Hugh Hendry's Eclectica Fund Sees Hyperinflation Via Deflationary Event; Constructs Asian Bear Portfolio

Hugh Hendry just released the May market commentary from his Eclectica hedge fund (see below). We haven't checked in on Hendry since his March update when we saw he liked Annaly Capital Management (NLY), but his time around we get much more in-depth macro commentary. Hendry has compiled eleven pages worth of insight complete with charts, pictures of Chairman Mao, and even lyrics from the band Gorillaz. The main takeaway from his commentary though is that he sees hyperinflation in store as sovereign entities will need to pay off their overwhelming debts via 'worthless fiat currency.' However, for this to occur, he argues that first we need to see a large deflationary event.

Curiously enough, Nassim Taleb mentioned this sort of scenario at an investment panel where Hendry was a speaker as well. Taleb presented the idea that if you were creating a portfolio today you should allocate a tiny portion to insurance against hyperinflation. If the scenario doesn't unfold, your cheap insurance expires worthless. However, if it does occur, your investment returns an exponential amount. We just yesterday detailed how legendary fund manager Seth Klarman is worried about inflation and has bought insurance to hedge this risk.

Turning back to Hendry's recent commentary, he writes that, "it is now commonly accepted that the magnitude of the financial problems confronting the world economy are so great that in all likelihood we will be confronted by a hyperinflation allowing sovereign debts to be paid off in worthless fiat currency. Just like the Bolsheviks in 1918 and 1919, the machine-gun of the Comissariat of Finance will pour fire into the rear of the bourgeois system. We do not dispute this outcome."

So, what would that deflationary event be that serves as a catalyst? His Eclectica Fund has essentially outlined two 'game changing' scenarios: 1. China's rate of economic growth slumps and 2. The Japanese Yen suddenly appreciates and bankrupts its domestic export base.

How has he positioned his portfolio for such a scenario? Hendry has built a short credit portfolio, "made up of over twenty single-name industrial, cyclical businesses which have the dubious distinction of suffering from gigantic financial leverage and Asian/commodity overdependence. Without a doubt, some of these businesses will not survive; others will have to be radically overhauled and restructured and we will make money." So, let the guessing game begin as to which individual names he's referring to.

Their aptly dubbed Asian bear portfolio is 3.5x short the fund's NAV and has a maximum loss of 8.5% and a maximum potential gain of 250% (if some of their names go bankrupt). In terms of other portfolio positions, the Eclectica Fund has seen strong performance from its European sovereign CDS positions as well as some of their interest rate 'swaptions' in the UK, Australia, and New Zealand. Lastly, Hendry mentions that since the Chinese have started to import corn, this could possibly be the birth of a new trend. Regardless though, he feels corn trading at $3.60 per bushel is too cheap and has started to build a position there as well.

Hendry is by far one of the more entertaining (and contrarian) fund managers out there these days and his macro insights never fail to leave you without contemplation. While we won't spoil the fun by telling you which Chapter Hendry is profiled in, suffice it to say that he certainly makes a lasting impression in Steven Drobny's recently released book, The Invisible Hands: Hedge Funds Off the Record.

Embedded below is the May market commentary from Hugh Hendry's Eclectica Fund:

You can download a .pdf by clicking here.

So, the inflation versus deflation debate wages on. While the vast majority of fund managers we cover on the site have had an inflationary bent, we know Hendry has been in the deflationist camp for a while now. Broyhill's Affinity hedge fund recently outlined ten reasons to buy bonds and Hendry would most likely agree with some of the rationale given that he doesn't think interest rates will rise anytime soon.

We've been posting up a bunch of the latest hedge fund investor letters, so make sure you check out insight from the following managers:

- Louis Bacon's Moore Capital Management

- Ricky Sandler's Eminence Capital

- David Einhorn's Greenlight Capital

- Jay Petschek's Corsair Capital

- Kyle Bass' Hayman Advisors

And for our past coverage on Hendry, be sure to check out his thoughts on how to invest $100 million. And as always, to prepare for either outcome, head to a previous post on investment scenarios: inflation versus deflation.

