In this episode, Alan Dunne and Cem Karsan explore a market that appears calm on the surface yet increasingly unstable underneath. As indices move sideways, they discuss how options flows and structured products are reshaping market behavior, driving rotation rather than direction. From the weakening of former leaders to the rise of defensives, the conversation turns to what these shifts may signal about a broader topping process. They also examine the growing influence of AI narratives, political incentives, and global tensions, not as isolated shocks but as forces building pressure within the system. The result is a discussion about how markets evolve when structure, policy, and sentiment begin to move out of sync.

-----

50 YEARS OF TREND FOLLOWING BOOK AND BEHIND-THE-SCENES VIDEO FOR ACCREDITED INVESTORS - CLICK HERE

-----

Follow Niels on Twitter, LinkedIn, YouTube or via the TTU website.

IT’s TRUE ? – most CIO’s read 50+ books each year – get your FREE copy of the Ultimate Guide to the Best Investment Books ever written here.

And you can get a free copy of my latest book “Ten Reasons to Add Trend Following to Your Portfolio” here.

Learn more about the Trend Barometer here.

Send your questions to info@toptradersunplugged.com

And please share this episode with a like-minded friend and leave an honest Rating & Review on iTunes or Spotify so more people can discover the podcast.

Follow Alan on Twitter.

Follow Cem on X.

Episode TimeStamps:

00:00 Intro to the Systematic Investor Series

00:23 Performance check: CTAs strong, trend tailwinds

03:13 Range-bound indices, but big dispersion and rotation

03:45 Why options pin the index: dealer flows and vol compression

05:42 Dispersion mechanics: idiosyncratic risk, falling correlation

07:32 Rotation as a topping process: leaders fade, defensives rise

09:54 OPEX and quarterly expiries: why timing windows matter

11:56 The March support effect, then weaker flows into April

17:02 AI narrative shock: anxiety, backlash, and policy consequences

22:32 Populism versus deflation stories: why inflation returns

32:43 Gold outlook: secular bull, but expect two-sided volatility

45:45 Rates as “tectonic plates”: vol compressed now, release later

50:23 Midterms, incentives, and the fight for control

57:42 Liquidity loop: markets stop rising, collateral stops expanding

Copyright © 2025 – CMC AG – All Rights Reserved

----

PLUS: Whenever you're ready... here are 3 ways I can help you in your investment Journey:

1. eBooks that cover key topics that you need to know about

In my eBooks, I put together some key discoveries and things I have learnt during the more than 3 decades I have worked in the Trend Following industry, which I hope you will find useful. Click Here

2. Daily Trend Barometer and Market Score

One of the things I’m really proud of, is the fact that I have managed to published the Trend Barometer and Market Score each day for more than a decade...as these tools are really good at describing the environment for trend following managers as well as giving insights into the general positioning of a trend following strategy! Click Here

3. Other Resources that can help you

And if you are hungry for more useful resources from the trend following world...check out some precious resources that I have found over the years to be really valuable. Click Here

Privacy Policy

Disclaimer

You're about to join Niels Kaastrup-Larsen on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent yet often overlooked investment strategy. Welcome to the Systematic Investor series.

Welcome back to the latest edition of Top Traders Unplugged where each week we take the pulse of the markets from the perspective of a rules-based investor. It's Alan Dunne sitting in again this week for Niels who's still in sunny Miami. And I'm home already but here in the hot seat talking to Cem today.

Cem, how are you?

Doing great here in Chicago in the hot seat, believe it or not, 61 degrees and sunny in Chicago in February.

Nice. So, no major snowstorms disrupting things in Chicago?

No, we were able to sidestep it. We never get to sidestep. We always get the front, snow in the face. But no, this time, somehow, we sidestepped it.

Very good. Well, plenty to talk about. We've no shortage of macro themes and topics and interesting developments in markets. Obviously, equities continue to gyrate, the rotation, trade. and you know, markets are under a little bit of pressure today, already. But maybe just, I mean, to talk about performance because it was helpful just to give the performance in context. We've had a very strong run for managed futures in the last six months or so continuing this month.

So, on the month Now, SocGen CTA index is up 2.96%, and SocGen Trend index up 3.38%. And year to date the SocGen CTA index is up 7.8%, and the trend index is up 8.25%. And for the Short-Term Traders also doing well at 0.8% on the month, and 3.15% on the year. So, certainly, positive sentiment around that.

And I think, coming from iConnections this week, that was certainly felt in terms of positivity around hedge funds in general but CTA's also certainly participating in that positive narrative. Obviously, a lot going on markets wise, but in terms of hedge fund performance and CTA performance, it's been a good stretch, Cem, hasn’t it?

Absolutely. And we, again, have talked about this at home, here, with all kinds of other people across the board here. I think the reality is this is going to feel a lot like ’22. Niels and I were talking a little while back about this, ‘22 was obviously a great year for trend.

Why? It actually ties into our vol complex, when vol is well supplied, and we're going to get into this, I'm sure, with dispersion a little bit later today. What you end up discovering is that the rotation is much higher, and that rotation paired with a clear trend, broadly, once that rotation starts represents a lot of opportunities for those who understand what's happening under the hood. So, I think that's what we're beginning to see. Expect more of that this year (knock on wood) for people like us. But, I am, again, quite optimistic for this year trend.

