Is This Good or Bad?

Courtesy of DB research.

A Call Option on Commodities Regulation

I am sure we all have been hearing a lot about the move to curtail speculative trading in the commodity markets. I thoight this was an interesting article. Whether one thinks speculators are net positive/negative for the market and the society (I personally think ETFs should be outlawed but let professional speculators speculate) I think it is likely that passage of speculative restriction would at least send the price down temporarily. Could I make money off this?

I thought perhaps I could buy some OTM puts on WTI. Turns out these options are still way too diamn expensive due to volatility and time value. Then I extended my analysis: who gets hurt if such rules get enacted? Can I buy some OTM puts on CME (who owns NYMEX where WTI is traded)? Well, these options are still too diamn expensive. What then - how about shorting CME and hedge out the equity beta portion by going long another exchange stock with minimal exposure to commodities? NYX perhaps?

The two stocks are very highly correlated so it seems to me like the equity sensitivity portion can be hedged. NYX seems to have higher dividends than CME which is good. Must look into how much commodities contribute to CME's earnings.

Though I wonder : is NYX gonna get hammered if that whole HFT thing gets busted up by the gubment?

Is There a Play Here? - LME Copper Curve

What's up with the LME copper in backwardation?



When the copper inventory is going up?



LME warrant cancellations are going nowhere:




Comex copper curve looks way different:


Time to short the timespread in LME copper? My guess is the backwardation might be caused by long only money and trend followers jumping in?

Oil? I don't see no fundamentals at play here

DOE released oil inventory numbers today and it is bearish all around with inventories in crude, gasoline and distillates all up substantially. As of now crude is hanging in there but refined products are down - despite a pretty big rally in stocks and USD taking further pounding.

How the hell is crude at $70 when demand is just not there? keep in mind that crude was around 25 bucks as of end of 1999 when the economy was booming. Has EM demand increased that much (maybe it has)? Because as you see below, US demand hasn't gone anywhere (although this probably isn't the best measure of inventory as implied demand is backed out from inventory changess).



And inventory is still sky high:


People say industrial production/manufacturing is rebounding but distillate inventory keeps piling on.




Now, it is entirely possible that distillate buildup was due to refiners taking advantage of very generous crack spread lately. To me, interesting trades are to be made in cracks. I have no idea whether oil should be at 60,70 or 80. Personally I am inclined to short but don't want to get caught on a wrong side of a directional trade in this market.

gasoline crack:

Commodity thoughts - Aug09 GS view as well as mine

• So far the biggest gainer has been base metals
o GS attributes this to EM’s outperformance over OECD in terms of economy (EM – specifically China and India hanging in there strong at least in terms of GDP).
• GS thinks that OECD economy is in an earnest upswing given the PMI and US employment numbers and that this would mean improvement in energy (they mean crude) demand.
o Energy a lot more geared to developed world demand.
• GS is very bullish on US econ in H2 due to huge boost in manufacturing.
o Q2 GDP showed inventory liquidation steeper than previously thought. That means more inventory that must be restocked.
o Ratio of ISM new orders to ISM inventory is at the highest point since 1975.
• My guess is that neither metals nor crude has been moving based on fundamentals. They will fall from here if stock market falls. It’s based more on investor appetite more than anything else.
o We need to see some slowdown in WTI inventory buildup – another big build today.

Nat Gas
• High inventory
• Cooler than usual summer has been a drag on demand
• Right now the concern is that storage will be breached. Once we pass that point we might see a sustained rally in natgas as people shift attention to reduction in drilling. Price has to recover to induce more drilling.
• I think the current situation is like when WTI tanked as it nearly breached the storage limit at cushing.
• Almost time to go long 2010 Nat Gas? Long Aug10 with a view that injection would be below 5yr average?


