tag:blogger.com,1999:blog-15659006867649249812024-03-18T21:49:04.084-07:00Asset PrimeCommodities insight, analysis, and educationCharleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.comBlogger40125tag:blogger.com,1999:blog-1565900686764924981.post-85550994853053959842013-03-20T17:27:00.003-07:002013-03-20T17:27:45.393-07:00Brent Crude and WTI - When the Same Thing Becomes Very DifferentA commodity must be fungible. The value of a bushel, barrel, or ounce of a given commodity comes not from its uniqueness, but from the fact that it is functionally identical to every other bushel, barrel, or ounce of the same commodity. Insuring fungibility is exactly the reason commodities contracts have explicit specifications. In addition, many different types of commodity are highly interrelated and as such, so is their price. Consider for example the relationship between oats and corn, both used frequently as livestock feed. If corn gets too expensive ranchers might begin feeding their livestock more oats. As more people forgo corn in favor oats, corn prices will inevitably fall as oats' go up, which will ultimately cause more folks to switch back to the (now cheaper) corn, and the cycle repeats. Obviously, the more related two commodities are, the more their prices are correlated. Nowhere is this fact more salient than in the various types of crude oil globally traded. And, unlike corn and oats, which have several non-overlapping uses, there's really only one thing to do with any type of crude: refine, then burn it.<br />
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The two major crude oil contracts traded in global markets are West Texas Intermediate, which is the American standard (what media outlets have traditionally meant when they talk about the "price of oil") and Brent Crude, which is the British standard. The former is traded on the NYMEX, the latter the ICE, and you can read their contract specifications <a href="http://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_contract_specifications.html" target="_blank">here</a> and <a href="https://www.theice.com/productguide/ProductSpec.shtml?specId=219" target="_blank">here</a>, respectively. Both are high-quality, refineable oils (referred to as "light, sweet crude") with the primary difference being that WTI contains less sulfur and is somewhat less dense than its British counterpart. Now, I'm not an oil man, so someone who's worked in petroleum engineering and/or regularly wears a huge cowboy hat could do a better job explaining the specifics, but my understanding is that less sulfur and a lower density means WTI is easier to refine, making it technically the superior oil. In theory, this should make for an obvious reltionaship between the contracts: higher quality, higher price. Not so.<br />
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For years the prices of the two contracts reflected the quality difference, as historically American Crude Oil has traded a few dollars above the price of Brent Crude. However, about 2008 (largely I'm sure as a result of the financial crisis) the two oils began occasionally trading places, with Brent breaking away from WTI in late 2010/early 2011 and never looking back. Observe this chart:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgB2LhYrYQyrZ_G-2_Z1yMEO4SZswphtbaQs2ODTgVeTPBCVzC3gX6sUICRzOprnXKCCkMgPeyD63wm6a0BDGUdLRVQ6KtDBBr2cmFheLP10q3IenRYvtEGfdEjNsRlxF6mHunL7-uP4Mx1/s1600/USandBrendCrudeOverTime-1.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="454" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgB2LhYrYQyrZ_G-2_Z1yMEO4SZswphtbaQs2ODTgVeTPBCVzC3gX6sUICRzOprnXKCCkMgPeyD63wm6a0BDGUdLRVQ6KtDBBr2cmFheLP10q3IenRYvtEGfdEjNsRlxF6mHunL7-uP4Mx1/s640/USandBrendCrudeOverTime-1.jpg" width="640" /></a></div>
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There are a few key things to notice. First, as mentioned above, observe Brent's breakaway from WTI beginning right around 2011, a pattern that seems to have more or less stabilized today, with Brent now consistently trading $10 - $20 higher than US crude. Think about that for a minute: two products with identical uses, the only difference their respective qualities, and the <i>inferior</i> product is valued by the market ~15% above the superior. That's like paying $45,000 for a Volkswagen Jetta when an A4 costs forty grand, or dropping $12 on a pound of Folgers when Shade-Grown Artisanal Hipster Roast™ only costs $9. <br />
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Brent most likely overtook WTI for three major reasons: the glut of domestic crude created as American supply has gone up from new oil discoveries; the decreased demand for oil domestically due to economic stagnation; and the ongoing, wrongheaded legal restrictions preventing the exportation of US crude. That a literally inferior product is more expensive in open global trading is a testament to just how screwed up the US oil market has become, and further proof, as I've written before, that <a href="http://assetprime.com/2012/11/its-time-to-lift-restrictions-on-us-oil.html" target="_blank">it's time to lift restrictions on US oil exports</a>.<br />
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That said, the other thing to notice about the chart above is how synched up the <i>movements</i> of the two crudes has been over the last five years. Even when they're at their furthest apart, a movement by one crude usually coincides with an almost identical movement by the other. This, of course, makes sense, as these two commodities are almost the exact same thing. In this way, any savvy oil investor should be knowledgeable about both types of crude, as the market climate may at any given moment favor one contract over the other, or in absence of a preference between the two, the other variety might be used as a powerful hedge (e.g. going long three contracts of WTI, and short one of Brent). <br />
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But in a classic case of the exception proving the rule (yes yes, I know that's not what that actually means), this lock-step relationship is by no means a permanent state of affairs. Here's a scatter plot of WTI prices compared to Brent Crude from 2008 through 2010:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgouLb5FA6hXFRxYuj8M6IQKkzlZNxs0btYIJNR-HDk4XzuvCtP6iBZIvG2KllkLfXvg6SFJ2q2rXjND4oOX2C0_j0keydI3p_aLJmSCvu1D1m6h726FYQeD-Y21y27m7jN_wHgHiqFffZ1/s1600/08-10CrudevsBrent.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgouLb5FA6hXFRxYuj8M6IQKkzlZNxs0btYIJNR-HDk4XzuvCtP6iBZIvG2KllkLfXvg6SFJ2q2rXjND4oOX2C0_j0keydI3p_aLJmSCvu1D1m6h726FYQeD-Y21y27m7jN_wHgHiqFffZ1/s320/08-10CrudevsBrent.jpg" width="305" /></a></div>
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The r_squared (extent to which variability in one is explained by variability of the other) is .9918 - almost a perfect correlation. Now, here's a scatter plot of WTI prices compared to Brent Crude from 2011 exclusively:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif3o71dFZ4FkusYZIbERawVm9FiBMzi3izXm0JnOHCEW_e8_adT2he8zeRIgPIXsdt0v2tXN4Xki8yT76Vr8GBIrNb2ddHmoZDWzhAS9YZB1J2xc-RT5YUera3JSHt9QaDvczuvk0FtpUF/s1600/11CrudevsBrent.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif3o71dFZ4FkusYZIbERawVm9FiBMzi3izXm0JnOHCEW_e8_adT2he8zeRIgPIXsdt0v2tXN4Xki8yT76Vr8GBIrNb2ddHmoZDWzhAS9YZB1J2xc-RT5YUera3JSHt9QaDvczuvk0FtpUF/s320/11CrudevsBrent.jpg" width="307" /></a></div>
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What the hell? These are still the same two types of crude oil, right? For reasons I cannot fully explain, though which I'm positive have more to do with geopolitics than actual supply and demand, the correlation between the crudes falls apart in 2011. We're looking at an R_squared of .5253, which, obviously, is a remarkably less meaningful correlation than the 99% we observed in years prior. That the correlation seems to evaporate when the two contracts switch places might indicate the relationship not only flipped, but moved out of synch entirely. So let's take a look at how the two have behaved from the start of 2012 until now:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4gq_3AU6Ii7clc_1nWPVtLN_j-5U4HnXaqlOLR-U84DSsknnuh_H0SDi9HA1ROe608FrsJdLAjn95ePGqXeuoTLY3LNpxgxknO4bVnx3ODc02_34sED-wurWiqEV3liVGHRR6VOgSBPUa/s1600/13CrudevsBrent.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4gq_3AU6Ii7clc_1nWPVtLN_j-5U4HnXaqlOLR-U84DSsknnuh_H0SDi9HA1ROe608FrsJdLAjn95ePGqXeuoTLY3LNpxgxknO4bVnx3ODc02_34sED-wurWiqEV3liVGHRR6VOgSBPUa/s320/13CrudevsBrent.jpg" width="306" /></a></div>
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Not bad. The R_squared is .7840, not as strong a correlation as pre-2011, but definitely moving back towards the lock-step we became used to seeing.<br />
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The takeaway point here is that highly related commodities tend to have high degrees of correlation, except when they don't. That first tidbit (related commodities are correlated) may not seem like news, but it's a fact commodities investors all too often overlook when thinking about risk. As mentioned above, using related (or near identical) commodities as a hedge is a great way to protect oneself in what are inherently risky markets, and taking a complimentary position in the other type of crude is a great way for oil investors to mitigate risk. That said, the more a market is caught up in politics (and it'd be hard to find a more politically charged market than US crude) the more likely it is to be reactive to exterior, non-market forces.<br />
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Though it may not seem like it, this difference between the price drivers for the two crude contracts is actually good news for oil investors; that the prices fall in and out of correlation allows investors to trade on different types of information. For example, an investor who's very attune to the geopolitics of oil would be well suited to make her play in the US crude market, where policy can affect the price as much or more than the underlying market factors. Conversely, an investor who's largely ignorant of US oil policy but has a very good understanding of global oil market fundamentals might want to stick to Brent Crude (though of course being aware that <i>major</i> shifts in US oil policy ought to effect all oil everywhere). Both investors then, as described above, could in theory use the other type of oil as a hedge.<br />
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Regardless, any oil investor needs be acutely aware that the powers governing oil prices can and frequently do have nothing to do with the underlying market forces, and one's strategy in these markets needs to take this information into account.Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com3tag:blogger.com,1999:blog-1565900686764924981.post-16786963559690756582012-11-20T14:47:00.004-08:002012-11-20T14:47:57.732-08:00It's Time to Lift Restrictions on US Oil Exports<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="http://si.wsj.net/public/resources/images/P1-BJ091_ENERGY_NS_20121112203603.jpg" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="320" src="http://si.wsj.net/public/resources/images/P1-BJ091_ENERGY_NS_20121112203603.jpg" width="194" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="http://online.wsj.com/article/SB10001424127887324073504578115152144093088.html" target="_blank">Chart taken from WSJ.com</a></td></tr>
</tbody></table>
The big news in energy last week was that the International Energy Agency projected the United States will overtake Saudi Arabia as the world's leading oil producer by 2020. If accurate, the significance of this information is hard to overstate, and its ramifications for the economic, military, and political future of the world are myriad and complex. In theory, at its most basic, this means cheap oil and an end to foreign energy dependence, but, as you'd expect from so multiplex a commodity, it's not that straightforward; indeed, the forthcoming US oil production boom is nothing short of a geo-eco-political imbroglio.<br />
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From a market point of view, the first consequence one would expect would be for crude to become a demand-driven market; if we have all the oil we need from sea to shining sea, supply would play less of a factor on the price of a barrel then would the demand to burn it up. Unfortunately, it's not that easy. For the price of a good to accurately reflect the pressures of supply and demand, the market has to be open to all participants - a market can't operate (or at least maintain liquidity) without scores of individuals buying and selling. However, it turns out the oil market is much more constraint-laden than other global commodity markets (rice, lumber, coffee, etc). There are a few reasons for this. The first, which I didn't know until after this story broke (and which became the impetus for my writing this piece), is that the United States generally prohibits exports of crude oil. That's right, America, bastion of free markets and free men, generally disallows the exportation of one of the planet's most basic economic inputs. (This, I have to assume, is one of the many reasons why Brent Crude, a somewhat inferior British grade of oil has for the last couple years been trading at a price significantly higher than its American counterpart, but that's a topic for another day.) While it isn't technically<i> illegal</i> to ship crude offshore, regulators certainly don't make it easy; as far as I understand (and someone please correct me if I'm wrong), any exporter of American crude is required to get dispensation from the Department of Commerce, and even then the exporter is highly restricted in his or her trade.<br />
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The other major piece of the puzzle is the US military presence in the Persian Gulf. <a href="http://www.npr.org/2012/11/14/165052133/u-s-rethinks-security-as-mideast-oil-imports-drop" target="_blank">NPR had a good story last week explaining the situation</a>. The gist is, for decades now, the US has kept several aircraft carriers permanently stationed in the Persian Gulf specifically for the purpose of keeping oil shipping lanes open, protected, and safe. Not coincidentally, the US and her allies get a ton of their oil from countries whose continued exports rely on open, protected, safe shipping lanes. Heretofore it's been a win-win, but if the US no longer needs foreign oil, then what interest would we have in protecting the shipping lanes of other nations, especially when every other oil consumer (China, India, Brasil, etc.) directly benefits from the US military presence in the Persian Gulf. (Anyone planning to run for President in the next four elections: I've just given you the sort of military policy that would likely resonate with about half the population.)<br />
