The article below is an excerpt from our Q3 2025 commentary.
In our fourth-quarter 2024 letter (click here to view past commentaries), we introduced a framework that has since shaped much of our thinking about commodity cycles—the “Carry Bubble.” Drawing heavily on The Rise of Carry by Lee, Lee, and Coldiron, we argued that the four major commodity cycles of the last 125 years fit neatly within a broader and more predictable carry cycle. It is worth returning to that idea now, and examining how such a regime ultimately ends and what may greet investors once it does.
The authors describe with careful precision the mechanisms that produce and extend a carry regime. The standard example involves borrowing in a chronically low-yielding currency, such as the yen, and investing in a higher-yielding asset, often in Australia. Provided exchange rates remain calm, the trader simply earns the spread between borrowing costs and asset returns.
Lee, Lee, and Coldiron argue that this is only one instance of a much larger class of trades. What they share is straightforward: each relies on leverage, and each depends on a world that does not change too abruptly. They are, in effect, short-volatility trades that do well when conditions stay steady.
In theory, such trades should not survive. Arbitrage should eliminate any persistent yield difference, either by pushing up asset prices or shifting exchange or funding rates. Yet the historical record shows that carry trades not only exist, but often produce durable positive expected returns.
The authors note that this outcome is not as puzzling as it seems. Carry trades often offer small, steady gains until they meet the kind of volatility that wipes out years of prior profits. The returns simply compensate the holder for that eventual risk. It is the quintessential picking up of pennies in front of the proverbial steamroller.
Once you recognize that nearly all levered short-volatility trades are simply carry trades in another form, it becomes easier to see how the “Rise of Carry” has come to shape almost every corner of modern markets. Private equity and private debt, for example, operate as large-scale carry trades: they rely on cheap bank financing to amplify the modest spread between borrowing costs and asset returns. As long as conditions remain stable, the PE investor is virtually assured a positive long-term result. Hedge funds function as “agents of carry” as well—using leverage to enhance returns and collecting fees on gains without having to repay losses. If tomorrow resembles today, as it often does, they earn substantial incentive fees; when volatility finally catches up with them, they simply return capital and start over. Even the S&P 500 now exhibits carry-like behavior, as executives—motivated by compensation tied to share prices—capitalize on the spread between low-cost debt and corporate returns by aggressively buying back their own stock.
Carry regimes come with several important quirks. To begin with, they are momentum-driven feedback loops rather than mean-reverting systems. When trillions of dollars chase levered short-volatility trades, both implied and realized volatility are pushed lower—just as a flood of money into a long-Tesla position inevitably drives the stock higher. Carry trades depend on the premise that what has worked will continue to work, which is essentially what low volatility represents. As a result, winners are carried upward: large companies grow larger, growth stocks surge, and value investing is pushed to the sidelines. Value requires the future to diverge from the present—an asset must be mispriced today and eventually be recognized as such. In a carry regime, that recognition rarely comes. Thus growth outperforms value, and large caps beat small caps. Because these regimes thrive in environments of low rates and low volatility, investors naturally assign high values to far-off cash flows and feel comfortable extrapolating strong earnings growth well into the future. Those distant cash flows, in turn, are discounted at low real rates, reinforcing the effect.
Despite their persistence, carry regimes are not the natural state of financial markets. Over long stretches of history, value has consistently outperformed growth and small-cap stocks have outperformed large caps. But those fundamental patterns are often suspended during extended carry regimes. Another notable feature is how much capital these regimes absorb once momentum takes hold. As money pours in, financial assets are pushed far above levels justified by the underlying economy. Whereas financial assets have historically averaged around 75% of GDP, during carry bubbles they can climb to well over 200% of GDP— much as we see today.
During these periods, real assets tend to hold very little appeal for most investors. Why bother with a finite, delineated resource when volatility is low, interest rates are benign, and the market offers a Hyper Scaler that promises to remake the world? As a result, natural resource equities typically struggle in major carry regimes. At best, investors ignore them; at worst, they become part of the short book used to reduce net exposure and make room for more leveraged long positions in winning carry trades. Looking back, we found that every major commodity bear market coincided with a carry bubble. In that sense, this cycle is no exception.
Why own natural resource equities at all? The answer is straightforward: carry regimes are inherently unstable. They persist only as long as conditions allow, and then they unwind abruptly. That was the pattern in 1929, in the 1970s, and again in 1999—and it will be the pattern in this cycle as well.
This naturally raises the question: what brings a carry bubble to an end, and what does the market look like afterward? In almost every instance, the catalyst is a major shift in the monetary regime—something large enough to reset the system and restore balance.
Put simply, a carry regime thrives when tomorrow looks like today; it ends when tomorrow looks markedly different. With so much capital tied to levered short-volatility positions, a meaningful rise in volatility is usually enough to trigger a broad unwind. These are, in effect, two ways of describing the same phenomenon. At the center of it all are the Central Banks.
