Guest Review: @pdxsag on A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market

Noted investor and polymath Edward O. Thorp wrote an autobiography back in 2017: A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market (3/5).

His first book, which enjoyed huge popular success, was his guide to counting cards in blackjack, Beat the Dealer, published in 1962.

In 1967, he wrote Beat the Market, a guide to market arbitrage using warrants and convertible bonds. Five years later, Fischer Black and Martin Scholes would publish their options pricing model which would win the Nobel Prize, largely inspired by the work in Thorp's book.

This latest book by Thorp (his fifth for a popular audience) is mostly a memoir, though it finishes with a few chapters of general advice on investing, geared to a mostly non-investing public.

Man for All Markets starts with Thorp's earliest childhood memories as an odd-duck and prodigy, continues through high school in rural Orange County, California – back when it actually had oranges – then college at Berkley before transferring to UCLA, starting his career in academia, then his side-hustles in the gambling and the investment worlds, the latter of which turned into his main-hustle after he quit work as a college professor to run full-time the hedge fund which he had started several years prior.

As a timeline: born in August 1932, he graduated high school in 1949, graduated college in 1953, and received his PhD in Mathematics in spring of 1958. He did a post-doc stint in 1959-1961 at MIT, where he met Claude Shannon and among a bunch of fun side-projects, they invented the first wearable computer for predicting roulette. He taught at New Mexico State from '61 to '65, before moving to the then brand-new UC-Irvine where he would remain until retiring from academia in 1982.

I had seen Thorp name-dropped in fin-twit a few times. He was remarked upon for his phenomenal investing record running an arb shop, almost as a proto-Citadel or Reniassance Tech. Equally often remarked upon was his youthful visage, easily passing for someone 10 to 20 years younger. In fact, here is a photo of him taken this month looking remarkably youthful at the age of 91.

Here Ed is in a pair of Tim Ferris interviews in May and June 2022. Based upon the show notes, it appears the first episode covers the outline of Man for All Markets, and the second episode uses the book's latter third on investing advice as jumping off points for discussing a wider range of topics.

Our interest in this autobiography was three-fold. One, did his story add-up?

I hadn't heard of him before last year. I was curious whether he truly was as he was presented by others on twitter as a proto Jim Simons or Ken Griffin. He boasted their acumen and success, but from the late 60's to the late 80's. This was well before the financialization of the economy in the later Greenspan era in which the numbers put up by the biggest hedge fund managers on Wall Street, the 0.1%, beggar belief if you bother to think about them in terms of buying power, instead of just numbers on a screen.

Two, did he share any useful information on the source of his youthfulness?

Since this was a memoir and one of his popular anecdotes was how he got into strength training at college in the early 1950's, we wondered what else he might have to share on the topic of health and longevity. He certainly looks great for his age, but was it lucky genes or something else. As an autist before the era of the internet, he taught himself card counting and investing arbitrage; then wrote the book on each. Maybe he taught himself the keys to health and longevity in a similar fashion.

Thirdly, we always like to see if we can read between the lines and pick up interesting bits that are usually missed by the conventional reading public.

This also relates to assessing whether his story adds up. Reading between the lines, you can often figure out whether someone's story adds up, or whether they are relying on borrowed ideas and successful execution of partners, which they spin a story around to make themselves into the central character. This is particularly true for anyone lucky enough to be entering adulthood in the 1950's and 1960's. The second half of the 20th century for the United States was such a phenomenal growth engine, many people got incredibly far just by being lucky enough to be in the right place at the right time, such as, for example, moving to Orange County, California, in the late-1960's.

As fortune has it, after I read the book I saw that blogger Rational Walk had written a pretty thorough synopsis of Man for All Markets not long after it was first published in 2016. I'll save myself a couple thousand words and direct your attention to his longer synopsis and then (more recently) in ten bullet points.

As to the first question, did his story add up? It certainly did to me. I went to a large suburban high school and a small engineering college. I knew first-hand the type of incredibly smart, 1% of the 1%, math and science guys which Ed's anecdotes from his youth fit to a 'T': self-taught in chemistry and electronics, cringy sense of humor – particularly for practical jokes, treated academic performance as a competition just like athletes treat sports competitions – if you don't win first place, you lost. With that character, the story definitely fit.