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Okay, you might think, so the Middle East would become more unstable (if that's possible) without a permanent US military presence, what has that got to do with the price of oil if we're extracting all we need domestically? Consider a world in 2025 where US oil exports remain strictly regulated, nations in the Persian Gulf must allocate tremendous expense to secure shipping lanes, and the Peoples' Republic of China has a fully modern economy with a healthy appetite for petroleum products. You've now created two entirely distinct international markets for oil, nurtured a hidden economy built on piracy and black markets, and functionally turned the United States into a global oil cartel. In this fertile breeding ground for militarism, the newly modern navies of the world would swell to protect oil access, conflicts in crude producing nations would flare up like oil fires, and all the while the US (whose oil consumption has incidentally been falling and will likely continue to fall) sits on an ocean of oil, unwilling to share and unable to profit from its export.<br />
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On the other hand, the US could lift entirely its restrictions on crude exports (treating crude the same way we treat almost every other commodity on the planet). In so doing, American crude would compete with Middle Eastern and other geographic varieties of oil; nations would have less incentive toward militarization as crude is more readily available; the global economy would grow as more countries are able to modernize on the back of readily accessible, transparently priced energy; and, most important to any commodities investor, the price of oil would reflect, simply, the price of oil.<br />
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I realize that in the course of this piece I have not addressed the very real need to switch to renewables. This is obviously tremendously important for the future of our planet, our environment, and our continued existence as a species, but the US won't hasten a fully green economy by extorting other countries and forcing them into war-mongering. As America moves forward, she should not cling to cold-war ideas about resource protection and paranoia; this is the land of the free, after all. Our markets should be likewise.</div>
Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-42236475929710331722012-11-12T15:44:00.003-08:002012-11-12T19:52:42.789-08:00General Public Finally Realizes Commodities ETFs are Terrible<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><span class="Apple-style-span" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><a href="http://si.wsj.net/public/resources/images/MI-BS378_COMMOD_NS_20121111181805.jpg" target="_blank"><img border="0" height="200" src="http://si.wsj.net/public/resources/images/MI-BS378_COMMOD_NS_20121111181805.jpg" width="181" /></a></span></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="http://si.wsj.net/public/resources/images/MI-BS378_COMMOD_NS_20121111181805.jpg" target="_blank">Chart taken from WSJ.com</a></td></tr>
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Today the Wall Street Journal ran an<a href="http://online.wsj.com/article/SB10001424127887324073504578109402867864658.html" target="_blank"> article describing why commodities ETFs are terrible instruments with which to make long-term commodities plays</a>. The crux is that, largely because of the roll yield, ETFs do not actually track the prices of the commodities they purport. Readers of this blog may remember that I wrote a functionally identical article nearly three years ago, first at <a href="http://www.hardassetsinvestor.com/interviews/2010-energy-etfs-the-tracking-problem.html" target="_blank">HardAssetsInvestor</a>, and <a href="http://assetprime.blogspot.com/2010/03/problem-with-commodities-etfs.html" target="_blank">a bit later right here on AssetPrime</a>.<br />
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Briefly, the vast majority of commodities markets follow a normal futures curve, wherein the prices for contracts of a commodity further out are more expensive than the contracts closer to expiration. That is, in February of a given year, the price for March widgets would be cheaper than the price for July widgets. (People usually call this situation "contango"; and while that's not technically correct, it's not worth getting into the semantic distinction in this article, other than to acknowledge that people are going to be using that word to describe a normal futures curve.) Most commodities ETFs work by holding the front month contract of a given commodity, then selling that contract shortly before expiration and replacing it with the next month in the futures chain. If, indeed, the market is in a normal futures curve, the next month contract in the chain will be more expensive than the contract approaching expiration. Selling low and buying high does not typically a profit make. Hence, even when the price of a commodity is increasing over time, much of that value may be lost to the monthly roll-yield penalty.<br />
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This is important, because the entire purpose of a commodities ETF is to track the price of a commodity, thereby providing investors exposure to those markets. Significantly, most commodities ETFs do not do this. At all. Commodities ETFs do not do the one thing they were created to do. Commodities ETFs are terrible.<br />
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<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><span class="Apple-style-span" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjhGTellJqEX7lelQ0nE1oc8rATX2waAGE-j0CcEutmPmhzK5wzSM71MH2hyphenhyphenNGZaG9y9X1dEu5GeH3oyJe4LNQJbZcCZPypxD76R7sEkAQ8b4kqEOCZzb7z2PbcqQmf8vv-8rz_MEYhhe2/s1600/121112RollYieldsFromiPath.png" target="_blank"><img border="0" height="210" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjhGTellJqEX7lelQ0nE1oc8rATX2waAGE-j0CcEutmPmhzK5wzSM71MH2hyphenhyphenNGZaG9y9X1dEu5GeH3oyJe4LNQJbZcCZPypxD76R7sEkAQ8b4kqEOCZzb7z2PbcqQmf8vv-8rz_MEYhhe2/s400/121112RollYieldsFromiPath.png" width="400" /></a></span></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjhGTellJqEX7lelQ0nE1oc8rATX2waAGE-j0CcEutmPmhzK5wzSM71MH2hyphenhyphenNGZaG9y9X1dEu5GeH3oyJe4LNQJbZcCZPypxD76R7sEkAQ8b4kqEOCZzb7z2PbcqQmf8vv-8rz_MEYhhe2/s1600/121112RollYieldsFromiPath.png" target="_blank">Roll yield explained, from iPath ETN prospectus</a></td></tr>
</tbody></table>
Interestingly, many of the banks that issue these ETFs (or ETNs, as the case may be) have gotten more upfront about the issue. <a href="http://www.ipathetn.com/us/about_ipath_etns/product_suites/commodities" target="_blank">The iPath commodities ETN page</a>, for instance, discusses the roll yield before even listing the funds one can invest in, and their "<a href="http://www.ipathetn.com/static/pdf/ipath-commodity-etns.pdf" target="_blank">iPath Commodity ETNs</a>" pdf sheet includes a handy graphic (displayed at right) explaining the nature of the problem. (Incorrectly, of course, calling a normal futures curve "contango" but again, that discussion belongs elsewhere.) I have to admit that I'm impressed at the level of disclosure by iPath here; I don't know the extent to which a bank is even required to do this. However, while the facts given are certainly correct, the prospectus fails to mention that the majority of the time, the market is in a normal futures curve ("contango") rather than an inverted curve when a fund would potentially make money ("backwardation") from the roll yield. That is, they fail to mention that most of the time, the roll yield is a bad thing.<br />
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Some banks, of course, have gotten wise to this problem and have implemented funds that attempt to avoid the pitfalls of the standard roll yield. The United States 12 Month Oil Fund (USL), for instance, (cousin to the much more popular USO fund) holds all twelve futures contracts for the upcoming year (one for each month) rather than just the front month contract. iPath (mentioned above) offers a series of Commodities ETNs that use a proprietary algorithm to select which contract a fund should hold. The basics of the strategy are overviewed in their document "<a href="http://www.ipathetn.com/static/pdf/pure_beta_basics.pdf" target="_blank">Basics of iPath Pure Beta Commodity ETNs</a>" on the iPath website. I examined USL in the aforementioned HardAssetInvestor article and found a much better statistical correlation between that fund and the price of oil compared to similar funds. I haven't had a chance to dig into the iPath Pure Beta ETNs (having just learned about them), but I'm very curious to know how good they actually are at mitigating the roll yield. You can be sure I'll report back here with any and all findings.<br />
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Even if it's coming three years too late, I'm glad to see folks are finally waking up to this. Most commodities ETFs that hold futures contracts simply don't do a good job tracking the prices of commodities.Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-914359207395872042012-11-05T23:53:00.000-08:002012-11-06T00:44:33.295-08:00Going Long on Election Knowledge - Investing in Information with the IEMThe most valuable commodity is information. I could hit the thesaurus and start coming up with different words for "information", but I won't do that - you get the point. Every investment one makes is, despite its underlying instruments, at its core, an investment in information. Whether you think a particular grain or metal will go up or down in value is the direct consequence of your information and the faith you have therein. In that way, buying a stock, or a gold contract, or a mutual fund, in essence, can be considered an investment in an information derivative. As a general rule, I'm not much of a fan of derivatives, whenever possible I prefer to invest in an instrument directly. Lucky for folks like me, there happens to exist a market that trades directly in information. <br />
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The <a href="http://tippie.uiowa.edu/iem/">Iowa Electronic Markets</a> is commonly referred to as a stock market for predicting the future. More accurately, it's a <i>futures</i> market where the underlying commodities are discrete, real-world events. The market bills itself as follows:<br />
<blockquote class="tr_bq">
<i>The IEM is an online futures market where contract payoffs are based on real-world events such as political outcomes, companies' earnings per share (EPS), and stock price returns.</i></blockquote>
I, of course, realize that this is very similar to Intrade and other information market sites that offer contracts based on real-world events. The IEM, however is different in two important ways. First, it is entirely not for profit; there is no<i> "</i>house", making money on the trading activity, nor any recurring custodial fees, nor any party interested in impeding your withdrawals - the market is run by the University of Iowa as an educational resource of the business school. And second, most importantly, the IEM is entirely legal in the United States. The same cannot be said of other online information markets. <br />
Regardless, here's basically how the IEM works using the current US Presidential Election as an example. The two outcomes for which contracts are issued by the market are:<br />
<ol>
<li>Democratic Victory (in this case, President Obama)</li>
<li>Republican Victory (in this case, Governor Romney)</li>
</ol>
<div>
There are precisely the same number of contracts issued for each outcome, and the price for each contract trades between $.00 and $1.00, such that the total value of the two contracts combined is $1.00. The contracts trade on an open market with the familiar bid/ask market pricing structure. When the election is over, any contracts held for the winning candidate are redeemable for $1.00, regardless of what they cost, and any contracts held for the losing candidate are redeemable for $0.00000 (repeating, of course). As of writing, the Democratic contract (Obama victory) is trading at $0.750, and the Republican contract (Romney victory) is trading at $0.250. So, if you were to today purchase 100 Obama contracts for a total of $75.00, should the president win reelection, on Wednesday your contracts would be worth $1.00 each, or $100.00 total, good for a 33.3333 (repeating, of course) percent return on investment; alternately, if you were to buy 100 Romney contracts, your cost would be only $25, but should the governor win the election, you'd be looking at a 300% ROI. </div>
<div>
(A quick aside, the contract is actually for the winner of the <i>popular</i> vote, rather than the winner of the electoral college and presidency, though the two are not always one and the same, you get the point.) </div>
<div>
The market also allows participants to functionally short contracts by purchasing the same number of each contract (for $1.00 per bundle) and then selling any sub groups of contracts, in essence, betting that the price of the contracts held will go up in value compared to the price of the contracts sold. Since the two outcomes are mutually exclusive, they have a nearly one-to-one negative correlation.</div>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><span class="Apple-style-span" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><a href="http://tippie.uiowa.edu/iem/media/2008_presidential.jpg" target="_blank"><img border="0" height="217" src="http://tippie.uiowa.edu/iem/media/2008_presidential.jpg" width="320" /></a></span></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="http://tippie.uiowa.edu/iem/media/08pres.html" target="_blank">Source: Iowa Electronic Markets</a></td></tr>
</tbody></table>
<div>
All that said, the IEM is actually most notable not just for facilitating bets seen to maturity (when investors take delivery of their info-commodity), but for providing a market throughout the election season, thereby becoming something of a barometer for overall sentiment around the race at any given moment. In fact, historically, the IEM has been shown to be a better predictor of the outcomes of elections than most major polling sources. The ridiculous graphic on the right (which came directly from the IEM's website) provides an illustration of this fact from the 2008 presidential election. The price of a specific contract, in essence, represents the market's belief as to the probability of the associated event occurring. The theory goes that these markets end up being more accurate than polls because when people are forced to vote with their wallets, as much as they may like one candidate or the other, they're still Americans after all, and Americans rarely pass on an opportunity to make some cash.</div>
<div>
