retaliation the other way as well.

For me, looking at the broader picture, I don't see the metals markets in terms of having—well, for example, if you are focused on primary metals and you have a situation where primary metals are attracting the tariffs, in other commodities or in other areas where tariffs have been imposed, there's generally a consequence: products which have metal contained, whether they be semi-fabricated products or raw materials, or finished goods, tend to then find ways to get into those markets on the basis that they don't qualify for the tariffs.

One of the things you'd expect to happen is potentially there would be an increased flow of things like scrap, or at least increased interest to look at scrap as a way of circumventing some of the worst effects of tariffs. There might be an impact on the desirability of buying or selling semi-fabricated products because they may, again, not attract the same level of tariffs as the primary metals. Those are all secondary consequences which may occur if those tariffs prove to be long lasting. That's the other big question. At this point in time, I don't think anybody really has a clear picture as to whether these are likely to be temporary issues or long lasting issues.

That's a big challenge right now. From my conversations with most of the traders I'm in contact with, people are taking a bit of a step back and waiting to see what happens.

Nicky

That's really interesting. Maybe pivot a little bit now, and just think about your experiences of running a global trading business as well. You've got a lot of experience in this area. The last eight, ten years have been punctuated by a global pandemic, a war, and now we've got tariffs. How do you think about, and given your reflections on managing risk in these environments and where opportunities actually arise from, and how the modern trading organisation takes advantage of them and positions for a given?

We have a slightly different kind of world now where the amount of financial capital in commodity markets is significantly scaled up, whereas perhaps a decade ago, the biggest trade sat with the trading houses. Today it's really split. You have the hedge fund world that has really ramped up, but also in some more fundamental bets as well.

Frans

Going back to how I tried to build the metals business at Koch and how I tried to run the overall trading business in my last view, I've always tried to look at the trading business—some people would describe the trading business as being about predicting outcomes, but my sense has been that, first of all, that's challenging. But secondly, I'm not sure that's how I've experienced it.

Generally speaking, trading companies, or the best way to think about trading is, you'll pay to connect global dots. The way you have to look at opportunity is to figure out what the problems are that need solving and whether you can create the capabilities to solve those problems and get a return that's adequate relative to the fact that you may not necessarily get paid back for things like optionality or information.

First and foremost, is there a bid-offer here? Can I collect it? Does it give me a reasonable enough return so that I can sustain this business in a way that allows me to benefit from upside events when they occur? There are a few things you have to look at in that.

You have to understand which buckets of risk you're looking at and whether or not you can create competitive advantage. For example, with regards to traditional trading houses, location and quality have always been core trading strategies. That's where they've had the competitive advantage derived from the merchant activities. Hedge funds, generally speaking, might struggle with that on a relative basis. They may not have the physical optionality to take delivery or to fund inventories.

On the other hand, on price and volatility, if you look at the recent history of how certain hedge funds have managed to build very significant flows from things like gas, you could probably argue that in those areas, merchants are just one of a number of players providing capital and perhaps their competitive advantage derived from their footprint on the merchant side in those areas is not that great.

Last year, crude was a good example. A lot of people I spoke to on the physical side of the market were pretty friendly towards what they were seeing around inventories and generally probably had a slightly bullish bias for most of last year. As it turned out, pricing underperformed. It goes back to understanding how you create competitive advantage and what the limits of that competitive advantage are.

Ultimately, it's about having two strands: you have a merchant activity which creates your ratable income, and then you have your potential exposure to upside events when things—when you get the tailwinds. In the last five years, we've seen a couple of those big events, which is one of the reasons why we see commodity trading companies doing very well.

Nicky

As we discussed, the trading firms today are changing a bit. We're definitely seeing the oil traders move more into assets, and credit and things like that. Where do you think that transition is going and where some of the opportunities are in assets?

We've seen oil traders buying refineries or buying even renewable production and things like that. I guess it's all about optionality.

Frans

Yeah. The value of optionality is highly cyclical and likely to be different for different assets. In the energy space, you've seen some assets provide very high levels of optionality—gas storage, oil refining, even. As people have built significant earnings, they've sought to divest some of those earnings into acquiring assets.