He also rubbed elbows with some incredibly smart people before they were household names – Claude Shannon, Fischer Black, and Warren Buffett. He also caught a massive fraud decades before he infamously became a household name – Bernie Madoff. I have no doubt Ed was truly the central character in his gambling and investing hustles.

What did we pick up between the lines? There were a few interesting things.

* Ed was born in 1932, a Silent. From our reading of Helen Andrews' Boomers, we know Silents were really behind all the social liberalism Boomers gave themselves credit for. True to form, Ed couldn't resist slipping in a few socially liberal comments and opinions from events in college as an undergrad, and also with regard to the current events as of his writing in the chapters covering general investment advice. Just wanted it to be known, I guess. (CBS pointed out the same thing in John McPhee's latest work. McPhee and Thorp are the same age.)

* Some of the best asides were of his wife's sharp judgement of character. Physiognomy is real, readers. Could have used more of these in the book.

As Vivian said at the start, “this is going to be a waste of time. Norman's been doing this for years and you can tell he's barely getting by. Just look at his worn-out shoes and shabby clothes. And you can tell from the quality of his wife's old and dated outfits that they were once better off.” (p.149)

My wife was an almost unerring judge of character, motives, and future behavior. I was repeatedly amazed when she applied this to business and professional people I introduced to her for the first time. She did this easily, based on so little evidence I couldn't believe it. But over and over again, Cassandra-like if I didn't listen, she was right... After meeting one of the characters, she said, “He's greedy, insincere, and you can't trust him... You can see he's greedy from the way he drives. The insincerity comes out when he smiles. His eyes don't really smile, too; they mock you. And his wife has a sad look in her eyes that doesn't add up. The face she sees at home isn't the one he shows the world.” (p.178)

* Post World War II really was easy-mode for anyone that was first to apply scientific rigor to some corner of business.

Much of what I read was dross, but like a baleen whale filtering the tiny nutritious krill from huge volumes of seawater, I came away with a foundation of knowledge. Once again, just as with casino games, I was surprised and encouraged by how little was known by so many. (p.146)

Our computers used so much electricity that the office was always hot. Our landlord didn't charge tenants for utilities, instead paying it form his lease revenues. When the heat got my attention, I calculated that the cost of the electricity we used was more than our rent. (p.169)

When the CBOE opened for business we appeared to be the only ones trading the [Black-Scholes] formula. Down on the floor of the exchange it was like firearms versus bows and arrows. (p.176)

*The Efficient Market Hypothesis was dunked on every chance Ed got. As a hard science guy, his disdain of economics and economists was subtle but sharp.

When the S&P500 Index fell 23 percent on October 19, 1987, a leading academic finance professor said that if the market had traded every day for the thirteen-billion-year life of the universe, the chance of this happening even once was negligible. (p. 190)

I also asked believers in the EMH to explain why the stock failed to recover in the eleven days after the hoax was exposed. The news for EMLX was good. So...? (p. 227)

* On the successful "word-cel that never reads" type of guy:

I also learned early that when I gave Ned my opinion on anything, no matter how careful or reasoned, it didn't have much impact. Others had the same experience. To make a decision, Ned would simply poll everyone he knew for their opinion and then go with the majority view. Once I figured this out, I stopped wasting my time sharing my thoughts with him. The Ned polling method works remarkably well in certain situations... But like most simplifications, this has a flip side. Here [Bernie Madoff] there were just two answers, fraudster or investment genius. The crowd voted genius and got it wrong. I call the flip side to the wisdom of crowds the lunacy of lemmings. (p219-220)

Good stuff. Strictly speaking none of that is new territory at CBS blog, but we're always on the look-out for evidence that tests our rules, be it confirms or contradicts.

Now, returning to the second reason for picking up this book. What did Ed have to say about health and longevity? Is it a case of lucky genes or is it something more, and, more importantly, reproducible by us? The short answer is nothing definitive. The book barely made a couple oblique references on the topic. However, there are a few things that can be gleaned from Ed and his life. A long answer will be its own future post.

