Some readers were having trouble viewing the ten-year-forward graphs. I reset them. You can now view them as normal web pages at here1 and here2
No more blogging till after New Year's. When I get the December update, I'll go through the full list with my picks for long and short.
Friday, December 25, 2015
Wednesday, December 23, 2015
Post Number 12: The Bottom in Oil
Back on December 14, I wrote:
"It is unrealistic to think that the Saudis and their Gulf allies will give on output without getting something in return. Since it is highly unlikely that the other OPEC members will cut output, this "something" has to be political. It will be tied up with the battles raging in the mideast. When it looks like there may be progress on those, we can start thinking about a firming of oil prices."
That time is now. The politics in the mideast are breaking the Saudis' way, and I believe understandings have been made.
- Iran has substantially cut back its support of the Houthis in Yemen. Apparently they are resigned to let the old Saudi-friendly regime retake control. It's possible that they simply are facing up to the reality that they could not win, but some kind of understanding is also possible.
- A potent anti- ISIS coalition has been formed in Iraq and is forming in Syria. The Iraqi army, the Iranians, the Russians and the US are on the same side, and are coordinating their efforts. This is already getting results in Iraq.
- Turkey looks like it may be getting onboard via closing its border with Syria. If so, there will soon be progress in Syria as well.
- The recent resolution of the UN Security Council on the issue is important. Not because the UN can or will do anything; it cannot. But it shows that the major geopolitical players are united on the importance of settling the issue. This is realpolitics, not symbolism.
So I believe we are at or near (in terms of time) of a bottom in oil. How to play this? I am trading oil futures from the long side. My idea is that there will be a good two-way market for awhile with an upward bias. This is buy the dip tactics. Here are some other ideas for readers who are not active traders.
- Do not buy the usual ETFs like USO or OIL. The contango will kill you. Instead, open a futures account and buy a deferred contract. Dec 2016 or even Dec 2017 are the cleanest ways to play this.
- The equities of E&P companies would also be good. You should be aware however, that these companies are already trading with implied oil prices that are higher than the current strip. So if oil just stays where it is, they could be in serious trouble.
- I would still stay away from natural gas producers. Although NG may get a bounce when the weather turns, there is an ocean of LNG lapping at the shores of the market. This is very bearish for international prices. See my post of December 14 for a little more color.
- The key risk here is that we run out of storage, and the spot price collapses further. If this happens, I do not believe the one or two year forwards will fall too much. They will be dominated by longer term considerations. Nonetheless, they will fall. Either keep this in mind when sizing your position or use appropriate money management techniques.
- The recent resolution of the UN Security Council on the issue is important. Not because the UN can or will do anything; it cannot. But it shows that the major geopolitical players are united on the importance of settling the issue. This is realpolitics, not symbolism.
So I believe we are at or near (in terms of time) of a bottom in oil. How to play this? I am trading oil futures from the long side. My idea is that there will be a good two-way market for awhile with an upward bias. This is buy the dip tactics. Here are some other ideas for readers who are not active traders.
- Do not buy the usual ETFs like USO or OIL. The contango will kill you. Instead, open a futures account and buy a deferred contract. Dec 2016 or even Dec 2017 are the cleanest ways to play this.
- The equities of E&P companies would also be good. You should be aware however, that these companies are already trading with implied oil prices that are higher than the current strip. So if oil just stays where it is, they could be in serious trouble.
- I would still stay away from natural gas producers. Although NG may get a bounce when the weather turns, there is an ocean of LNG lapping at the shores of the market. This is very bearish for international prices. See my post of December 14 for a little more color.
- The key risk here is that we run out of storage, and the spot price collapses further. If this happens, I do not believe the one or two year forwards will fall too much. They will be dominated by longer term considerations. Nonetheless, they will fall. Either keep this in mind when sizing your position or use appropriate money management techniques.
Monday, December 21, 2015
More off Topic on Quantum Computing
More off Topic on Quantum Computing
The last post on quantum computers got more hits than all my previous posts combined! That shows pretty starkly that people are not interested in commodities. So I'll do one more post on the subject, than go back to what I actually know best.
I read through Google's paper on the D-Wave benchmarks http://arxiv.org/abs/1512.02206. The results really do seem good. Compared to a classical computer running the same type program, the quantum machine was many orders of magnitude faster. Probably more important, the running time increased more slowly than the classical machine as the problem got larger. So far, so good.
Now, the benchmark problem can be solved at about the same speed with special purpose algorithms aimed at that problem. It could be solved even faster with special purpose classical hardware. This type of attack, building the hard and software for one purpose alone, was pioneered by Alan Turing when he built the (possibly) first computer in order to break Nazi codes in WWII. But that's not really a fair comparison. Longer term, it's almost always cheaper to solve problems with a general purpose machine.
