.

Are there other such stories in the making? Perhaps lithium? Cobalt? In any case, I stumbled upon this interesting story from the book. So emblematic of the pattern of boom and bust in stock markets, on the back of commodity demand cycles.

John Thomas North, age twenty-nine, debarked in Iquique [this is in Chile, and a place which was a hotspot for nitrate mining] in 1871. He was one of thousands of British citizens who came to seek their fortunes in South America during the nitrate era. He had some training as a mechanic and a keen eye for business, and he started his new life in South America by getting into a surefire business: the shipping of water to Iquique from springs farther north. He familiarized himself with the nitrate trade as well, watching as desert properties were bought and sold, and speculating a bit himself if he saw an attractive deal.

Then came the war and the Chileans. The takeover of Iquique and the Tarapacá threw all previous ownership—all the deals that Peru had made—into question. In the confusion and uncertainty many owners were willing to sell cheap. North began buying. He worked closely with the new Chilean inspector of nitrate mills (another British-born émigré) and was soon making serious money, buying nitrate properties at distress-sale prices and turning them around, sometimes in the same day, for two, three, or four times as much. He advertised his success in London, where he used his growing personal fortune and portfolio of nitrate holdings to float loans to start companies like the Liverpool Nitrate Co. Ltd., which gathered British investors for more purchases. In the mid-1880s, nitrate speculation went wild in England, thanks in great part to North’s enthusiasm. During his increasingly opulent visits home, he described to the rich of his nation the enormous profits to be made by anyone smart enough to buy and sell chunks of the desert and shares in the refineries that made nitrate. It was an absolutely necessary commodity. Fortunes were there, in Chile, for the taking. Enormous investments were made in North’s companies. North built some refineries himself, and then sold stock in them. His investors began making 10, 15, 20 percent dividends in a single year. “The company promoter has only to whisper the magic word ‘nitrates’ and the market rises at him,” marveled London’s Financial News. Speculators started calling Chilean nitrate white gold.

…Then the bubble burst. Rampant nitrate speculation led by North pushed share prices well beyond the value of the land and mills. To keep returning high profits the refineries overproduced, flooded the market with nitrates, and held down prices. By the end of 1890 shares in nitrate companies were being sold for a quarter the price they had commanded a year or two earlier. One day North’s broker entered the London Exchange to find men piling copies of his latest company’s prospectus on the floor and setting them on fire. North kept telling nervous investors that nitrate sales naturally fluctuated, that the core value of his enterprise was buttressed by the value of his railroads alone, and that the long-term future was bright. But even North could not single-handedly keep the nitrate market afloat. As precipitously as they had gone up, the value of nitrate investments went down. North, his fortune depleted but not gone, retreated into private life.

The book is a fabulous read. Some of my snippets from the book are here.

This can even happen at national scale. Consider the semiconductors fabrication business. TSMC started at a time where it was still possible to setup a fab and hope to be competitive. Over time, it got much better while others were not able to keep up (partly because of the scale TSMC got to). It got to a point where even Intel has thrown in the towel and is willing to outsource to TSMC. But at this stage, almost no other country can hope to build their own TSMC. China has been trying for a long time and has sunk a large amount of money into it - with no success. Even America is struggling.

You either enter the race early, or you forget about it altogether.

An incredible connection is to an even bigger idea. In The Lessons of History, Will Durant says: Every advance in the complexity of the economy puts an added premium upon superior ability, and intensifies the concentration of wealth, responsibility, and political power. This links up so powerfully with the idea. Not only industries but the whole economy is becoming that way. As it gets more complex, few people are in a position to play any meaningful role. The starting off skill-set (and even resources) you need to participate in the big leagues gets higher and higher. Disparity increases.


Related books:
1. Cod: A Biography of the Fish that Changed the World - Mark Kurlansky
2. The Lessons of History: Will Durant, Ariel Durant

The question really is about taste. Not everything that can be built ought to be built. How do we decide what to build? Maybe machines can answer that question by A/B testing their way through the world. But then maybe not.

Google A/B tests everything. Right down to the shade of blue to use on their buttons. On the other hand, Apple supposedly uses the taste of its developers and designers. Its products reflect the aesthetics of their designers. If Apple had followed what its users asked for, it would have built a monstrosity. Taste is critical.

So that leaves the question of how many people do we need? When something is cheaper, there is far more demand for it. And the marginal effort that humans are required for, are multiplied a thousand-fold and so you still need as many people.

Sometimes that does not happen. That category of job is completely destroyed. But then the cognitive bottleneck moves elsewhere. And you need people there. For example, maybe creating beautiful marketing collateral for a company becomes easier and cheaper. Then many more companies will actually create marketing collateral. Each of them will need people who make the choices from among the variety that a Midjourney or Dall-E can throw up; those that can prompt these systems to come up with plausible suggestions. And then once you have the collateral, there are more people running the campaigns that use that collateral.