So, back to the current year, when I say that the Obama contract is trading at $.75 to the Romney contract's $.25, this implies that, as of now, the market is giving Obama a 75% chance of winning the popular vote to Romney's 25%. Note how much more strongly the market is predicting an Obama victory than are most pollsters. However, this does not mean the market believes it's going to be a tremendously lopsided victory, in fact, just the opposite, as the IEM also offers a proportional vote contract that pays out based on the relative vote share for the major-party candidates (Republican or Democrat). That is, if you happen to be holding a Romney contract in this market, and Romney ends up winning, say, 48% of all votes cast either for Romney or Obama, that contract will be worth $.48, while an Obama contract would be worth $.52. As of writing, the Obama contract is currently sitting at $.505, while the Romney contract is trading at $.492 (an enterprising arbitrageur could take advantage of those totals not summing to $1.00). </div>
<div>
So, the IEM is giving Obama a 75% chance of winning the popular vote, but only edging Romney out by something in the neighborhood of 1% of all votes cast for the two major candidates. Agree with those sentiments? If not, I know a place you could potentially make a profit from your contrarian sensibilities.</div>
<div>
It's been said that knowledge is power, and for most investors power is money, but in the information markets, interestingly, money is also apparently knowledge.</div>
<div>
If you're interested in investing in, or just learning more about the IEM and the presidential markets check out the following (I swear I'm not getting any kickbacks or anything, I'm just a fan):</div>
<div>
<ul>
<li><a href="http://tippie.uiowa.edu/iem/faq.html" target="_blank">Iowa Electronic Markets FAQ</a></li>
<li><a href="http://iemweb.biz.uiowa.edu/quotes/Pres12_Quotes.html" target="_blank">IEM Presidential Markets Real Time Quotes</a></li>
<li><a href="http://en.wikipedia.org/wiki/Iowa_Electronic_Markets" target="_blank">Wikipedia entry on the IEM</a></li>
</ul>
</div>
<div>
<br /></div>
<div>
<i>NB: Obviously I've chosen to focus on the presidential election in this post, but the IEM offers contracts for all kinds of other events, often around politics, but also concerning miscellaneous goings on in the popular zeitgeist. All of which are, naturally, very, very interesting. It's a great market to follow.</i></div>
<div>
<br /></div>
Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-68875347400560943332012-07-09T12:41:00.000-07:002012-07-09T13:02:33.166-07:00China's Taste For WineThough not traded on a futures exchange, wine is still, literally anyway, a commodity. Further, it's a commodity that many people invest in, typically in the form of collectible rare/old wine. At a party when this ever comes up, usually someone says something like: "over time, rare wine is one of the safest investments when compared to blah blah blah". There's rarely any data to back this up, but that doesn't matter because it seems believable and it's kind of cool. Someone should look into that.<br />
<br />
But rare wine isn't the order of the day. No, today I'm interested in exported wine. Specifically, wine exported to China. A <a href="http://www.globalpost.com/dispatch/news/regions/africa/south-africa/120611/china-let-them-drink-wine">recent article on GlobalPost.com</a> (which is a publication I had never heard of until two weeks ago) addresses growing wine consumption in China:<br />
<blockquote class="tr_bq">
Wine bars and boutiques are sprouting across Beijing, and trendy young consumers are flocking to wine-tastings at swish hotels. A dramatic 54 percent rise in wine consumption in China between 2011 and 2015 is predicted, a reflection of the increasing affluence of China’s middle classes, according to a new study by Vinexpo, Asia’s biggest wine exposition.</blockquote>
Let's leave aside for the moment that this study was conducted by a "wine exposition" (whatever that is) and focus on the purported reasoning behind the growth. Specifically, that the increase in wine consumption is "a reflection of the increasing affluence of China's middle classes." The article also goes on to say that 40% of Chinese wine imports are from France, specifically. Plenty of countries make wine; that the increase in imported varietals seems to be focused on French<i> </i>wine implies not just that an increasingly affluent middle class wants to buy wine, rather, that they want to buy good wine. <br />
<br />
Curious about how this trend might affect the American wine market, I pulled some numbers from the USDA Website via the <a href="http://www.fas.usda.gov/gats/default.aspx">FAS USTrade Query system</a>. First, a look at total wine exports from the US, by country, over the last ten years (note, all volumes reported in Kiloliters):<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiC_lZhRJx-2kxkZVjCkw9oYmPiBMMoEw15zNV33em3n_TCqn7AprJckMSo7Qfvv-yobVUZKChlAI2zp7LjK_ck2hWs5VwpXEHQUp6-NBnEdeR5YPwxEC6QJne36mOw00MMFvYKkMeqo5IC/s1600/Graph01TotalWineExportsWithYear-2.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="243" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiC_lZhRJx-2kxkZVjCkw9oYmPiBMMoEw15zNV33em3n_TCqn7AprJckMSo7Qfvv-yobVUZKChlAI2zp7LjK_ck2hWs5VwpXEHQUp6-NBnEdeR5YPwxEC6QJne36mOw00MMFvYKkMeqo5IC/s320/Graph01TotalWineExportsWithYear-2.png" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">US Total Wine Exports by Country, 2002 - 2011 (click to enlarge)</td></tr>
</tbody></table>
The first takeaway? Whatever amount of American wine the Chinese are importing now or in the next few years is largely insignificant at this point. We ship so much wine elsewhere that any changes in Chinese demand for US wine are unlikely to be of major concern for the next few years. That doesn't make it uninteresting, however. To get a better idea of the changes in China, specifically, let's take a look at the percentage of <span style="background-color: white;">total </span><span style="background-color: white;">US wine exported to four specific countries over that same time frame:</span><br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhCOhhn0S7JGPHA1LDS3C8Qhks6N2yIV38-woYLdBZ5xQoQcRl-SdQLrV811P7N0h8jCAsQuIxqD8mqZi5tVc7UnpQ4ziQAH0vTzg1L9Tw1BNhuT1Rno8JQ3WXGpzSmDzDoOfNkKSZKmaFg/s1600/Graph02PercentofTotalExports.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="214" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhCOhhn0S7JGPHA1LDS3C8Qhks6N2yIV38-woYLdBZ5xQoQcRl-SdQLrV811P7N0h8jCAsQuIxqD8mqZi5tVc7UnpQ4ziQAH0vTzg1L9Tw1BNhuT1Rno8JQ3WXGpzSmDzDoOfNkKSZKmaFg/s320/Graph02PercentofTotalExports.png" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Percent total wine exports to four countries (click to enlarge)</td></tr>
</tbody></table>
<div class="separator" style="clear: both; text-align: left;">
Okay, now we're getting somewhere. As a percentage of total wines exported, one can see that the amount of wine we ship to China and Hong Kong has been gradually increasing, while that same total for Japan and France hasn't been following any overt pattern. Now let's compare the raw totals for the three biggest Asian importers of US wine:</div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPw4bohvyI3euOrI3smTmQZzbVwD2cy1oYZADT5nrIIRhQ_JAATLLCAhkqnXRUGfIdjjC0k12GoTABKuifJkZrc5qSSsHaLwtpbscn08IW0iX2pgBtUuWb2unCsOqIbDWAZhzLIOxovTzQ/s1600/Graph03TotalExpJpnChinaHk.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="237" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPw4bohvyI3euOrI3smTmQZzbVwD2cy1oYZADT5nrIIRhQ_JAATLLCAhkqnXRUGfIdjjC0k12GoTABKuifJkZrc5qSSsHaLwtpbscn08IW0iX2pgBtUuWb2unCsOqIbDWAZhzLIOxovTzQ/s320/Graph03TotalExpJpnChinaHk.png" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Total imports from Japan, China, and Hong Kong (click to enlarge)</td></tr>
</tbody></table>
<div class="separator" style="clear: both; text-align: left;">
Interesting. The total amount of wine exported to Japan has more or less been hovering around 25,000 kiloliters, while exports to China and Hong Kong have steadily grown. But remember, the article tells us that the Chinese are developing a taste for <i>French </i>wine, which, accurate or not, has a reputation for being better than most other countries' wines. The next question, then, is what <i>type</i> of wine is China importing from the US? <span style="background-color: white;">When reporting wine export numbers, the USDA breaks out the figures into six categories:</span></div>
<div class="separator" style="clear: both; text-align: left;">
</div>
<ol>
<li>Sparkling Wine</li>
<li>Effervescent Wine</li>
<li>Grape wine of an alcoholic strength not over 14% in containers holding 2L or less.</li>
<li>Grape wine of an alcoholic strength not over 14% in containers holding more than 2L.</li>
<li>Grape wine of an alcoholic strength of over 14% in containers holding 2L or less.</li>
<li><span style="background-color: white;">Grape wine of an alcoholic strength of over 14% in containers holding</span><span style="background-color: white;"> </span><span style="background-color: white;">more than </span><span style="background-color: white;">2L.</span></li>
</ol>
<div>
I don't know, exactly, what the distinction between sparkling wine and effervescent wine is, but types 3 through 6 could generally be thought of as "standard bottled table wine", "standard boxed table wine", "fortified wine" and "holy hell I have a death wish", respectively.<br />
<br /></div>
<div>
Standard table wine makes up the bulk of exports to all three of these countries, but here's where things get interesting. Let's look at how export numbers to Japan, China, and Hong Kong compare when caged specifically to standard table wine:</div>
<div>
<br /></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi09DiUow2s8ayXaue-aIVi_3aRwbPkezjGVpHQ4gGeXtO4IUcsKspBbRSjc8b7c0Z5-zA2_geORuOcjt7drBcazyfq-k96pcyYRUiH3b2SwiRggRgKnj68uqT7jS-EIYjJjZ5KssWbSzku/s1600/Graph04StndrdBttleTableJpnChinaHK.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="213" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi09DiUow2s8ayXaue-aIVi_3aRwbPkezjGVpHQ4gGeXtO4IUcsKspBbRSjc8b7c0Z5-zA2_geORuOcjt7drBcazyfq-k96pcyYRUiH3b2SwiRggRgKnj68uqT7jS-EIYjJjZ5KssWbSzku/s320/Graph04StndrdBttleTableJpnChinaHK.png" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Standard table wine exports to Asia (click to enlarge)</td></tr>
</tbody></table>
<span style="background-color: white;">Interestingly, the China and Hong Kong trends for standard bottled table wine follow </span><span style="background-color: white;">pretty closely</span><span style="background-color: white;"> the general trends for ALL wines exported to those countries, while the Japanese trend looks altogether different. A little stats shows that this is precisely the case. </span><span style="background-color: white;">Who knew the Japanese had such a taste for Night Train?</span><span style="background-color: white;"> </span><br />
<ul>
<li><span style="background-color: white;">R_squared value comparing </span><span style="background-color: white;">total</span><span style="background-color: white;"> global wine exports to standard table wine exports by country:</span></li>
<ul>
<li>Japan: .1567</li>
<li>Hong Kong: .9754</li>
<li>China: .9671</li>
</ul>
</ul>
<span style="background-color: white;">That means that ~97% of Hong Kong and China's change in wine importation from the US over the last ten years can be explained in terms of their importation of wine at 14% alcohol in containers smaller than 2L. That is, standard table wine. </span><br />
<br />
<span style="background-color: white;">The article mentions that the majority of wine consumed in China is produced domestically. </span>What the change in export number then means, really, is not that China is drinking <i>more</i> wine, per se, but that more people are drinking <i>better</i> wine. <span style="background-color: white;">To that end, the article's thesis is entirely correct, but not just for French wine, for</span><span style="background-color: white;"> </span><i>all</i><span style="background-color: white;"> high quality wine. </span><span style="background-color: white;">U</span><span style="background-color: white;">ntil Chinese vineyards begin rivaling the quality and consistency of the best vineyards in France, the United States, and elsewhere, </span><span style="background-color: white;">as China's citizenry gains spending power in the global economy, look for this trend to continue.</span><br />
<br />
<span style="background-color: white;">If you were hoping to come away with an investment idea here, you may be out of luck; there is no grape futures contract in existence, but even if there were, it's unlikely investing in such an instrument would be worthwhile. Grapes aren't the key here, it's craftsmanship, tradition, and quality. To that end, investors in rare wine may actually see a boon from the growth of wine exports to China. If demand for quality keeps up, that rising tide should, in theory anyway, boost the values of all high quality bottles.</span><br />
<span style="background-color: white;"><br /></span><br />
<span style="background-color: white;">Normally I'd say something like "it's a good time to own a vineyard in Napa or </span><span style="background-color: white;">Bordeaux</span><span style="background-color: white;">", but really there's no need to state a priori truths.</span>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-70916166386408196632010-04-27T10:20:00.000-07:002010-04-27T10:25:40.465-07:00Even Newer Futures Contracts!Hard Assets Investor just published an article of mine running down the new futures contracts that I had <a href="http://assetprime.blogspot.com/2010/02/new-futures-contracts.html">discussed previously</a> (Cobalt, Molybdenum, and Distillers' Dried Grain), as well as the proposed Canadian Oil Futures contract. You can read the full article <a href="http://www.hardassetsinvestor.com/features-and-interviews/1/2107-the-new-futures.html">here</a>.Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-38729354864697047492010-04-20T12:00:00.000-07:002010-04-21T12:02:20.583-07:00Nice try US government, we're still not buying natural gasTwo weeks ago the Wall Street Journal <a href="http://online.wsj.com/article/SB10001424052702303912104575163891292354932.html?KEYWORDS=Overstated#printMode">ran an article with the headline: "Natural-Gas Data Overstated"</a>. Apparently, the Energy Department has for some while been screwing up its statistical projection for natural gas and significantly overestimating the country's gas supplies.<div>
</div><div>Basic economics tells us that when demand stays constant and supply diminishes, prices go up. And according to this report, supplies, in fact, have diminished, albeit somewhat artificially. And how did the market react? It didn't:<div>
<script src="http://charts.wikinvest.com/wikinvest/wikichart/javascript/scripts.php" type="text/javascript"></script><div id="wikichartContainer_86CC16DE-3C12-105F-4B0A-1CA6210307EB"><div style="width: 300px; text-align: center; vertical-align: center; margin-top: 22px;"><a href="http://get.adobe.com/flashplayer/"><img src="http://cdn.wikinvest.com/wikinvest/images/adobe_flash_logo.gif" alt="Flash" style="border-width: 0px;" />
