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Posts Tagged ‘risk’

0 Apr 14 2011 @ 10:55am by Matt Smith in Crude Oil, Economy, energy consulting, Global Energy, Natural Gas, risk management, Risk Strategy

What The Wizard Of Oz Can Teach Us About Risk Management

I was off spinning my wheels on an idea for another post this week, when I came across the movie ‘The Wizard of Oz’, and I realized it provided some simple yet sage advice for energy hedging. Believe it or not, via Munchkins, Toto, and the Wicked Witch of the West, we can glean some useful tips to guide us through the minefield that is energy risk management: » read more

2 May 20 2010 @ 10:35am by Matt Smith in Economy, energy consulting, Global Energy, risk management, Risk Strategy

Commodityspeak Through the Medium of Shakespeare.

To tie in with the shindig that is the launch party of our UK office at Shakespeare’s Globe Theatre on June 15th, I present to thee forthwith ten quotes Billy the Bard would say if he were involved in commodity risk management:

1) There is nothing either good or bad; but thinking makes it so – yes, markets are driven by various forces passing the parcel, from fundamentals to technical analysis to outside influences. But sentiment, opinion and fear/greed also play a starring role. So even if something is not in bad shape, if the consensus makes it so, then prices will reflect this.

2) Measure for Measure – a measured approach to mitigating risk is the way forward, and ties directly to my haiku on risk management: uncertainty is…..an ever-present threat so….hedge hedge hedge hedge hedge.

3) Chaos is come again – Othello knew where it was at…crude down 23% in 13 unlucky trading days, from top of the pops (high of the year $87.15 on May 3rd) to the drop of all drops ($66.91 today – May 20th).

4) Better three hours too soon than a minute too late – hedging is not about picking the bottom of the market, it is about mitigating risk.

5) Though this be madness, yet there is method in’t – why it makes sense to quantify risk in commodity markets. Although no-one can perfectly predict the future, by equipping yourself with a Batman-like utility belt of tools for assessing the potential evolution and volatility of a market – from macroeconomic or econometric models to Value-at-Risk to technical analysis – you can establish parameters to quantify present and future risk and reward.

6) Foregone conclusion – Pah! Shazbat! Unlike in Othello, there is no foregone conclusion in commodity markets. Which is probably a good thing too, as there would be no need for an energy consultant (= Unhooray!).

7) Screw your courage to the sticking-place, and we’ll not fail – having the knowledge to stand by your convictions on market opinions is key. And then develop, evolve, and expand on this opinion by using research, analysis, facts, and cement.

8) The winter of our discontent – no thank you, we have already been through this – no need for a sequel.

9) When shall we three meet again? – the witches from Macbeth are always good for a quote, even without mentioning hubbling and bubbling, toil and troubling. There’s many clichés to describe this – a rising tide lifts all boats, in times of crises all markets correlate, etc, etc, – the point is, following commodities is about monitoring all assets – be it equities, bonds or currencies, as they all influence each other, and can provide insight into the short-term movement in another.

10) By the pricking of my thumb, something wicked this way comes – two words for you – hurricane season. This year is predicted to be one of the most active seasons for years based on some key factors. That said, some say a trained chimp can predict hurricanes better than NOAA.

If you wish to attend the UK event, please click on the ‘Much Ado..’ picture at the top of the post.

I bid thee farewell.

0 Apr 15 2010 @ 10:55am by Matt Smith in Capital Markets, Crude Oil, Global Energy, Random

Goldbugs and Black Gold.

Obligatory picture of The Clampetts

Alrightee, it’s time to dig into a couple of well-coined terms, take a look at two of the more currently favored investments in commodityworld(tm), and explain why the movement in one (gold) may help our view on another (black gold).  

So first up, gold. Gold prices have hit a new high for the year in the last week, and are building a charge towards a new all-time high. As for a goldbug, it is a fictional character, a supervillain who appears in Marvel comics an investor who is bullish on gold prices. Goldbugs can be, but are not always, rather pessimistic on the world or alarmist (= hoarding gold, cans of Spam, and shotgun shells).  

Come and listen to a story about a man named Jed, 
A poor mountaineer, barely kept his family fed,
  

Secondly, crude oil – aka black gold, Texas tea. ‘Black gold’ was coined as gold rush prospectors in the late 19th and early 20th century struck oil instead. Current crude prices also reached a new high for the year in the past few weeks (but are a long way off their record of $147 from July 2008). The reason for comparing and contrasting crude and gold is because at times they travel similar price paths, despite their obvious differences (ie my car can’t run on gold).  

