Regarding… Vol 2 no 27 – Dogwifhat

Dear Fellow Investors and Friends,

Welcome to this week’s edition of my investment letter, where I try to make sense of the world around me and share stuff that I find interesting.

I do appreciate you taking the time to read this.

Today is Thursday, July 18th, the 200th day of the year. There are 166 days left until the end of the year.

Intel was founded 56 years ago today. It started life as N.M. Electronics Corp, named after its founders, Robert Noyce and Gordon Moore. Look where we are today – the global economy is built on computer chips. Everything runs on chips from your car, your home automation system, and your computer games to Bitcoin and AI.

I don’t own a dog, so this is not a picture of my dog:

It is the Dogwifhat meme that became popular in late 2019. Three years later, the WIF token was launched alongside a nonsensical website, on which any utility of the token is explicitly denied: “I mean, bro, it’s literally just a dog wif a hat.”

Today, the WIF token has a market cap of $2,4bn, which would place it at number 29 on the JSE All Share Index, slightly more valuable than the Foschini Group.

From the mysterious Bitcoin to the ridiculous Dogecoin and onwards to the laughable Dogwifhat token via the crooked crypto exchange FTX, most people regard the market for cryptocurrencies as somewhere between outright fraud and nonsensical farce.

Of course, no serious investor should be seen anywhere near the vicinity of these things.

And the really serious investors say smart things like, yes, I can see a use for blockchain, but crypto is a joke.

But is it? Let’s try to decode what’s going on.

A blockchain is like a filing cabinet. It consists of blocks – files – of information linked to each other. It has the desirable attributes of being permissionless and distributed.

Permissionless means it is an open network where anyone can see what’s in the files – or blocks – of information. Distributed means the files in the cabinet – the blocks – are stored across many computers on the network. The system is thus fully decentralised, with no single person or group in control.

However, being distributed in such a way immediately raises the question of whether one can trust the information on the block.

Cryptography is the process of coding information so that only the person a message was intended for can read it. It has been used to code messages for thousands of years and is today used in bank cards, computer passwords, and e-commerce. Cryptography is designing mathematical puzzles and then solving those puzzles utilising an algorithm.

An early form of cryptography used to record contracts was to make notches in a stick corresponding to an amount owed and then split it lengthwise, so each party had a complete record. The two halves – the keys – could be joined later as an audit of who owed how much money to whom.

Similarly, a simple encryption could have a key that says, “Use the letter preceding the ones in the code.” The word “dog” would then be transformed into a code as “eph.” If you have the key, you can decipher the code.

In the same way, cryptography takes information and transforms it into binary code – a string of 256 bits (0’s and 1’s) using a key. Like a physical key, it locks (encrypts) data so that only someone with the correct key can unlock (decrypt) it. This process is called hashing.

Importantly, you can’t hash backwards. If you have a key, you can’t hash it to get to the info. A string of 256 bits has 2 to the power of 256 possible combinations. To give you a sense of how many that is, 2 ^ 256 roughly equals the number of atoms in the universe. Thus, it is doubtful that you can “guess” the information in a string of 256 bits, no matter how many computer chips you string together.

Validating the blockchain is referred to as mining. Mining involves using computers to run algorithms to process the most recent block. Bitcoin mining is a network-wide competition to generate a cryptographic solution that matches certain criteria – the key. Once that’s done, you’ve effectively matched your two sticks, validating the info.

I love formulas. And the essence of the crypto ecosystem is described in this one:

(Ledger – Trust) + Cryptography = Cryptocurrency

Cryptography introduces trust into a decentralised, anonymously distributed system of record keeping.

But you can’t have a blockchain without a cryptocurrency. It costs money to “mine.” Chips are expensive and use a lot of electricity. Cryptocurrencies incentivise computers to run the algorithms that validate the information on the blockchain, thus bringing trust into the system and making a permissionless, decentralised system function.

There are many physical commodities, each with different uses. The same holds in the digital world. The Bitcoin blockchain is the most prominent. However, there are many other blockchains with different properties and functionality. Some are programmable, others are linked to digital asset ownership, and some have no function at all.

Dogwifhat, anyone?

Let’s revisit the start: the critical use case of blockchains is that they are a system that creates decentralised, permanent records, accessible to anyone.

The benefit of decentralisation is that no one person – or committee of people – governs the system. Most centralised systems are open to abuse by those who seek and obtain power. They are vulnerable to the misjudgments of “expert” committees that react to incentives that often do not have the best interests of those they govern at heart.

Additionally, a centralised system has less redundancy than a decentralised system. An attack can take out the centre of power, which makes the whole system vulnerable to collapse.

Another crucial aspect of crypto is the permanent record on the ledger. Once you have placed information on the ledger – an instruction, a transaction, a value, an asset – it cannot be changed, and everyone can trust that information.

Finally, blockchains and their associated tokens – or cryptocurrencies – are joined at the hip. The tokens are rewards for the actual costs the “miners” incur for verifying information on the blockchain. One can’t exist without the other.

Blockchains and cryptocurrencies represent true decentralisation, an antidote to the centralisation occurring on the internet, in politics, and society.

“Don’t be Evil” becomes “Can’t be Evil”.

Next week, I’ll explore how one would value all these different cryptocurrencies, and the week after that, I’ll explore the counterarguments against blockchain and crypto.

Of course, I welcome feedback and criticism. I’m writing these pieces primarily to develop my thinking around the topic, so other points of view are most welcome!

One should never be too dogmatic about any subject.

Maotai is a sorghum-based spirit called baijiu, the national liquor of China. Kweichow Moutai Co. Ltd is a Chinese company specialising in the production, sale, and distribution of Maotai liquor. It has become the most famous producer of this type of liquor – a cultural icon.