Will there be an infinite regress though? Will we always be able to find other things for people to do? Maybe. Maybe not. But almost surely the cognitive burden of the tasks expected of humans will likely only increase. Will we be able to upskill the human population to meet that challenge? It will be incredibly hard, to say the least. Which is why I've maintained for a long time that the defining problem of our lifetime will be that of employment and employability. Why this matters is a question for another post.

I recently wrote a post wondering about the factors that led to the creation of Silicon Valley. The presence of Stanford. The role of Stanford’s then dean, Fred Terman. The early startups like Shockley semiconductor and Hewlett-Packard that were a magnet for great talent.

But a big driver of everything was the cold war, and the crazy amount of money the US Government pumped into research in pursuit of the defense and space programs. Surprisingly (to me at least), Lockheed had a large setup at the Stanford campus, where they did cutting edge research. Where did they get the money to do this? The US Department of Defense. Who were the early customers of Hewlett-Packard? Defense manufacturers.

The entire spending on the US defense and space program had a salutary effect on the development of technologies and, perhaps more importantly, the talent pool that would later build silicon valley. One could draw a straight line from those days to America’s dominance today in the technology sphere. And the incredible wealth they have created.

It is not as if the US did not have more pressing social problems then. Perhaps you could point to the prevalent racism. Or I’m pretty sure at poverty in the interiors of the country. Was that a reason to not invest in the space program? Very far from it.

The pursuit of seemingly irrelevant science programs creates ripples and second order effects that can compound into incredible outcomes. And as Steve Jobs famously said in a different context - you can only connect the dots looking backward.

So what about Chandrayaan 3? Is that a program India should have pursued given its crushing poverty? You know where I stand, and why.

P.S.: Image credit Wikideas1

P.S. - Image credit to someone who was probably on the IIT Bombay campus in 2006-07 and who created a collection of images. If someone knows who it was, please do connect.

The first is the sheer audacity of the enterprise. We are talking today about the $200 genome or the $1000 genome. At the time this project was proposed in 1990, it was projected to cost 3 billion dollars. And it wasn’t just the cost. The human genome has about 3.2 billion nucleotides. The plan was to sequence it by breaking it up into fragments of 2000 nucleotides each and then piecing them together. That would be 1.6 million such fragments. There were no automated machines to do this yet. It wasn’t clear that they could be built. The whole thing was awe-inspiring.

And that is the point. The greatest things done by humans have probably seemed impossible except to the crazy few. Magellan’s trip around the globe. The Manhattan Project. The moon landing. The human genome. Reusable rockets. Zero-carbon civilization? All major human progress will seem impossible until it is not.

But the exact opposite is true as well. The promise of a cure for cancer has been around since the first time someone managed to edit a gene - in the 1970s! Five decades have passed since then. We are closer to the goal, but it still seems elusive. The promise of AI came even earlier - in 1956 - at Dartmouth. And it is only now, finally, that there is a global feeling that we are very close to achieving that dream.

This book was written in 2003. Already there was talk of how having the human genome would enable the cure of hundreds of diseases by precise targeting. Celera was trying to build a business based on genetic data. The excitement was palpable. Companies had been bid up to insane valuations and had crashed back to earth. And now twenty years later, we are seeing the same movie again. Is this the cycle when the dream comes true?

What’s the lesson for an investor? At any given time, there are a number of audacious goals being pursued. Net-zero. Saudi Arabia’s Neom project. Curing cancer. Mars landing. Quantum computing. In each wave, the excitement swells. Capital gets pumped into the projects. And we take some more steps toward the goal. The big breakthroughs happen when enough of the pieces are in place. The AI revolution taking place now has been enabled by many different pieces - GPUs, theoretical breakthroughs in deep neural networks, cloud computing, large-scale data available on the internet, and possibly many others.

So how does one judge if it is a good time to invest? It would seem that to invest well one needs to be a fortune teller. But perhaps not. Will we be able to cure cancer? That depends on whether the pieces are in place. Is sequencing cheap enough? Is enough data available? Are the business models in place? Is the regulatory framework conducive? To even ask the right questions, we need to know how things fit together. What are the bottlenecks? That needs study, clarity of thought, and a deep sense of history.

As Benchmark Capital’s Matt Cohler has succinctly said, “Our job is not to see the future, it’s to see the present very clearly.”

The answer is, as always, it depends. Any decision in investing is a function of your process. Whether you should be averaging down when the price falls, or selling out, is at least partly decided when you make the initial investment. The decision depends on what your thesis was when you made the investment.

Borrowed Conviction

There is one scenario when it is impossible to figure out the answer. That's when you've invested simply based on a tip from a friend, or worse, a TV channel. In that case, you probably don't know what the original thesis was, and whether something had changed. If you got the tip from a friend, you could call them. And hopefully, they'll know enough to be able to tell you what to do, and why. Otherwise, it was probably a mistake to buy in the first place. And it will probably be a mistake to hold on or double down. But you really have no way of making an informed decision - unless you dig in and do some research now. If you do decide to do some research, watch out for the endowment effect.

What's your thesis?

In the happier situation where you did your homework before investing, we have something to work with. As I see it, there are two broad reasons you can make a specific investment.

