Lakewood-Views

Bernanke clarity -- there is none

noreply@blogger.com (Mark Rzepczynski) — Fri, 24 May 2013 18:48:00 +0000

“If we see continued improvement and we have confidence that that is going to be sustained, then we could in -- in the next few meetings -- we could take a step down in our pace of purchases.” - Ben Bernanke

What does this mean? If there is improvement and the Fed believes it can be sustained, then they may reduce the amount purchased. This is as clear as mud. The market reaction was swift. Equities feel so investors do not believe that the economy can run on own at current growth rates. There was more information from the market than from Ben Bernanke.

The power of agri-technology - corn planting

noreply@blogger.com (Mark Rzepczynski) — Fri, 24 May 2013 18:34:00 +0000

The big fear this spring was the poor corn planting. Planting was not happening fast enough given the cold wet weather. Yet when the weather turned, the corn seeds went into the ground at a rate faster than anyone anticipated.

On May 3rd only 12 percent was planted. By the 10th, 28 percent was planted and then the report for May 17 came out and the eye-popping number of 71% was reached. The new number this week may be closer to 90%. The farmers got up early and planted like there was no tomorrow. The reason for this strong number is that many farmers are now using better tractor technology and 36 row planters versus the normal 12 and 18 row planters. With GPS and large planter, you can get mor ein the ground if you have dry weather.

The planting problem has been averted so now the market can move on to other growing risks. The focus will also be on demand and how the old crop will move off the farm.

Farmland - is there value?

noreply@blogger.com (Mark Rzepczynski) — Mon, 13 May 2013 22:48:00 +0000

The farmland rental rate has slowed over the last 12 months with the decline corn prices. The rental rate is still moving upward but momentum is down so the frenzy of the last two years has fallen. This comes from an Iowa State survey which showed a 7% increase in the last year versus 18% in 2012 and 16% in 2011.

Still there is talk of a farmland bubble

The Kansas City Federal Reserve said irrigated cropland in its district rose 30% in 2012, while the Chicago Fed reported a 16% increase. And despite the drought in Iowa last year, farmland prices have nearly doubled since 2009 to an average of $8,296 an acre. Prices in Nebraska have also doubled during the same period.

Robert Shiller, professor at Yale, and the master of bubble research has also commented that farmland may be in or facing a price bubble. The supply is tight and low interest rates have allowed for more speculative behavior. If there is a strong decline corn prices this year, we could see farmland price fall this year. This is an llliquid asset, so investors should be cautious about purchases at this time. Value could be limited.

Corn planting race against time

noreply@blogger.com (Mark Rzepczynski) — Mon, 13 May 2013 21:33:00 +0000

A very interesting risk is being faced by corn traders - the race against time to plant. With poor spring weather the planting of this year's corn crop has been delayed. As of the most recent report, only 28% of the crop has been planted. The average for the last five years has been 65% and last year the amount planted by this time was 85%.

What makes this so critical is that after May 20th, the number of growing days will be potentially curtailed and the yield per acre will decline. The farmer's rule of thumb is that you lose 1 bushel per acre for every day of planting delay after May 20th. Additionally, the key pollination period will move to later in the summer which will also affect the yield if there is a hot period at this critical time.

Hence, there is a race against time to reach for potential maximum yield. Very few markets face this type of risk.

Commodity cross correlations falling

noreply@blogger.com (Mark Rzepczynski) — Fri, 10 May 2013 12:55:00 +0000

The correlation across sectors within the commodity asset class have started to fall. They are still not near their medians but these correlations have started to come down and suggests that commodity sectors are being driven by the local supply and demand effects within the markets. The chart shows the overlapping 30 month correlation between sectors for the last 10 years. The hash marks represent the current levels.

Correlation between the equity markets and commodity markets also have fallen significantly. We have moved from very high positive correlation which for the DJUBS commodity index and the S&P 500 was above .8 to now a negative .7. This has been a frustration for many investors, but the futures market seem to be more closely linked to the real economy and not to financial assets. There is now more diversification with holding commodities than we have seen in the past. The cost has been return.