Kyle Bass Sees Inflation & Significant Currency Devaluation Around the Globe (Hedge Fund Hayman Advisors)

Today via ARHedge we present you an excerpt from Kyle Bass' latest letter to investors of his Hayman Advisors firm. If you're unfamiliar with Bass, he launched his hedge fund in 2006 with $33 million in initial capital. In August of 2006, he began shorting around $4 billion of subprime securities through various derivatives and eventually turned $100 million into over $700 million based on his prediction of the crisis. This isn't the only major prediction he's been correct on, either. Bass was even predicting sovereign defaults back in May of last year. Needless to say, he's been right on the money. His latest missive is entitled, 'The Pattern is Set - Betting the Bank of a Keynesian Free Lunch'

Via ARHedge, here is an excerpt from Hayman Advisors' investor letter from May 11th:

He writes, "The ECB's monetary policy action simply adds to the moral hazard that was originally created on the fiscal side of the problem. The pattern is now set. This is exactly how very smart people meeting together in order to 'solve' a debt crisis frequently (and now permanently, it appears) mistake a solvency crisis for a liquidity crisis. From now on, it seems everything will be deemed to be a liquidity crisis that will be met with more 'bail-outs' and debt financed spending. This will eventually break traction in a violent way and facilitate severe inflation or even hyperinflation. The one thing the EU taught us this weekend is that paper money will be worth less (maybe much less) in the future."

Bass' notion of hyperinflation is intriguing because we haven't seen too many managers talk about the prospects for that outcome as most are fixated merely on the inflation versus deflation debate. However, we do recall black swan extraordinaire Nassim Taleb himself recently touching on how, from a portfolio construction point of view, it makes sense to allocate some capital to inexpensive insurance against possible hyperinflation. The wager doesn't cost you much and if you 'win', it pays off big. If hyperinflation doesn't come to fruition, then you haven't lost much capital. An intriguing thought certainly and Bass would probably agree with him on that notion.

The Hayman Advisors founder then ends his letter with a decisive analogy writing,

"This weekend, the EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world. We believe the agreement released was nothing more than a Potemkin agreement in order to placate bond investors. In the end (and there will be a reckoning for many countries) nations, including the United States, need to dramatically cut spending and get their fiscal balances in order. Unfortunately, our elected officials are on the hamster wheel of electoral cycles and are not able to make tough decisions like this as they would likely not be re-elected without a "sea change" in public opinion towards government spending and deficits. We are therefore on the path to significant currency devaluation around the world that will likely result in significant inflation. We increased our holdings of gold on Monday morning as well as taking other steps to position ourselves for the most likely outcome over the next few years. Interestingly enough, based upon the market reaction in the last 36 hours, it seems the law of diminishing returns applies to bailouts as well."

You can read the rest of his brief letter over at ARHedge.

So, we now see that Bass has increased his gold holdings and joins countless other hedgies who see gold as a safe haven and a way to hedge against currency devaluation. Lloyd Khaner of Khaner Capital last week gave an in-depth presentation on gold at the Value Investing Congress. And as we all know, John Paulson launched his gold fund as a bet against the US dollar. Not to mention, other prominent hedge funds like David Einhorn's Greenlight Capital as well as John Burbank's Passport Capital are storing physical gold.

It's very clear that number of prominent investing minds are concerned about currency devaluation and inflation going forward. Today seems to be inflation versus deflation day here on the site as earlier we posted up hedge fund Broyhill's contrarian bet on long-term treasuries and their ten reasons to buy bonds. Obviously this differs drastically from the vast amount of other hedge funds who have been short treasuries, wagering on rising rates and possible inflation. Well, the debate wages on, but we certainly know where Kyle Bass stands now, don't we?

What 100 Trillion Dollars Looks Like (Inflation? What Inflation?)

With all the talk of inflation down the line as the US Dollar slowly but surely implodes, we thought we'd take a bit of a humorous Friday approach to the topic. Below is a picture of what 100 Trillion Dollars looks like.

Well, 100 Trillion Zimbabwean Dollars, that is.

(click to enlarge)

Inflation? What inflation?

One would think that 100 trillion dollars would be quite the spectacle, but it's really not when you have a ten trillion dollar bill. This just goes to show that things can always be worse-off somewhere else, so keep that in mind. Who cares about inflation when you've got hyperinflation to worry about. And to those unaware of the situation, no this is not a joke. A loaf of bread in Zimbabwe costs $16 million Zimbabwean Dollars... at least it did back in 2008. Who knows what it costs a year later.