It's also important to know that D-Wave is something of an outlier in the world of quantum computer research. Most of the research is going into quantum gate (or circuit) machines. These are truly general purpose, with their qubits a rough analogy to traditional computer bits. IBM, Google itself and many academic institutions are doing this research. Depending on who you ask, these are between eight and twenty years away. A very few people think they will never be practical. There has been a noticeable increase in research funding in the last year or so, which may be telling you something.
A number of the academic researchers dislike the D-Wave approach (also called the "adiabatic" approach). They have two issues. First, there is theory that limits the speedup that adiabatic machines can achieve. This has to do with the speed which the quantum state can be changed without ruining the whole system. Second, D-Wave made the design decision to emphasize the quantity of qubits over the quality. Some think that they will have to reengineer the qubits from the ground up to make it practical.
It's hard to know what to think about this. However, I note that some of these same critics were pooh-poohing that D-Wave ever had any quantum effects. It is now clear that it does. Also, I seem to remember the same type of objections when computers first became widely useful (Yes, I am that old). They argued that IBM was sacrificing quality of design for larger and cheaper. This was especially true for software. Guess who won?
Math geeks only: This also reminds me of the solving of the Poincare Conjecture a few years back. The mainstream math community had a program in place that was working to solve it along established lines. Along came G. Perelman who was an expert in Alexandrov spaces, something of a mathematical backwater. But it was just what was needed to solve the problem!
OK, can one make a buck on any of this stuff? In the last post I mentioned a back door to buying D-Wave. That's probably still the cleanest way. However, Google is quite active in both quantum gate and adiabatic hardware, so that would be an alternate way. IBM appears to be concentrating on gate machines, so the payoff may be further down the road. Microsoft is working on an even more speculative approach, using the topology of certain two-dimensional particles to provide an ultra-stable qubit system.
There are also a fair number of private companies who are doing research in the area, particularly in software that could run on future machines. These might be interesting for angel investors who understand what they are getting into and can afford to lose the entire investment. The hope is that the patents will eventually be bought by some of the big boys once a useful gate machine is developed.
Ok, that's all on this. Next post: back to commodities.
The last post on quantum computers got more hits than all my previous posts combined! That shows pretty starkly that people are not interested in commodities. So I'll do one more post on the subject, than go back to what I actually know best.
I read through Google's paper on the D-Wave benchmarks http://arxiv.org/abs/1512.02206. The results really do seem good. Compared to a classical computer running the same type program, the quantum machine was many orders of magnitude faster. Probably more important, the running time increased more slowly than the classical machine as the problem got larger. So far, so good.
Now, the benchmark problem can be solved at about the same speed with special purpose algorithms aimed at that problem. It could be solved even faster with special purpose classical hardware. This type of attack, building the hard and software for one purpose alone, was pioneered by Alan Turing when he built the (possibly) first computer in order to break Nazi codes in WWII. But that's not really a fair comparison. Longer term, it's almost always cheaper to solve problems with a general purpose machine.
It's also important to know that D-Wave is something of an outlier in the world of quantum computer research. Most of the research is going into quantum gate (or circuit) machines. These are truly general purpose, with their qubits a rough analogy to traditional computer bits. IBM, Google itself and many academic institutions are doing this research. Depending on who you ask, these are between eight and twenty years away. A very few people think they will never be practical. There has been a noticeable increase in research funding in the last year or so, which may be telling you something.
A number of the academic researchers dislike the D-Wave approach (also called the "adiabatic" approach). They have two issues. First, there is theory that limits the speedup that adiabatic machines can achieve. This has to do with the speed which the quantum state can be changed without ruining the whole system. Second, D-Wave made the design decision to emphasize the quantity of qubits over the quality. Some think that they will have to reengineer the qubits from the ground up to make it practical.
It's hard to know what to think about this. However, I note that some of these same critics were pooh-poohing that D-Wave ever had any quantum effects. It is now clear that it does. Also, I seem to remember the same type of objections when computers first became widely useful (Yes, I am that old). They argued that IBM was sacrificing quality of design for larger and cheaper. This was especially true for software. Guess who won?
Math geeks only: This also reminds me of the solving of the Poincare Conjecture a few years back. The mainstream math community had a program in place that was working to solve it along established lines. Along came G. Perelman who was an expert in Alexandrov spaces, something of a mathematical backwater. But it was just what was needed to solve the problem!
OK, can one make a buck on any of this stuff? In the last post I mentioned a back door to buying D-Wave. That's probably still the cleanest way. However, Google is quite active in both quantum gate and adiabatic hardware, so that would be an alternate way. IBM appears to be concentrating on gate machines, so the payoff may be further down the road. Microsoft is working on an even more speculative approach, using the topology of certain two-dimensional particles to provide an ultra-stable qubit system.