The volatility of commodities have also fallen in response to the fall in correlations within the commodity sectors. This will be a continuing theme in the commodity markets. Note, for example that the correlation between ag and energy markets has at times been negative. The same applies to base and precious metals. Most of the correlation across sectors are well below .5. Commodities as an asset class just do not move closely together.

The 511th reduction in rates

noreply@blogger.com (Mark Rzepczynski) — Fri, 10 May 2013 12:41:00 +0000

Interesting stat form Bank of America - there have been 511 rate cuts around the world since June 2007. The surge of liquidity has not abated after five years, yet there is limited inflation in the G7. In fact, inflation has been going down not up. Emerging market inflation is higher but well under control versus historical levels. There is no value in bonds because governments do not want them to have value.

Talk of the Great Rotation to equities has risen and fallen since the beginning of the year. Much of this change in sentiment is based on the investment public not truly accepting that governments have only one policy choice that they like - cutting rates.

A commodity review in one chart

noreply@blogger.com (Mark Rzepczynski) — Fri, 03 May 2013 21:15:00 +0000

The commodity markets can be divided into four phases over the last ten years.

Phase I was the super cycle period from 2003 until June of 2008. The market hit an extreme based on strong emerging market demand and under supply from a lack of investments in the 1990's. This came to an abrupt stop with the Great Recession.

Phase II was the Great Recession period which hit trade flows very hard. An overbought market and a major recession caused a massive overshoot on the downside in commodities.

Phase II was the reversal period which matched some of the gains in stock markets as economies started to recover. The combination of quantitative easing and a pick-up in growth created a nice rally in commodities. The rally never got to the old highs since the recovery around the world was not as strong as expected.

Phase IV was the link between commodities and the reality that economic growth rates will be lower than in the early 2000's. Global growth is lower. Emerging market growth will be positive but still lower than before. Developed market growth is anemic. Oversupply from investments in energy and mining is having an effect on prices. The result has been a price decline in line with the real economy.

Phase V --- ???? The markets may be more micro driven on the fundamentals of supply and demand. We can expect the index to be range bound with some markets having large up or down moves. If growth exceeds expectations, there will be a commodity rally.

Looking at the investment world is critical

noreply@blogger.com (Mark Rzepczynski) — Fri, 03 May 2013 20:58:00 +0000

Thinking is more interesting than knowing, but not so interesting as looking
-Goethe

The real voyage of discovery consists of not in seeking new landscapes but in having new eyes.
-Proust

Reading about observing trees and growth in Spring. These quotes are very apt for the investment world. It is all about seeing what is going on. Do we know the environment we are in?

Corporate underfunding a large prorblem

noreply@blogger.com (Mark Rzepczynski) — Fri, 03 May 2013 20:56:00 +0000

A Bloomberg sample of corporate pension plans shows significant underfunding in the companies within the S&P 500 and Canadian TSX. The median fund shortfall is a little over a half a billion. The median discount rate is 4.15% and the median expected return is 7.28%. Pensions have too high an expected rate of return and to a degree too high a discount rate. The rate should be close to the risk free rate of return if you want to know what the present value of these liabilities will be with some certainty.

It is greater that their portfolios will do well this year as evidenced by performance through this week, but there is still a lot of risk in the market and you need significant excess returns to offset the pension shortfall.

More flexibility - more uncertainty in monetary policy

noreply@blogger.com (Mark Rzepczynski) — Fri, 03 May 2013 20:53:00 +0000

"the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes."

The latest FOMC minutes tell us that the Fed wants to have more flexibility to adjust asset purchases. Of course, this increases the amount of uncertainty in the market because we do not know the criteria that will be used to make these changes. Lower unemployment? Higher asset prices? We do not know and this is a critical issue for the markets.

Commodities and equities - the 20 year difference

noreply@blogger.com (Mark Rzepczynski) — Fri, 03 May 2013 20:50:00 +0000

Commodity markets more closely follow the real economy and a comparison of equity charts shows the effect. New highs are being reached in equities but the output gap has still not be closed in many economies so commodity prices are not seeing the large run-up. There is no increase in valuations to drive prices higher.