Good stuff. Well, I mean that's probably a good jumping off point. I mean, in terms of where we're at in the moment. Obviously, you look at the broader indices, I mean the S&P 500, Nasdaq, edging a little bit lower, but broadly in a range for the last kind of two to three months. But within that, obviously a huge amount going on in terms of dispersion, in terms of rotation, and big moves at the sectoral level, industrials, material stocks doing well, obviously…

Staples…

Yes, staples doing well, as well, and software under pressure. I mean, the temptation is always to assign a macro narrative to it. But, you know, obviously there's a lot going on from an options and a market flow perspective as well. So, what's your perspective on what's driving it?

Yeah, we always try and educate on this. Obviously, we've been talking about this for a good five years publicly, but hope, you know, sometimes we still confuse people. This is the most important concept of how markets work these days. And if you don't understand this, and you're in markets, you're missing one of the biggest, most important things in markets.

And the reality is that markets… One of the biggest components in markets, these days, are options and things that look like options; structured products and other things that sell forms of vol, particularly upside and at the money vol. And those are primarily at the index level.

And because they're at the index level, and because they're bigger than ever, what you get is a lot a vol compression, which means the indexes themselves are quite pinned until a big enough event happens or something that can release that vol or make it squeeze higher, which generally is a move up or some type of bigger or big enough event that's a shock, a true surprise to markets. The broader index then is pinned.

And that happens because, again, dealers are long the vol that they're getting delivered. They have to buy when the market goes down and sell when the market goes up in order to capture a profit. This pinning effect, which is vol compressing at the index level (and this is the part that's very counterintuitive), forces things at the single list level to move away from each other.

Why would that happen? Why would single stock vol actually tend to increase, and why would, importantly, correlation dramatically decrease when that happens? It’s pretty simple. Idiosyncratic risk still exists in the world. There is always some news.

If news happens, by definition, something happens to one stock based on earnings, other stocks… a CEO passes away, a new drug comes about. Those drugs will move because they're not the vol centers themselves. And idiosyncratic news matters for that one stock.

But if the market is pinned, that means things have to go the other way to compensate for this. And so, what this does is this drives massive rotation, dramatic rotation. And actually what we see is, is increased volatility, historically, at the single list, while index is pinned.

And there's a reason for that, and that's the growth of options and structured products, and their effects, on the underlying at the index level. So, that is happening in spades. We called for that about four months ago. We said, wait, the next six months till about April, May. You will see not only volume compression at the index level, but massive rotation. And that's what we're seeing.

So, it's important to understand that's the true driver here. This is a topping process that's defined by sideways chop. And even though the vol of risk is expanding, the index is pinned as a result. And that's driving historic dispersion, and shouldn't be a surprise in a topping process, that we are seeing the generals being shot.

This is what happens, this is how it works. If the generals are being shot, and there is going to be weakness there, you have to see strength somewhere if the index is pinned. And it shouldn’t be a surprise that money goes to more defensive underperforming areas and places that are more out of favor and under owned.

And that's why we've seen things like staples explode higher in a way that's almost incomprehensible to people, like 30%, for something that is not growing earnings, really. It is a structural phenomenon that is the counterweight to the other side of what's happening underneath the hood. Something like energy. Again, great performance. Why? It’s the same reason. Again, what people will paint.

Some of that is idiosyncratic by the way, to be clear, because of the things going on, Middle East, etc., and those are driving some move in energy that has been dramatically shorted, under owned, early in the year.

So, it shouldn't be surprising that, if you get a little positive news there, a little bit of push on something that's under owned, especially given the pressures and the other items that are core to the market leadership, that would get a huge kind of push up. But once that starts going, that pushes the other things down as well.

And so, this is the process that is so critical to understand and allows for prediction, understanding of rotation, and when to move, and where to be.

And obviously you described kind of the impact on the index, that the range stays intact, I guess, driven by the gamma flows, I guess. I mean, are you looking at a schedule of expiries to give an indication of when this might be more susceptible for a breakout?

Yeah, absolutely. So, you see often these headlines that this OpEx is the biggest OpEx in history. You'll hear that all the time now. And the reason is because almost every OpEx is the biggest in history. The growth of structured products and the growth of option flows is secular and is exponentially increasing at this point. It is a such a small part of the market that is accelerating and creating adoption.

I like to liken it to kind of a tipping point for a technology. It is a more precise tool but the problem is it didn't have enough volume and network effects for adoption until more recently. And the impetus now, obviously paired with those network effects of a need for more non correlation, more capital efficiency, is driving, not just a bull cycle but a exponential growth there.

So yes, each expiration matters more because they tend to be issued at expirations. But obviously, the most important ones are the quarterly OpExs. And we've talked about this at length, you know, March, June, September, December, always the biggest. It's not a coincidence that, historically, we've seen tons of vol events when the vol events happen like in that February to March window, in that August to 7th September window.