There are also a fair number of private companies who are doing research in the area, particularly in software that could run on future machines. These might be interesting for angel investors who understand what they are getting into and can afford to lose the entire investment. The hope is that the patents will eventually be bought by some of the big boys once a useful gate machine is developed.
Ok, that's all on this. Next post: back to commodities.
Monday, December 14, 2015
Off Topic
Off Topic - Investing in Quantum Computing
I know this is a commodity blog, but there was important tech news last week. Google announced that they have definitely achieved quantum calculation with their D-Wave II computer. To my knowledge, this is the first quantum computer that has been used to solve a real life problem.
This is a subject dear to my heart because I wrote my doctoral dissertation on a closely related subject: optimizing a function over a countable set with many local maxima (really).
Here's a little background: A quantum computer can be vastly more powerful than a traditional (classical) one. The quantum machine uses the superposition of and between its bits to do much faster calculations over a much larger set of states. No one to my knowledge has replicated a classical computer with quantum bits. However, D-Wave has created a computer that uses the structure of a particular type of problem (optimising a function over a.....) to solve it quantum mechanically.
An important thing to know is that this type of problem is extremely important in real life. Google is undoubtedly interested in its applications to machine learning. Other D-Wave partners include Lockheed, NASA, I-Q-Tel (the venture cap arm of the DoD), and Goldman. This could be used to schedule trucks and airplanes, plan optimal routes, price complicated derivatives, aim interceptors at incoming targets, decrypt current codes. And as they say in marketing: a whole lot more.
Several other companies are working on quantum computing: IBM, Microsoft, Google itself, and probably a bunch I don't know about. However, this is the first clear success. My guess is that they are first to market because they concentrated on a machine that does only one thing. The others appear to be working on more general devices. Microsoft is working on a potentially breakthrough topological machine.
D-Wave claims to have a lot of patents around its technology, but I have no way of knowing what these are and whether they will hold up.
Can you invest in this? Surprisingly you can. An early angel of D-Wave is Harris & Harris, a publicly traded microcap venture/angel firm. They claim to own "between 2.5% and 5%" of D-Wave. Most of their investments are in biotech, and I think they got into D-Wave via its potential for computational biology. The firm's financials are poor. They are losing money and bleeding cash from operations.
Here's my speculative back of the envelope: EV of Harris & Harris is $60 million. If their other investments are worthless and they own 4% of D-Wave, that puts the breakeven value of D-Wave at $1.5 billion. Seems like a decent punt to me. (Note: I am not saying their other investments are worthless. This is for calculation only.)
Risks:
- This is very very very speculative.
- Given the national security implications, it may not be monetized in the usual sense.
- H & H may simply use the investment as an advertisement to attract more money to blow on bad investments.
- I may not know what I'm talking about.
I know this is a commodity blog, but there was important tech news last week. Google announced that they have definitely achieved quantum calculation with their D-Wave II computer. To my knowledge, this is the first quantum computer that has been used to solve a real life problem.
This is a subject dear to my heart because I wrote my doctoral dissertation on a closely related subject: optimizing a function over a countable set with many local maxima (really).
Here's a little background: A quantum computer can be vastly more powerful than a traditional (classical) one. The quantum machine uses the superposition of and between its bits to do much faster calculations over a much larger set of states. No one to my knowledge has replicated a classical computer with quantum bits. However, D-Wave has created a computer that uses the structure of a particular type of problem (optimising a function over a.....) to solve it quantum mechanically.
An important thing to know is that this type of problem is extremely important in real life. Google is undoubtedly interested in its applications to machine learning. Other D-Wave partners include Lockheed, NASA, I-Q-Tel (the venture cap arm of the DoD), and Goldman. This could be used to schedule trucks and airplanes, plan optimal routes, price complicated derivatives, aim interceptors at incoming targets, decrypt current codes. And as they say in marketing: a whole lot more.
Several other companies are working on quantum computing: IBM, Microsoft, Google itself, and probably a bunch I don't know about. However, this is the first clear success. My guess is that they are first to market because they concentrated on a machine that does only one thing. The others appear to be working on more general devices. Microsoft is working on a potentially breakthrough topological machine.
D-Wave claims to have a lot of patents around its technology, but I have no way of knowing what these are and whether they will hold up.
Can you invest in this? Surprisingly you can. An early angel of D-Wave is Harris & Harris, a publicly traded microcap venture/angel firm. They claim to own "between 2.5% and 5%" of D-Wave. Most of their investments are in biotech, and I think they got into D-Wave via its potential for computational biology. The firm's financials are poor. They are losing money and bleeding cash from operations.