Part of that is around optionality, but also it's partly around the fact that people are expressing a point of view through assets. There are some benefits to that. The main benefit of being a trading company is that you can deploy your capital opportunistically to the area where you see the biggest opportunity. To the extent that you're building a big asset portfolio inside your business, that's fine, but you reduce the ability to move your capital opportunistically.

The other challenge that comes from having an asset portfolio alongside a trading portfolio is it can be challenging to measure marginal value added. How do you deal with the challenge of recognising whether you're deploying your capital and resources wisely when it's very hard to understand whether the thing that's creating the value is your asset position or your trading position? Having some degree of separation in place to allow you to be objective around that and to also potentially be in a position where instead of looking at assets as being long-term holdings, you look at them as being opportunistic as well and perhaps see opportunities to divest when you think the upside in the cycle is less attractive.

It's understandable why people are doing it. Especially if people are considering going into public markets, it makes sense. Public markets have traditionally discounted trading income relative to asset income. That might be unfair, because if you've got a decent trading franchise, a lot of companies can prove the sustainability in those earnings. But that's the reality. If you've got a strategy to go public, one of the greatest examples of that probably was when you saw Glencore going public and having a big asset portfolio definitely helped to raise the valuation of the company.

At Koch, we generally adopted the philosophy of looking for other ways to control the benefits of being an asset owner without necessarily being an investor ourselves. There are hybrid solutions out there where you provide, for example, security of income through offtake agreements or through price protection that give you some of the upside of being an asset owner without actually operating the asset yourself. In those types of arrangements, it's easier to keep transparency around where the money is being made.

Nicky

That's really interesting. So it sounds like a source of edge is coming from trading the asset, not just trading around the asset as well.

Frans

Yeah, I think so. We've seen some super returns because we've seen very significant events that have given those assets what would probably be considered to be unsustainably high levels of returns. But if you look at the history of the markets and how people have ended up owning those assets, in a lot of cases, they've also carried them through pretty painful times during cyclical downturns.

If you look at the last 20 years and see how people have looked at asset portfolios, generally they've had a positive experience. But if you look, for example, recently at the results that came out of Glencore and see some of the write-downs they took on some of their big asset portfolios, those things can work the other way as well.

There's a balancing mechanism. From a management point of view, my experience is that optimising assets and optimising trading also requires slightly different skill sets and mental models about how you function in the world. They're not necessarily opposite, but they're sometimes conflicting.

If you're an independent trader and you own a large asset portfolio, it also potentially undermines your ability to be a third party that people feel comfortable with because there is no conflict. That's another factor to consider.

Nicky

That leads us nicely into the next point. What we're seeing in many trading firms today is they're not just building portfolios of assets, they're building portfolios of traders. Some of the ways potentially like a multi-strat hedge fund would work is now, we're starting to see a similar set up in some trading firms where they look at different unique aspects of traders.

How do you think about, as a trading manager, developing traders for edge, or how do you look at whether a trader has edge and putting them in a portfolio together and thinking about how you run traders per se?

Frans

Having exposure to different types of activity or different asset classes or different regions gives you the benefit of carrying the entire business through periods where some of the businesses will be eking out an existence. If you're trying to deal with the challenges of being in the trading world, one of the biggest challenges is sustaining yourself through low margin returns and having a bit of a portfolio can help you smooth out some of those ups and downs.

In terms of traders and where I've learned which traders have functioned the best and where traders have worked well, a high-level observation would be that some of the best traders I worked with understood very clearly what they didn't know and understood how they had to recognise that there were certain things going on with their markets which looked very attractive.

Generally speaking, for example, around price movements or outright price movements, rather than relative value or qualitative moves where you could get sucked into thinking that actually because you knew inventories were going to go down or you knew that something was happening regarding a supply issue, you'd have an edge to predict pricing.

That's sometimes a very hard temptation to resist, because if you get a price trade right, it's relatively the most straightforward trade off is to put on and take off. My own experience is that understanding and having the humility to understand whether that's through local judgement is really important.

Having a regular process to understand whether actually you've got a competitive advantage, really being hard on yourself and recognising where you've been lucky or smart, is a really important part of understanding how to create sustainability in your earnings and avoid getting into a situation where you have a great business, but you end up diluting your returns because you end up doing stuff that you don't really have a competitive advantage in.