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<strong>Click here to download Flash Player now</strong></a></div></div><script type="text/javascript">if (typeof(embedWikichart) != "undefined") {embedWikichart("http://charts.wikinvest.com/WikiChartMini.swf","wikichartContainer_86CC16DE-3C12-105F-4B0A-1CA6210307EB","300","245",{"startDate":"01-04-2010","endDate":"19-04-2010","embedCodeDate":"2010-4-20","showAnnotations":"true","liveQuote":"true","ticker":"NG00"},{});}</script><div style="font-size:9px;text-align:right;width:300px;font-family:Verdana"><a href="http://www.wikinvest.com/chart/NG00" style="text-decoration:underline; color:#0000ee;">View the full FUTURE:NG00 chart</a> at <a href="http://www.wikinvest.com/">Wikinvest</a></div></div><div>
</div><div>
</div><div>Other than that spike the day of the announcement (April 5) natural gas investors apparently couldn't care less about the US Government's overstated inventory figures. </div><div>
</div><div>This highlights the fact that in the US we have access to about as much natural gas as we could ever want. Granted, a lot of it is underground, but unless gas stocks were actually low (like, in danger of running out) knowing that our stocks are slightly less than previously thought doesn't actually affect the price. At some point, the functional supply of gas changes from a number of mmBTUs to the categorical figure "plenty". If we got to a point where we were consuming enough natural gas to see stocks diminishing the gas drillers could ramp up production so quickly that no blip would be seen.</div><div>
</div><div>So, nice try government, but the market knows better.</div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-87089385986950011072010-04-13T16:28:00.000-07:002010-04-13T16:53:34.213-07:00Building a Better Gold/Silver SpreadYes, I realize the blog has been morphing into my simply posting links to articles I am writing for other blogs, but I assure you there's still original content to be had here.<div>
</div><div>Regardless, <a href="http://www.hardassetsinvestor.com/features-and-interviews/1/2084-building-a-better-goldsilver-ratio.html">here's a new article I wrote for Hard Assets Investor, wherin I devise a multivariate statistical model for the Gold/Silver spread</a>.</div><div>
</div><div>The basic idea is that, since gold and the US Dollar are highly correlated, and gold and silver are highly correlated, while silver and the dollar are NOT highly correlated, you can use silver coupled with the USD exchange rate in a multivariate model to observe statistical deviations from historical norms.</div><div>
</div><div>The takeaway? Even though past performance does not guarantee of future returns, according to this model at least, gold is trading well above its historical expectation for the current values of silver and the dollar. If you buy into the model, the play would be to short gold, buy silver, and buy a foreign currency with US Dollars.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-19214238431333336862010-04-01T13:59:00.000-07:002010-04-01T15:38:50.322-07:00Diversify by investing in grainsOn Monday, Hard Assets Investor published <a href="http://www.hardassetsinvestor.com/features-and-interviews/1/2062-using-grains-to-diversify-your-portfolio.html">another article of mine</a>, the premise of this one is that it turns out Grains (Corn, Oats, Rice, Soybeans, Wheat) have fundamentally NO correlation with the broader stock market. This makes them an excellent candidate for investors seeking <i>true</i> diversification.<div>
</div><div>When I say "true" diversification, what I mean is that most investors' idea of diversification is owning lots of different types of stock, and maybe a few bonds. The problem is that stocks (and even bonds, depending on which ones you own) tend to have high co-correlations. That is, if the share price of Coca-Cola suddenly bottoms out, you can bet that a lot of other companies will as well. If interest rates go up at some point ever in the future (I know, ridiculous right?), all other factors being equal, the entire stock market will go down. Lot of good your owning stocks in different industries does you then.</div><div>
</div><div>The traditional view has long been that you should own some combination of stocks, bonds, and cash or money-market funds, weighted depending upon your risk tolerance and age. The problem is that with those three categories its nearly impossible to diversify within your risk tolerance. That is, stocks are riskier than bonds are riskier than cash.</div><div>
</div><div>That said, commodities provide just as much risk (and upside) as stocks while, as my research demonstrates, offering little to no correlation with the broader market, depending upon which commodities you invest in (i.e. not oil or gold).</div><div>
</div><div>You all know my <a href="http://assetprime.blogspot.com/2010/03/problem-with-commodities-etfs.html">issues with Commodities ETFs</a>, but if you're purely looking for diversification, an ETF that holds a big basket of different grains might be the way to go. Personally though, if you have an account with a futures brokerage I always prefer owning the contracts directly.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-85413648473611712722010-03-01T10:17:00.000-08:002010-03-01T16:50:23.134-08:00The Problem with Commodities ETFsLast week, Hard Assets Investor published <a href="http://www.hardassetsinvestor.com/features-and-interviews/1/2010-energy-etfs-the-tracking-problem.html">another one of my articles</a>. In it, I compared the correlations between several energy ETFs and the prices of commodities they are tracking. The takeaway message is that, for the most part, ETFs do a bad job tracking commodities prices. There are a few reasons for this.<div>
</div><div>The first, and primary reason why the correlation is less than perfect, is that the front-month futures contract for every commodity is constantly changing. Since most ETFs hold only the front-month contract, this means that sometime before expiration, the fund must sell its holding of one (soon to expire) contract and then purchase another (soon to be front-month) contract. There is almost always a significant discrepency between the two prices, particularly if it's a commodity that doesn't deliver every month. Take a look at the futures chains on the CME group website for <a href="http://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude.html">crude oil</a>, <a href="http://www.cmegroup.com/trading/metals/precious/gold.html">gold</a>, and <a href="http://www.cmegroup.com/trading/commodities/grain-and-oilseed/corn.html">corn</a>. As of writing, the difference between the front month and second month contract is about 40¢, $1, and 10¢, respectively. That may not seem like much, but that price difference represents a pure loss in the value of the fund with every roll that takes place. Just to prevent declines, the fund would, on average, have to be increasing in value between 1 and 5% a month. That means that, depending on the commodity and the fund, a monthly percentage increase, if not sufficiently high, may actually mean you're losing money.</div><div>
</div><div>The second problem with ETFs is that they create a secondary market on top of what is already a volatile market in its own right. And, while the underlying instruments are the same for both, (futures contracts) the factors driving the supply and demand may be drastically different. For example, while natural gas might be moving up on strong demand <a href="http://assetprime.blogspot.com/2010/02/wsj-commodities-headlines-continue-to.html">resulting from a particular weather forecast</a>, if the primary participants are energy hedgers, no such demand would exist for UNG, the world's biggest natural gas etf. As such, UNG might theoretically follow the price of gas with something of a lag, rather than actually track the price in real time.</div><div>
</div><div>Don't take my word for it, take a look at this graph comparing oil price movements with the price of USO, the world's biggest crude oil ETF, over the last four years:</div><div>
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</div><div>
</div><div>Now, you might be saying "those charts seem to follow each other reasonably well" but that's the problem. Reasonably well isn't good enough. An investor buying a share or shares in a commodity ETF that puportedly tracks the price of a commodity wants her investment to actually do just that, not merely track the price "reasonably well".</div><div>
</div><div>It's true that there are some ETFs, especially those dealing with precious metals, that eliminate the problem of the roll yield altogether simply by buying and hoarding the commodity in question and storing it in a vault somewhere; no futures contracts required. While certainly effective in mitigating the problem, this only works for a very specific subset of commodities that do not have a cliff for their usefulness. Other than those few cases, in general, the moral is that if you really, truly want exposure to commodities, don't waste your time with an ETF. As they stand, very few of them can be relied upon to achieve their goals. Though that may change in the future, for now, your best bet is get into the futures market directly.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com4tag:blogger.com,1999:blog-1565900686764924981.post-78251218192896210572010-02-23T13:45:00.000-08:002010-02-23T13:45:30.129-08:00New Futures Contracts!Last week, a couple of the major commodities exchanges announced the addition of some new futures contracts to help producers and consumers of raw goods hedge their expenses, and simultaneously give commodities traders three more reasons to develop stress-related ulcers.<div>
</div><div>First, across the pond, the world's foremost metals market, the London Metal Exchange (LME) yesterday opened trading of cobalt and molybdenum futures. In shocking concordance with my <a href="http://assetprime.blogspot.com/2010/01/time-for-lithium-futures-contract.html">previous post about the emerging need for a lithium futures contract</a>, the cobalt contract is designed specifically with battery manufacturers in mind, cobalt being a major input to rechargeable batteries in things like laptops and cellphones. Molybdenum, which I had never heard of before <a href="http://online.wsj.com/article/SB10001424052748704269004575073432850743498.html?KEYWORDS=Cobalt+Futures">this Wall Street Journal article</a>, is apparently used in the production of stainless steel.</div><div>
</div><div>Meanwhile, here in the States, the ever-growing Chicago Mercantile Exchange announced that it will be adding a contract for distiller's dried grain (DDG), a by-product of corn ethanol production. This is interesting because, with the addition of the contract, which will begin trading in April, ethanol producers can now effectively hedge every step of their production. For example, before the harvest you might buy a corn contract so as to protect yourself from unexpected price swings at your local grain elevator. Then, once you've got your corn and begin distilling ethanol, you can sell both a DDG and ethanol contract to lock in prices for your two resultant byproducts. Further, you can buy or sell oil, gas, or natural gas contracts to take advantage of spread deviations between the fuels. This is also interesting because the DDG contract may become a major hedge-staple for corporations that produce ethanol for non-fuel purposes... you know, like Jack Daniel's. The government, and now the private markets, are conspiring to make ethanol a real and viable energy source with plenty of economic safegaurds.</div><div>
</div><div>A bizarre reaction to these announcements is concern that opening these contracts to the public will increase volatility in the prices of the commodities and could potentially drive them too far one way or the other. Yes, that is true, prices will become more volatile... but only for the traders. The hedgers (people producing and consuming ethanol) actually need volatility to protect themselves from things like price-fixing and sudden, unexpected swings. Without and open public market, there's no way to plan for and predict what DDG would and will cost. Also, hedgers are not entering and exiting positions over and over to make a quick buck, they are locking prices in, exiting positions, and taking the difference as market protection.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-8204514547251197972010-02-17T14:04:00.000-08:002010-02-17T18:58:49.452-08:00Increase in Housing Starts Contributes to Lumber Run-Up, or is NonexistentAs per my <a href="http://assetprime.blogspot.com/2010/02/lumber-supply-shock-nothing-else-drive.html">post last night</a>, and <a href="http://online.wsj.com/article/SB10001424052748703444804575071003242087756.html?KEYWORDS=housing#printMode">today's news on housing starts</a>, I certainly ought to eat a little crow; according to the Census Bureau, January housing starts were up from December, as well as January 2009. Specifically, according to the <a href="http://www.census.gov/const/newresconst.pdf">Bureau's report</a>: <div><i></i></div><blockquote><div><i>Privately-owned housing starts in January were at a seasonally adjusted annual rate of 591,000. This is 2.8 percent (±11.5%) above the revised December estimate of 575,000 and is 21.1 percent (±12.3%) above the January 2009 rate of 488,000.</i></div><div></div></blockquote><div>So yes, it appears I was wrong with <a href="http://assetprime.blogspot.com/2010/02/why-i-am-bearish-on-lumber.html">my initial assessment</a> and the housing market indeed showed signs of picking up in January, potentially contributing to the Lumber run-up of the last month. However, the actual meaning of the housing start increase is slightly more complicated than the above quoted numbers and, I would make the case, much less meaningful than reports are making it out to be. Let me explain.</div><div><div><div>
