Archive for the ‘risk management’ Category

1 Aug 12 @ 8:46am by Matt Smith in Random, Risk Strategy, energy consulting, risk management

‘That’s not a motto, that’s just you saying a bunch of things.’

There’s a hilarious line in the film Role Models, where Paul Rudd turns to Seann William Scott and says, exasperated: ‘That’s not a motto, that’s just you saying a bunch of things’. Not only did this make me chuckle, but it struck a chord, as there are many mottos bantered around in financial markets which are, well, just a bunch of things and little else. So this week I thought I would seek inspiration from my work colleagues – my own role models, per se – to provide me with some words of wisdom. Some relate to energy, and some relate to life. But all we can relate to, so enjoy:

‘Without energy there is no capacity to do work.’
- This makes sense in a couple of ways, my learned colleague told me; not only is this the dictionary definition for energy, but without energy, there would be no Summit. He’s got a point (well, two in fact).

‘You may not believe everything that is said, but if you look hard enough, and take the emotion out of it, you might see some truth worth hearing.’
- This is a message we try to get across to clients; even if you don’t believe us, we are here to tell you the stark truths.

‘Change will come when the pain of staying the same is worse than the pain of change.”
- Again, at some point, clients realize it is wrong to fear change, especially when maintaining the status quo involves the pain of losing money.

‘You can’t always get what you want…but when you try sometimes, you get what you need.’
- This is something our CFO tells (sings?) to his kids, but it relates just as well to hedging strategies; you may not get what you want (= the lowest price), but you get what you need (= budget certainty).

‘You know what you get when you don’t get what you want…experience.’
- And the flip-side of not hedging; if the market turns against you, you gain the experience of why hedging makes sense.

Five further mottos for life:
–’Never mistake activity for achievement.’
–’Never celebrate mediocrity.’
–’No one said life is easy.’
–’You get what you get and you don’t throw a fit.’
–’I will not idly tiptoe through life only to arrive safely at death’s doorstep.’

Thanks so much to this week’s role models…Ann Barzak, Deena Burnett, Evan Cox, George Willett, Joe Higgins, Joyce Gee, Michelle Kerbow, Phil Wafford, Roger Durham, Tom Muddell.

I leave you with two mottos from our CEO, Steve Wilhite (it’s great he humors my occasional whims…), one for work and one for life:

‘Most people fail to plan, not plan to fail…but failing to plan is like planning to fail.’

‘Work then play, work then play, work then play – if you do that, the work is better and so is the play.’

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0 Aug 5 @ 10:58am by Matt Smith in Capital Markets, Economy, risk management

The Sunny Side of the Street

I am a sucker for Satchmo, so presently we are going to take a walk on the sunny side of the street. Mixed economic data has made it easy to fret about the validity of a global recovery since we exited ‘the great recession’ last year, even though market behavior has indicated there is nothing to worry about (Treasury Secretary Tim Geithner says there still isn’t).

However, now that skepticism is growing that we may double dip (go to Google insights here to see its growing popularity), I find the contrarian in me wanting to look out in the great wide open to find some indicators that illustrate a positive picture. And trust me, it’s not that easy to do. However, here is what you can find if you direct your feet…to the sunny side of the street.

First up, a key barometer of economic activity: manufacturing. After a synchronized swan dive by the manufacturing sector across the world in 2008, activity has rebounded just as stomach-wrenchingly swiftly, like a sudden bout of turbulence. The chart below shows Purchasing Managers Indices for the manufacturing sector across time for major economic regions. It illustrates that manufacturing (the lion’s share of industrial production) across the globe has shown expansion for at least ten consecutive months ( a reading above 50 on the PMI indicates expanding economic activity). And although recent months have shown a slowing across the sector, we remain in positive terrain:

This next data point involves Warren Buffett’s favorite indicator - US weekly rail traffic. The Sage of Omaha follows this with fervor, as railcars are considered the lifeblood of the American economy, shipping goods across the country. The data illustrate that although rail traffic may not be showing stellar improvement (while also being well below pre-recessionary levels), it shows a steady pace of improvement year-over-year, a trend that a number of other economic indicators are illustrating:

We go no less random as we head to our final indicator – the US savings rate. The below chart illustrates how savings rates have bottomed out in the US in the last five years, as the over-leveraged US consumer has realized (or been forced to realize through tighter credit constraints) the need to borrow less and save more. But this rise in the savings rate is not necessarily a cause for concern - China’s savings rate of 38% certainly indicates an economy can grow rapidly even while saving significantly. So while a higher savings rate may mean somewhat less consumer spending, it also provides the fuel for investments in new productive assets in our economy, the ultimate long-term source of growth:

So there we have it; some reasons to be cheerful, 1-2-3. Sometimes it is easy to get swept along in a sea change of market sentiment, and it is good to look at the opposing view, regardless of if you buy into it or not. But if this has left you feeling rather fretful, just remember you can always put on some Satchmo, kick back, relax, and be swept away elsewhere.