To see why, it helps to recognize that Central Banks are the primary enablers of carry. In theory, the returns from a carry trade compensate the investor for the risk of a sudden break in the status quo—a spike in volatility, or in equity markets, a crash. But in recent decades, Central Banks have repeatedly stepped in to prevent those breaks. The 1990s saw the “Greenspan put”; the Global Financial Crisis brought “Helicopter Ben”; and COVID led to the United States’ first near-direct monetization, with stimulus checks mailed to millions of households. When policymakers reliably cushion markets from catastrophic loss, the incentive to push carry trades for years becomes entirely rational.
For a carry trade to unwind in a lasting way, Central Banks must either be unable or unwilling to operate as they normally do. That can take the dramatic form of a central bank—or its currency—losing credibility, or a more measured form: a major shift in the monetary regime. In practice, a fundamental regime change functions much the same way as a Central Bank that can no longer conduct business as usual.
These shifts are uncommon, but far from unprecedented. Over the past 125 years, they have appeared three times. Every forty years, the monetary world is forced to admit that its prior promises no longer match its present constraints The first came in 1929, when Britain finally abandoned the idea of returning to the classical gold standard at its pre–World War I parity, a system that had been in place since the Napoleonic era. The transition ultimately culminated in the creation of the Bretton Woods exchange system some 15 years later. The second shift arrived in 1971, when President Nixon stunned markets by ending the dollar’s convertibility into gold. The most recent occurred after the Asian currency crisis, when many countries broke their dollar pegs and revalued their currencies below market levels to spur exports—an adjustment that led to trillions of U.S. Treasury securities being accumulated as foreign reserves.
Each of these regime shifts brought its corresponding carry bubble to an end. Just as important, each one set off a powerful bull market in resource equities. For years, we have argued that the current commodity bear market would end the same way—with a monetary regime change—and we now see more clearly why. A shock of that magnitude breaks the carry cycle and forces a broad rotation out of carry-dependent assets and into whatever had been neglected and underowned. In this cycle, that points directly to resource equities.
We believe we are nearing another monetary regime shift. The current Administration has shown little interest in maintaining the status quo, and both Secretary Bessent and Stephen Mirran have repeatedly pointed to growing global monetary imbalances and the need for a new framework. Earlier this year, the so-called “Mar-A-Lago” accords circulated as one possible approach, though they have recently been overshadowed by tariff proposals. In our view, the two discussions are closely linked, and we would not be surprised to see the topic of monetary regime change return to the forefront. The popular press increasingly refers to this as the “monetary debasement” trade, and headlines appear on it almost daily. At the same time, China continues to expand its official gold holdings, seemingly in an effort to build a gold-backed alternative to the U.S. dollar for international commerce.
Although the exact form of the coming regime change is uncertain, it is increasingly clear that tomorrow will not look like today. And that is precisely the environment in which carry regimes give way.
Lee, Lee, and Coldiron devote several chapters to describing what a post-carry world might look like. They argue that the most likely trigger is persistent inflation—strong enough to limit the Central Bank’s ability to counter disruptions by expanding its balance sheet. We largely agree. Although the 1929 carry regime ended in deflation, the scale of recent money creation and the parallels to the 1970s suggest that inflation is the more probable outcome this time.
Perhaps the crisis begins with a failed Treasury auction or a major policy error. The specific catalyst matters less than the pattern that follows. Financial assets that thrived under the carry regime will be the first to fall as leveraged investors face margin calls. Gold should continue to rise, both as a safe haven and as protection against inflation. Oil is also likely to perform well, attracting capital precisely because it was not a crowded carry trade during the bubble. This marks the start of a broad rotation out of high-valuation, high-duration assets that depend on low volatility and into assets with the opposite profile. In this environment, resource equities stand out as one of the few reliable places to protect a portfolio.
And the swing from carry to anti-carry can be dramatic. Ten years after the 1970s carry bubble collapsed, oil companies accounted for one-third of the S&P 500’s market capitalization. Commodity stocks were the only sector to deliver real returns over the preceding decade. Exxon and Schlumberger were the two largest companies in the world, together representing about 5% of the index—much as Nvidia does today at roughly 7%. When the Forbes 400 debuted in 1982, roughly one quarter of its members owed their fortunes to the oil business, and those fortunes represented nearly 20% of the list’s total wealth. Today, oil wealth makes up less than 6% of the membership and only 3% of the aggregate wealth. Instead, the current Forbes 400 is dominated by technological and financial-related fortunes – just as you should expect in the late stages of a carry regime. Together, these industries make up half of the list and represent two-thirds of the wealth. Technology fortunes alone make up 20% of the list and represent 42% of the wealth. Financial fortunes make up nearly 30% of the list and 22% of the wealth.
As the market shifts from carry to anti-carry, even modest exposure to natural resource equities may be the difference between being added to—or quietly falling off—the 2040 Forbes 400.
In every era, the end of carry has looked less like a gentle turn in the road and more like a sudden clearing of the stage, with new actors stepping into the light. When the script changes, it does so abruptly. And when it does, capital rushes back to the few things with real scarcity, real cash flow, and real value. History’s verdict has been remarkably consistent: the moment the future stops resembling the past, the world remembers why it needs resources. And so do investors.
Curious to learn more now? Read more in our Q3 2025 research newsletter, available for download below.
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