It was listed in 2014 and, by 2021, had become that most elusive of investments, a ten-bagger. Just in time for the chairman to be jailed for life for corruption after a court found him guilty of taking bribes. After that, this staple of any self-respecting portfolio of Chinese assets has gone backwards, losing over a third of its value:

Despite this decline, Kweichow Maotai is the world’s largest liquor company by market value and the largest single component of China’s benchmark CSI 300 index. But the sheen seems to be coming off due to a glut in baijiu, causing wholesale prices to decline sharply.

My take: Investors in China have lost their shirts on cyclical sectors like property. Now, more stable sectors, such as drinks, are starting to come under pressure. I would continue to be careful here.

Burberry has always been the runt of the luxury goods litter, consistently underperforming its peers. But it came out with an especially weak set of results this week, causing a sharp decline in its share price; from £24 early in 2023, it has declined to a recent low of £7 per share.

But it’s not only Burberry. Both Swatch and Richemont have also produced poor numbers. Weakness in China – for so long, the broad underpin for the sector – is the common denominator. It’s also clear that aspirational luxury is under acute pressure at the top of the interest rate cycle. For now, only the top end of the market is proving resilient. The purveyor of ultra-luxury, Hermes, still trades on a 45 P/E.

My take: You should have exposure to this sector in the long term. I’ve always maintained that – like insurance companies – you should never buy their products, just their shares. However, the entry point is not right now. Some of the companies in the sector, like Richemont, have misallocated capital, and those chickens still need to come home to roost. Some have management problems like Kering, the owner of Gucci. And all the companies in the industry enjoy elevated ratings, leaving little margin for safety.

This 10-year chart says it all:

The share price increased from R11 ten years ago to R50 this week. That’s a compound annual growth rate of 16%. Since the COVID lows, it has also been a ten-bagger, like Kweichou Maotai. But unlike Kweichou Maotai, you get to keep your gains here. The Bell family, which controls 70% of the shares, has offered minorities R53 per share.

But to earn that return, you had to have been patient, an attribute that is sorely lacking even among the best of us.

My take: This is yet another example of a small but good South African family-owned business that investors on the JSE have discarded in the rush for offshore assets. Investors just do not have enough exposure to the JSE’s small and mid-cap shares.

Bell is a significant holding in the MW Investments Value fund.

I wrote about why I call the MW Investments Worldwide Flexible Fund the cockroach last month in “The Cockroach”: This week, the unit price of the fund hit a new all-time high.

This is the Rand price (excluding dividends) of the cockroach over the past 5 years:

Factors driving this performance include significant exposure to:

• Gold (c.17% of the fund), which hit new all-time highs this week.
• Long-dated South African government bonds (c.16% of the fund), where yields have declined from 13% to 11,5% since the election.
• South African value stocks (c.5% of the fund), which have also enjoyed a post-election bump.

Notably, the fund has achieved this with relatively low volatility – the second lowest in its category of over 90 funds.

My take: This fund will never shoot the lights out. It is too diversified. However, this diversification helps it consistently produce returns in excess of inflation over time. Like a cockroach, it survives disasters and thrives in good times.

Source – the Substack YWR – Your Weekend Reading. You can subscribe here. I have.

My take: If you want to outperform, you must do something different from the crowd. Owning the above list of stocks is NOT being different from the crowd; it is the crowd.

Charlie Munger’s life was marked by enormous financial success, but he also faced terrible personal setbacks that would have utterly broken most men. How did he survive and thrive? He refused to view himself as a victim and insisted on soldiering through it all.

“Everybody struggles,” he told Becky Quick. “The iron rule of life is that everybody struggles.”

Here’s a fascinating Substack post on the hardships he faced.

My take: The obstacle is the way. The best way to deal with the inevitable hardships life will throw your way, is to face them head-on. The Stoics practice “Memento Mori”, meaning “Remember you must die.” It serves as a reminder of our mortality and the transience of earthly pleasures and hardships.

Thinking about your investments in this way isn’t a bad idea, either.

This Bitcoin compendium contains everything you always wanted to know about Bitcoin, blockchain, and crypto but were afraid to ask.

It was compiled by Kevin Gee, who writes “A Letter a Day,” a daily email that contains a letter or interview with a famous founder, investor, or operator. You can find his Substack here.

Princeton Computer Science Professor Ed Felton’s series of lectures is worth the time if you want to get into the nuts and bolts of the technology behind blockchains.

You can find the first lecture here, with links to the follow-up lectures.

And if you still don’t understand anything about crypto, this short video should help – a lot.

I came across Andrew Bird’s new album, Sunday Morning Put-On, this week. Bird’s previous work swung easily between pop, rock and folk – but this album is a full-on throwback to ’30s and 40’s style jazz. It happens to include quite a few covers from that time as well.

My friend Mark Rosin is a jazz aficionado and has been trying to get me to listen to more of it – unsuccessfully so far. I know Brubeck, Monk, and Davis are legends in the music world, but most of their work can’t be described as easy listening.

This album, on the other hand, can. It falls easily on my untrained ear and is a joy to listen to. One critic described the album as an LP that reminds us just how quietly brilliant Andrew Bird can be. I agree!

Here it is on Spotify, and Apple Music.

Finally, my stepson Ben started his first-ever job this week. All three of our boys are now employed. One day, hopefully soon, they will be able to provide for me and Amanda. Come to think of it, we should have had more children. Oh, well. The three we have will just need to work harder and longer or get second jobs.

I can sense those lazy days of being retired getting closer and closer. You know, pottering around the house, doing nothing in particular, watching the clock tick away the remaining hours of my life. All while the three boys are slaving away to earn enough to keep us fed, clothed and housed.

Life is good! But you still need to be careful out there.

Piet Viljoen
RECM