Crops coming late?

noreply@blogger.com (Mark Rzepczynski) — Fri, 03 May 2013 20:48:00 +0000

There is still snow in the upper Midwest, so planting of corn will come late. Corn needs a specific number of growing degree days to reach maturity. If planting comes late, there is a chance that maturity will not be reached before frost. This will take a bite into the size of the corn corp. It is early to state that there will be a problem but the chance of a crop problem is growing.

Agriculture is always a seasonal business and when season change is late there will be problems.

Commodity asset class drivers over the last ten years

noreply@blogger.com (Mark Rzepczynski) — Thu, 25 Apr 2013 03:27:00 +0000

There has been a lot of talk about the super-cycle in commodities but it is important to breakdown the source of the gains in prices. Commodities have been range-bound for the last few years when you look at an index but there is a lot more going on when you break-up the performance by sectors.

The big rally in commodities has really been driven by the precious metals markets. They were a dominant driver pre-Great Recession but were certainly the key driver in the post-Recession, new QE period. This return increase was driven by flows into ETF's and other financial products that made gold more accessible to retail customers than before. That movement into gold and a lesser extent silver has stalled but the rise of gold relative to other commodities is still a important story in the commodity markets.

The gold story is an anti-inflation story. It is a story against weak currencies and a story against excessive debt, and it is a story that has played out at this time. We have not had the large crisis in the EU which some expected. Inflation has been under control at this time and financial assets have done well. The gold move is not about supply shortages but demand driven by substitution from other assets.

The second large commodity theme has been the strong move in the base metals which is driven by the demand from China and its infrastructure and real estate development. There has been an investment lead rally in China which created strong demand for copper, iron, lead, zinc, and other base metals. With the slowdown in China and the shift to consumerism, prices have been on the way down. Investment in mining from a few years ago has led to new supply so there is a natural mean reversion in this sector.

The energy sector has seen increases in oil prices related to geopolitical risk and demand from emerging markets, but that has cooled with a reduction in tensions and slower global growth. The great increases in natural gas has created a new market structure in the US.

Agriculture markets have had similar returns as the index but with more volatility given supply shocks. Agriculture markets see more mean reversion and offer more trading opportunities given seasonal factors. This may be the place of greatest potential opportunties in the short-run.

Capital controls and convertibility

noreply@blogger.com (Mark Rzepczynski) — Tue, 23 Apr 2013 00:38:00 +0000

It is surprising that markets have not shown further reaction to the the Cyprus problem of convertibility. This is an issue that will touch all markets around the world. If there is an increased probability that governments will not allow convertibility, there will be less desire to hold any currency outside of your home or if you believe there will be a convertibility problem with your home currency, there will be a desire to hold another store of value such as the dollar.

If the single currency Euro has a convertibility problem what about other currencies from countries that are "less developed". The Cyprus restriction means that all euros are not the same. Your Italy euros may not be the same as a French or German Euros. The EU governments with the ECB now states that it has the power to make changes in the system with little regard for the Euroholders. Of course, there has to be restrictions on the Cyprus banks or there will be a flood of money out of the country, but is there a better way to handle the problem.

The dollar rally is a result of the convertibility issue. There is a belief that the dollar will not be restricted. Nevertheless, I want to hold deposits in Banco de Mattress.

Could using reserve requirements be an answer?

noreply@blogger.com (Mark Rzepczynski) — Tue, 23 Apr 2013 00:10:00 +0000

Jeremy Stein wrote an interesting FT editorial on reserve requirements as a win-win solution to solving the large Fed balance sheet from QE purchases. It is an interesting proposal and could be a simple way out from selling all of their Treasury holding.

You may remember reserve requirements. It is the central bank policy that every economic student is taught in their intro course on banking. Fractional banking is how money will be expanded in an economy. Changing the reserve requirement will have a direct impact on the size of money in the economy. A reduction in the reserve requirement means that banks can issue more new demand deposits. An increase in reserve requirements will cause shrinking of the money supply. Of course, the Fed does not use reserve requirements anymore to make their monetary decisions. It has been viewed as too blunt an instrument relative to change rates. But, we do not change rates anymore because we are in a zero rate environment. We have moved to QE, so reserve requirements may not be so blunt a policy tool as before.