Here's my speculative back of the envelope: EV of Harris & Harris is $60 million. If their other investments are worthless and they own 4% of D-Wave, that puts the breakeven value of D-Wave at $1.5 billion. Seems like a decent punt to me. (Note: I am not saying their other investments are worthless. This is for calculation only.)
Risks:
- This is very very very speculative.
- Given the national security implications, it may not be monetized in the usual sense.
- H & H may simply use the investment as an advertisement to attract more money to blow on bad investments.
- I may not know what I'm talking about.
Monday, December 7, 2015
Thoughts on OPEC and Energy
Post Number 11 - Thoughts on OPEC and Energy
So OPEC has met and couldn't do anything to goose the crude market. Here's my take on the situation:
- Most commentators got this right. It is unrealistic to think that the Saudis and their Gulf allies will give on output without getting something in return. Since it is highly unlikely that the other OPEC members will cut output, this "something" has to be political. It will be tied up with the battles raging in the mideast. When it looks like there may be progress on those, we can start thinking about a firming of oil prices.
- US shale may be declining, but US deepwater Gulf of Mexico is increasing. Gulf production may even be profitable at prices near here. Remember, a big part of the cost of producing in the Gulf is buying the acreage rights from the government. This is done in an auction. At lower oil prices, there will be lower bids and thus lower costs.
- The big story to my mind is LNG. There is an ocean of LNG capacity being built in Australia, the mideast, Russia, the US and soon the Mediterranean. I do expect that this will find markets. Many nations want to use more NG to reduce pollution, both the global warming and the smog types. Nonetheless, world prices will come down hard. Remember that the cost of producing NG is extremely low, especially where the only alternative is flaring. Liquefaction and transport do cost money, but much less than current prices. This will also eliminate a manufacturing advantage that the US has. As if US manufacturing doesn't have enough problems....
So how to play this? You could short nearby crude and roll every month to pick up the carry. I know that sounds like picking up pennies in front of a steamroller. But with a small position, it does make some sense. I would not short US natural gas. The nearbys are vulnerable to a turn in the weather. The more distant positions do have room to fall, but I don't see a catalyst at this time. Better to wait for a rally in the spring.
A trade that may be interesting is long Travelcenters of America (TA). This is a gasoline and diesel marketing company. The thesis is that low fuel prices will lead to continued volume growth. It is trading at a PE of about 6. I don't have it, and don't want to do the work. If any you out their have researched it, give me an email.
So OPEC has met and couldn't do anything to goose the crude market. Here's my take on the situation:
- Most commentators got this right. It is unrealistic to think that the Saudis and their Gulf allies will give on output without getting something in return. Since it is highly unlikely that the other OPEC members will cut output, this "something" has to be political. It will be tied up with the battles raging in the mideast. When it looks like there may be progress on those, we can start thinking about a firming of oil prices.
- US shale may be declining, but US deepwater Gulf of Mexico is increasing. Gulf production may even be profitable at prices near here. Remember, a big part of the cost of producing in the Gulf is buying the acreage rights from the government. This is done in an auction. At lower oil prices, there will be lower bids and thus lower costs.
- The big story to my mind is LNG. There is an ocean of LNG capacity being built in Australia, the mideast, Russia, the US and soon the Mediterranean. I do expect that this will find markets. Many nations want to use more NG to reduce pollution, both the global warming and the smog types. Nonetheless, world prices will come down hard. Remember that the cost of producing NG is extremely low, especially where the only alternative is flaring. Liquefaction and transport do cost money, but much less than current prices. This will also eliminate a manufacturing advantage that the US has. As if US manufacturing doesn't have enough problems....
So how to play this? You could short nearby crude and roll every month to pick up the carry. I know that sounds like picking up pennies in front of a steamroller. But with a small position, it does make some sense. I would not short US natural gas. The nearbys are vulnerable to a turn in the weather. The more distant positions do have room to fall, but I don't see a catalyst at this time. Better to wait for a rally in the spring.
A trade that may be interesting is long Travelcenters of America (TA). This is a gasoline and diesel marketing company. The thesis is that low fuel prices will lead to continued volume growth. It is trading at a PE of about 6. I don't have it, and don't want to do the work. If any you out their have researched it, give me an email.
Wednesday, December 2, 2015
Dean Foods (DF)
Post Number 10: Dean Foods (DF)
In Post 8 I discussed why I was bullish on milk volumes and that I was particularly looking for a turnaround in fluid milk sales. Dean Foods is the largest company in the space, and I now am long. Here is some more on the financial aspects of it.