</div><div>First, regarding the meaning of the number itself, the 2.8% increase in housing starts is an increase in the <i>seasonally adjusted</i> housing start <i>rate</i>. Because the US Housing market is highly seasonal (i.e. more building projects begin in the spring and summer months) examining trends on a purely month to month basis is not meaningful when analyzing long-term trends. Housing starts will almost always go up in March, and they will almost always go down in October. As such, the US Census Bureau developed a statistical method called X12 (and its predecessor X11) used to remove the expected seasonal effects of this type of data. The best article I could find describing the algorithm is, oddly enough, on <a href="http://www.dallasfed.org/data/basics/seasonally.html">an old Federal Reserve Bank of Dallas webpage</a>, but suffice to say the algorithm is designed to remove expected seasonal effects for a given data series, thereby showing the actual overarching trend. Thus, the published number is a point estimate for what the current annual housing start <i>rate </i>is; in this case, 591,000 housing units started per year. As with any statistical analysis, there is a margin of error to that point estimate, and the margin is given right in the reporting sentence. "This is 2.8 percent (±11.5%) above the revised December estimates..." Wait a minute, 2.8% ±11.5%? That should give us a range of –8.7% to +14.3% and, if I'm not mistaken, –8.7 ≤ 0 ≤ 14.3. As any statistician can tell you, a confidence range that includes zero is not statistically significant at all. And the Census Bureau uses a 90% confidence interval in their calculations, so it's not as though they're being overly conservative with their estimates and confidence ranges. In other words, this number is fundamentally meaningless. In fact, if you actually bothered to read the report (as apparently no one in the media did) you'd see that the "±11.5%" figure is asterisked with a footnote that reads as follows:<div></div><blockquote><div><i>"90% confidence interval includes zero. The Census Bureau does not have sufficient statistical evidence to conclude that the actual change is different from zero.</i>"</div><div></div></blockquote><div>So, in other words, there is no evidence that there was a change in the seasonally adjusted rate WHATSOEVER. This number is meaningless.</div><div>
</div><div>Moving on, despite the lack of evidence for a month over month change, the increase in rate from January last to now does appear to be truly significant, with a confidence interval of 21.1 percent ±12.3% (between 8.8% and 33.4%) for the change from January 2009's seasonally adjusted rate. (Note that that range does not cross zero.)</div><div>
</div><div>The report also lists the raw housing start numbers (those that haven't been seasonally adjusted). Here are the highlights (all numbers pulled from the aforementioned report):</div><div><ul><li>2008 Year in full: 905,500</li><li>2009 Year in full: 554,500</li><li>January 2009: 31,900</li><li>November 2009: 42,300</li><li>December 2009: 37,100</li><li>January 2010: 37,800</li></ul><div>
</div><div>The takeaway from all of this is that the housing market has improved significantly since 2009. In fact, using either the December or January estimate for the seasonally adjusted housing start rate yields a significant improvement over the 2009 total figure. However, there is not sufficient evidence to suggest that any further progress has been made over the last two or three months, the numbers (both seasonally adjusted and raw) do not demonstrate sufficient statistical significance to draw that conclusion. Starker still, is that the market today remains at about 65% of where it was in 2008.</div></div><div>
</div><div>How did the Lumber market today respond to all this? Somehow, despite the hype, prices moved mostly sideways; either this information was already priced in, or it doesn't really exist.</div><div>
</div><div><i>Full Disclosure: As of writing, author is short May 2010 Lumber (LBK10)</i></div></div></div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-83933860176383155802010-02-16T17:48:00.000-08:002010-02-16T20:47:48.471-08:00Lumber Supply Shock, Nothing Else, Drive Prices Up<blockquote></blockquote>Today's Wall Street Journal ran a <a href="http://online.wsj.com/article/SB10001424052748703562404575067750815490316.html?mod=WSJ_Commodities_LEFTTopNews#printMode">great article</a> on the recent surge in Lumber prices. (Though, sadly, the online version's headline was changed from the print's pun-tastic "Builders Nailed by Lumber Prices" to the infinitely more boring "High Lumber Prices Threaten Housing Market".) The article does a fantastic job explaining the why's behind the recent insane price movements in the lumber market, which I have <a href="http://assetprime.blogspot.com/2010/02/why-i-am-bearish-on-lumber.html">discussed at length in a previous post</a>. In that post I laid out my then somewhat limited understanding of the reasons for lumber's price increase, which the WSJ article largely confirms and significantly expands upon. Basically, here's what happened:<div><ul><li>Due to a dramatic falloff in demand, largely the result of a depressed housing market, lumber mills and loggers have significantly decreased production. According to the WSJ article, lumber output fell 45% (!!!) between 2005 and 2009.</li><li>As the housing market remained stagnant, lumber wholesalers saw no need to maintain large inventories throughout 2009, further disincentivizing output from loggers and mills.</li><li>Because of the lack of demand and low prices, several lumber mills have indefinitely shuttered. This, of course, in itself drove prices higher. The article specifically mentions Canfor Corporation, a Vancouver-based producer responsible for half a percent of total North American lumber output, who indefinitely ceased operation on January 5th 2010 as one of the major mills to shut down amid the sluggish market.</li><li>Annually, home builders restock their lumber supplies in January and February in anticipation of the upcoming spring building season. As supply was already incredibly tight and production was being scaled back across the board, wholesale buying triggered a supply shock up the chain, sending prices higher. </li><li>Additionally, some firms continued buying on anticipation of consumers taking advantage of the federal home-buying tax credit before it expires.</li><li>As the industry was not in any place to suddenly ramp up production, the market created something of a feedback loop, driving prices higher from January through to today.</li><li>Exacerbating the problem is that shuttered/suspended mills do not have the capital (or guarantee of near-term capital) to quickly start up operations again.</li></ul><div>What is perhaps most interesting about this is that everyone seems to be in agreement that the surge is entirely supply driven. To the question of demand, the article says the following:</div><div><blockquote></blockquote><blockquote><i>"The supply crunch is striking because, just a few years ago, the North American lumber industry was able to supply enough wood to start more than two million homes a year. That was nearly four times the pace of home starts in December."</i></blockquote></div><div>In other words, home-building demand hasn't simply petered out, it's fallen off 75%, and still, the price goes up purely as supply stays tight. But perhaps the most interesting quote, in my mind anyway, comes towards the end of the article, in a discussion of near-term production prospects:</div><div><i></i></div><blockquote><div><i>"The ongoing recession will keep production light, said Matt Layman... who called this the only sustained supply-driven rally he has seen in 30 years of trading lumber."</i></div></blockquote><div>Thirty years is a long time, and Mr. Layman's quote only serves to highlight just how strange this market rally seems on the surface. My readers already know that I'm bearish on Lumber, but honestly, everything about this rally seems crazy to me. At least now we understand the circumstances that pushed prices high in the first place, but for this kind of rally to be sustained... I'm just not sure what it would take short of a spectacular resurgence in the housing industry.</div><div>
</div><div>Tomorrow, the US Census Bureau will announce the figures for January housing starts. A slight bump will be good news for the lumber bulls, a downtick could mean the beginning of the rally's end. I'll put a post up as soon as we see what happens, and what it's immediate effect may be.</div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-11150043112692367312010-02-16T16:11:00.000-08:002010-02-23T13:42:55.358-08:00Why I Love CommoditiesSorry about the dearth of posts lately, but I've been out of town. Speaking of...<div>
<div>I just got back from a trip to beautiful Whitefish Montana. If you're a skier and/or outdoor enthusiast, I can't recommend the city highly enough. On the train ride out there, I ended up having dinner with a couple of Montanans who own and work a farm on the eastern edge of the state. We got to talking and I asked them what they raise, to which the response came from the husband: </div><div> "Durum wheat, peas, and chickpeas." On hearing the word wheat, my interest was piqued, so I asked: </div><div> "I'm curious, do you ever use futures contracts to hedge your crops?" </div><div> To which he jumped into a very long, very interesting discussion about the commodities markets. The short answer to my question was no, because there is no durum wheat futures contract, he doesn't really have the option to hedge in the commodities markets, however, he can often lock prices in advance with individually agreed upon "forward" agreements with grain purchasers, though he admitted that this is not as useful as a true futures contract because there is less liquidity in the market.</div><div> "If you can't deliver your full crop," he said "you'd better have the cash". Following this conversation, the man's wife asked me: </div><div> "How do you know so much about wheat?" I explained that I was a commodities investor and sometime analyst, to which she said, "Wow, because you sound exactly like our son."</div><div> "What does your son do?"</div><div> "He's a wheat farmer."</div><div>
</div><div>The commodities markets have always fascinated me because, in some sense, it is one of the last, pure markets in the country. When you put a bid in for a commodity like wheat, you're not betting on earnings reports or interest rates, CEO scandals, cash flow statement readjustments, corporate lawsuits, etc. etc. You are simply betting on the price of a bushel of wheat. It is one of the few places in the world of business where the Montana Farmer and Wall Street Analyst are not just peers, but equal experts, and it is a market that is open to EVERYONE. If that doesn't stir your inner capitalist, I don't know what would.</div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-51465157869764893622010-02-08T06:36:00.000-08:002010-02-08T13:05:03.473-08:00Why I am Bearish on LumberBy bearish, of course, I mean pessimistic. In other words, I expect the price to go down.<div>
</div><div>Here's a chart of Lumber futures prices over the last month:</div><div><script src="http://charts.wikinvest.com/wikinvest/wikichart/javascript/scripts.php" type="text/javascript"></script><div id="wikichartContainer_E04399BA-D2C0-3662-C2C0-AD30CA16960E"><div style="width: 390px; text-align: center; vertical-align: center; margin-top: 22px;"><a href="http://get.adobe.com/flashplayer/"><img src="http://cdn.wikinvest.com/wikinvest/images/adobe_flash_logo.gif" alt="Flash" style="border-width: 0px;" />
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</div><div>
</div><div>Of particular interest is the big upward movement starting on January 28th. Between then and this last Friday, lumber TWICE went up the session limit of $10 / thousand board feet (mBF). At the beginning of the month, I was bearish on Lumber because I suspected housing starts have not actually increased whatsoever (and at the time I took a short position, only to be stopped out in accordance with <a href="http://assetprime.blogspot.com/2010/01/follow-up-regarding-my-aforementioned.html">my personal trading philosophy</a>), however, now I am even more bearish because I don't think this pricing run up either makes sense or is in any way sustainable.</div><div>
</div><div>Quick background about the market, the random length lumber futures contract (what most people mean when they say "lumber") is used extensively by lumber industry participants, that is timber harvesters and construction companies, to hedge against erratic price movements in the cash market (the price you get at your local mill on any given day). The biggest factor affecting lumber prices is the US housing market. When the housing market is booming, lumber skyrockets. When home construction is depressed, so too the lumber market. There is very little else driving lumber prices, as most of the lumber we use is grown domestically, we export almost none of it, and what lumber we do import comes almost exclusively from Canada.</div><div>
</div><div>Now that that's out of the way... a recent <a href="http://in.reuters.com/article/rbssIndustryMaterialsUtilitiesNews/idINN0210885020100202">article from Reuters</a> basically comes to the following conclusions as to why the price has shot up:</div><div><ol><li>There are fewer mills currently in operation (many had closed down when the housing market dried up), creating a minor supply shock in the cash market and sending prices up.</li><li>There is an expected increase in demand as the result of the approaching "Spring building season".</li><li>A "realtor survey" showed pending home sales were up 1% in December.</li></ol><div>My reason for being bearish on Lumber right now is that I believe there is a logical fallacy at play in the market. Follow me here on this treatise:</div><div><ul><li>If the housing market picks up (i.e. demand increases)</li><ul><li>Lumber inventories (i.e. supply) should be pressured and may diminish.</li><li>If inventories stay the same or diminish</li><ul><li>The price should go up.</li></ul></ul></ul><div>This is basic supply and demand, but I've made each bullet cascading to point out the conditional nature of how the market, in theory, responds. The other way for the price to go up would be as follows:</div><div><ul><li>If lumber inventories diminish (i.e. supply decreases)</li><ul><li>If the housing market moves sideways or picks up (i.e. demand stays the same or increases)</li><ul><li>The price should go up.</li></ul></ul></ul>Note the difference between the two cases. In the first, demand is the driving conditional; in the second, supply. Also note, and this is what's important, that demand, and demand alone, has an effect on the other predictive variable in the equation. That is to say, when demand changes, there is NECESSARILY an effect upon the supply. (Yes, I know, it's <i>possible</i> that demand has been perfectly predicted and supplies tailored to meet the expected demand, but this is incredibly unlikely in a market based upon a fungible commodity such as Lumber.) When supply decreases, on the other hand, there is by no means any necessary or expected response in demand. Demand could stay the same, demand could increase, demand could decrease. There's simply no way to know, or even extrapolate, based on supply alone. </div><div>