That selling may go away is not a coincidence. These are things that are structural to those realities. What I think I would highlight, that's important, and why I feel strongly that this vol compression will continue despite the bad macro, and despite what I think is a topping process, is because it seems like we are clearly sidestepping the vol event in the February/March window, which is kind of what I expected this year given the size of vol compression, which will mean support into March OpEx. And that's counterintuitive to people who think up/down. But the reality is, when you have short put exposure to dealers, and dealers are short stock and long call and long volatility at the money, what that drives is either an activation of that left tail in the markets that then creates a vol event, which is rarer, but when it happens it is a tinderbox, in a sense, underneath the market.

But if that doesn't happen and it doesn't start early in a cycle, that risk needs to be bought back, meaning the futures hedges and what's being protected against those structured products needs to be bought back. And that is ultimately a buying structural pressure. Those are those vanna and charm flows that we talk about. And those vanna and charm flows are coming. You can see them during different parts of the day. And this is why we keep getting sell-off and then buy-back, sell-off and buy-back.

Expect more of that regardless of this military action that we're probably likely to see in Iran. Expect that despite all of the other things you can go through today in macro and how wild this is in the short term. But once more topics come through those vanna and charm flows dramatically drop off and that would be a period where I would be much more cautious, getting into late March into April, once those flows are off the table.

Again, once those flows come off the table it doesn't mean we're going to have vol event again. It means vol is likely to still be compressed. It's just the supportive flows come off the table and you're much more likely to see kind of a stair-step down continuation of some kind in that window. So, my view is, probabilistically, the window is much more sounding like, starting in May, will go away this year. Maybe it starts in April, but we've been talking about that for a while now.

And the view that this is very much a topping process as opposed to a consolidation ahead of a move up. Obviously, we're seeing more negative price action in what you call the general, the previous leaders. Is that what has given you confidence that it's the topping process?

Yes. I think there's couple things. A big one is, let's put this way, consumer staples are up 30%. There's a reason markets, when they rotate this way are, are seen as weak. That is not where the growth is. That is not where multiples are going to expand. That is not where, if they get more money, you know, consumer staples aren't going to all of a sudden put that back to work and drive a CapEx cycle. It is a defensive part of the market.

There is a limitation to how far and how fast certain areas of the market can go. And, meanwhile, now that we've gotten moves, for example, in software to a point, there's so much concentration and leverage in those parts of the market that, despite the market itself being placid, you're creating massive risk underneath the surface. There are people who are in institutions that are stuck, that have to get out, and that, if it gets worse, will have to liquidate.

Despite what we're seeing at the index level, there is nothing exciting. Think something like long-term capital management. The way a risk really appears, from a placid market pinned environment, is through concentration, leverage, and illiquidity. Again, concentration, illiquidity, and leverage always is the reason that things go from a placid state to something bigger. So, what we're seeing is, that under the hood, if you look at private equity and private credit, that stuff shouldn't be a surprise to you. I've been, again, talking about that for a while, being a kind of canary in the coal mine, that it will get worse. That, itself, is a tinder box sitting underneath the market.

And you know, when something comes down 50% like software has all of a sudden, everybody starts playing to buy calls to, you know, oh, this is going to come back right away. This has been an incredible opportunity. Guess what? Dead cat bounce, dead cat bounce, dead cat bounce. It's not a surprise because there's overhead supply that needs to get out, that is stuck. And ultimately, until those that are stuck get out, you know that part of the market is stuck.

I'm not saying software is going lower per se. It is incredibly cheap. I actually am very bullish of software come six months from now. Put it on your board and come back to it in six months, or nine months, or whenever it is. But the truth of the matter is, that part's not coming up quickly anytime soon.

The leadership has major issues and the part that we've rotated now to is reaching its capacity for how far it can go. And so, at some point this falls out, you know, under its own weight. So, yes, to your answer. Yes, it's partially from the outside looking in. It's partially because of what's happening under the hood. But understand that, itself, is a representation of reality, not the opposite, and that the actual rotation is a function of pressures in the system holding things at bay. But the reality is the market is already on its way down.

Well, you mentioned kind of three factors, or two, which are related to a third which is AI. But I mean, we're talking about private credit and, you know, we've all been talking about private credit and the risks in the space and how just because you put a label of ‘private’ on it, it doesn't mean it's diversifying. And we're very much seeing that. Obviously, a lot of the private credit exposures are to software, which has been underperforming. And obviously, the big thing with driving software is this shift in the narrative around AI.

And obviously, we had more out this week around that with this research report, the Citrini Research report, which has been much discussed and very provocative, you'd have to say, but paints a very stark, I suppose, picture of the potential impact. I mean, the software side of things is only one part of it, obviously the deflationary impacts, the impacts on white collar workers, etc.

I mean, I think most people in the market would obviously see it as a very extreme representation, but it does point to a fairly logical narrative that we could be into in a significantly more disinflationary period, if we get this greater adoption of AI. So curious to get your thoughts on that and where that fits in and how it may drive markets from here.

The most important thing about the Citrini piece, which again… I mean, I was shocked. People who don't even really follow markets, kind of high-net-worth individuals that are not even looking at markets on daily basis, are asking me about the article. The biggest and most important thing that article showed me was that how anxious the world is about this.

The converse fact that we're talking at length about this substack article by somebody who has actually… This isn't a comment on him or whatever… It's not like a research piece out of Goldman Sachs, although they all now responded to it - that is the biggest, most important thing we should recognize.