Stein believes that this could be a simple way to solve the current banking problem of the large balance sheet. Go back to old school monetary policy. Right now there is a significant amount of excess reserves held at banks. These can be reduced through increasing the reserve requirement while still offering interest payments to the banks. An increase in reserve requirements will rescue the amount of money that can circulate in the economy. It would be the same as selling some of its balance sheet. Problem one of excess money can be solved.

Problem two for banks is that they need to have more capital. Reserve requirements may serve as a substitute for bank capital. It is a ready source of funds that can meet the needs of banks instead of Basel III requirements. It si a nice bank cushion.

Reserve requirement adjustments are a win-win for bank capital management and for fed policy.

Trade deals to the rescue?

noreply@blogger.com (Mark Rzepczynski) — Mon, 22 Apr 2013 23:58:00 +0000

Talks on trade deals are now occurring and this is good for the global markets. There is the fear that a slow growth global economy will lead to trade wars.If there are talks of regional or bilateral trade, countries may be able to avert any major trade battle.

The US is in bilateral talks with the EU and the EU is in talks with Japan to open up markets. In the case of Japan, the issue is not import restrictions but the regulations and standards used in Japan, The setting of standards can serve as a trade barrier. There are also talks between the US and Japan through the TPP Trans-Pacific Partnership. The TPP talks have been stalled based on cross border fiance restrictions, but it seems like there is a desire to get some things done.

Trade needs to enhanced and if a global trade deal cannot be made regional or bilateral deals are a start in the right direction.

Long-term dollar swings and commodities

noreply@blogger.com (Mark Rzepczynski) — Mon, 22 Apr 2013 20:03:00 +0000

There have been a number of long-term dollar swings since the beginning of floating exchange rates and we are currently in another potential transition point for a dollar rally.

The long-term dollar swings have been:

1968-1978 Decline -The Bretton Woods destruction and move to flexible exchange rates

1978-1985 Appreciation -Dollar gain from Volcker period of Fed tightening

1985-1992 Decline -The offset from Volckerism overshoot

1992-2001 Appreciation - The period of Great Moderation, the tech productivity boom

2001-2011 Decline - Ascent of emerging markets and EU

2011 - ? Appreciation - Global decline

Commodities have done poorly during periods of dollar appreciation and have done well during periods when the dollar has been in decline. A simple explanation is that since most commodities are priced in dollars, there will be a drag on commodity demand when there is a dollar appreciation.

'68-78 was the period of stagflation and major price hikes in agricultural and energy;

'85-92 was the ascent of energy and agricultural prices;

'01-'11 was the period of the super cycle.

The period of dollar ascent matched poor emerging markets and falling commodity prices. The early 80's was the period of Latin American crises. The '92-'01 was a period of the Mexican and Asian crisis. Avoid commodities during a dollar appreciation and crisis period.

Heath brothers and solving decision problems

noreply@blogger.com (Mark Rzepczynski) — Sun, 21 Apr 2013 19:26:00 +0000

The Hearth brothers have written a new book called Decisions: How to Make Better Choices in Life and Work. The Heaths have written a number of interesting and popular books on decisions and choices and this is their latest attempt to provide advice on how to make any decision less difficult. They state that there are four reasons fro why bad decision are made:

Narrow framing - limiting the options to consider

Confirmation bias - looking for evidence that supports our point of view

Short-term emotions which fade - letting our emotions drive our decisions

Overconfidence - assuming we have the answers to any question

These problems have been discussed by many other authors and are well-know to almost anyone who studies decision theory. The Heath brothers try to solve the problems though a useful set of hints through what they call the WRAP method.

Widen Options

Reality tests assumptions

Attain distance before deciding

Prepare to be wrong

There is not a lot new here but I think I can get used to employing the WRAP method as a simple devise to help with any decision. Have I WRAPped it up? Or as said in filming, "It's a WRAP!"

This could a simple way of looking at complex finance problems.

