Friday, January 25, 2019

Why hasn't the Major Buy Occured

Back on 8/8/2018 I posted "Major Buy in the Materials Cycle?" The thesis was that the commodity markets were going to implode because of a growth slowdown in the commodity-intensive emerging markets (mostly China). This would provide a low risk window to load the boat in the materials sector. I guessed that this would take about six months.
Well, six months have come and gone. I have loaded the boat in oil (WTI). That trade was timed perfectly, and I am actually taking some off at this point. But we haven't seen the major commodity-wide selloff that I was hoping for. So outside of oil, I'm still only in opportunistic positions.
What has happened? For one, the market is thinking that the US and China will come to some sort of agreement. That is clearly in the best interests of both parties. So that's supporting prices. Also, there has been increased demand from countries such as India that have made up some of the difference.
Probably the most important thing is that people in the sector are thinking like me: the long run needs higher investment and that needs higher prices. So people are willing to accumulate inventory.
I'm sure most readers of this blog are acquainted with the "fat pitch" concept. Unlike in baseball, where you only get a limited number of pitches to look at, in investing the pitches keep coming. If you have to put up monthly numbers, maybe you have to swing at some to justify your management fees. I don't have this pressure anymore, so I can just sit back. That's pretty much where I am now.

Sunday, January 13, 2019

More on Bitcoin

Last November, I wrote my only post ever on Bitcoin. At the time I didn't have a market forecast, but I thought that there would be a ceiling on the market caused by large "foundational" holders using upmoves to monetize their assets. The Bitcoin market collapsed shortly after I wrote the post. Then in mid- December the market started to move up on light volume.

At the time I guesstimated that maybe 40% of the Bitcoin were held by the large owners ("Bitcoin billionaires"). Since then, a Bitcoin data analysis shop, Flipside Crypto, has estimated that the 1000 largest Bitcoin addresses control 85% of the Bitcoins! Flipside also says that some of these addresses have been inactive for years, but are now starting to reawaken. I don't know much about Flipside, but their analysis may have merit. They keep track of Bitcoin on the individual address level. During December, the percentage of coins trading in the top 100 addresses fell pretty sharply.

If they are right, this may start moving up again. I'll keep a watch on it, although I will not trade the market.

Longer term, I continue to think that the future for all the crypto assets will depend on progress in making them more usable. Right now this doesn't look too promising. The Lightning Network is Bitcoin's hope for transaction expansion. But it has only had tepid usage so far. There are real concerns about its intra-day security. Ethereum got clogged up with just one crypto game, Crypto-Kitties. Probably more important, some of the crypto developers are cutting staff. It seems that a bull market was needed for their economic sustainability.

Finally, there may be a mathematical problem with the process all cryptos use to avoid "double spending". It's possible that all these processes are susceptible to certain kinds of hacks, such as 51% attacks. Recently a moderate size cryptocurrency, Ethereum Classic, experienced this. NOTE: this is not the Ethereum that most people know about. It's a smaller fork. So the whole idea may have inborn problems.

I usually say "time will tell" in cases like this. However, many basic questions of computer science have resisted proof for decades. For example P=NP and the security of RSA encryption. Easy to state; impossible to prove. So time may not tell.

Tuesday, January 8, 2019

Update on Cocoa

A while back I mentioned that I was going to trade cocoa from the long side. I thought that arrivals from the Ivory Coast were going to be light for the first part of the season. There is really no crop problem; it's just one of timing. However, the market can get upset on simply that. In cocoa most of the speculators have no fundamental crop information. They just see the published numbers. When those look bullish, they buy.

It's getting a little late in the game for this. Rainfall in the cocoa zone has been close to average, so I really do not see a big fundamental move. We are at the top of a long held trading range. So if we break out, there could be a lot of technical buying. I'm hoping for that, and an eventual long->short.

Monday, January 7, 2019

More Traffic

There's been a big increase in traffic to this blog since my call on the bottom in oil prices on Dec 26. As of now, that was within a few pennies of the dead-ass bottom. That was pure luck. I'm a commodity strategist, not a tactician. Nonetheless, I have been trading these markets for many decades, and I guess I've learned a little about tactics as well.
So welcome to all the new readers. I am going to try to publish posts more frequently from now on. I started this blog as a way to describe my own trades. I know from experience that if you put things down on paper and invite others to read them, you have a forced discipline. Sloppy stuff gets called on the carpet.
I'll keep doing this. But I'll also give my thoughts on markets that I may not have a position in. Of course, I will make it clear whether I am just giving my opinion or actually have dollars on the line.

So here goes...