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0 Jul 30 @ 7:56am by Matt Smith in Crude Oil, Economy, Natural Gas, Risk Strategy, risk management

Keep Calm and Carry On

The phrase ‘Keep Calm and Carry On’ originated from a planned  poster campaign by the UK Government to drive on the ’stiff upper lip’ mentality of the British public as they faced the onset of World War II.  Although this poster was never officially released, it became popular after copies were discovered in a shop in the north of England about ten years ago.

This phrase has resonated with me recently, as financial markets continue to tread water and trade sideways, as the outlook for the global economy remains somewhat mottled. We have had our recession, and we have experienced some semblance of a recovery. But now we are at a fork in the road; from hereon out we may experience a double-dip in the global economy (top of the pops on google search), we may see economic growth gather pace, or we may see the global economy stall and stumble along a path inbetwixt a recovery and a recession.

So it is no surprise given this backdrop that we see sideways action in our dearly beloved commodities. After crude pre-empted a global recovery last year by more than doubling between January and June, prices have traded within a broad range ever since, as prices await the next signal that global oil demand will continue to increase by virtue of a clearly strengthening global economy – both in developing and developed countries:

US natural gas prompt prices have followed a similar sideways pattern, despite having a different set of influences at work. Being both a domestic market, and a radically-changing one at that, prices have remained subdued yet supported as market participants await further clarity on future supply from game-changing sources (i.e., unconventional supplies) and technology. All the while, prices look for further improvement in future demand by virtue of improving economic growth: 

 So, in this current state of flux, the best thing we can do (as well as being in constant dialogue with an energy consultant, of course) is to keep our heads, and wait for the dust to settle, realizing that commodity prices can turn on their heads at any time. Yet all the while, remembering the mantra…to keep calm and carry on.

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1 Jul 15 @ 10:55am by Matt Smith in Capital Markets, Economy, Global Energy, Natural Gas, risk management

A Smörgåsbord of Startling Charts

I can’t recall a time when consensus has been so divided as to whether prices are set to rally or crash, be it in commodities, equities, bonds, or currencies. So to add to the confusion, here’s some startling charts I’ve been looking at in the last week that highlight some of the changing dynamics and/or current dichotomy in markets:

The first chart up is actually two charts, and they are taken from last week’s IMF World Economic Outlook. The key takeaway from the retail sales chart (left) is the incredible strength exhibited by emerging economies over the past few years, despite the global slowdown and the temporary move into negative territory by advanced economies. As for industrial production (right), the dip has been pronounced for both emerging and advanced economies. However, although strength in emerging economies has dragged the overall world data back into positive territory, advanced economies are still showing contraction from where we were at the beginning of 2007 (as previously discussed here):  

The following index is getting a lot of attention, and is being watched ever more closely as it experiences its 34th consecutive down day. Yep, that’s right. This chart is the Baltic Dry Index, which measures the cost of shipping dry bulk commodities. It acts as an acid test for emerging market demand for raw materials such as coal, iron ore and steel; it basically gives guidance for the economic health of emerging markets, and to a certain extent, future pricing for coal and other commodities. It is still to be seen whether this fall is due to a collapse in demand (and, hence, shipping prices), or whether the supply of ships has increased, raising competition and reducing costs. Whatever the case, the move lower is certainly raising worries about the strength of a global recovery: 

Next up is the 800-pound gorilla in the corner of the US natural gas room: shale. According to EIA data, we know that approximately 8 Bcf/day of US production currently comes from shale, which is approximately 14% of total US production. As for how much production is expected in the future, estimates are wide-ranging, and add to the cloak of mystery and intrigue of shale. The EIA predicts this number to be 16.4 Bcf/day by 2035, making up 24% of the natural gas consumed in the US. An interim report released recently by MIT called ‘The Future of Natural Gas’ shows a large disparity from the US government data, looking at 12 Bcf/day in the next year, to about 29 Bcf/day by 2030 (given current drilling rates and mean resource estimates); whatever the number, shale is set to be a significant influence on the future of US natural gas:

Finally, we take a look at US oil inventories. WTI crude oil is currently sitting around the mid-$70s, despite inventories in the US still above both last year’s level and the 5-year average. The overall inventories picture is, however, somewhat emasculated when compared to the inventory levels of Cushing, OK, where WTI is priced. Near-capacity inventories were making headlines a few months ago, but have dropped off the radar despite remaining at elevated levels. The point is this; crude oil prices at Cushing remain relatively unaffected, despite supply bottlenecking to push inventories to near-capacity. The flipside of this means that once this bottleneck eases, and once both US inventories and Cushing-specific inventories fall, crude will have one less downward influence to weigh on prices:   

So that’s what was on the burrito block this week – hope you enjoyed it. Please feel free to highlight any startling charts you may have seen recently. Laters ‘taters.