Nicky

That was really interesting. It just brought back memories to me then of filling out those trade management sheets in the early days and having to go through the framework. I think having that rigorous framework actually is probably one of the things I learned at the start of my career that I've taken all the way through is actually having a process and a rigorous process around trades, but it kind of did feel like doing your homework at some times when you're getting marks on them.

Frans

The overall objective was simplification. If you're living in a very complex world and you're dealing with so many variables, it's very hard to count which ones you're incorporating. A lot of people struggle to express in plain language what it is that they're betting on.

Another fact I came across is a lot of people really didn't necessarily understand what their underlying assumptions were that were implicit in their bets. For example, if you take a simplified trade in which somebody was forecasting that inventories were going to decline and then have a price bet on, the implicit assumption is that lower inventories will lead to higher prices.

Sometimes, it's good to talk about what those implicit assumptions are, because what a lot of people have learned the hard way in the past few years, as new capital has come into the market, is it presents an opportunity because you have more money coming into the space and it creates opportunities for certain dislocations to occur.

But it also has to lead to a widening of your assumptions, because the relationships that you may have gotten used to are now very different because of those flows. The overall phenomenon I've witnessed is that having an explicit discussion about what your assumptions are, trying to quantify things that you may not have thought about, and, as Charles Koch was always good about reminding us, things that you can quantify are the ones that you tend to focus on because things that are easy to measure are easy to talk about.

But that doesn't mean that the most important variables you need to be focused on are always the ones that are easy to measure. Sometimes the things that are difficult to quantify are actually the most important. Having some process or some discussion about what that might look like and whether or not you still feel comfortable with the overall upside/downside is really important.

Lastly, there are a lot of human behaviour biases that occur in every business, whether you're a hedge fund or a trading business. One of the things we learned as well is that there is probably a very limited correlation between levels of conviction and outcomes.

What I'm trying to say about that is that sometimes people would be very highly convicted about a trade and size it accordingly and less convicted about a trade and size it down accordingly. In our experience, there was actually not particularly strong correlation between the actual outcome of the trade and the level of conviction.

It's probably better to introduce some objectivity around that and to be a little bit more consistent in how you apply yourself. That hopefully over time also improves the results from the portfolio.

Nicky

Perfect. So speaking of high conviction, where do you see opportunities in the investment space or in the commodity space today, for the next few years? What kind of things do you like from a return perspective?

Frans

On the trading side or on the brokerage side right now, the fact that you've got new flows of capital coming into the market is a positive. It's a risk in the sense that you've got to recognise that's going to affect the way price setting mechanisms evolve.

But generally speaking, it should allow for more dislocations to occur between physical and financial markets. That's generally speaking a tailwind for either a brokerage company or a trading business.

On the commodity side, my own sense is that it's extremely difficult to make future predictions. If you look, for example, at the battery metals in the last few years and some of the investments that have taken place in, say, lithium or cobalt space and see what the price performance is there, it's a tough gig to make those forecasts.

Looking at market structure and thinking about what opportunities are, I would think that people should be having conversations at mining companies on the precious side to look at that forward curve and to recognise that there's a pretty strong incentive to be countercyclical, not to wait for the downturn, and to actually think about whether that forward contango gives you some pretty decent opportunity to lock in some of those supersized returns.

That's probably a discussion which is difficult to have because mining companies right now are feeling that they owe it to the shareholders. But from an optimisation point of view and a risk/reward point of view, there's probably some value in having those conversations.

On the copper side or on the aluminium side, we've seen a period of pretty choppy sideways markets. It's a very difficult picture because you've got some tailwinds in theory from some of the energy transition market developments, but you've also had some headwinds which have come around, for example, around the general growth in China, around tariffs, and what does that mean in terms of outcomes around global trade?

It's a tough one. In the short term, you've got to remain relatively opportunistic and recognise that the lesson of the last five years is that the future is very hard to predict. Keeping some degree of flexibility in the way that you allocate your capital will continue to be an important part of maximising your returns.

Nicky

Spoken like a true trader. Well, all that leads me to do is thank you very much, Frans, for coming in and talking to us today. It's been an absolute pleasure. I've learned a lot. So thank you.

Frans

Thank you.