And why is that important, itself? Because there is a political consequence to this that everyone is ignoring. There is a social zeitgeist and anxiety to what is about to happen, and it is, now, just starting to slowly come into the the psyche. It is now starting to explode. And that is so critical.

We all like to think about things in a closed loop, as if, oh, this is how technology operates, in this world, outside of reality. it does not operate outside of the real world. It is part of a much bigger real world with other things that affect it.

And so, I think that the real, real thing that people are completely underpricing, in my opinion, is the real time pushback and political backlash that I would expect coming from this. That is the most important thing that you can think about.

That paired with… (I'll give a couple more things before I want to get back to that), There is way more friction in the system than people expect. I'm not saying it's not coming fast. It is coming fast and it's coming faster than people expect, and they should wake up, and people need to adopt it.

But it’s not just the friction in the system, not just the political backlash and the regulatory things, that have not caught up to it, which will start to catch up. Importantly, you know, there's all kinds of questions from big corporations, enterprises, about how they adopt these things and how it's going to be used.

Just because a new technology comes about and changes the world doesn't mean the adoption of it happens as quickly as people think. And, historically, that's always the case.

So, you have friction in the system that's being underestimated. You have an incredible… based on the talk about the article, an incredible pushback and political backlash that's likely coming quicker than people expect. And lastly there is an assumption that again this is all in a vacuum. This assumes no global conflict, no internal upheaval, no commodity shortages, free flowing capital and strong liquidity continues. And none of those things are guaranteed. And I will actually highlight those, as we're talking through today.

I am willing to bet that one or more of those becomes a problem in the next year or two. And so, my point is, not only that this is far from guaranteed, this world that is being painted. But much more likely than not it is incredibly uncertain in one of many, many paths, and a less likely one at that, I would paint. I will follow back on to the most important part, as I mentioned, which is the pushback and political backlash piece.

Everyone, as you're seeing in the long end of the curve now, everyone in the political dialogue has now turned deflationary. Universally you can see it in positioning. I have now, for six years, been talking about how we are (in the next 20 years, starting six years ago) going to a structurally higher interest rate environment tied to populism. Not surprisingly, this has been, and we've talked about this throughout time, the big pushback to that.

Well, what about AI? This is the big conversation. This is the most important thing in finance, the discount rate, what is going to happen to the price of money? What is going to happen to the long end of the curve?

This is now the third time in six years that the world has turned deflationary again. And every single time was right before a more inflationary push. I do not know how quick this will be deflationary. And I'm not saying that technology is not deflationary. Since the beginning of time, you know, growth of technology is deflationary. And I understand the speed of this is quick, and that it's accelerating. But one thing I know for sure is that populism and the growth of populism is increasing demographically. That's why I know it for sure, because the baby boomers are dying off and the millennials, who believe that they need a much more fair system and that the system is broken, are coming to political dominance.

We know that that's demographics, and that's accelerating just demographically, never mind the level of frustration because they are not getting what they want, as we saw this last year, actually, the K shaped economy is becoming more K than ever. And add into that the now combustible AI realities, because this is not just deflationary, but this is hurting the exact kind of cohorts that are most in pain.

Yeah.

I ask you, was Covid deflationary? If we sat here before Covid, and looked at Covid, we would say that's probably going to be really deflationary.

All of the waves of inflation that we see in history are driven by a catalyst, a catalyst that then releases the political realities that are actually underneath the hood. So, I would ask people to not worry so much about the deflation that is likely coming from the catalyst, which is AI. I would instead look past that for what the much bigger trend is and what is likely to come as a result.

Yeah, well, that's interesting because when I read the Citrini report, one thing that is notable is that it doesn't discuss any policy reaction at all. There's no mention of what the Fed would do in this environment. I think it does touch on kind of yields falling. But I mean, this is at the heart of… We can talk about Kevin Warsh. I mean, he has touched on this. If you go back to his TV interview, I think I saw it on CNBC last summer, he said AI makes everything cheaper.

So, he's already been positioning for this. So, I mean, that's one dimension. And then you've got the fiscal side as well. But as you say in the first instance… and Covid was the same. I mean, the initial impulse from Covid was disinflationary, deflationary.

How long did that last?

Well, it lasted a quarter, maybe?

A month?

Well, I mean, if you shut the economy down, that does stop demand growing pretty quickly, but as soon as it comes back…

But the way you get markets going, by the way, similar to last year, is you get markets down.

Yeah.

So, then you can generate a response and the response itself becomes the thing that moves markets paired with people getting short. Institutions are at the zero percentile last June, and then guess what? Now they're back at the, you know… They got up to the 50th and now are back down to the 40th or so.

And so, this is not a conspiratorial thing. If you're sitting in that chair, and you're Bessent et. al., and you're trying to figure out, now that there's this overhang where you have all the refinancing of debt, and the liquidity draw, and markets themselves (which are the biggest driver of liquidity) have now slowed and are no longer kicking in. And you can no longer do, you know, issuance at the short end of the curve, and increasing that like you were before. You're kind of stuck.

No, exactly.