DF has suffered majorly from the decline in milk volumes. For awhile it was overridden by their WhiteWave brands, but they were spun off three years ago. The remaining company simply had to cut costs hard, and management must be given credit for doing this. Operating expenses have fallen by over a quarter. Of course milk costs have gone down as well, but so have selling prices. Even so there is reason to be optimistic on margins. Dean has an active branding program which is showing some signs of success. The boutique milk types like flavored and lactose-free will also help here. Most important, Dean has a lot of operating leverage to volume improvement. Here's a simple spreadsheet that illustrates DF's upside to a turnaround in fluid milk consumption. I have assumed that volume grows by 1% per year and margins increase by two percentage points as the branding and specialty milk initiatives pay off. I also assume that temporary cash items like changes in receivables will be zero. They were strongly positive in 2015, which is why 2016 FCF will be down.
In Post 8 I discussed why I was bullish on milk volumes and that I was particularly looking for a turnaround in fluid milk sales. Dean Foods is the largest company in the space, and I now am long. Here is some more on the financial aspects of it.
DF has suffered majorly from the decline in milk volumes. For awhile it was overridden by their WhiteWave brands, but they were spun off three years ago. The remaining company simply had to cut costs hard, and management must be given credit for doing this. Operating expenses have fallen by over a quarter. Of course milk costs have gone down as well, but so have selling prices. Even so there is reason to be optimistic on margins. Dean has an active branding program which is showing some signs of success. The boutique milk types like flavored and lactose-free will also help here. Most important, Dean has a lot of operating leverage to volume improvement. Here's a simple spreadsheet that illustrates DF's upside to a turnaround in fluid milk consumption. I have assumed that volume grows by 1% per year and margins increase by two percentage points as the branding and specialty milk initiatives pay off. I also assume that temporary cash items like changes in receivables will be zero. They were strongly positive in 2015, which is why 2016 FCF will be down.
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Monday, November 30, 2015
Gold or Nickel?
Post Number 9: Gold or Nickel?
I attended a meeting of an investment club a few days ago. The attendees were not professional traders, and the presenters were pretty much of the "I predicted the crash of '08 and I'm predicting it again" sort. In a room of true believers like this, there was one question on most minds: When do I buy gold and silver? Actually there were two questions; the other was: when will I make back my losses on gold and silver?
I added my two cents to the discussion saying that there were better hard assets to invest in than gold. I didn't have my charts with me, so it was mostly a qualitative statement that some things are cheap and other are dear. I promised to put up some charts on this site. So here are two.
First, lets talk about a metal that really is a good value, nickel. Here's a chart of forward ten year returns versus constant dollar price. BTW this chart is explained in detail in Post 2.
Like most of my charts it is done on a ratio (log) scale to better show the percentage changes. The red line is where we are now. So the model is forecasting that nickel will more than double in ten years. That's in constant dollar terms. If you believe there will be some inflation (most of those at the meeting certainly did) then it will do even better. BTW, the model has an R squared of 67%. That's great for a long term forecast.
Experienced commodities traders will counter with: The fundamentals are terrible. China is slowing, and there is no other buyer to take its place. Production is only slowly being cut back, and there are going to be surpluses for awhile. All of this is true, but remember that this is a ten year forecast. In the past, ten years has been long enough to work the surplus out. In terms of trading, I plan on waiting for some kind of trend reversal signal, probably based on moving averages.
Now here's the same plot for silver:
The fit is not as good at the low end of the price. That is because the series goes back to the time of the Hunts and the associated craziness. Since the mid 80s the fit is much better. It's forecasting a (50%) decline in the real price. It will take an awful lot of inflation to make up for that.
I attended a meeting of an investment club a few days ago. The attendees were not professional traders, and the presenters were pretty much of the "I predicted the crash of '08 and I'm predicting it again" sort. In a room of true believers like this, there was one question on most minds: When do I buy gold and silver? Actually there were two questions; the other was: when will I make back my losses on gold and silver?
I added my two cents to the discussion saying that there were better hard assets to invest in than gold. I didn't have my charts with me, so it was mostly a qualitative statement that some things are cheap and other are dear. I promised to put up some charts on this site. So here are two.
First, lets talk about a metal that really is a good value, nickel. Here's a chart of forward ten year returns versus constant dollar price. BTW this chart is explained in detail in Post 2.
Like most of my charts it is done on a ratio (log) scale to better show the percentage changes. The red line is where we are now. So the model is forecasting that nickel will more than double in ten years. That's in constant dollar terms. If you believe there will be some inflation (most of those at the meeting certainly did) then it will do even better. BTW, the model has an R squared of 67%. That's great for a long term forecast.
