Asset management, Behavioral finance, Hedging, Market psychology, Market research, Market trends, Risk management, Stock market, Trading, Trend following

Lessons Of Japan’s 1980s Bull Market

Afer popping, Japan’s 1980s bull market gave way to an 82% drop over the following 20 years.

Three decades later, Japanes equities are still more than 40% below peak valuations.

One of the most effective methods of navigating the boom/bust cycles has been the systematic trend following.

Sooner or later a crash is coming, and it may be terrific

Roger Babson, 5 Sep. 1929

If everybody indexed, the only word you could use is chaos, catastrophe. The markets would fail

Jack Bogle, founder of The Vanguard Group

As of December 2018, passive index funds controlled 17.2% of the stock of all U.S. publicly traded companies, up from only 3.5% in 2000. The 5-fold increase was in part the consequence of the ongoing stock market growth, which now has the distinction of being the longest running bull market ever recorded. Buoyed in large part by central banks’ unprecedented quantitative easing (QE) programs, the rising stocks have lulled many investors into complacency.

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Commodity price, Commodity risk, Energy crisis, Hedging, Market psychology, Market trends, Oil market, Risk management, Trading, Trend following

Six Principles To Adopting Best Practices In Commodity Price Hedging

  • This week Sinopec disclosed the latest hedging mishap, losing $690 million amid last year’s oil price collapse.
  • Unless price risk management is organized as an integral part of core business operations, it can devolve into eratic and risky game of speculation that can cause massive damage.
  • The six simple but important guiding principles could help commodity firms create a world class risk management process and turn price risk into a source of value and competitive advantage.

This week Sinopec disclosed that it had incurred $690 million in losses in the fourth quarter of 2018. The losses were attributed to Unipec’s oil hedging bets. Unipec clearly took the wrong directional exposure to oil prices in the period when they staged a sharp, 40% collapse (October-December 2018). This much is understandable. However, such losses did not need to happen – I maintained heavy exposure to oil prices over the same period and not only avoided heavy losses but actually generated significant profits by simply adhering to a systematic trend-following model.

As I detailed here, systematic trend following enables nimble navigation of market price roller-coasters, eliminating rogue trader risk and removing human error. Trend following models respond to market price fluctuations as they unfold, without distraction, without emotion and without strong convictions that could ultimately turn out wrong (always a costly discovery).


Unipec’s hedging mishap is only the last in a long series of incidents underscoring the fact that commodity firms ought to take their hedging operations seriously and seek to develop them following best practices in price risk management. Price risk management should be integrated with the firm’s overall business operation and make part of the firm’s business strategy. Otherwise, hedging risks to turn into a dangerous game of speculation which, in many cases, has spun out of control causing massive damage.

Organizing to manage price risk

A purposeful, effective approach to managing price risk requires an adequate organizational framework. For any organization, the questions of what risks are taken, in what measure, and how they are managed are strategic questions and should be decided at the board level. The implementation of these decisions should be owned by the firm’s CEO.

1. Explicitly designate the proper role of risk management

Managing commodity price, currency, or interest rate risk should enable a firm to take risks in a controlled and purposeful fashion, accept occasional losses and communicate such losses to its stakeholders openly and transparently, without losing stakeholder confidence in the validity of the firm’s strategic choices or the management’s capability to achieve them.

Without clarity and guidance from the company’s board and the CEO, the firm may be vulnerable to serious risk-related disruptions, or failure to take advantage of favorable market events.

2. Identify main sources of risk

Running a formal audit of key areas of risk exposure – by business unit and by risk category – should form the foundation of a firm’s risk management process. For each category of risk, alternative instruments and methods of risk management should be identified and their respective advantages and disadvantages thoroughly examined and documented. Having evaluated the pros and cons of the available alternatives, management can formulate specific objectives and strategies to be implemented in achieving those objectives.

3. Define firm’s risk appetite and methods of risk management

Definitive risk management strategies should set forth the company’s risk management methods and its appetite for risk. It should also set out the responsibilities for risk management throughout the organization. At that point, management should anticipate the necessary organizational adjustments, training and staffing requirements and it should undertake a thorough documentation of the management process, controls, restrictions and paperwork flow.

4. Adopt a gradual approach

The best part about developing an effective price hedging process is that firms do not need to bet the proverbial ranch on it. At first, firms can apply their new risk management process only to a smaller portion of their risk exposure – say, 5% or 10% of their hedge book – and add to that in subsequent periods as the firm, its staff and stakeholders grow more familiar and comfortable with the process and its impact on the firm’s performance.

5. Maintain and refine your operation continuously

Finally, the whole solution, once implemented will almost certainly need adjustments and maintenance. Constant monitoring and periodic reviews must remain an integral part of a firm’s risk management strategy. For this purpose, firms should establish an independent middle office staffed with a team of highly skilled risk professionals who regularly report on exposure and risk issues directly to senior management and the CEO. The challenge of developing and implementing this business process should be no more difficult than that of developing any other business project.

6. Communicate, communicate, communicate!

For this to happen, the communications aspect of the project within the organization may be as important as its operational execution: all parties involved should be offered the opportunity to question and understand the process and be periodically kept informed about its progress and results. While the challenges involved aren’t slight, the objectives and their potential should go far to kindle managers’ entrepreneurial spirits and be well worth their efforts.