How do you get into the market going into the midterms or into the rest of the year, what do you do? You have got to take it down to take it up. So, that's part of the whole story here. And, I think that pairs really well with the AI realities that we're seeing. And so, I think markets look forward. And so, I would encourage you to, yes, be prepared for the deflationary part, but the deflationary part will last a minute and the real story is still the big one, which is the secular realities underlying populism, and the move of money from the top to the bottom, and the political necessities of them.

But does that mean… I mean, you're skeptical about the actual ultimate level of adoption of…

No, absolutely not.

Okay.

What this means is we're heading to UBI, and that we're heading to people getting big checks at the bottom to placate and get people on the bottom of the distribution less angry.

But would the likes of UBI be enough? I mean, if people are losing their 300,000 jobs a year, you know, UBI doesn't help you that much.

What’s it going to take to make people not be in the streets? So that's what they're going to do, and that's a lot.

There is an interesting debate about this because with any new technology that has a productivity impact, there are supply elements, there are demand elements, there is the kind of economic viewpoint that higher productivity means a higher neutral rate because it encourages a build out of CapEx to take advantage of the technology.

So, in that scenario, if the Fed is actually cutting rates in response to disinflationary pressures, they're moving in the wrong direction. And we had this debate kind of back in the Greenspan's new paradigm in the ‘90s where he was originally keeping rates on hold but ultimately had to raise rates. But I mean, back then part of the discussion was around financial stability. Less about that…

Yes, but this is also about financial stability. I mean, understand there's another narrative we're not even talking about, which is US debt. The reality of the situation is that this is an unsustainable level of debt and it is growing at an unsustainable rate in a populous period that's not going to slow down, it's going to increase. So, there is no way out of this.

And this dovetails into our conversation about the Fed. This is the ‘why’ the Fed and the Treasury are now on the verge of shaking hands and become coming, you know, not independent. There is a debt jubilee coming. That is the first and most major… We've known it for a long time, but that is the actual first actionable sign that it's coming and not. They're not just shaking hands and saying we're going to work together and communicate, they're saying the ‘why’. And the why is because the Fed needs to buy, in Trump's words, they need to buy the US debt. That's been publicly talked about by the leadership. That's what's happening.

We need to turn on the printing press or however you want to think about it, hit the button, make all the zeros go away. To be clear, that itself is not, you know, as people think. People think that's a big time dollar weak or relative to the benefit it's actually dollar strength because the second you kind of wipe that all out, you have a debt jubilee, you start from scratch again.

But I do think that this, what we're talking about here, in the Federal Reserve involvement, turning on the printing presses that inevitably coming as a result of the AI story, everything also is being done because, quite simply, it's going to help, it's going to be an excuse to solve the bigger issue, which is the US's overhang of debt.

So expect a response, at some point, in the next, call it three years while, while Trump is in office, in my opinion, amidst some crisis, the crisis that is coming, to hit the button at the Fed and make all the debt kind of get adjusted. We saw this, by the way, in Japan. I don't know why we're going to be shocked that this is going to happen here. We support it.

This wasn't Japan's idea as much as it seems. It was supported by the US Federal Reserve and, as our allies in Japan, we needed to kind of help fix that problem there. And, we did, over 30 years, and guess what, there is no external debt anymore in Japan and we will move to a similar scenario here.

So, my point is that is linked in to the coming crisis and AI. It all is coming together in a way that fits very beautifully into a very simple solution. And that solution is really the only way out.

Yeah, I mean one of the expressions of that kind of concern about, you know, debt monetization and maybe dollar concerns, obviously, has been the metals: gold, silver. We saw an explosive move higher and then a big correction. I mean, from an options market perspective, how does that look now? What's the expectation there?

Yeah, so again, I think this is important. I think you know this, but in late ‘21, early ‘22, we were very adamant. One thing we pounded the table on here, along with a lot of other places, is the best performing asset over the next 20 years. And I said this again five years ago, four years ago would be gold. And not only would it be the best performing asset but it would be the most volatile over the next 15 to 20 years.

We said that again four or five years ago when it was a very unpopular opinion and that the answer was to buy out of the money calls on gold because you both benefited from vol up/market up, vol up and you got the convexity. That has been the best trade that you could possibly have made during that period. That is not over. Again, that was a 15-year (no pun intended) call. We are amidst a secular move. Now, that is not a 3-month call. That is a 15-year call which we are about five years into, call it.

And so, this is how you play this game. You play it with out-of-the-money volatility to the upside and it will be volatile. And actually, at the beginning of these moves, they are more right tail volatile but eventually they become more two sided volatile with right tail volatility. And the reason is, the more something triples, the more speculative interest there is, the more social zeitgeist and understanding of the reality there is, these are later adopters, early adoption means everybody needs in.

But once people start getting into a convex product it becomes more two-sided volatile because you have to keep flushing out the weak hands. And that's where we are now entering, in terms of precious metals. It has entered the social zeitgeist. People understand the realities, they are speculating, it is moving fast. But you are going to get some real tail wagging in precious metals going forward.

The most unique thing to what's happened to gold so far, that will not happen, is that has been one-sided. And so, expect if we're moving towards things like a debt jubilee… Are we in deflation, are we in inflation?

The very fact that we're asking that question at the scale we are means there is, at least, a very different narratives on both sides, and the ability for people to lose faith in the reality and then re-adopt the reality. But I think the bigger structural reality is the one that is more secular, that I've been talking about ,and that is that gold is structurally, for lots of reasons - the same reasons I talked about five years ago, going higher.

