Anyone for oil?? Anyone?? Bueller?

So the stock and bond markets are yawn-worthy these days.  What’s a trader to do?  Clearly, it’s time to sell oil:

Excuse me, your oil is leaking.  Source: thinkorswim by TDAmeritrade.

Excuse me, your oil is leaking. Source: thinkorswim by TDAmeritrade.

WTI crude is down about 25% from mid-year highs.  Since end-Sep, there has been a pretty much straight-line fall of around $20.

A lot of headlines can, have, and will be written about this fact.  Among the themes I’ve already seen:

  • Russia is doomed, as are a lot of EM countries which rely on high oil prices to sustain government spending.
  • US shale oil is doomed, as break-evens for these wells is around $75.  That’s the end of a great run in job creation, US oil self-sufficiency, etc. etc.
  • Global industrial production will get a nice lift from cheaper energy prices.
  • Global inflation will have a big drag.  Probably not exactly what the world needs, with inflation at or near zero in much of the developed world.

And some more of my thoughts, which I haven’t read other places (yet).

  • Alternative energy, particularly electric cars, will face a big headwind as Americans see sustained gas prices < $3.
  • Remember Scotland’s referendum, which relied on oil revenues to handle the gap in government spending?  They assumed $110/barrel.  So they would already be about 30% in the hole.  Ouch.
  • Systematic trading is a great way to take advantage of these types of moves.  I’m pretty sure there aren’t many fundamentals guys staying short oil at this level (or likely remained short at the $80 or $75 level).  Momentum strategies would still be short.
  • Tying together my previous posts on the subject:

In sum, thanks to the oil price for keeping markets lively the past week or so.


I love gold!!! …or not.

Another common portfolio question I hear: ‘What do you think of gold?’  Admittedly, this question isn’t quite as popular these days as it was a couple years ago.  I wonder why that is…

Let’s look at the data, shall we?

Screen Shot 2014-11-07 at 10.13.05

Goldmember is half the man he used to be. Source: Google Finance.

Looks like a very impressive run, even through the financial crisis.  I remember the deluge of ‘Cash for your Gold’ boutiques that opened during 2009-2011; sensible, seeing as the buyers of your ‘scrap’ gold benefitted from at least two tailwinds:

  1. Emotional sellers: the gold price became common knowledge, splashed across evening news and in everyday conversation.  People wanted to take advantage of this opportunity.  Shrewd buyers could fulfil the new supply by bidding low: those new to trading gold may be OK with selling at a 10% (or more) discount.
  2. Inventory appreciation: seeing as the gold price rose nearly continuously, these boutiques needn’t be in a hurry to sell their inventory.  Unlike the Ma & Pa selling their fine wares, the boutique owners could await THEIR price.

Of course, all of this changed in 2012, and particularly 2013.  With inventories suddenly depreciating at an increasing rate, boutiques turned into forced sellers.  So that business becomes essentially untenable.

Alright, let’s review why people seem interested in owning gold:

  • It’s pretty and rare.  OK, no argument there.  Has been for a long time.
  • It’s value-dense.  I can see why many folks in developing countries, particularly the unbanked, use gold as a savings vehicle.  Definitely more portable than large quantities of bills.
  • It’s a great inflation hedge.  Hmm…really?  Let’s look:
Upward-sloping line?  Yes...ish.  Source: Bloomberg via Erb and Harvey (2012).

Upward-sloping line? Yes…ish. Source: Bloomberg via Erb and Harvey (2012).

If Gold was a truly good inflation hedge, I would’ve hoped for a much smoother upward-sloping line in the chart.  What this chart tells me is that some outlying observations really pull the slope up; the correlation here doesn’t seem too great.  For most of the observations (CPI between ~75 and 200), gold’s price seems to be anti-correlated with inflation.  Oh dear.

  • It would be handy in a disaster scenario.  Really?  So we’re making assumptions about what would actually have value in times of crisis, the likes of which we haven’t seen since…well…a very long time.  I mean, even during hyper-inflationary periods one can buy any real asset to hold value; gold isn’t special there.  And if we’re saying that In a World where people no longer accept currency of any kind, gold will maintain value… I’m more on the ‘guns and ramen’ side of the fence.

In sum: no, I don’t hold gold in the portfolio.  I’m not a fan.  I do like gold’s volatility for trading strategies, however: it’s in the same bucket as the rest of my commodities exposure.

Extra Credit: for those interested in a great, and fortunately prescient, article on gold, see this Erb and Harvey (2012) paper.

No one likes commodities anymore

A prime example of why I don’t favour long-commodities in the portfolio: I don’t understand how/why they can fall, seemingly forever, on well-known economic themes.

Grains had it bad for most the year, but oil caught up.  Here are 2 long-only ETF/ETNs showing the issue: USO follows the oil price, and CORN follows the corn price.

Screen Shot 2014-11-04 at 13.30.48

One characteristic that has been nice is sustained trends.  That means medium-term momentum funds have made a killing on these products this year.  A small pat on the back for inclusion of the managed futures mutual fund.

In other news, the equity markets seem to be rattled again – just a couple days after the JCB adding a ton of stimulus, and GPIF buying a new $180bn in equities.  Maybe back to proper two-sided markets??

What about commodities?

I’ve been posting a lot about seeking diversification….so what about commodities?  I mean, surely they’re the obvious addition to an equity/bond portfolio?

Hmm… kinda.  My 2 cents on commodities:

  1. Long = wrong.  Long-only commodities is a poor choice, in my opinion.  I think of it this way: there is no fundamental reason for commodities to endlessly grow – unlike, say, equities.  Yes, each area of commodities (grains, metals, energies) has had a good run at different times.  But they can fall seemingly without end (such as grains recently).  A vehicle for those who disagree with me can go for an ETF such as DBC to keep long commodities exposure.
  2. Roll yield matters.  Another reason I don’t buy long-only commodities is the roll cost.  Back in the day (I’m thinking JM Keynes’s “normal backwardation” concept) most commodities paid long positions roll yield; incidentally this became a large part of the return for holding commodities.  With the advent of much long-only money, backwardation became contango; thus long-only has to pay for the privilege of holding a position.  I don’t like this.
  3. Simple strategies help a lot.  Back to my days in hedge fund land.  Just about any combination of momentum, carry, and seasonality strategies can outperform long-only.  So I stick with these.

In sum, these reasons underpin one of the key reasons I picked a managed futures mutual fund the other day.  Access to that different return stream, without paying away the roll yield each and every month.