Oil prices, both Brent and WTI, remain depressed:
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A few weeks ago, Michael Masters, of the eponymous US investment firm, made the point to FT Alphaville that bad things can happen whenever investors mistake the fruits of production for the means of production, and apply long-standing “long only” strategies (more suited to equity index markets) to assets like commodities.
Earlier this month, Nomura put out a note that observed much the same point.
Specifically, they argued that commodities should be treated like currencies and valued with macro-trading tools that incorporate the concepts of carry, value and momentum. Read more
Good news for those looking out for crude bottoms!
JBC Energy reports on Friday that the economics that make storing surplus oil in floating tankers profitable are finally in play. Contango, in other words, has returned sufficiently enough to the market to incentivize those intermediaries who have the physical means to store oil, to purchase it for storage purposes and delayed sales, thus helping to balance the surplus in the market. Read more
As they say on Battlestar Galactica, “all this has happened before and all this will happen again”.
And it’s not just Joseph and the pharaoh who offer worthwhile precedents for the “sell-to-store” commodities warehousing carry trade. It turns out similar activities and concerns were very much rife in the grain markets in the 1920s as well.
Here follow some wonderfully evocative of today snippets from the 1921 Federal Trade Commission report on the grain trade: Read more
Bored with zero interest in the bank? Why don’t you check out the latest in aluminium-backed deposit accounts? You take the excess aluminium off our hands, we sell it forward, and hey presto you get interest rates conventional banks just can’t beat!
(It’s the way the gold market has been compensating for its oversupply for generations.) (Terms and conditions apply.)
All of which is another way of saying the world’s aluminium oversupply burden has created some excellent carry opportunities in the off-market storage space over the last few years. Read more
There’s a stupid rumour going around in the gold community that the Comex is “bleeding” inventory (especially from the JP Morgan vault) and that this will in some way compromise delivery that causes a default.
Kid Dynamite has already done the bulk of the heavy lifting in trying to debunk this story, as has Miguel Perez-Santalla at BullionVault, but we wanted to emphasise some points that go beyond the mechanics and which might be helpful. Read more
The gold market has always been partial to “carry trades”. But in the post 2008 world the nature of the carry-trade has changed.
In collateral terms, whereas gold mostly traded on “special” terms before 2008 — because you had to pay to borrow it — meaning it was privy to more of a “stock lending” profile, post 2008 it went fully into “collateral” mode. Read more
There’s been a lot of speculation about what really drove the volatile gold price move this month. Some are still defiantly searching for conspiracies or under-handed activities by authorities.
But it’s probably Nouriel Roubini who has provided one of the best and most logical explanations. In his opinion every bit of the gold move can be explained by shifting inflation expectations. Read more
An excellent observation from John Kemp over at Reuters on Tuesday regarding the spot/forward disconnect we’ve been talking about:
The increasingly close linkage between hedge funds and spot prices since 2010 has also coincided with a sharp reduction in the correlation between front-month and far-forward prices. Correlation between spot month and forward prices, generally above 90 percent until 2010, is now often less than 50 percent (Charts 5-6). Read more
There’s an enlightening interview with Oleg Deripaska, chief executive of Rusal, in the Telegraph this Monday (h/t Neil Hume).
Turns out the metal tycoon believes aluminium may do better than expected this year, largely because much of the excess capacity that has plagued the industry has finally been cut back. Read more
From the IEA’s latest oil market monthly report:
The paradox is that US product stocks have been falling faster than normal and European refiners have been running flat out despite tepid product demand in both markets. Hurricane disruptions and a string of refinery glitches (especially on the West Coast) are only part of the US story. In both regions, the bottom line is that exports have become a key driver of refining activity and profits, not just the outlet for surplus product that they used to be. To wit, in Europe even gasoline cracks have staged a dramatic recovery, despite vanishing demand at home. Read more
A while ago we observed that negative gold leasing rates were potentially signalling something awry with the Libor rate.
That judging by gold forwards, the Libor component of the gold lease rate calculation (Libor-GOFO = Lending rate) was coming in much lower than what might otherwise be expected. Read more
We appreciate that this will not be news for anyone who’s been watching oil markets closely.
However, we still think it’s a valuable recap. Read more
Investors looking for commodity exposure through fund offerings usually have one of two basic choices. They can opt for pure long strategies via funds which take positions in the underlying physical commodities or which perpetually roll the same position over and over in the futures market, or they can opt for so-called ‘curve placement alpha’ strategies.
Ever since ‘contango’ became a problem for many commodity markets — a structural phenomenon which leads to capital decay over time — the latter strategy has become increasingly popular with investors. Read more
Something of a strange one this. Every analyst and his dog has for the longest while been preaching that demand for crude post-crisis has really been all about emerging market demand… that the US, by and large, has become increasingly irrelevant when it comes to global supply and demand.
Look at any financial market long enough and it starts to resemble the repo market.
Conventional sales and buybacks. Islamic finance. Covered bonds. Commodity contango or backwardation trades. Most of them have some form of sale and later buyback of assets, inbuilt into the trade. The level of the buyback implies a yield-type return, exploiting the market’s current preferences. Read more
John Kemp at Reuters has penned a cracking column on the current peculiarities afflicting the crude markets.
As Kemp notes, ask anyone in the market — specifically the physical market — and they will tell you the market is tight. Not just tight. Really tight. (And most likely that the recent backwardation reflects this tightness.) Read more
Over in the spot iron ore market… there’s a small case of crisis going on.
As Reuters reported on Thursday, prices have been falling consecutively on “slow Chinese demand” and hefty spot supplies. It’s so bad, Reuters says miners are flooding cargoes into the market just to get the best prices while they can. For now, the price of spot iron ore is still more than double miners’ production costs of around $50 a tonne, so the incentive is quite clear. Read more
It’s only been four days, yet the backwardation in WTI — which caught everyone by surprise on Monday — has already started to ease.
Of course, if it turns out to be this short-lived, the theory that the flip may have been caused by a short squeeze rather than fundamental tightness, becomes easier to imagine. Read more
A heads up — This is a three-part series attempting to explain the current backwardation in the market. We will make three arguments: 1) That contango trades helped to create fake demand in 2009/2010 2) that index funds replaced Saudi Arabia as key swing players, 3) that the Brent-WTI deviation can be explained by the current super-backwardation.
We’ve been harping on for a while now about how a scarcity of quality collateral in the market (read US Treasuries) has been wreaking havoc in the repo markets — and how QE-related large scale asset purchases have only added to the problem.
We’ve noted too that these factors require a major investor rethink when it comes to how funding markets operate, and also in how to interpret the Treasury yield curve. Read more