How do investment ideas form a contagion?

noreply@blogger.com (Mark Rzepczynski) — Sun, 21 Apr 2013 19:08:00 +0000

Jonah Bergers has writtena new book called Contagious: Why Things Catch On which I am currently reading. I am trating to filter his views throuhg the lens of finance and investing. Why do ideas catch-on in finance? Themes or mems seems to develop in finance. They are usually based on some simple facts but start to take on a broader life. The current rally and talk about a great rotation is a case in point. There are some posiitve numbers but there is also a story for why the market should head lower. The positive story seems to have had a more contagious impact on investors. Is this a CNBC effect?

We have mor etalking heads in finance and they all poin to the same story for why thinsg catch on. Berger uses STEPPS as a simple device or reason for contagion. The combination of

Social currency

Triggers

Emotion

Public exposure

Practical value and

Stories

all create the opportunity for a contagious result. Investing media seems to be a likely place for STEPPS to take hold. I am surprised we have not studied this more.

Kuroda - the Volcker of deflation

noreply@blogger.com (Mark Rzepczynski) — Sun, 21 Apr 2013 18:56:00 +0000

Many have cheered the new BOJ and their movement to increase inflation. The yen is down and the Nikkei is up. How can we question the wisdom of current policy. However, Japan still has to define the role of the central bank. Monetary policy is not the solution for structural flows. How are those going to be solved?

BOJ head Kuroda is now being thought of as the Paul Volcker of Japan. Paul Volcker stopped inflation through high rates and slower money growth. Kuroda will be the opposite of a an inflation fighter, the deflation slayer. Yet, like Volcker he is going to have to warn of the limits of monetary policy.

Globalization falling - look at financial flows

noreply@blogger.com (Mark Rzepczynski) — Sun, 21 Apr 2013 18:47:00 +0000

Globalization is declining and we should be worried. Even with all of the changes in communication and all of the discussion concerning the world being flat, the world is moving back in time with respect to financial flows. International trade also has declined and is growing at a slower pace since the Great Recession, but finance is still a more important segment to global markets. This decline in trade should not be surprising given the decline in global GDP, but more importantly, the decline in the growth of financial assets around the world will affect long-term global imbalances. Financial flows are what has been an oil that drives the trade engine. Financial flows are what will solve the great savings imbalances around the world. Flows are slowing and there are many who do not care.

Financial assets were growing around the globe at a rate of around 8% and has been flat since the end of the Great Recession. There has been a 60% decrease in cross border capital flows since the peak in 2008. European banks have reduced their cross border flows by $3.7 trillion with $2.8 trillion being intra-Europe. Europeans do not want to lend to other Europeans outside of their country. This is even with the same currency!

There is a movement to localized finance whereby debt and equity raising is done from local investors who are keeping money within their home country. There is also an increase in capital controls across the globe to stop hot money inflows and outflows. The major government institutions like the IMF have pushed to reduce hot money flows and have embraced the institutional school of capital flows which states that there is harm with how money is raised for project financing and current account deficits are financed.

The decline in cross border flows is going to further negativelyimpact trade and is going to fragment the globe into regions and localized markets. New development will now be restricted to the desire of local bankers and politicians without the chance to receive funds based on the value of the project. Of course, this is the positive view to cross border flows. There is also the view that cross border flows are bad and this return or movement to localized financing will reduce the change for a financial crisis.

I fall into the camp that reduced flows are negative for the globe and will casue more harm by not allowing savings to find the right home.

Natural gas pricing around the world - market design matters

noreply@blogger.com (Mark Rzepczynski) — Sun, 21 Apr 2013 18:15:00 +0000

There is a huge difference in the price of natural gas around the world. The price in Japan is three times higher than what you will find in the US. Prices in the EU are tied to oil and double of what you will find in the US. The natural gas supply gains are very localized and unlikely to change in the near-term.

The development of shale gas has been a key driver for the decline in the US prices relative to the rest of the world; however, contract pricing for natural gas around the world has a big impact on overall demand. The pricing of natural gas is more complex than just saying the US is drilling more relative to the rest of the world. The pricing design mechanism for a commodity will have a large impact on the ultimate price of exchange.