Review of Material World: The Six Raw Materials That Shape Modern Civilization

Ed Conway is a journalist who has gotten interested, in Vaclav Smil fashion, in the materials that underlie our civilization and world. Hence his new book, just published in November: Material World. While Vaclav Smil has argued that the "four pillars of modern civilization" are cement, steel, plastics, and ammonia, Conway focuses on six raw materials that he thinks are underrated: sand, salt, iron, copper, oil, and lithium.

It's not entirely clear that "underrated" is Conway's organizing concept for choosing these six, and one thing we quickly see is that he is not as logically organized, thorough, or data driven as Smil. But his argument seems to be that these are underrated and overlooked since on the one hand they are so important, but on the other hand they are cheap relative to the value they create (copper is under $4 per pound), they are used in enormous volumes (big, bulky, yet overlooked flows), and because they are bulky, producing them requires displacing even more enormous amounts of overburden and ore. Tearing down mountains, and that sort of thing.

Another point that Conway raises is that these raw materials less fungible than the casual observer might realize. Sand, for example, comes in different varieties with important differences in grain size and shape and mineral composition. The sand that is needed for making high quality optical glass is different than the sand that is acceptable for use in making concrete. Sand is also turned into silicon for making semiconductors, but that has more to do with the refining and ingot producing process than the raw ingredient sourcing. If you have ever thought, "how can sand be rare, or important?," the answer is in these idiosyncrasies that make the different types non-fungible.

The iron chapters got our attention because we have been thinking quite a bit about iron, steel, and metallurgical coal. Conway observes that iron accounts for 95% of the metal that we produce and use, and that it is "so fundamental to our lives that it is just as good a measure of living standards as GDP." The most developed countries in the world have an installed base of steel of about 15 tons per capita. (As he puts it, "iron is the bones of our society.") The per capita figure for China is only about half as much. His back-of-the-envelope calculation is that if everyone in the world were to come up to the developed country amount of steel per capita, it would be an additional 144 billion tons - four times the amount that has been already produced in human history.

We had already been thinking lately that, if the GDP per capita of India keeps growing then their use of steel per capita (and oil too, of course) should as well. India is already the largest importer of U.S. metallurgical coal for making steel. India is the second largest steel producer but its per capita consumption and per capital installed base lag far behind the rest of the world. The straightest path forward would be for steel production to continue to grow, resulting in increasing demand for imported metallurgical coal. (Every ton of steel produced requires almost a ton of metallurgical coal to go in the blast furnace alongside the iron ore.)

The writer "Coal Trader" argued recently that "emerging markets appear to be approaching a level of self-sufficiency and mutual support. They no longer seem to rely heavily on the investment and consumer demand from major Western corporations." If Coal Trader is right and their economies are decoupling from the U.S. (the "training wheels are starting to come off," he says) we should see it in their GDP growth figures (e.g. India). And if they decouple it should make demand for these raw material commodities less volatile. (Coal Trader had an interesting observation: "I believe we need to invest as if our offices were in Singapore, or perhaps even Jakarta.")

If these countries continue to develop, they should soon begin consuming much more oil per capita too. Enough to make a big difference to total world oil demand. India is currently something like 5% of world oil demand with per capita usage that’s only about one-third of China. If India develops just to the level of China, it would cause incremental increased oil demand of around ten million barrels per day. An astonishing figure, it dwarfs any possible near-term savings from electric vehicles in richer countries, and the incremental demand would be almost as big as total U.S. oil production. And note that it will take machines built of steel to burn this oil.

People who are short commodities are betting against the up-and-to-the-right GDP trends of countries like China and India. Maybe those trends will continue and maybe they won't, but they are the status quo. Which brings up another point from the book. 

As we have elsewhere observed, there is a great tension between physics-based pessimism (Malthusian) about natural resources and economics-based optimism (some might say cornucopianism) about the ability to respond to higher prices with substitution and invention. As an example, the new lithium-iron-phosphate (LFP) battery chemistry seems like a major point in favor of the cornucopian, economist viewpoint. We would not have thought it possible a few years ago to make a battery with just lithium and iron. 