Experienced commodities traders will counter with: The fundamentals are terrible. China is slowing, and there is no other buyer to take its place. Production is only slowly being cut back, and there are going to be surpluses for awhile. All of this is true, but remember that this is a ten year forecast. In the past, ten years has been long enough to work the surplus out. In terms of trading, I plan on waiting for some kind of trend reversal signal, probably based on moving averages.
Now here's the same plot for silver:
Tuesday, November 24, 2015
Post Number 8
There is a major change in the way developed market consumers are eating. The era of low and no fat diets are over. It turns out that diet has surprisingly little to do with cholesterol levels; most of it is genetic. It also turns out that eating appetite satiating protein foods takes off more weight than a carb-heavy diet. This change is most evident at breakfast, where eggs and meat are replacing grains. I believe there are great investment opportunities in this space. In this post I'll talk about the commodity background for milk. In the next post I'll go into specific investments and move to eggs.
Milk
US consumption of milk has changed rapidly over the years. Consumption of fluid milk is down; consumption of cheese, ice cream and yogurt are up. Here's a graph of total US consumption of milk on a milk-fat basis:
The next graph zeros in on the milk products that have been growing quickly. This chart includes exports, which have been growing until recently.
However, consumption of beverage milk has been declining:
Some of this decline has to do with long run factors such as smaller families, plant based alternatives and the increase of the lactose sensitive population. However, a lot has to do with price, as you can see in the graph.
So how to play this. Yogurt is the obvious play, but most of the players are private. Danone is an exception. However, Danone is strongly circumscribed by the French government. A while back it received a takeover offer, but the gov did not allow it. So I would stay away.
The same holds true for specialty cheeses (in the US that means non-American and non-cheddar). I simply can't find an investment vehicle.
I am going to recommend that one play for a rebound in fluid milk. Why go to the declining part of the market? Because I think the decline is over, and a rebound is near.
- Lactose free milk has been introduced and is strongly gaining share. This requires very little processing above what is already done at dairies.
- Milk has taken off among health-conscious athletes. This is particularly true for flavored milk. This group often leads the general consumer.
- The price of raw milk (the input to the dairy) has fallen both in the US and the world market. This is good for both consumption and processing margins. It has to do with the slowdown in China. Here's a graph of New Zealand milk export prices along with the stock price of Dean Foods, the largest US dairy.
Next Post: Dean Foods
There is a major change in the way developed market consumers are eating. The era of low and no fat diets are over. It turns out that diet has surprisingly little to do with cholesterol levels; most of it is genetic. It also turns out that eating appetite satiating protein foods takes off more weight than a carb-heavy diet. This change is most evident at breakfast, where eggs and meat are replacing grains. I believe there are great investment opportunities in this space. In this post I'll talk about the commodity background for milk. In the next post I'll go into specific investments and move to eggs.
Milk
US consumption of milk has changed rapidly over the years. Consumption of fluid milk is down; consumption of cheese, ice cream and yogurt are up. Here's a graph of total US consumption of milk on a milk-fat basis:
The next graph zeros in on the milk products that have been growing quickly. This chart includes exports, which have been growing until recently.
So how to play this. Yogurt is the obvious play, but most of the players are private. Danone is an exception. However, Danone is strongly circumscribed by the French government. A while back it received a takeover offer, but the gov did not allow it. So I would stay away.
The same holds true for specialty cheeses (in the US that means non-American and non-cheddar). I simply can't find an investment vehicle.
I am going to recommend that one play for a rebound in fluid milk. Why go to the declining part of the market? Because I think the decline is over, and a rebound is near.
- Lactose free milk has been introduced and is strongly gaining share. This requires very little processing above what is already done at dairies.
- Milk has taken off among health-conscious athletes. This is particularly true for flavored milk. This group often leads the general consumer.
- The price of raw milk (the input to the dairy) has fallen both in the US and the world market. This is good for both consumption and processing margins. It has to do with the slowdown in China. Here's a graph of New Zealand milk export prices along with the stock price of Dean Foods, the largest US dairy.
Friday, November 13, 2015
Southern Peru Copper
Post Number 7 - Southern Peru Copper
I said in the last post that I was going to start a series on the milk and egg markets, both of which have some interesting prospects. But I've gotten several emails asking me to spend some time on more specific trades. So I've added a new page about the trades I actually have on. You can get to it from the right hand side on this page. Here's one that I have on now...
One commodity strategy that has proved profitable over the years is to buy the low cost producer during the down part of the cycle. This is a highly contrarian trade for two reasons. First, all producers will be doing badly when prices of their product are low. Second, P/E ratios are normally very high since earnings are so low. The key is being able to wait out the cycle and eventual high returns.
But not all producers are able to wait it out. Some will go broke. Others will survive but have to have severe recapitalizations. That's the reason I like the low cost producers. Normally they will continue to make some profit even in the lean years. So their chances of survival are high.