Crude (red line), Gold (blue line), 2001 - present

Then one day he was shootin at some food,
And up through the ground came a bubblin’ crude.
  

So, what are the similarities? Both gold and crude currently have an inverse relationship to the US dollar (gold up, dollar down). Gold has held this trend for a good deal longer than crude, for which it has strengthened in the last few years as a weak dollar has been a symptom of a flight into riskier assets (a cheaper dollar has also fueled this flight into riskier assets). Both gold and crude are also seen as an inflation hedge. However, crude is likely to get much more beaten up in a deflationary (or disinflationary) environment, as it is tied to so many parts of the economy. Another shared trait is their high fund flows – investments du jour syndrome.  Nymex crude futures – the world’s most actively traded commodity contract – reached a record volume this week (April 13th), while the gold market is currently being scrutinized as to whether it is being manipulated, a classic signal of a hot market. 

Oil that is, black gold, Texas tea.  

Marvel-ous Goldbug!

As for their differences, investment in gold is known as a flight to safety, whereas crude oil (at least currently) is viewed as the complete opposite. Crude oil is consumed, unable to be traded again, while its demand is very much driven by economic strength. Gold’s availability (or lack thereof) is also a key differentiator; buying physical gold (eg, coins) commands a 7% scarcity premium over a paper trade. This also serves to illustrate that the gold market is a much smaller market than crude. In the cold light of day, the two commodities have very different supply and demand dynamics. 

So they loaded up the truck and moved to Beverly.
Hills, that is.Swimmin pools, movie stars. The Beverly Hillbillies!
 

So what can we learn from all of this? While gold is likely to remain supported in most eventualities – a recovery leads to inflationary pressures, renewed concerns encourage a flight to safety – crude will likely only benefit from the former of these two outcomes, and only if the US can rebalance away from debt-fueled consumption. But should forces conspire, it seems most likely these two may well finish the year scaling to new heights, leaving the vision of a poor mountaineer well in the past. Thanks for visiting.

Y’all come back now, y’hear?

2 Mar 18 2010 @ 6:33am by Matt Smith in Capital Markets, Crude Oil, Economy, Global Energy, Natural Gas, risk management, Risk Strategy

A recipe for disaster, or ingredients for success?

I really like the quote that says ‘an optimist invented the plane, whereas a pessimist invented the parachute’. I am not declaring myself in either of these camps (I am obviously a well-balanced realist), but believe it would be misguided not to consider the upside and downside risks to current commodity pricing. Admittedly, some of these issues apply more to some commodities than others, but essentially, the sentiment is an ever present theme. So, let’s kick off with looking at some of the ingredients that could derail markets:     

  1. Economic data turning for the worse, led by housing, manufacturing and employment
  2. A deflationary economic environment
  3. A falling equity market
  4. Excess supply
  5. Emerging markets successfully cooling their economies 

ECRI Weekly Leading Index

Let’s tackle each one of these individually (yet briefly too). First up, economic data turning for the worse. The chart (left) illustrates the ECRI weekly leading index, which takes the temperature of the US economy on a regular and timely basis (ie, erm, weekly). This index bottomed out at the start of the recession (which makes sense as it it is a leading index = forward-looking), and has moved higher at a fair clip ever since. That is, until the last 12 weeks, when it has turned decisively lower. This index is an aggregation of a number of data points, hence its weakness raises a rather large red flag. Next up, a deflationary environment. We are already seeing signs of deflation creeping into markets, be it through wages or rent, or through pricing pressure on everyday goods due to new-found frugality in consumers. And a falling equity market would likely occur through the simple equation of the above bullets: 1 + 2 = 3. As for commodity-specific data, serious risks of surplus supply exist across commodity markets; for US natural gas it is from shale plays and increasing rig counts, for crude oil it is from quota non-compliance by Opec, for UK natural gas it is from LNG; and the beat goes on. Then the final bullet: emerging market risk. This one is a toughie. Too much growth could power commodities to such a high price that they crimp potential growth in lagging developed markets. On the other hand, if governments in these emerging markets (especially India and China) go overboard in efforts to quell excessive liquidity and credit in their economies, they risk putting the brakes on growth, which would surely upset global markets. 