Base Metals
• Manufacturing is going strong – Chinese and US PMI ticking up consistently
• US auto and housing sector – which are especially metals intensive – appear to be recovering.
• Nickel the most closely aligned with speculation and risk taking – it has the highest $/ton so lowest storage cost.
• Hence it is also the most vulnerable to reversal in investor flows
• A decent RV trade for shorting risk appetite? -> Long copper short nickel
o Short nickel could also be a way to bet on Chinese lending tightening. Suspicion is that loose money has caused many companies to stockpile metals for SHFE-LME arb. Reduction in credit would make that trade less profitable.

Corn
• Price has traced back after a nice run in july as crop concern over crop condition has eased.
• Thinks the general price level is low and has limited downside. Likes for a medium term long bet.

Soybean
• Export demand has been very robust and that has help push price up.
• Old crop inventory has been falling (due to high exports)

Wheat
• Supply seems ample worldwide
• In US, weather has been good for current growing season. No upside catalyst in sight.

Coffee
• News of tight supply has caused a recent rally

Sugar
• Continues to surge as below average monsoon season bodes poorly for Indian harvest. At the same time, Brazil has been getting too much rain which caused some concerns there.
• India is No.1 consumer and No.2 producer (behind Brazil)
• Fundamentals look good but did the price run too high?

Nat Gas - Production vs Rig Count

A buddy asked me a question earlier and I thought it's worth posting here.

He e-mailed me the following charts: historical natural gas production and rig count. As you can see the number of rigs have plummeted while production has held up. How is this?

First, by definition the Baker Hughes counts drilling rigs - these are rigs that are in drilling stage and not yet in production. Think of these as future production indicator. Another way of think of is this: if rig count fell to zero then nat gas production should fall at a natural rate of depletion (wells lose productivity as more and more gas sucked out), which is estimated at around 30% a year.

Say if we started 2009 production at 60Bcf/day and there was 0 rig count throughout the year by end of 2009 production would stand at around 42Bcf/day.

BAKEGAS Index


DOEGPROD Index

Copper - time to short?

An article on Bloomberg today - a ML metals analyst Michael Widmer commented that copper price might have overextended itself given its recent rally despite sharp rise in inventory.

I have done some work on metals inventory vs price and found that there isn't much one can infer one way or another. On a daily basis it does not seem to matter at all. On a longer horizon it works OK but then how practical is it to hold a metal position for a whole month based on last month's inventory data (this is analyzing data on monthly frequency and constructing trades that way). No clear relationship among inventory, warrant cancellations and price that I could decipher. As you see in below chart that on monthly basis inventory and price movement seem to be quite negatively correlated, but as you can see in the period 2005-2006 it is hardly a sure thing.

HOWEVER, this just might be enough argument to push me into going short copper - finally.

Higher metals price -> Higher supply?

Due to a huge increase in metal prices this year a large portion of previously closed production capacity (due to high cost of operation) should now be profitable again. The question is: will production come roaring back?

According to Barclays, globally around 3.8Mt of idled aluminum production, 1.2Mt of zinc concentrate, 500Kt of lead concentrate, 190Kt of nickel concentrate and 265Kt of copper concentrate production would be profitable at current prices. To put in context, those numbers are around 9%, 10%, 6%, 14% and 1.5% of 2008 total worldwide production, which are substantial. If all of that production came back online that it could really impact prices.

However, there is more to re-starting production than current price. Barclays estimates it could cost $25mm to restart each 100Ktpy of zinc mine as well as $25-50mm for capex. These are some huge sums of money especially in this tight credit environment (which could explain why miners have been so eager to sell new equity – a quick search on Bloomberg returned 225 pages worth of new stock offerings since Jan 1 2009). Given the financial constraint in this environment the producers will wait and see to make sure that higher prices are here to stay on a sustained basis – and that will introduce even further delay to restoration of production capacity.

The only place where production activity is picking up in a major way seems to be China – where the government is pumping money (their version of stimulus) to prop up basic materials and heavy industries.

Listening to various Q2 earnings calls for miners/refiners it does not seem to me like they're rushing back to crank up production just yet.