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0 Jun 23 @ 10:57am by Matt Smith in Crude Oil, Global Energy, risk management

The euro’s the one, and not the yuan.

The euro and the yuan = the Sonny and Cher of the currency markets

After the fireworks and celebrations in the streets that followed the announcement that the yuan is set to be unpegged from the US dollar to float freely, the initial excitement, like the bubbly, has now lost its fizz. What initially appeared as a selfless act of cooperation and compromise by China, has morphed into the realization that this announcement was just a mere gesture by them to avoid getting flame-grilled at this week’s G20 meeting about their position as ‘currency manipulator in chief’. While this move into the limelight firmly positions the yuan as the sexy currency du jour (à la Cher), one of its currency counterparts – the euro – is considered much less attractive (sorry, Sonny). But nonetheless, I’m backing Mr Bono (= the euro) to have a bigger influence over financial markets in the coming months, and specifically, over commodityworld(tm).

Let’s take a step back. So, what’s the big deal about letting the yuan float? It is this: China has pegged their currency to the US dollar for the past few years, which has meant their exporters (a huge driver of their economy) have been charging the world artificially deflated prices for their goods. Good if you are a Chinese exporter and good if you are a purchaser of Chinese goods; bad if you are a producer of competing goods. Unfortunately, most of the world, and especially the US and Europe, are net purchasers of Chinese goods, meaning the undervalued yuan has allowed Chinese producers to undercut domestic producers of similar goods.

Yuan renminbi vs US dollar, March 2009 - present

Letting the yuan float means it will likely strengthen versus other currencies (since it was considered artificially pegged at a low level).  

A strengthening yuan would be good for the global economy because it would make Chinese goods more expensive, hence increasing the competitiveness of other countries, and promoting the rebalancing of those economies with striking trade imbalances (notably, the US) . It should also calm inflationary fears and ease concerns of a housing bubble in China, as a strengthening yuan would be the equivalent of a bucket of cold water on the economy. However, it is more likely that China would let their currency float because they believe their economy is strong enough to be supported by domestic demand, or because of the benefits that an improved purchasing power (from a strengthening currency) gives them in buying goods internationally. Or, alternatively, they think their currency will weaken (it would be hilariously ironic if it did, but isn’t beyond the realms…).

Then what’s the big deal about the euro? The euro is the official currency of 16 Eurozone countries. What started out as an attempt to build a superpower strong enough to rival the economic power of the US back in 1999 has ended up turning ever more sour in recent months. The weakest links in the Eurozone chain (= PIIGS) are dragging down the strongest countries in the Eurozone, as waning confidence in the collective currency is causing its devaluation. The chart below is a great illustration of the decoupling seen in the euro at the beginning of the year. While the euro tracked risk appetite during 2009, following a similar path to equities and crude oil (as an inverted flight from safety caused the dollar to weaken and funds to flow into the euro and other risk assets), the considerable sovereign default risks that countries like Greece and Spain are facing have caused a massive move out of the euro, and hence its rate versus the dollar to fall. Drawing this back to commodityworld(tm), and specifically crude, the two have become reacquainted in the past two months, and as the euro has had a relief rally in recent weeks, so have risk assets. Going forward over the next few months, the Eurozone is likely to face further and increasing default risks, which can only have a detrimental effect on the euro, and risk generally. This puts headwinds against crude oil advancing at a strong pace, regardless of the decoupling seen earlier in the year:  

Maybe I am being too cynical here; perhaps this move by China’s policymakers is a clear signal that they are willing to cooperate with the global financial community. Yet for all of the furor that the announcement has made, there has been little evidence that it will have a dramatic impact on markets (and hence commodities), in the short term at least. In the meantime, the bigger influence on commodities, and specifically crude oil, is more likely to come from the euro, which should come under further selling pressure as it struggles to find the cure for the economic illnesses infecting a number of its member-nations. As for how this will play out over the long term? We don’t know. And we won’t find out until we grow.

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