If a crisis does arise… solutions will be familiar and mastered

As Milton Friedman famously put it,

it is worth discussing radical changes, not in the expectation that they will be adopted promptly but for two other reasons. One is to construct an ideal goal, so that incremental changes can be judged by whether they move the institutional structure toward or away from that ideal. The other reason is… that if a crisis.. does arise, alternatives will be available that have been carefully developed and fully explored.”

Risk management is no more difficult than any other organizational challenge

The considerable potential of an effective risk management process in terms of profitability and resilience should make any firm’s development initiative well worth the effort. And keep in mind: any practically solvable problem has no chance of remaining unsolved if you make a determination to tackle it. As Johann Wolfgang Goethe put it:

“Whatever you can do, or dream you can, begin it. Boldness has genius, power, and magic in it. Begin it now.”


Alex Krainer has actively traded commodities, FX and treasury and equity futures since 1996 and managed hedge funds based on his proprietary trend-following model. Over a six-year period, from 2007 to 2013 he has outperformed Dow Jones Blue Chip index of Managed Futures Funds (track record audited by KPMG). In 2015 he published “Mastering Uncertainty in Commodities Trading” that condenses his 20+ years of deep research into the problem of market speculation.

Description: Trading and hedging commodity price risk

Mastering Uncertainty in Commodities Trading

Commodity price, Commodity risk, Economics, Energy crisis, Hedging, Inflation, Market research, Market trends, Oil market, Politics, Risk management, Trading

The coming oil price shock: could the crisis in Venezuela trigger an energy crisis?

Measured by historical standards, the price of oil has been extremely volatile in recent years. From over $114 per barrel in the summer of 2014 it collapsed more than 75% in only 18 months’ time. Then it tripled to $86/bbl in October 2018, only to drop by 40% to $52/bbl two months later. The question is, why is the oil price so very volatile? Is the market foreshadowing greater disruptions in the future? A closer look into oil supply and demand fundamentals suggests that a great crisis could be in the making – possibly with alarming repercussions.

The looming oil shortage

In 2012 a report produced by the UK Ministry of Defence predicted that oil prices would rise significantly out to 2040, and by “significantly,” they meant to $500 per barrel. From today’s perspective, this may seem farfetched. However, we should not dismiss UKMOD’s warning lightly. This could turn out to be the most important development facing humanity for decades to come. Continue reading

Asset management, Commodity price, Commodity risk, Economics, Hedging, Market trends, Risk management, Trading, Trend following

How trend following can help industry hedgers: the Palladium edition

Palladium price has more than doubled since the early 2016 making the white metal more valuable than gold for the first time since 2002. Its impressive performance attracted much attention from the financial press, which published numerous articles and analyses about the palladium market. If you diligently read the analyses, you may learn that automotive industry accounts for some 75% of demand for palladium, that its global production is as little as about 200 metric tons per year (vs. about 3,000 tons for gold), that only two countries (Russia and South Africa) produce more than three quarters of its global supply, and that the demand for palladium is expected to continue to grow. Presumably that implies that palladium price should remain high and possibly continue to rise. Continue reading

Asset management, Behavioral finance, Risk management, Trading, Trend following

On model risk in quantitative trading

  • Quantitative strategies have become increasingly popular in trading and investing
  • The experience with using them has been mixed, largely as a result of three categories of problems
  • Still, quantitative approach is well worth exploring and offers important advantages to their users

Over the past few years, the use of quantitative strategies has become increasingly popular in trading and investment management. According to JPMorgan, passive and quantitative investors now account for 60% of equity assets under management (vs. 30% ten years ago) and only about 10% of trading volumes originate from fundamental discretionary traders.[1] Appealing new buzzwords like, robo-advising, artificial intelligence and machine learning stoked the imagination of many investors and boosted the quantitative trading gold rush. Continue reading

Commodity price, Commodity risk, Hedging, Oil market, Risk management, Trading, Trend following

Groupthink in commodity price forecasting, its disastrous consequences and how to master price uncertainty

  • In financial and commodity markets, large-scale price events are not predictable. Even so, most market professionals rely on forecasts most heavily in making forward-looking decisions.
  • At times, this has disastrous consequences (see below)
  • Large-scale price events are far and away the greatest source of external risk for commodity-related businesses. Their severity and frequency has been on the increase in recent years.
  • An alternative approach to mastering uncertainty is to explore systematic trend-following strategies which, if used appropriately can turn price risk into a source of profit and hard to match competitive advantage


According to the latest Reuters survey, over one thousand energy market professionals expect the oil price to average between $65 and $70 a barrel in the years 2019 through 2023. Only 3% of respondents thought that Brent Crude Oil might increase above $90/bbl next year. So, market experts do not expect any surprises and largely agree that oil price will remain where it is. This groupthink reminds me of a similar situation some 15 years ago. Continue reading

Asset management, Commodity price, Commodity risk, Hedging, Market trends, Oil market, Risk management, Trading, Trend following, Uncategorized

How we navigated the oil price roller coaster

Extreme price events are far and away the greatest source of external risk facing oil and gas producers and other energy-dependent companies. Frequency and severity of such events has been increasing dramatically since about 2005/2006 causing ocasionally severe pain for many industry participants.

Case in point was the 70% oil price collapse through 2014 and 2015, from over $100 to below $30 per barrel. In the aftermath of this decline, U.S. mining industry – which includes oil and gas producers – reported losses of $227 billion, wiping out eight previous years’ worth of profits as the following chart shows: Continue reading