People have gotten longer and longer precious metals and I think this will get pulled in increasingly to a beta-one kind of market down kind of environment, for six months or so, and then it would be a time, again, to buy it with convexity to the upside later in the year.

And that view on equities market down/vol down, I mean that's because people are already positioned for that or to have a downside cover on, is that it or is there something else?

It's part of it for sure. So, it's several things. One, massive structure product issuance that's driven by people trying to get out of equity exposure and non-correlation. And the more they move into non-correlation and move to these types of trades, it reflects that they are all compressing as well. That's the biggest part. The very important big part as well is that vol beta to markets is cyclical. It shouldn’t be a surprise. We've talked about this at length.

So, I mean, again, I've walked through this history at length several times but you know, if we just got a massive vol… Everybody's fighting the last war, right? If we just got a massive vol event last April and even the August before, we had an incredible success of adding vol to the portfolio during those periods.

I mean that was pretty painful for anybody who was in the vol space or trying to hedge, and everybody in mass, you know, exodus to vol as hedges. And if anything, the vol selling accelerated because, you know, if it makes money in the meantime it's not going to help you when the mark goes down. Why own it? ‘23, ‘24, ‘25, right. vol compression and then boom, vol event, vol event. And so, we're on the other side of that. We're in the ‘you better be hedged’. The market's crazy. The world is crazy. You’ve got to own puts. I don't want to sell my stock, it's up all this money, I don't want to, you know, pay the taxes, etc., etc. Put a Band-Aid of vol on it, that should help.

The pain trade is what happens when the market goes down. What is the most painful thing to the most number of people? And the answer right now is market down, vol down, precious metals down.

That is the most painful trade. So, if you want to know what the highest probability is, that's the highest probability trade.

I mean away from the macro, there's plenty of political, geopolitical risk out there at the moment, events unfolding. We've got concerns around Iran, a possible strike there. Are these events adequately priced? Are they going to be meaningful? Are they greater risk events than currently priced, would you say?

The reality is markets, as you know, are a voting machine. And so, a lot of what we're talking about, the macro matters and it matters more on a multi-year basis. And things like that are big, structurally important things, like what is happening in Iran, are very important, structurally, to economic outcomes, but really only in the sense that they somehow affect the flow of capital and the flow of kind of economic consequences.

And so, us going into Iran, which yes it does seem, you know, as much as I think their was a way out, and there would have been a preference by this administration for a way out of this, they were pressured, heavily, by a consortium across the Middle East to avoid this outcome. But Iran has been, you know, bolstered, has become a proxy both bolstered by China and has held in strict opposition to some type of a kind of a deal. We are going to go into Iran and it's going to happen soon.

And my view is that, you know, as much as they're trying to prepare for the oil energy effects, that is an accelerant to a global conflict. We are going towards, and I've been saying this again for five years before Russia/Ukraine even happened, going towards a broader global conflict.

You know, Venezuela was a proxy war, Iran's a proxy war, you know, Israel in Gaza is a proxy war and eventually Taiwan will be a proxy war. The reality of where we are right now is this is an important accelerant. The Middle east has always been the most dynamic spark in accelerants to global conflict and this one is, in my opinion, an important one.

So, that said, it's not what's going to drive some big shock today because it's understood, it's well known, it is only through the flow of oil in the short-term that that could be… You know, if we saw a huge spike in oil and they weren't able to control that, which I think they will because they've coordinated with Saudi etc. But outside of that, you know, I think this is more an accelerant to a much broader process.

So, it needs to be measured and weighed. It, it likely means more of a breakdown and bifurcation of the world order, which we've been trending towards for quite a while now. We don't need Iran to happen or not happen to see that's where things are going. This is just, kind of, an accelerant and a moment, an important moment in that and where we're heading there.

And from a market perspective obviously it is reasonably well priced in expected at a stage. It won't come as a shock if there is a move, but, I mean, second order impacts are more prolonged impacts…?

Yes. Think about it this way. We knew Covid was happening in December. You know, the narrative of it being important didn't matter till late February, middle of late February. This is important and it's maybe not a Covid situation, but pair this global increase in global conflict, which is only accelerating from here, pair it with the political voting kind of laws that are being passed in the US that's going to happen around midterms, and the likely internal upheaval that's happening. So external upheaval, internal upheaval, in the US, pair that with the AI disruption we just discussed.

You know, this is a building of pressure in a system that is very structurally and, by the way, we're at record valuations at the same time. So, it's a recipe. That doesn't mean the market is going to crash. It does not mean the pressures on the system, the risk relative to the potential returns in the system are building and are, importantly, dangerous for markets. But the flows will dominate between, and I think it’s much more likely, and they're not unknown things, that's the other thing. It's, you know, the pot being boiled.

So, again an argument for market down/vol down, you know, a slow, controlled demolition that then necessitates a response but at least for the powers that are here in the US, does not lead to an uncontrollable situation that they could not then kind of manage. And so, this is, again, the most likely path for lots of reasons I mentioned. But again, just because those things are happening and known does not mean they're already priced, in a sense.