One reason is essentially that the security in question in undervalued compared to current fundamentals. You have not invested assuming there is an immediate catalyst for value to be unlocked. You expect things to work out over a three to five year period. In those cases, it might often make sense to buy more, subject to overall exposure and portfolio considerations. More on this in a minute.

The other reason sometimes is that you think a specific catalyst should cause the price to go up. Like the launch of several new products. Or benefits coming from some regulatory changes. You expect prices to move favorably in a relatively short time. In those cases, a material drop in price might actually be a strong sign that your thesis was wrong. In that case, rather than buying, it might be time to accept a mistake and exit. But watch out, the market can often test investors like you, before bouncing back. But adding to the position might still be a mistake.

Humility is important

For conviction investors, it is easy to assume that when the price of one of your investment falls, it is simply because the market is stupid. That might be true, but it is dangerous to have this as your default assumption. All seasoned investors will tell you that the market is not wrong very often. So when the price does drop, you must try and ascertain the reason.

Sometimes a stock will drop right after an earnings announcement. The earnings might even look good and you might wonder why the stock dropped. But perhaps the market expected better results. Sometimes things are even more subtle. The market might not like that the EBITDA margin was lower than expected. Or that earnings came more from other income than regular operations. There is more to earnings than the earnings per share.

Even so, the question you need to ask is - does this affect my thesis. If you are expecting your thesis to play out over a longer period, you should check if the result suggests something that might derail the long-term view. While quarterly earnings may not matter as such, they can contain hints that your thesis is turning out to be wrong.

Premeditation

One way to mitigate the heart-burn when you see your investment drop in value is premeditation. That is, instead of being reactive, you can be proactive. Before you make your original investment, you can ask yourself what you would do if the price were to drop. Is this position a time-sensitive position or a long-term bet. In either case, what could convince you that things are not working out. Can you think of some situations that can cause the price to drop, but which you know you shouldn't worry about.

This is easy to say, but much harder to do in practice. In general, if you're buying, odds are that you are already convinced you are right. Which is why it is important to make this part of your process. And it rightly belongs in the analysis step. This is a practice that can be applied to many things other than investing as well. I will write more about this at some point.

Meanwhile, I hope you never are in a position when you have to wonder if you should buy the dip!

Who are you?

I'm not interested in a philosophical answer to the question. Although, if that's what moves you, it might have some bearing on your investment process as well. No. I'm looking for more prosaic stuff here. Are you someone looking to manage money full time? Will you be investing your own money or other people's money? What are your investment goals? Things like that.

The first question you'll want to answer is about time. What sort of time do you have to devote to investing? Could you do it full time. By full-time, I don't mean you have to watch the markets all day. But you have to be thinking about it, and reading, and learning all the time. If you cannot afford to do that, if simply because you have a remunerative full-time job, that's okay. But then your goals from investing should be more modest as well. And your process design choices have to be such that they are not time consuming.

The second question is about your source of capital and your risk appetite. Is it permanent capital, i.e. can you be sure it will not be withdrawn at the worst possible times? Even if it is your own money, you might have to draw it down for life emergencies. Risk appetite in this context does not mean your ability to accept losses. It is about whether you might ever have to dip into your capital against your wishes. If you're investing all or a substantial part of your savings, do not consider it permanent capital. If it is other people's money, it is almost never permanent capital. Then you're constrained to deliver at least somewhat consistent performance. That will necessarily have an impact on your investment process.

A related question is whether you have a constant source of new capital. If you are in a job that let's you save meaningful amounts of money, then how you think about which companies to buy would be different than if you were constrained to only invest a fixed amount of money. Similarly, it will also affect how you think about portfolio construction and about exits. Ditto if you're investing the cash flows of a business that generates cash that it cannot redeploy.

Then there is the question of what is your investing goal. You might be looking to multiply a small some of money and might be willing to take meaningful risks with it. This might sound bad to some but isn't necessarily so. Taking risks does not mean gambling. You might be happy to just earn a reasonable return instead of leaving it idle in a bank. You might even think of investing as a means for keeping yourself sharp and learning. Whatever it is, the answer to this question has a meaningful impact on your design choices.

And finally, the big one. What drives you. You may not necessarily have an answer to this on day one. You're more likely to discover this as you invest. Here are some possible answers to keep in mind.

You love finding great companies that are doing good work. And by investing in them, you derive a thrill for being a part of that good work. You love being the contrarian - finding value in what the market shuns. And then getting rewarded for being smarter than the others. You're the analytical kind, who loves numbers and statistics. And you like to bring that skill to work making you money. Or you derive pleasure in finding the worst run companies, and frauds, and shorting them to make money as they crash and burn. This is a process of self-discovery. The more your process aligns with what drives you, the more you're likely to do well.

Good design is context specific

When we something is designed well, it is always in the context of a specific task or problem. This is as true of a teapot as it for a software application. And so it is for an investment process. It is easy to think that the point of an investment process is to generate returns. But there is a heavy context of the person, his circumstances, and his goals.

So before you sit down to design your investment process, know thyself.