</div><div>What we have in the lumber market is the second scenario. Supplies seem to be diminishing because of the drawdown in milling operations. However, that in and of itself, in theory anyway, should not cause the price to go up. For that to happen, we'd need to see that demand has at least <i>not diminished, </i>or at best<i>, </i>has <i>increased</i><i>. </i>If this were the other way around, if we knew that demand really was increasing, we could infer that supply was likely to decline, and the facts about the mill drawdowns would confirm this, and we could say that yes, indeed, lumber prices <i>ought</i> to go up. However, we cannot say that demand for lumber is increasing, we can only say that supply looks like it <i>might</i> be decreasing, and there is at best a <i>possibility</i> that demand is on the rise, depending on how much faith you put in a self-reported survey from an industry with a financial incentive to make itself look healthy. As for the "spring building season" mentioned in the Reuters article, it's important to note that this is buying by retail lumber dealers in <i>anticipation</i> of the season. This is not a construction company buying lumber to build a house. Unless that lumber is actually used, it will just sit on the shelf, delaying future orders and adding to the supply.</div><div>
</div><div>Of course, we can talk about what a market <i>should</i> or <i>shouldn't</i> do in theory, about what's the <i>right</i> or <i>wrong</i> expected price movement based on any set of information, but the truth is that a market cannot be right or wrong. A market simply <i>is. </i>Lumber is trading at over $270 / mBf because someone was willing to buy a contract at that price, and someone was willing to sell. However, while the market itself cannot be wrong, the participants in the market can be. Extrapolating that supply is decreasing based on mill slow-down is an assumption, and it can be incorrect. Believing the housing market is picking up is an assumption, and it too can be incorrect. If two people, a buyer and a seller, have the same incorrect assumptions, the price they agree on will force the market in a particular direction, and this will happen regardless of the assumptions' validity.</div><div>
</div><div>Now, this buyer and this seller, they might be right. It might be the case that lumber supply is falling, and that demand is picking back up, but personally, I don't think so. I don't think the housing market is picking up, and I don't think supplies are in any way close to depleted enough to cause a significant shortage. Housing starts declined in December, you can read the <a href="http://www.randomlengths.com/base.asp?s1=Daily_WoodWire&s2=Other_Industry_News&s3=Housing&pub=list">reports on the Random Lengths website</a> (a sort of trade-mag for the lumber industry); do we have any reason beyond the above "realtor survey" to believe they have increased since? Again, maybe. Maybe I'm wrong about this, it's very possible, but I simply don't see housing starts increasing enough to justify this price run up.</div><div>
</div><div>Again, I could be wrong. I could be dead wrong and the US housing market might be ready to explode and the decline in mill output might cause a serious supply shock, but even so, in closing, let me drop a little perspective. The last time lumber was consistently trading above $260 / mBF was May - August 2007. Between then and now, it broke the $260 barrier only one other time: August 2008.</div></div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-4096394204751629352010-02-06T10:14:00.000-08:002010-02-06T18:13:04.934-08:00WSJ commodities headlines continue to tell us when it's cold outside<div>As I discussed in <a href="http://assetprime.blogspot.com/2010/01/natural-gas-investors-vs-meteorologists.html">a prior post</a>, whatever the natural gas market is the other nine months of the year, during the winter it's an inverse thermometer for the Eastern seaboard. Take a look at these natural gas headlines for the last month from the Wall Street Journal: <span class="Apple-tab-span" style="white-space:pre"> </span></div><ul><li><blockquote></blockquote>1/6/2010 - <a href="http://online.wsj.com/article/SB10001424052748704842604574642712567521046.html#printMode">Cold Weather Heats up Natural Gas, OJ Markets</a></li><li>1/15/2010 - <a href="http://online.wsj.com/article/SB10001424052748704363504575003333654141768.html#printMode">Natural Gas, off 2.5%, Falls on Mild Forecast</a></li><li>1/23/2010 - <a href="http://online.wsj.com/article/SB10001424052748703822404575019470927429004.html#printMode">Chilly Forecasts Lift Natural Gas</a></li><li>1/27/2010 - <a href="http://online.wsj.com/article/SB10001424052748703906204575027163209848880.html#printMode">Natural Gas Falls on Milder Forecasts</a></li><li>2/1/2010 - <a href="http://online.wsj.com/article/SB20001424052748704343104575033541486459572.html#printMode">Elements Hold Down Natural Gas</a>* </li><li>2/2/2010 - <a href="http://online.wsj.com/article/SB10001424052748703422904575039710972534900.html#printMode">Cold Weather Boosts Natural Gas</a></li></ul><div>Couple things to notice here, the first is that the 1/23 headline was modified from its original incarnation "Cold Forecasts Warm Up Natural Gas Prices" sometime between when I wrote <a href="http://assetprime.blogspot.com/2010/01/natural-gas-investors-vs-meteorologists.html">my prior post</a> and now. In fact, you can still see that headline as the page's title. So it's good to see that someone over there is insisting on slightly more variety of diction, even if the changes are occurring four or five days late. </div><div>
</div><div>The second, and more important thing to notice, are the functionally opposite headlines occurring 24 hours apart on 2/1 and 2/2. Anyone at all (say, for example, a professional commodities analyst) could point to at least TWO prior headlines that month and say that the news of EITHER 2/1 or 2/2 supports her model of rising OR declining gas prices. The volatility of these markets, especially when the weather is your primary driver, makes every session a significant one.</div><div>
</div><div>
</div><div>
</div><div>*In the print version of the 2/1 article, there was also a B-Roll shot of some dudes playing football in Washington DC with the caption:</div><div><blockquote>"ICING THE KICKER? Unusually warm weather was a boon for football players in Washington in November; not so for those betting on gas."</blockquote>Awesome. That picture really helps me get a better understanding of the natural gas situation. You couldn't have put a chart there or something? (NB: Yes I appreciate the irony of making fun of a superfluous picture, and then not showing said picture myself while discussing it, but wsj.com seems not be hosting it. Apologies.)</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-46082209522511463252010-02-05T17:23:00.000-08:002010-02-05T19:24:13.561-08:00Commodities, the Nation of Greece Conspire for a Terrible Week in Europe<div>If you own stocks, this week probably wasn't your favorite. Still, it could have been worse; you could be European. The EU got smacked around this week in a scene not unlike the penultimate brawl in <i>Road House</i>, you know, when that dude with the stick beats up all of the bouncers at the Double Deuce. Take a look at the Euro over the last three months:</div><div>
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</div><div>
</div><div>Then go ahead and change the view so that you're looking at the price over one month. I'm not a geopolitician, but from what I understand, Greece, Portugal, and to a lesser extent Spain, are all having terrible times restructuring their debt, so much so, in fact, that investors are fleeing EU investment vehicles for the "security" of American government bonds and the US Dollar. The dollar, in essence, this week fed on the ballooning deficit of three EU nations and the fears they brought to investors. The side effect here is falling commodities prices, as gold, copper, and oil all declined significantly over the last few days, thanks primarily to steady increases in the value of the dollar. Gold, for example, is down about $60 from where it opened on Thursday.</div><div>
</div><div>I find this notable for three reasons:</div><div><ol><li>The EU is experiencing the WORST of both possible worlds, as a collection of economically diverse, fully autonomous nations beholden to one central economy and currency, when one country suffers, EVERYONE suffers. This would be the equivalent of a debt crisis at an Illinois community bank making the dollar worthless in Japan. To what extent is Greece's fiscal stability the business of other EU nations? How beholden is Greece to EU nations helping it out of a jam?</li><li>Commodities prices are decreasing as a function of a strengthening dollar against the Euro, specifically. The dollar has been falling against the Yen all month while moving more or less sideways against the Loonie. With all of the global trade that goes on, I would not have expected a simple shift from European to American investments, on its own, to have that sizable an effect on commodities prices; typically you'd need the dollar to get stronger against EVERYTHING for this kind of pricing plummet.</li><li>Investors are fleeing Europe for the stability of the dollar. That's the US Dollar. The currency of the nation with 10% unemployment and interest rates of functionally 0. The nation with a $1.4 Trillion deficit. The nation currently fighting two wars. If the US economy is somehow the world's safe-haven right now, that does not bode well for the world.</li></ol></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com4tag:blogger.com,1999:blog-1565900686764924981.post-26923288133063059572010-02-02T09:17:00.000-08:002010-02-02T17:42:03.948-08:00Recently Published Article on Hard Assets Investor<div>Yesterday, the good folks at Hard Assets Investor were kind enough to run a somewhat lengthy article I had written for them about which classes of commodity provide the best hedge against dollar inflation. You can <a href="http://www.hardassetsinvestor.com/features-and-interviews/1/1978-the-best-commodities-to-hedge-inflation.html">check it out on their fantastic blog</a>.</div><div>
</div><div>For the article I compared various commodities closing prices to the <a href="http://assetprime.blogspot.com/2010/01/why-swiss-franc-is-my-favorite-dollar.html">USD/CHF exchange rate</a> for that day, and analyzed the correlation (or lack thereof). The article makes extensive use of scatter plots and highlights the R_Squared value expressing a relationship (if any) between the two factors; I was considering publishing the full regression outputs, but they aren't any more telling than the graphics combined with the R_Squared values that appear. Also, I should point out, as I did in the article, that the data sets have some degree of auto-correlation, so these should not be taken as predictive analyses. Rather, they serve as a means to compare the correlations BETWEEN different commodities. Anyway, for the, you know, actual content, go <a href="http://www.hardassetsinvestor.com/features-and-interviews/1978-the-best-commodities-to-hedge-inflation.html">read the article on HAI</a>.</div><div>
</div><div>Quick and dirty summary:</div><div>Good Hedges: Precious metals, Grains</div><div>Bad Hedges: Meat, Lumber</div><div>There, satisfied?</div><div>
</div><div><i>Full disclosure, as of writing, author is short March 2010 Lumber (LBH10)</i></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-8576592567237163972010-01-28T13:54:00.000-08:002010-01-28T16:11:40.215-08:00Wall Street Journal Reporter Sets New Standard for Awful Journalism<div style="text-align: left;">Despite its attempts to predict the future, I'm generally a fan of the Wall Street Journal; I know of no other publication that so succinctly and clearly gives you the day's most important business news. People who read the WSJ thinking they're getting an edge on where the markets are headed couldn't be more self-deceiving, but if you're just looking for the basics of what happened in the markets, you'd be hard pressed, in my mind, to find a much better source. Also, for those scant of us who follow commodities, the WSJ is one of the few places I know among major media outlets that actually gives page space to the markets (albeit succinctly and usually on the back of section C).</div><div>
</div><div>Okay, now, with that caveat out of the way, I have to say that yesterday's article: "<a href="http://online.wsj.com/article/SB10001424052748704905604575027422492620244.html#articleTabs%3Darticle">Traders Bet on an Oil Breakout</a>," which purports to be the day's "Commodities Report" is unquestionably one of the most shallow, poorly researched, amateurish articles I have ever read. Anywhere. In my life. </div><div>
</div><div>Let's start with the headline:</div><div></div><blockquote><div><i>"Traders Bet on an Oil Breakout"</i></div><div></div></blockquote><div>Is that so? Which traders? What kind of break out are we talking about here? Up? Down? How big are these bets? Surely the article will expand...</div><div>
</div><div>Moving on, from the second and third paragraphs we get this:</div><div></div><blockquote><div><i>"Since October, prices [of oil] have largely ranged from $70 to $80 a barrel, the narrowest four-month band since mid-2007. An oil "fear gauge"—the </i><i>CBOE</i><i> Crude Oil Volatility Index—early last week fell to the lowest level in more than two years.</i></div><div><i>But in the past few sessions, trading in the crude-oil options market has shown signs of reviving... While oil prices remain within that trading band, the volatility index has bounced off the bottom, according to some traders."</i></div></blockquote><div></div><div>Note that this does not say that the crude oil market has picked up, rather the crude oil <i>options</i> market has shown <i>signs</i> of reviving, and we're given this graph of the volatility index to, I have to assume, support that statement. See if you can pinpoint the obvious bouncing off the bottom mentioned in the above paragraph:</div><div>
</div><div><span class="Apple-style-span" style="color: rgb(85, 26, 139); -webkit-text-decorations-in-effect: underline; "><img src="http://sg.wsj.net/public/resources/images/MI-BB040_COMMOD_NS_20100126182025.gif" border="0" alt="" style="display: block; margin-top: 0px; margin-right: auto; margin-bottom: 10px; margin-left: auto; text-align: center; cursor: pointer; width: 183px; height: 267px; " /></span></div><div>
</div><div>See that big, significant bounce way down at the end there? Neither do I. It looks much more like random movements typical of every single market everywhere on the planet since the invention of markets. Which traders claimed the volatility index has jumped off the bottom? Oh right, <i>some</i> traders.</div><div>
</div><div>Back to the article, jumping ahead to the seventh paragraph, the author switches gears to talk about what's driving oil prices, and we get this doozy, possibly my favorite series of sentences that I've ever seen in a serious publication about financial markets:</div><div></div><blockquote><div><i>"New swings, either up or down, likely will be triggered by expected changes in supply or demand. Some expect oil prices to tumble, taking a cue from last week's selloff in stocks, which fell on fears of another downturn in the global economy. Others say prices will soar because of stronger economic growth and fuel consumption."