I mean you talk about you know, vol already being elevated in equities and metals, and curious to get your thoughts on fixed income because, obviously, yields have been very much trapped in a range about three and a half years now. So, is that an area where we could see that vol expansion and what would that mean?

Great question. The answer is, if we are entering, let's say, a nine-month period or so, you know, into the end of a midterm period, that is likely building in pressure with reactionary forces and it is seen as deflationary with potential, likely, I would say, for inflationary response. How do you trade that? And the answer is building pressure in a system.

Sumo market, I like to call it. Just because two tectonic plates are pushing strong enough against each other that something doesn't move doesn't mean it's safe because the more pressure that's in a system the more combustible it is once a move happens. So, my answer is, in the short to medium-term I think it is vol compressing much like tectonic plates are vol compressing. But the ultimate response will be a dramatic release of volatility in that space. And I think that's probably you know, six months plus out.

I think if you play for, you know, coming significant, dramatic, structural volatility there, in the future, while still being, you know, short of that volatility in the short-term, I think that is probably the big structural play there.

You mentioned, briefly there, elections. Obviously, the midterms are a big factor, kind of, I suppose, looming over the markets in the backend of the year. I mean, obviously, I suppose the narrative, to date, has been the administration is going to want to run the economy hot, keep policy easy, get prices down, get rates down. They have had mixed success on all of that to date. And, obviously, the economic data has looked a little bit disappointing, Q4 GDP coming in well below expectations.

So, there's the kind of the economic element to it and then there's kind of the practicality around the voting and some of the concerns around that, you know, and possible voter intimidation, etc., which we've talked to people like Gary Gerstle on the podcast as well. So, I mean, where do you see this playing into that kind of trajectory of markets, you know, you've been talking about possibly down, recover later. Midterms, obviously, will be in November. So where does that fit into that timeline?

Yeah, so you have to understand incentives. There are structural flows and supply and demand, but then there is, for the things that we don't know that are more human, the bigger picture things, those can be kind of modeled broadly based on incentives. And that's a harder thing, but it is actually, you know, statistics are a thing, and human beings themselves and entities do react to those incentives.

So, the reality is that, you know, all politicians (and this is a kind of probably a magnified version of this) are trying to maintain control and stay in power, whether politicians, dictators, leaders, however you want to think about it, right? People in power want to stay in power. The question is, how far are people willing to go to stay in power? And we've gone to an extreme in terms of, I think, how far this administration is willing to go to stay in power. And I think that's not controversial at this point.

We talked about it maybe when it was controversial. The State of the Union just happened and President Trump was pretty vocal, again, at hinting how he plans to be here for a third term, ha, ha, ha, laugh about it, say the quiet part out loud. That is very much true and I've talked about that for a year plus very publicly.

You know, if you are intent to do that, your intent to maintain power… I know about this because I come from a part of the world where this has been the case. And by the way, you know, the playbook has been played out and put in front of Trump for a long time. He's become very close to Erdogan and he's watched how he's managed these things. This is not a coincidence. There is a playbook and it works. I hate to tell you, it works. And the US Is not immune from it.

And so, the administration knows that they would like to win without control because if they can win without it they have the public’s support and they did it fairly. Right? But if they can't, they'll cheat. And that's not a judgment on Trump, by the way, It's a judgment on politicians and power since the beginning of time. It's like saying that we judged, you know, Augustus and Caesar poorly. People in power want power for lots of reasons. And Trump is no different. Actually, if anything, he's one of the bigger… He thinks he sees things for what they are and says things for what they are, but he does it with a bluster and a lack of reverence for the institutions that came before him.

And so, my answer to you is, I think the original plan, as I understood it from people I know on the inside, for a structural kind of overtake of power to control the ballot box later, for the eventual election. But the wave, partially driven by the Epstein stuff, partially driven by the acceleration of AI and the UK economy, a lot of these things are leading to incredible unpopularity, historically of the President in the US.

And it shouldn't be a surprise that the response to that is an acceleration of the things that they need to do for the midterms, because if he were to lose both houses, he will have already essentially lost the final election in the years following because he would lose full control. And so, the inability to control the presidency in two and a half years, and that outcome is a function of the midterms going completely against him, and that is unacceptable to him. So, we are seeing an acceleration of internal control which will then accelerate the response.

What, specifically, does that mean, control of the ballot box?

So, they're declaring… I mean, if you go read the headlines, and again, I recommend everybody go take a look at, at the actual verbage. But, it's a group of pro-Trump attorneys who had drafted an executive order aiming to give President Trump unprecedent powers over elections. It's a full-on control the ballot box, deciding who can vote, who can't vote, what is required to vote. And even though this is actually, you know, not legal, this power comes down to the States.

Trump's model has been very clear. Just think about tariffs. What he did with tariffs is illegal. Does that mean it didn't matter over a year and a half? No, he forces the courts to respond. And if you do enough things, in enough ways, and you do them fast and hard enough, it overwhelms the system and you get what you want anyway, at least for some period of time. And all that matters is that he has that control now for nine months or eight months.

