commodities

The Ban on Iran: Tehran continues with threats

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As promised, the European Union followed through with their promise to ban all oil imports from Iran today in an effort to halt the country’s nuclear development program.  The halt on oil was accompanied by a number of other provisions including sanctions on trading with their central bank.  Just days after the US, French, and British militaries sent a flotilla of warships through the gulf, the combined effect of the ban and military actions are sure to add pressure to our already tense relationship with Iran who reiterated their threat of a closure of the Strait of Hormuz.  Markets responded … Read more

Investors Turning to Active Commodities Strategies?

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I hooked up for lunch with commodity relative value fund manager I spoke to on Monday. He’s looking to raise raise capital for this new fund which he will be managing with other experienced traders and we went through his pitch book. 

I’ve sat with some of the best hedge fund managers in the world. The best of the best know the theory but more importantly, they can give you tons of examples of actual trades that went for and against them. That’s exactly how this manager presented his views. He has the academic and industry credentials, but it’s his actual commodity trading experience in Canada and the US that came through as he walked me through one trading example after another.

I love talented alpha managers. I’ll repeat what I’ve been stating the last few posts, there is exceptional alpha talent in Quebec that is being underutilized or worse still, totally ignored. I met two of Montreal’s best hedge fund managers today and I wouldn’t bat an eyelash to invest in either one of them (the other is an equity market neutral manager).

The question I get from outside-Quebec investors is if they’re so good how come the Caisse and other large Quebec institutions don’t invest in these new and existing hedge funds? There are a lot of reasons. First, reputation risk. There have been quite a few scandals in Quebec with institutions getting burned with funds like Lancer, Norshield, Norbourg, and other frauds. The last thing any institution here needs is to read that some hedge fund they invested with blew up, especially if it’s a local fund (the media in Quebec are merciless).

Second, unlike other places, Quebec lacks the entrepreneurial drive to develop the absolute return industry here in Montreal. There

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Inflation Speculation

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When currencies do not serve as a long-term store of value, economic actors search for ways to preserve future purchasing power, which often mean purchasing commodities. But most commodities are not cheaply storable over long periods, so actors get forced into the few that do: gold, silver, etc. There is a problem here, stemming from dumb money. When dumb money shows up for purchase of generic “commodities” distortions follow: backwardation, large storage demand, and warped market incentives.

Eventually overproduction catches up, but the volatility when it breaks can be huge and self-reinforcing, with c0unterparties raising margin to protect themselves.  Extreme volatility causes exchanges to raise margin requirements substantially, which reveals which side of the trade is inadequately financed, which typically is the side that was winning, which leads to a reversal in price action.  The dumb money is revealed.

Now after a washout, the dumb money often assumes that powerful entrenched interests colluded against them to deny them their long-deserved free ride to prosperity through speculation.  The exchanges are in cahoots with the other side.  Well, no, the exchanges have two interests, which are solvency and transaction volume, which drives their profits.  Solvency is a more primary goal for an exchange, because the second goal can’t exist without it, and exchanges are not thickly capitalized.

Many different types of financial systems are subject to these risks.  Think of AIG: they were rendered insolvent by rising margin requirements as their creditworthiness was downgraded, largely because the rating agencies concluded they were going to lose a lot of money off of their many bets on subprime residential credit.  Think of all of the mortgage REITs that got killed as repo haircuts rose on all manner of mortgage-backed securities at the time that values for the securities were depressed.  Alternatively, think of Buffett, who entered into derivative trades where he received money and bore the risk, but his agreements limited the margin that he would have to post.

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Barclays Offers New Variation of 19 Existing Commodity ETNs

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Barclays rolled out 19 new commodity-based exchange-traded notes (ETNs) last Thursday (4/21/11).  The 18 new Pure Beta products attempt to track the same commodities as 18 existing iPath ETNs, the primary difference being the process used by each underlying index to roll future contracts.  The iPath Seasonal Natural Gas ETN (DCNG) was also introduced, although it is not part of the new Pure Beta methodology.

Barclays new Pure Beta indexes intend to provide a more representative measure of commodity market returns by reducing the negative impacts of contango.  Instead of rolling futures contracts on a monthly basis, they may roll into one of a number of futures contracts with varying expiration dates.

Each index will attempt to provide the best proxy for the average price return of the front-year futures contracts for each commodity in the index, while avoiding parts of the futures curve that are subject to persistent market distortions.  A new Barclays’ special report, The Basics of iPath Pure Beta Commodity ETNs (pdf), provides additional information and background on the methodology.

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George Soros: China will be the NEW world currency

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[youtube=http://www.youtube.com/watch?v=JJVZ8sf6uBI&feature=player_embedded&w=450&h=350] The US Dollar has been the king of currencies for some time now. According to Soros, there was a flight from all currencies, which is why the price of commodities, especially gold and oil, were generally rising. He also stated that an orderly decline of the dollar was desirable and that the entire system needed to be reconstituted towards a global currency. When commodities, notably oil, is bought and sold in the futures markets it is done in U.S. Dollar denominations. This is why we see such a strong negative correlation between the price of crude oil and the … Read more