</i></div><div></div></blockquote><div>Go ahead and read that again. Maybe think about having a calligrapher write it out and then frame it and put it on your wall. It would almost make a nice zen koan were it not so idiotic. Consider that this reporter, whose job is, apparently, to write news stories about financial markets, actually took the time to write that first sentence and pass it off as legitimate reporting. Did anyone read this article and suddenly have the epiphany that changes in supply or demand of a commodity might affect the price (<i>either</i> up or down, remember)? Next, we get two fantastic sentences telling us that <i>some</i> people think the price of oil will go up, while <i>other</i> people think the price will go down. Does this reporter have some insider on the NYMEX who's sending her tape recorded conversations from the back rooms, or has she made this inference all by herself? In other news from the world of logical tautologies: </div><div><ul><li>If P, therefore P. </li><li>Q or (not Q).</li></ul>The rest of the article goes on to talk about the proposed oil position limits by the CFTC (which I've <a href="http://assetprime.blogspot.com/2010/01/why-imposing-oil-position-limits-is.html">previously discussed at length</a>) and how they've caused some speculators to exit the market. This second half, so to speak, in its own right is actually a reasonable bit of reporting, but it certainly doesn't belong under this headline of "Traders [Betting] on an Oil Breakout". It's sort of like reading two different articles, one written by a reporter, and one written by that reporter's (admittedly precocious) 9 year old child.</div><div>
</div><div>What could have been improved? Other than "everything", this article is essentially three different articles, none of which is actually meaningful in its current incarnation. If this were an article discussing the signs pointing to a return to volatility in the oil market (as the headline purports) then a lot more work should have been done to determine if that "bounce" in the CBOE Volatility Index reported by <i>some</i> traders as the bottom is the result of explicit returns to the market by speculators and/or hedgers, or if it's just random noise. There is a mention in the article that Southwest Airlines, Newfield Exploration Co, and Chesapeake Energy all "recently" increased their hedging positions. If the CBOE volatility index increase is the result of hedgers taking greater positions, that implies less volatility than if these were speculators reentering the market. Do some reporting and figure out which it was.</div><div>If, on the other hand, the article were to focus on this crazy "supply and demand" theory that's been posited by the author, it should actually show some trends and figures for supply and demand. Is there a correlation between oil reserve estimations and volatility? How have global import/export numbers looked for 2009? What do the fundamentals suggest?</div><div>And lastly, if instead the article were to focus on the proposed CFTC regulations, maybe it could talk about how those regulations will affect volatility. The article ends with a quote from the global head of energy trading a Société Générale (a European corporate bank I've never heard of) talking about why hedging is important for companies that produce and consume oil. This is altogether worthless information. Of course hedging is important for companies that produce and consume oil. A better, more meaningful question to end the article would have been: "If enacted, how do you imagine the CFTC imposed position limits on speculators will affect volatility and/or liquidity? What does your bank plan to do if these limits are enacted?" At least then we would have seen an opinion that may provide insight into the the current state of the market.</div><div>
</div><div>Seriously Wall Street Journal, proofreading means more than checking for spelling or grammatical mistakes.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-17101908776120676832010-01-27T09:46:00.000-08:002010-01-27T09:46:00.267-08:00In the sugar markets, turns out Homer Simpson was shockingly prescient<div><i></i></div><blockquote><div><i>"In America, first you get the sugar, then you get the power, then you get the women."</i></div><div>-Homer Simpson</div><div></div></blockquote><div>Sugar Futures hit a 29 year high Monday, which I probably don't need to tell you, is totally insane. (No, it's not insane that sugar prices are up, it's just the phrase: "29-Year High".) Sugar prices were basically sideways for all of 2008, bouncing around 15¢ / pound, followed by a slow but rather unremarkable build through the middle of 2009 (along with every other market on the planet) then a couple bumps to up around 24¢ / pound in August, where it began moving back down, only to all of a sudden skyrocket over the last couple weeks to more than 30¢ / pound intraday on Monday. As of this writing, prices have come back down a bit to 29.3¢ / pound.</div><div>
</div><div>The sudden price move is the direct result of Indonesia expecting a "530,976 metric-ton production shortfall", as well as an atypical monsoon season in India (the world's second largest sugar producer and single largest consumer on the planet) that turned them from a net exporter of the crop, which they are historically, to a net importer, which they almost never are. (Source: <a href="http://online.wsj.com/article/SB10001424052748704762904575025460308519940.html#printMode">WSJ.com</a>) We've also seen declines in sugar production from the world's top exporter Brazil, and greater sugar demand than ever before from emerging markets such as Pakistan and China. </div><div>
</div><div>In other words, let me put on my reporter hat, ahem: Further exacerbating the sugar situation are declines in sugar supply everywhere in the world, coupled with increases in sugar demand everywhere in the world.</div><div>
</div><div>I've quickly pulled some figures from <a href="http://www.fas.usda.gov/htp/sugar/2009/Nov_sugar_2009.pdf">the USDA's most recent global sugar report</a> (released November 2009) and reprinted them below. Remember that this does not take into account more recent news, like Monday's announcement regarding Indonesia (all data in thousands of Metric Tons):</div><div>
<span class="Apple-style-span" style=" line-height: 18px; font-family:Arial, sans-serif;font-size:12px;"><table align="center" border="1]]" style="position: relative; "><tbody><tr><td align="center" style="background-image: initial; background-repeat: initial; background-attachment: initial; -webkit-background-clip: initial; -webkit-background-origin: initial; background-color: rgb(0, 191, 255); background-position: initial initial; "><b>Region</b></td><td align="center" style="background-image: initial; background-repeat: initial; background-attachment: initial; -webkit-background-clip: initial; -webkit-background-origin: initial; background-color: rgb(0, 191, 255); background-position: initial initial; "><b>Year</b></td><td align="center" style="background-image: initial; background-repeat: initial; background-attachment: initial; -webkit-background-clip: initial; -webkit-background-origin: initial; background-color: rgb(0, 191, 255); background-position: initial initial; "><b>Total Production</b></td><td align="center" style="background-image: initial; background-repeat: initial; background-attachment: initial; -webkit-background-clip: initial; -webkit-background-origin: initial; background-color: rgb(0, 191, 255); background-position: initial initial; "><b>Total Imports</b></td><td align="center" style="background-image: initial; background-repeat: initial; background-attachment: initial; -webkit-background-clip: initial; -webkit-background-origin: initial; background-color: rgb(0, 191, 255); background-position: initial initial; "><b>Total Exports</b></td><td align="center" style="background-image: initial; background-repeat: initial; background-attachment: initial; -webkit-background-clip: initial; -webkit-background-origin: initial; background-color: rgb(0, 191, 255); background-position: initial initial; "><b>Total Use</b></td></tr><tr><td style="text-align: center;">North America</td><td style="text-align: center;">2007/2008</td><td style="text-align: center;">13,374</td><td style="text-align: center;">4,019</td><td style="text-align: center;">938</td><td style="text-align: center;">16,324</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;">2008/2009</td><td style="text-align: center;">12,136</td><td style="text-align: center;">4,455</td><td style="text-align: center;">1132</td><td style="text-align: center;">16,690</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;">2009/2010</td><td style="text-align: center;">12,498</td><td style="text-align: center;">4,360</td><td style="text-align: center;">913</td><td style="text-align: center;">16,166</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td></tr><tr><td style="text-align: center;">South America</td><td style="text-align: center;">2007/2008</td><td style="text-align: center;">39,117</td><td style="text-align: center;">1,488</td><td style="text-align: center;">20,959</td><td style="text-align: center;">18,568</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;">2008/2009</td><td style="text-align: center;">39,576</td><td style="text-align: center;">1,605</td><td style="text-align: center;">23,255</td><td style="text-align: center;">19,088</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;">2009/2010</td><td style="text-align: center;">43,830</td><td style="text-align: center;">1,393</td><td style="text-align: center;">26,052</td><td style="text-align: center;">19,218</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td><td style="text-align: center;"></td></tr><tr><td style="text-align: center;">Asia</td><td style="text-align: center;">2007/2008</td><td style="text-align: center;">69,097</td><td style="text-align: center;">13,731</td><td style="text-align: center;">16,153</td><td style="text-align: center;">63,574</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;">2008/2009</td><td style="text-align: center;">52,724</td><td style="text-align: center;">15,740</td><td style="text-align: center;">10,879</td><td style="text-align: center;">64,914</td></tr><tr><td style="text-align: center;"></td><td style="text-align: center;">2009/2010</td><td style="text-align: center;">54,906</td><td style="text-align: center;">19,383</td><td style="text-align: center;">11,161</td><td style="text-align: center;">64,916</td></tr></tbody></table></span></div><div>
</div><div>Not the most obviously elucidating snapshot I realize, but the major thing to notice is the decrease in sugar output from Asia, coupled with its aggregate import/export flip. </div><div>
</div><div>I don't know enough about the cycles or other price drivers in the sugar market, but just going on this data I would seriously think twice before selling any sugar contracts at all; a 29 year high may be just the beginning. </div><div>
</div><div>Looks like Homer was right:</div><div>
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</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-75008262507133049812010-01-26T09:35:00.000-08:002010-01-26T09:35:00.569-08:00Gold Through the AgesI've never been on the "CONSTANTLY INVEST IN GOLD ALL OF THE TIME!" bandwagon that seems to exist for some inexplicable reason, nor have I decided whether or not I like the idea of a gold standard, in theory or practice. I like the idea of the Dollar being pegged to something, but I've always been worried that there's nothing stopping everyone from collectively realizing that gold isn't actually useful for anything. I was chatting with a buddy of mine over beers last week, and when I mentioned my trepidation about the intrinsic, actual worth of gold, he said something I found interesting. This friend of mine, I should say in advance, is a big gold standard advocate, so you may have to take this with a grain of salt, but here's, basically, the point that he made (I'm paraphrasing here, I don't typically carry around a tape recorder when I'm having beers with a friend):<div><div><div><div><ul><li>In Ancient Rome, an ounce of gold would buy you the nicest hand woven cloth garment, likely died a beautiful and uncommon color.</li><li>In Viking times, an ounce of gold would buy you a coat of soft, warm, and sturdy furs well made and stitched together with intricate designs and fastened with beautiful artisanal leather work.</li><li>In the Wild West, an ounce of gold would buy you a Wyatt Earp type three piece suit with a frilly shirt imported from France and a perfectly steamed fur-felt cowboy hat.</li><li>Today, an ounce of gold will buy you a beautiful, custom tailored Armani suit with a silk neck tie.</li></ul><div>The more things change...</div></div></div></div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-82506972004399367222010-01-24T17:33:00.000-08:002010-01-25T13:04:57.317-08:00Why the Swiss Franc is my Favorite US Dollar BarometerWhenever I analyze the value of the dollar, either on its own or as a benchmark to compare with one or more commodities, I almost always use the US Dollar/Swiss Franc exchange rate (USD/CHF), which is the number of Swiss Francs you can get for one dollar. This may strike some people as strange, insofar as there exists another instrument, <a href="http://en.wikipedia.org/wiki/U.S._Dollar_Index">the US Dollar Index</a>, which is designed specifically to provide a snapshot of the dollar's global worth. The USDX, as it's called, compares the dollar to a weighted basket of other world currencies, specifically the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc. The idea is that by having a basket such as this, the effects of bi-national issues on currency prices should be minimized by the other currencies in the basket. It's a good enough barometer for most cases, but there's a few reasons why I prefer the Swiss Franc:<div><ol><li>The weighting of the currencies, though based on real economic data, is somewhat arbitrary. Currently for example, 57.6% of the weighting falls to the Euro, as it was determined that that percentage is how much the dollar is affected by that currency. If geopolitical relationships were to change at all, that 57.6% (or any other weighting) becomes less meaningful.