And so, they are intent to do whatever they can, illegal, or legal, or any other way, to change the course of this outcome. And they will layer in whatever they have to do, to do that. Now, will they be successful? Hard to say. Historically, the answer is yes, they will, unfortunately. And, at least in swaying the results to some extent. So again, people will…

We live in a political world where people will see what I'm saying as somehow politically anti-Trump or anti-whatever. This is not anti-Trump. It is not anti, even. It is a discussion of the realities of what has happened in every… It happens in Russia, it happens in Turkey, it happens all over the world. And it's not just in today's age that it happens. It literally has happened since the beginning of time. And it is an attempt to control the outcomes of the election. And those that support the administration will gladly look past that.

You know, this administration will look past that because it serves what they want. But the reality is, as a structural reality, this is the truth. And so, that is more what we're trying to talk about, to help judge future outcomes and plan accordingly.

I mean, equally, there is the market reaction to something like that. You know, historically you might have expected an adverse reaction to something like that, but it hasn't necessarily been the case with a whole range of kind of issues.

Honestly, it never really has been. I mean, more so than ever there's a delay I guess but, again, in the short-term markets are voting machine and long-term they're a weighing machine. Yes, these things bend the realities of markets eventually. But that, eventually, can happen in five years, Alan. And it can be after things have already passed, and other things have kind of melded over, and there's been a reflexive effect.

News and effects matter, they go into the equation, but the things we know more are the voting machine. And the voting machine ultimately affects the weighing machine in the long run as well. Actually, it's the biggest effect. Markets are the biggest driver of liquidity in the world.

And so you have to… You cannot, as part of a process of predicting what happens to markets, think of news and I draw a linear line to results in markets. Actually, you need to start with markets and the voting machine first, put these ingredients in, model what's going to happen in the short-term, and see how that might affect the long-term outcomes for those macro effects. It is a much more complex multi-dimensional system.

But the reality of the situation is, actually, I think we do people a disservice by painting a picture that, X macro is happening, so you need to sell. It is that they both are true. I know that is complicated for people, and confusing, but I hate to tell you markets are actually reflexively incredibly important, especially at this point, to all the outcomes at play. And what drives markets in the short-term is primarily not the macro news itself.

Well, I mean we've talked about this reflexive process in the past, and we've talked about it as a positive aspect of the market dynamic in a sense of we've had the wealth effect. Obviously, the K shaped economy has been much discussed, and we've talked about in the past as the market rises that improves collateral values, etc., and that, with leverage, people then have to buy more.

It sounds like you're saying we're at that point now, maybe because we're seeing some cracks in certain asset values, that reflexive process is pausing or maybe even starting to go into effect.

So, you asked, I should say, for why do I feel confident that this is becoming a topping process? I mentioned the leadership and all the rotation etc., probably the simpler point, that I didn't make is when markets stopped going up, the momentum liquidity effect (that you're mentioning), which is that re-leveraging effect, which is by-far the biggest driver of liquidity in the world…

Again, we've painted the numbers, we'll do it again here, US$500 trillion along assets, they go up 20%. You know, that's a US$100 trillion of new collateral that then can be leveraged for new investment in one year. What does that do? How do you compare that to like the liquidity of the Federal Reserve or the Treasury?

The other things are… Never mind the wealth effects and the other things that are happening under the hood. Otherwise, markets are the biggest driver of the economy now, the biggest driver of markets themselves in the world.

So, I know it's kind of a loop, and it's hard to think about it, but if markets slowed down and stopped going up, all of a sudden you remove this counterbalance to other things that may have been already kind of drawing on the economy. And the economy has been drawing on liquidity at the bottom. We have also kind of reached our natural ending point, for now, of how much issuance we can do on the short end. So how much like soft QE we can do, which we've been doing as well. So that has slowed.

We’ve reached the five-year anniversary of the bottom in interest rates, and refinancing, and debt, that is a two, three year draw - massive on liquidity - because everybody now needs to refinance at higher interest rates. All of these things are draws on liquidity, structurally.

And the administration is trying to do things like the SLR ratios, and the stablecoin, etc., to try and counterweight that. But the reality is those overhangs are strong, and the only real way they can counteract that… And they can do that, they can counteract that, that's the reality. And they could keep this going, but they need the market to keep going up to do that. And if they're not, it gives out under its own weight. And so, that's where we are.

And so, the simple fact is, the more this hits against a ceiling and can't keep going up, and they can't get the momentum moving for all the structural reasons I have, eventually the even worse part happens, which is the negative draw that's happening across the market now gets drawn from de-collateralization and the negative effect that comes from that. And so, the risks, to the downside, are significant at this point if the market can't keep going… and it has stopped going.

Good stuff. Always good to get a whirlwind tour of all the big macro factors and also what are the true drivers of the short-term equity market movement. So, fascinating to hear all of that. So, thanks for joining us again.

Niels will be back next week. I'm not sure who's with him, but Niels will be back to anchor next week's episode. So, get your questions in the for Neil's and, from all of us here at Top Traders, thanks for joining and we'll be back soon with more content.

Thanks for listening to the Systematic Investor Podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review. And be sure to listen to all the other episodes from Top Traders Unplugged.

If you have questions about systematic investing, send us an email with the word question in the subject line to info@toptradersunplugged.com and we'll try to get it on the show.

And remember, all the discussion that we have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also, understand that there's a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your valuable time with us and we'll see you on the next episode of the Systematic Investor.