Commodity price, Hedging, Market trends, trading, trend following

On effective trend following strategies

A question frequently arises among trend followers on the nature of effective trading strategies. The old school of thought holds that strategies should be simple, ultra robust and effective across markets and time frames. I happen to disagree so here I share a hard-won piece of knowledge that should help settle this question. Continue reading

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Commodity price, Commodity risk, Economics, Energy crisis, Hedging, Inflation, Oil market, Policy, Social development

Is an epic energy crunch in the making?

Last year I published a report with the (justifiably) bombastic title, “$500 per barrel: could oil price rise tenfold?” One of my central claims was that producing oil requires investment of real capital including materials, equipment and highly skilled labor, and that, “as more and more resources are required to generate the same amount of liquid fuels, energy production is becoming ever more expensive to society in real terms.” Thus, as it becomes more expensive in real terms (as the deteriorating EROEI figures indicate), the fact that energy has recently become cheaper in nominal (dollar) terms can only be a temporary abberation. EROEI stands for energy return on energy invested; in the early 1900s, we obtained 100 barrels euqivalent of oil per barrel invested (EROEI of 100 to 1); today we are at about 15 to 1 globally and at 11 to 1 in the USA. Continue reading

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Asset management, Behavioral finance, Commodity price, Complexity, Economics, Expertise, Hedging, Market psychology, Psychology, Stock market, trading, trend following

The illusion of expertise in financial markets

Participants in financial markets have to deal with uncertainty on a daily basis. Their need to research and understand markets has given rise to a massive industry delivering security prices, reports and expert analyses to traders and investors seeking to make sense of the markets and predict how they might unfold in the future.

The need to understand stuff is innate to our psychology: when something happens, we almost reflexively want to know why it happened. But the compulsion to pair an effect with its cause sometimes gets us jumping to conclusions. If such conclusions turn out to be mistaken or irrelevant, they could prove useless – or something worse. Consider two recent titles from the ZeroHedge blog, published 89 minutes apart: Continue reading

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Commodity price, Economics, Energy crisis, Hedging, Market research, Oil market, trading

Saudis to unveil the big secret? Not likely.

Over at OilPrice.com Nick Cunningham wrote that Saudi Arabia might finally reveal one of its closest kept secrets as they prepare to sell some 5% of its oil monopoly, Saudi Aramco, to the public. The Saudis and their Wall Street bankers expect Aramco to be valued at $2 to $3 trillion, which would generate north of $100 billion for the Saudis and massive underwriting fees for Wall Street Banks.

Since both the Saudis and Wall Street hope for the highest possible valuation for Aramco, we should not expect that they’ll “unveil” anything less than the rosiest plausible figure for their oil reserves. Continue reading

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Asset management, Commodity risk, Complexity, Economics, Expertise, Hedging, Market research, Policy, Risk management

Economic forecasting is exercise in futility

Economists can’t forecast for a toffee… They have missed every recession in the last four decades. And it isn’t just growth that economists can’t forecast; it’s also inflation, bond yields, unemployment, stock market price targets and pretty much everything else.” – James Montier

Forecasting commodity prices and economic indicators is demonstrably an exercise in futility. Our markets and economies are complex systems and as such, their future unfolding is impossible to predict with any degree of certainty. Concretely, let’s take a look at how the leading economic analysts did at predicting oil prices, GDP growth, unemployment and stock market indices. Continue reading

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Commodity price, Commodity risk, Hedging, Risk management, trend following

Risk, Uncertainty and Profit

Frank Knight, the grand old man of Chicago wrote “Risk, Uncertainty and Profit,” one of the five most important economics books of the 20th century. Among other invaluable insights, Knight proposes that, “The responsible decisions in organized economic life are price decisions; others can be reduced to routine.” Knight recognized that price at which a firm sells its products or purchases materials tends to have greater impact on profitability than any other element. Based on the income statement of an average S&P 1500 company (and assuming constant sales volumes), a 1% improvement in the selling price would generate an 8% increase in operating profits. Conversely, a 1% drop in the cost of goods sold would lead to a 5.36% increase in operating profits. This impact was more than double that of a 1% increase in sales volume[1]. For commodity businesses where operating margins are typically very low, hedging can have a much greater impact on profitability. Continue reading

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Asset management, Commodity price, Commodity risk, Hedging, Risk management, trend following

Lessons in trend following: how we traded sugar

Sugar prices have soared on the CSCE (Coffee, Sugar and Cocoa exchange) from just over $0.10 per pound in August 2015 to over $0.23 at present – a fairly sharp jump by any standard, particularly after several years of continuously falling prices. I trade sugar using our trend-following model and to channel my inner Donald Trump – we’ve done tremendously well, generating a respectable grosss annualized return of nearly 10% per annum over a 5-year period. Now, the main reason I find this remarkable is that I know next to nothing about the fundamental economics of the sugar market. I know it goes into biscuits and beverages, that it comes from sugar cane or sugar beets, but that’s about it. Continue reading

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