In the book, Conway points out that even as the ore concentration of copper has plummeted over the past century, the price has fallen in real terms. There have been huge fluctuations, having to do with the capital cycle in copper mining, but worse ore grades have not caused prices to rise. The Malthusian and Cornucopian forces have held in balance. (Perhaps the long-run destiny is for these forces to always remain in balance?)

It therefore seems prudent for an investor to make not highly leveraged bets ("torque") on much higher commodity prices, but rather to find ways of benefiting from the status quo of growth, development, and human invention.

So let us talk about ways to do this. As we have observed in the past, owners of royalties on natural resource production make money in status quo conditions, they do well if prices rise, but they can even benefit if the producers foolishly over-expand their capacity and drive down their commodity price (which they have a marked tendency to do throughout history), at least as long as they own a royalty on the new production too. 

The opportunity that we have seen is that these royalty interests in hydrocarbons are bond-like assets priced to give equity-like returns because of ESG investing and because of a brutal bear market, and subsequent investor disinterest, in natural resource production.

We have mentioned both Natural Resource Partners and Pardee Resources in past writing. NRP derives a significant portion of its revenue from royalties on metallurgical coal production, but also from thermal coal production as well as an interest in a soda ash business in Wyoming. While the partnership owns 13 million mineral acres, it does not own any surface acres. In contrast, Pardee owns about 155,000 surface and mineral acres, mostly in West Virginia, with active metallurgical coal production. 

The current market capitalization of NRP at $96 per share is $1.2 billion. NRP has a more complicated balance sheet, with debt, preferred stock, and warrants. (The liabilities keep going up as the share price goes up, because of the warrants.) Depending on the valuation assumptions you make, they probably have $371 million of additional liabilities, less around $80 million potentially earned during Q4, for an estimated current enterprise value of $1.5 billion. 

Assuming the recent level of $80 million of quarterly free cash flow, the FCF/EV yield would now be about 21%. Amazingly, this is higher than the FCF yield of the coal miners, who have to reinvest a significant portion of their cash flows back into production as capital expenditures. It is surprising that the royalty, which is the senior security in the capital structure of the mine, seems cheaper than the producers' equities. 

There is a slide in NRP's investor presentation showing annual free cash flow figures for NRP since 2015. For the year 2016, which was when the coal market crashed and most of the miners in the industry went bankrupt, the partnership still had free cash flow of $76 million. If that were to happen again (a 75% decline from current level), the FCF/EV on the current valuation would still be 5%.

Recently, the producers' cash cost per ton of met coal has been around $100 per ton, with Arch at $97/ton and Warrior at $114/ton. In 2016, the cash cost of met for Arch was only $53/t. With the producers' costs per ton having doubled since 2016, it ought to be difficult for the market-clearing price to drop as low as it did in 2016 (at least for a protracted length of time), and hence it ought to be difficult for free cash flow to drop that much again.

Then there is Pardee, which has a market capitalization of $164 million at $250 per share. Factoring in the end of year special dividend and estimated fourth quarter free cash flow, their enterprise value is probably now around $130 million. (That's $830 per acre of surface.) Pardee generated around $7.6 million of EBITDA in Q3, so that would be an annualized yield of 23% on the enterprise value.

The edge perhaps goes to Pardee at this point based on valuation, as well as the fact that it is "two-pillar" since it is trading (arguably) below the value of the surface. In fact, one thought experiment would be to consider that Pardee could theoretically sell the surface and timber for an amount in excess of the current enterprise value, while retaining the mineral rights (meaning coal royalties) as well as other assets. (Pardee is very unlikely to actually do this; it is just a thought experiment.) Not to say that the land is of exactly the same quality, but Weyerhaeuser just bought land for $2,685/acre in the southeastern U.S.. It is very difficult to find any land with timber in the U.S. for less than $1,000 per acre. Land prices of three digits per acre tend to be swamp or desert.

4/5.