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

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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

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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

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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, 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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