So let's talk about copper. Prices are down from their highs, but still not extremely cheap. Here's the graph I introduced in Post Number 2, but for copper only:
Remember the x-axis is the deflated price going back to 1980, and the y-axis is the ten-year forward return. (If you are unsure about the graph, I explain it in detail in Post 2.) The red line is where the price is now. So the model is forecasting a return of 0.75, or a (25)% loss. Using a multi-factor model, the ten year return is (15)%. Still bad.
Now the stocks of commodity producers often bottom before the commodity itself. This is because the producers have the ability to cut costs and run lean. So they can make do even in poor markets. Along this line I want to be involved in the lowest cost major copper miner. Here is a list of costs I got from various annual reports:
Company Ticker Operating Cost/Lb.
Southern Peru SCCO 1.06
Freeport FCX 1.52
Rio Tinto RIO NA
Billiton BHP 1.13
Codelco 1.35
Antofagasta ANTO 1.40
Quantum FM 1.40
Anglo Amer AAL NA
These numbers are mine from various sources. SCCO is the lowest cost major. It is also close to a pure copper play.
So this is a dilemma. I'm still bearish copper, but I like the company. Sounds like a spread trade to me! Here's a graph of the spread at aproximately one to one value ratio of stock to copper.
(Apologies for the poor graphic; I was in a hurry and just lifted it from my trading platform. I usually prefer to do stats and graphics in R even tho it takes a little work.) The point is that this looks like it has gone parabolic since 2014. Actually, the scale is pretty tight, and I think it has a ways to go yet.
One more thing: if you are willing to pay some more in trading costs, you can look at the SCCO junk bonds instead. These are yielding 7.4%. Of course their delta to copper prices is a little less, so you wind up shorter copper.
I said in the last post that I was going to start a series on the milk and egg markets, both of which have some interesting prospects. But I've gotten several emails asking me to spend some time on more specific trades. So I've added a new page about the trades I actually have on. You can get to it from the right hand side on this page. Here's one that I have on now...
One commodity strategy that has proved profitable over the years is to buy the low cost producer during the down part of the cycle. This is a highly contrarian trade for two reasons. First, all producers will be doing badly when prices of their product are low. Second, P/E ratios are normally very high since earnings are so low. The key is being able to wait out the cycle and eventual high returns.
But not all producers are able to wait it out. Some will go broke. Others will survive but have to have severe recapitalizations. That's the reason I like the low cost producers. Normally they will continue to make some profit even in the lean years. So their chances of survival are high.
So let's talk about copper. Prices are down from their highs, but still not extremely cheap. Here's the graph I introduced in Post Number 2, but for copper only:
Now the stocks of commodity producers often bottom before the commodity itself. This is because the producers have the ability to cut costs and run lean. So they can make do even in poor markets. Along this line I want to be involved in the lowest cost major copper miner. Here is a list of costs I got from various annual reports:
Company Ticker Operating Cost/Lb.
Southern Peru SCCO 1.06
Freeport FCX 1.52
Rio Tinto RIO NA
Billiton BHP 1.13
Codelco 1.35
Antofagasta ANTO 1.40
Quantum FM 1.40
Anglo Amer AAL NA
These numbers are mine from various sources. SCCO is the lowest cost major. It is also close to a pure copper play.
So this is a dilemma. I'm still bearish copper, but I like the company. Sounds like a spread trade to me! Here's a graph of the spread at aproximately one to one value ratio of stock to copper.
(Apologies for the poor graphic; I was in a hurry and just lifted it from my trading platform. I usually prefer to do stats and graphics in R even tho it takes a little work.) The point is that this looks like it has gone parabolic since 2014. Actually, the scale is pretty tight, and I think it has a ways to go yet.
One more thing: if you are willing to pay some more in trading costs, you can look at the SCCO junk bonds instead. These are yielding 7.4%. Of course their delta to copper prices is a little less, so you wind up shorter copper.
New Page
I've gotten several emails asking me to spend some time on more specific trades. So I've added a new page about the trades I actually have on. You can get to it by clicking on "Current Positions" on the upper right hand side on this page.
Monday, November 9, 2015
Who's the Current Sucker?
POST 6 - Who's the Current Sucker?
Garrison Keillor, the NPR host and comedian has a tagline about a town where "all the children are above average." It's somewhat funny (at least it was the first time), and highlights what this post is about. The fact is that generating positive alpha is a zero sum game. For every supergenius hedge fund manager who outperforms, there is a corresponding schlub who loses. So one way of analyzing the markets is figuring out who the suckers are and how much money they have to lose.