</li><li>Since most of what I'm writing about concerns comparisons of the dollar's strength with commodity values, I need a barometer that can gauge the dollar's worth in global commerce. Surprisingly, the USDX is <i>not</i> the index used to gauge how strong the dollar is in global trade; that honor falls to the <a href="http://en.wikipedia.org/wiki/Trade_Weighted_US_dollar_Index">Trade-Weighted US Dollar Index</a>, which is a basket of about 27 or so foreign currencies, weighted by trade volume with the United States, and adjusted annually as trade volumes change year to year. You might think that this index would make a better currency barometer, but the fact that it's changing every single year actually makes it difficult to use when gauging long-term trends. Within a single year it's great, but otherwise you run into consistency problems.</li><li>This is a bit more of an aesthetic reason, but the USDX is not a real currency. Like all indices, it had to be assigned an arbitrary starting value on a given date which, in this case, happens to be 100 as of March, 1973. So, when I read that the USDX is trading at 78, that means that the dollar is 22% weaker today against an oddly weighted basket of currencies than it was in March 1973. Sweet, good to know. No, when considering the value of the dollar, I want a tangible gauge. I want to know how many units of another nation's currency my hard-earned greenback will actually buy me. I can't walk into a bank tomorrow and say: "I'd like to exchange $100 for 57.8% Euros, 13.6% Yen, 11.9% Pounds Sterling, etc. etc." Well, I guess I could, but I'd look like an idiot.</li></ol><div>All of that explains why I prefer not to use the USDX, but why the Swiss Franc? The nation of Switzerland has basically two major economic sectors (three if you count cheese with holes in it): high-end watches, and banking. The country is essentially a giant bank. Its historic neutrality protects it from major geopolitical upheaval and it's terrain makes it largely impenetrable in the event of a new world conflict. Its vast stores of gold give the economy a fundamental and irrefutable value, while its conservative approach to asset management make it's currency extremely stable. Because of Switzerland's limited industrial focus, the United States will almost never be in any sort of trade dispute with the country, unlike, say, with the EU, Japan, China, England, or even Canada, where trade relationships are intricate and new regulations, national or international, can have more dramatic effects on currency values. Because of Switzerland's unique status on the world stage, its exchange rate with the dollar truly lets you know how much the dollar is worth to the rest of the world.</div><div>
</div><div>I've been to Switzerland twice, it's a beautiful country, one I hope to return to some day. On my most recent trip there (in 2005) I held onto a SFr 5.00 coin, which today sits on my night stand and which I'll occasionally throw into my pocket if I need a bit of good luck. It is my favorite piece of legal tender I've ever possessed; hefty but not too bulky with beautiful engraving on each side. At the time I acquired it, the coin was worth about $3.85, as of this writing, it's worth about $4.80. Given what's happened to the US Economy between 2005 and 2010, that seems just about right.</div></div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com1tag:blogger.com,1999:blog-1565900686764924981.post-73561918607331964112010-01-22T16:52:00.000-08:002010-01-22T20:07:00.206-08:00Natural Gas Investors vs Meteorologists: The Eternal StruggleHere are three headlines from the Wall Street Journal, each of them from the month of January:
<ul><li>1/6/2010: <a href="http://online.wsj.com/article/SB10001424052748704842604574642712567521046.html#printMode">Cold Weather Heats Up Natural Gas, OJ Markets</a></li><li>1/15/2010: <a href="http://online.wsj.com/article/SB10001424052748704363504575003333654141768.html#printMode">Natural Gas, off 2.5%, Falls on Mild Forecast</a>
</li><li>1/22/2010: <a href="http://online.wsj.com/article/SB10001424052748703822404575019470927429004.html?mod=WSJ_Commodities_LEFTTopNews#printMode">Cold Forecasts Warm Up Natural-Gas Prices </a></li> </ul><div>I particularly like the 1/6 and 1/22 headlines, clearly demonstrating that WSJ commodities reporters are proficient with a middle school thesaurus. Anyway, take a look at Natural Gas prices over the last month:</div><div>
<script src="http://charts.wikinvest.com/wikinvest/wikichart/javascript/scripts.php" type="text/javascript"></script><div id="wikichartContainer_439B84BB-67E1-45A6-8087-58B2682211AE"><div style="width: 390px; text-align: center; vertical-align: center; margin-top: 22px;"><a href="http://get.adobe.com/flashplayer/"><img src="http://cdn.wikinvest.com/wikinvest/images/adobe_flash_logo.gif" alt="Flash" style="border-width: 0px;" />
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</div><div>That is some crazy volatility, and it has almost everything to do with weather forecasts. Though natural gas <i>could</i> be used to do just about everything oil does, currently, the cleaner burning fuel is used primarily for heating homes and other buildings. As such, during the winter months, when people are burning a lot more natural gas just to stay warm, the price can be driven by minor changes in the local weatherman's ten day forecast. In the summer, by contrast, Natural Gas is much more likely to follow energy patterns in general, and be driven by the same things that oil prices are driven by (reserves, projected refining capacity, projected demand, currency effects etc. etc.). I can just imagine natural gas speculators listening to the weatherman's tone before he actually announces the forecast, trying to get some glint of an overarching mood: upbeat means sell, foreboding means buy. Those who bought natural gas expecting the price to go up, no doubt, must become furious when the weatherman announces, jubilantly, that "this weekend's not going to be nearly as cold as we thought," with some sort of big, game show host smile. By contrast, when the forecast is worse than expected, natural gas bulls likely experience a kind of odd schadenfreude, delighting at the weatherman's gloomy and altogether dejected countenance as he warns his viewers to stay inside where it's warm. Truly, by literal definition, the weatherman is the natural gas investor's nemesis. By the same token, I've got to imagine natural gas sellers are quick to send the weatherman flowers when the forecast's got him down. </div><div>
</div><div>Obviously in the winter you'd expect prices to go up and in the summer to go down; in fact, there are whole businesses built around simply buying gas in March, pumping it into a salt cavity in the ground, and then selling it in November at much higher price. Why I find this so interesting, however is that the <i>nature</i> of the natural gas market changes every year from your typical energy market in the mild months, to a crazy spot market when the weather's cold. </div><div>
</div><div>Allow me to demonstrate. Here's a graph showing natural gas prices (in red) compared with oil prices (in blue) for the months of May, June, and July, 2009:</div><div>
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</div><div>Now, here's the same chart from 11/1/09 to today:</div><div><script src="http://charts.wikinvest.com/wikinvest/wikichart/javascript/scripts.php" type="text/javascript"></script><div id="wikichartContainer_241561EF-009C-2E75-5DD0-58F412379BE6"><div style="width: 390px; text-align: center; vertical-align: center; margin-top: 22px;"><a href="http://get.adobe.com/flashplayer/"><img src="http://cdn.wikinvest.com/wikinvest/images/adobe_flash_logo.gif" alt="Flash" style="border-width: 0px;" />
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</div><div>Look at that divergence. It's as though people are buying natural gas to, you know, use it. Winter month natural gas prices are a perfect example of when a commodity market actually does its job: establishing prices for commodities.</div><div>
</div><div>A word of advice to any tri-state weathermen out there: stay away from the <a href="http://maps.google.com/maps?f=q&source=s_q&hl=en&geocode=&q=One+North+End+Avenue,+New+York,+NY+10282-1101&sll=37.0625,-95.677068&sspn=44.069599,75.146484&ie=UTF8&hq=&hnear=1+North+End+Ave,+New+York,+10282&z=16&iwloc=A">NYMEX building</a>, unless you're looking for a fight.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0tag:blogger.com,1999:blog-1565900686764924981.post-91427155318519744442010-01-21T19:53:00.000-08:002012-01-16T17:05:50.931-08:00Commodities 101: How does one invest in commodities?<div><i>This post is part of Asset Prime's "</i><a href="http://assetprime.blogspot.com/2010/01/commodities-101-overview.html"><i>Commodities 101</i></a><i>" series.</i></div><div>
</div><div><when most="" people="" talk="" about="" investing="" in="" this="" site="" re="" usually="" referring="" to="" commodities="" futures="" because="" of="" the="" reaching="" effects="" that="" prices="" have="" there="" are="" dozens="" ways="" an="" investor="" can="" gain="" exposure="" on=""></when></div><div>The most direct way to invest in commodities would be to actually buy or sell the tangible goods themselves. You know, like growing your own Soybeans and then selling them to a grain elevator, or renting space in a meat locker and filling it with Frozen Pork Bellies, or melting down old pop cans and casting the aluminum into ingots and then hoarding those ingots until Aluminum prices rise. If you're not quite up to that level of commitment, fortunately there are myriad financial instruments at your disposal to get you going. One of the easiest ways to invest in commodities, particularly for folks already familiar with equity trading, is to buy and sell the stock of corporations whose earnings rely heavily on commodities prices. Think gold prices are going up? Buy stock in Barrick Gold (ABX) or Harmony Gold Mining (HMY). Think Lumber prices are going down? Buy stock in home construction companies such as Toll Brothers (TOL), or maybe sell lumber producers like Plum Creek Timber (PCL) and Weyerhaeuser (WY) short. Got a hunch about Corn? Buy or sell Archer Daniel's Midland (ADM) and/or General Mills (GIS). The major drawback of this approach is that all corporations have factors other than commodities prices dictating their stock performance, so that the change in a commodity's price may not cause the desired effect in the stock price.</div><div>
</div><div>Another option would be buying or selling shares of mutual funds, index funds, or ETFs that seek to somehow track the prices of individual commodities or some basket thereof. These instruments, that typically trade like stocks on the major exchanges, are all relatively new to the investment world and each has its own unique means of "achieving" its price goals. Some buy the underlying physical commodities and keep them in storage, others hold futures contracts at a certain specified leverage, still others have more exotic ways of attempting to track the underlying commodities. While these instruments may be a good option for some investors, in general, there is a gap between the price movements of these funds and those of the underlying commodities, usually the result of the expenses of maintaining and managing the funds, or liquidity problems with the instruments. </div><div>
</div><div>All that said, other than buying and sitting on physical goods, the most direct and, for our money, best way to invest in commodities is via commodities futures contracts ("futures" for short). These instruments provide investors the most unmitigated access to the commodities markets possible. Because they're so important to the commodities markets, we'll go over futures contracts in greater detail in a later Commodities 101 post. For now, suffice it to say that "commodities" and "futures" are just short of being purely synonymous, and if you're serious about investing in commodities, you need to understand futures and how they work</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com1tag:blogger.com,1999:blog-1565900686764924981.post-16657503657150404332010-01-20T13:42:00.000-08:002010-01-20T17:10:23.654-08:00Time for a Lithium Futures ContractUntil practical physics and/or electrical engineers devise a better battery, lithium-ion is the power-source of choice for the ever-growing electrification of our automobiles. The batteries are going to become more efficient, more compact, with larger capacity and a longer life, and within ten years they're going to be integrated into the engines of every car that rolls off the assembly line. And all the auto industry needs to accomplish this is firm resolve, technical knowhow, and 700 million tons of lithium.<div>
</div><div>The <a href="http://online.wsj.com/article/SB10001424052748704561004575013000547392886.html#printMode">Wall Street Journal today reports</a> that Toyota Motor Corporation secured access to a long-term lithium source in Argentina, outbidding potential Chinese buyers.</div><div>
</div><div>As lithium increasingly becomes an input into our transportation and energy industries, demand for the metal is going to skyrocket, as will the number of mining operations seeking to acquire and sell it, making the price about as volatile as the element.* If the auto/battery/lithium mining industrial complex is going to maintain any semblance of sanity there will need to be a hedge for producers and consumers of lithium. This is the same thing that happened with palladium, a metal used almost exclusively in the production of catalytic converters, when wild price swings pre-futures contract made establishing budgets and allocating funds close to impossible for automotive manufacturers. A listed futures contract will afford automakers a relative stability when it comes to protecting themselves. I'd put the over/under at about four years before a contract is listed on either the LME or the COMEX (or both). Any takers out there?</div><div>
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</div><div>*As an unfortunate side effect, look for these sorts of chemical/financial volatility puns to be used in 100% of news stories related to lithium price movements.</div>Charleshttp://www.blogger.com/profile/13925152943165002636noreply@blogger.com0