That was all a bit hectic. Let’s have a brief interlude of humor before we truck on with the flipside of the coin:

Alrightee. Now to the path that could lead prices higher. In all fairness, it is pretty much the polar opposite of the pessimistic points:      

  1. Improving economic data  – especially industrial production / manufacturing
  2. An inflationary environment
  3. Continuing strength in equities
  4. Continuing demand growth for goods / commodities
  5. Continuing emerging market strength
Bloomberg Financial Conditions Index (Mar 07 – Mar 10)

For the prosecution of falling prices, I would like to present exhibit number one – a chart which illustrates an improving environment in financial markets – aptly named the Bloomberg Index of Financial Conditions. This shows that financial conditions have continued to improve at a trampolining rate since the financial meltdown-panic heydays of late 2008, an indication that the market is continuing to normalize after the shocks of recent years. Essentially, we have clambered over the wall of worry and beyond the territory of financial woes.    

As you well know from my rants, markets are all interlinked, hence bullets 1,3, 4 and 5 go essentially hand-in-hand here. Improving economic data (1) will undoubtedly be driven by higher demand for goods (4), boosting equities (3), while continuing emerging market strength (5) from domestic growth will too spur on global investor sentiment (back to 3, then 4, then 1). It is as inevitable as wrinkles and gray hair that inflation will once again rise up, although when this will arrive it is impossible to say. But one thing is for sure, a commodity rally will be a natural by-product of both an inflationary environment or an improving economic environment. It is on the horizon. 

I don’t know what’s going to happen. I can make a guess, but that is all it would be – a guess. It is much more important to to keep an open mind, but also be aware of all eventualities. So I sign off as I began; with a good quote – ‘the pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails’. I believe we are poised between the devil and the deep blue sea, and all we can do is hang in there, and sail broad reach. Ahoy.

0 Feb 26 2010 @ 10:55am by Matt Smith in Capital Markets, Economy, Global Energy, Natural Gas, Technology

Burrito Bites

Happy Friday! This week has been distinctly dominated by dark clouds and impending economic storms on the horizon. Economic data has been consistent (in that it has been consistently downbeat), while next week brings a new month and a new set of data – sweaty-palm time if you have placed all your chips on rising markets. As for life here in energyburritoland, I have gained some interesting perspectives on energy markets this week. There’s fascinating stuff going on in natural gas, as prices fall while storage levels deplete (now at a deficit versus last year). And while colder weather is being scapegoated for the increase in demand, in reality it seems its the (improving) economy, stupid. (smokescreened by enfeebled economic sentiment). And just to provide a contrast, crude oil and US crude product prices continue to exhibit strength while demand has nipped out to go to the store and not returned…in 18 months. Anyhow, here’s to a weekend of downing tools and raising hell toasts: 

This clown was caught speeding. Seriously.  

Natural gas may help cut emissions. (ya think?!).

–Life is creating smarter grids, appliances and consumers.

–This weightlifting ant is able to bench press 100 times its bodyweight. Without breaking a sweat.

–The next three links are like a burrito bite of burrito bites dedicated to Google. First up, as someone who uses about 17 different Google applications, I really should realize there is no such thing as a free lunch – big Googlebrother is watching you. 

–Then there is more – big Googlebrother is also playing (in the energy markets). 

–And finally, courtesy of big Googlebrother Earth via Treehugger, US military airplane graveyard

–Headline of the week: The Best Way To Enjoy Wine: Try Overpaying. (Aw, c’mon, wine snobs: we all know it’s true).  

–There’s been more hype about this in the energy world this week than a new Apple iproduct… a ‘power plant in a box’ from Bloom Energy.

Competition for the oddest book title of the year. This year’s shortlist contains book titles including worm hunters, lethal robots and Nazi spoons, with previous champions being “Bombproof Your Horse” and “Living With Crazy Buttocks.”

The Burrito Deluxe Award of the week goes to San Francisco Fed’s Janet Yellen. Like a port in a storm, she was once again the voice of reason this week, telling it like it is on the US economy. If David Rosenberg is Batman, Janet Yellen is Wonderwoman. 

The Burnt Burrito Award of the week goes to global econonic data this week. There were some bright spots (from GDP upward revisions), but generally, they sucked. Big style.

Have a good one!