Market design matters with determining ultimate demand and supply within a market. If there is a an active spot market, there will be significant more price volatility. If there is a long-term contract market, prices will be less volatile and will adjust slowly to changes in supply. If the contract ties the prices to other energy sources, there will be a an average price per BTU of energy. If supply is determined by long-term contract, spot supply will not be able to come to the market and lower costs.

While many often talk about competitive markets, in reality the desire for a competitive market may not be that strong. The energy company that invests in natural gas development would like to know with certainty that their investment will pay and would like to lock-in long-term prices. This makes project financing easy. Similarly, the demanders of energy would also like to lock-in prices to determine their energy input costs. Both parties would like longer-term pricing but with flexibility if there is a change in supply or demand. Contracting is not just on the price side. The suppliers would like to ensure that they can sell a fixed quantity and demanders would like to have certainty in quantity as well as price. Hence, there developed the take or pay contracts in the US. The key to contract markets will be the number of comepetitve players and the opportunity for new entrants in a market. if there are more players or entrants, there will be a greater demand for a spot market.

These long-term pricing designs work well when there is little surprise in the market. If there are shocks, a spot market can serve as a safety valve for the market. In the US, given coal contracts are starting to roll-off, there ill be increased demand for gas. Switching will continue. Pricing in natural gas is on the rise because contracting behavior is changing market structure.

Where is the commodity super cycle?

noreply@blogger.com (Mark Rzepczynski) — Sat, 20 Apr 2013 14:28:00 +0000

The major long-term theme in commodity markets for the last decade has been the commodity super-cycle. It has not disappeared, it has expired with the changes in economic growth around the global. The 2000-2008 period will be noted as a special global growth period with the ascent of emerging markets. This was the time where everyone was talking about the BRICs and the growth of the middle class in emerging markets. China grew at extraordinary rates and there was no global crisis for almost eight years. In commodity markets, under investment meant that supply could not keep up with demand. Prices moved above marginal cost and new investment began.

Move forward post-crisis, trade fell off a cliff in 2009 only to rebound smartly along with global growth. We may not have seen as strong a growth cycle in the US but the rest of the world showed strong gains. However, these growth gains did not continue in 2011-12 and now global growth is less than the 2000-08 average. BRIC GDP is lower, global GDP is lower by at least a third, trade is about half the average, global confidence has fallen, and manufacturing is down.

In fact, commodity prices seem to better represent the real economy than the global stock markets. Commodity markets which represent immediacy is showing weakness while forward looking markets like stocks is showing strength.

The super-cycle is following the lack of super growth. There should be no surprise here.

Can the stock market go higher?

noreply@blogger.com (Mark Rzepczynski) — Fri, 19 Apr 2013 19:15:00 +0000

One of the key ways that equities can move higher is through increases in margins, but the problem is that margins are already high as seen by the charts from Zacks. Our guess is that margins will start to decline in-line with the higher cost of regulation and specialized labor. If that is true, earnings will come down. The momentum in stocks has been a margin story and not a revenue story. You can have a situation of declining margins yet more revenue but that seems less likely with the current macro environment.

Is there a commodity rotation?

noreply@blogger.com (Mark Rzepczynski) — Fri, 19 Apr 2013 18:38:00 +0000

Everyone has been talking about the Great Rotation into equities this year. With the recent stalling in prices, the fervor for this talk has declined, but there are other rotations within asset classes. In particular, there is a rotation in commodity behavior with the what seems like the end of the super cycle.

During the commodity super cycle, prices were macro-driven by the movement in global growth.The surge in China growth pushed commodity prices higher but with the Great Recession, there has been flattening in commodity momentum. The market has moved from being macro-driven to one that is more localized. The cross correlations in commodities are at the lowest in years. The commodity rotation has moved to behavior that emphasizes commodity specific behavior.

Additionally, the dampening of inflation expectations has reduced the demand for precious metals which has been a strong driver in commodities. The idea that commodities are needed as a hedge against the next round of inflation has fallen from favor which has placed more emphasis on those markets which have inventory shortages and not a desire to hold real assets.

The conclusion is that investors have to "think local" to make money in commodities