Vanadium. Long time readers know that I had a very big position in Vanadium miners starting in Jan 2018. The Vd price went up and is now coming down. Here's a chart of vanadium pentoxide.

BTW, the chart is from a junior miner, Prophecy Development Corp., which has a claim in Nevada USA.
The key to the market going forward is how large the speculative stocks of Vd were built up. In my experience, this kind of bull market, combined with media blabbering about future Vd flow batteries, is the kind of move that leads to large buildups. So it may take awhile to work them off.
However, they will be worked off, and the long term for Vd is good. China used to be a large producer (from steel slag from domestic iron ore) and a small consumer. Now it's a small producer (they are using iron ore from Australia/Brazil that has no Vd.) and a large consumer. So at some point this will be another good trade. I just dipped my toe into Large Resources. (LGO in Toronto). LGO is a Canadian company with a Vd mine in Brazil. I believe it's the best Vd mine in the world. So I'm looking to add to that, either on declines or on signs of stability in the Vd price. Right now it's a very small position.

Wednesday, January 2, 2019

Oil Econometrics

Whenever I make a large trade I always develop a statistical model for it. I find that gives me a framework to trade around. Now, models are not always statistically good, and there may be reasons I don't trust them anyway. But they are a first step. Here's how I went about the oil model.

My simplist framework is this. First I deflate the price. then I form a moving average of the deflated price. I then estimate a model using the price ten years ago and time as independent variables. So it looks like this:

log(defPrice) = a + b * log(MovAvg(defPrice[-10]) + c * time

The -10 term is for mean reversion. Time is there because most commodities have secular trends in price. For most the trend is downward; commodities are getting cheaper relative to services etc. For a few the trend is upward, probably because of increasing difficulty of extraction.

Oil is one that has had an increasing trend. In the model, I manually stopped the trend five years ago. This is due to a new technology, fracking, that has somewhat changed the game.

Using monthly data, the oil model is surprisingly accurate. It's R-squared is about 85%. All the other diagnostics (about 20 of them) are also good. For example, here's a plot of the residuals versus pure normality:

This is fairly good. The residuals are pretty much normally distributed, although they miss on the upper tail. That doesn't bother me. There's a lot of evidence that liquid asset prices have fat tails, and in commodities the "fat" is usually on the upside.

Forecast for spot Brent...
Assuming inflation at 2% and the $US unchanged,
the price will be 64% higher in ten years.

Now that may not seem like a big move. I have found however, that a commodity rarely takes the full ten years to get to equilibrium. More like two or three.

For shorter term (1 - 3 years) forecasts, you need to input data on supply/demand/capacity. That's for another post.

Monday, December 31, 2018

More on Oil

This is the biggest trade I have had on for awhile, so I'm following it more closely than usual. Since (as my name says) I'm a strategist rather than a tactician, I normally spend my time doing analysis rather than watching the markets. I did all that market watching when I was trading other people's' money, and I am done with that. No more monthly numbers for me!
Several people have asked me how to trade this. I am long WTI calls starting in Dec 2020 and further out. The rationale is that the market is underpricing the long term value of crude. I don't really have a clue where the market is going to go short term, so I stay away from the nearbys. You could also trade this with an equity of an oil producer. In this case though I prefer the futures market. I don't know where the stock market is going to go. More important, if I'm wrong about crude, the downside of the distant months is maybe $10. If you are in a stock with a dicey balance sheet (as most of them are) the downside is zero. So there's that.

Here's a chart of Dec 2020 WTI vs. Feb 19:

I apologise for the poor quality. I normally use my stat language, R, to draw graphs, but this is just from Interactive Brokers website. BTW, IB is a great broker, even though their charts are only so-so. You can see that the Z20 contract (red and green bars) has held up pretty well, even if the nearby is in the pits. If we take out last Wednesday's highs, I think we are in the clear. If I were a technician, I would be adding there. But of course I'm not. I only add on declines.

Wednesday, December 26, 2018

The Bottom in Oil

Several months ago I mentioned that I thought a major bottom in commodities was about six months away. Well, I think it's partly here now, and I am trading it. This morning I bought crude oil.
First off, I think it's cheap. I have a ten-year price model that says its undervalued. Not only is the spot price cheap, but it's cheap all the way out the curve. Additionally, options are cheap as well. So I bought a bunch of long dated slightly out of the money calls. This is a big trade.
Soybeans are also getting into my buying zone, although not as clear at this point.
One more trade: I covered my short long dated SPY calls. I really don't know where the stock market is going short-term, but I sense there is the possibility of a fierce rally here. So I don't want the gamma to blow up on me. I still think we will not get back to the old highs for a long time, but discretion is the better part of valor.