In the past there was a steady and reliable supply of suckers. In the equity markets they were retail investors and actively managed mutual funds. There have been numerous studies, both from academics and industry, that show these two groups underperform. So there was a lot of alpha on the table to harvest. The rise of index funds and ETFs have sharply reduced this. Note that hedge funds have underperformed a balanced portfolio for about fifteen years.
In the commodity space, the situation is a little more complicated. Sure, the retail commission house customer is a reliable loser. But another loser is the passively managed funds. Why? Because these index funds regularly come to the market to roll very large positions. The short term traders see them coming (I was going to say "the floor", but that dates me.) and front run their rolls. Over time this adds up to a lot of money.
Another important set of losers, more important to my style of trading, are the financial investors. These are long-only portfolio investors who buy the commodity asset class as part of their portfolio. Now we can argue whether commodities ex gold are in theory a reasonable part of of a balanced portfolio. But what happens in practice is that these buyers come in when commodities go up, and they leave when commodities go down. In other words they are late stage trend followers.
I started my trading career in the 70s, during the big commodities run up. I remember the financial investors (We called them crossovers.) coming in in the late 70s and early 80s. I remember the analyses they wrote about the portfolio diversification commodities would give. I am ashamed to admit that I even wrote one for a commodities hedge fund. Well, what happened? Volcker tightened, and the bubble burst. Commodities went down in real terms for twenty years (see Post 1). The crossovers crossed back again, back into stocks and bonds and out of commodities. In net they lost a lot. It gave that generation of investors a bad taste about commodities.
It took another generation to repeat the mistake, but repeat they did. In the 70s, the mantras were non correlation and inflation. In the 00s, the mantra was BRIC. Same result. We are now in the stage of their exiting commodities. I believe we still have a ways to go on this. The point is that once they leave, they won't be back soon. So a large pool of commodity suckers has left the table.
What does this mean for trading? It means that we should be looking for singles and doubles, not home runs. It also means we should favor mean reverting trades rather than momentum. The late stage momentum guys will not be there to bail you out.
P.S. I realize the last few posts have been pretty general and not about tradable ideas. I'll get to that in then next post.
Next Post - Milk and Eggs for Breakfast
Garrison Keillor, the NPR host and comedian has a tagline about a town where "all the children are above average." It's somewhat funny (at least it was the first time), and highlights what this post is about. The fact is that generating positive alpha is a zero sum game. For every supergenius hedge fund manager who outperforms, there is a corresponding schlub who loses. So one way of analyzing the markets is figuring out who the suckers are and how much money they have to lose.
In the past there was a steady and reliable supply of suckers. In the equity markets they were retail investors and actively managed mutual funds. There have been numerous studies, both from academics and industry, that show these two groups underperform. So there was a lot of alpha on the table to harvest. The rise of index funds and ETFs have sharply reduced this. Note that hedge funds have underperformed a balanced portfolio for about fifteen years.
In the commodity space, the situation is a little more complicated. Sure, the retail commission house customer is a reliable loser. But another loser is the passively managed funds. Why? Because these index funds regularly come to the market to roll very large positions. The short term traders see them coming (I was going to say "the floor", but that dates me.) and front run their rolls. Over time this adds up to a lot of money.
Another important set of losers, more important to my style of trading, are the financial investors. These are long-only portfolio investors who buy the commodity asset class as part of their portfolio. Now we can argue whether commodities ex gold are in theory a reasonable part of of a balanced portfolio. But what happens in practice is that these buyers come in when commodities go up, and they leave when commodities go down. In other words they are late stage trend followers.
I started my trading career in the 70s, during the big commodities run up. I remember the financial investors (We called them crossovers.) coming in in the late 70s and early 80s. I remember the analyses they wrote about the portfolio diversification commodities would give. I am ashamed to admit that I even wrote one for a commodities hedge fund. Well, what happened? Volcker tightened, and the bubble burst. Commodities went down in real terms for twenty years (see Post 1). The crossovers crossed back again, back into stocks and bonds and out of commodities. In net they lost a lot. It gave that generation of investors a bad taste about commodities.
It took another generation to repeat the mistake, but repeat they did. In the 70s, the mantras were non correlation and inflation. In the 00s, the mantra was BRIC. Same result. We are now in the stage of their exiting commodities. I believe we still have a ways to go on this. The point is that once they leave, they won't be back soon. So a large pool of commodity suckers has left the table.
What does this mean for trading? It means that we should be looking for singles and doubles, not home runs. It also means we should favor mean reverting trades rather than momentum. The late stage momentum guys will not be there to bail you out.
P.S. I realize the last few posts have been pretty general and not about tradable ideas. I'll get to that in then next post.
Next Post - Milk and Eggs for Breakfast
Thursday, November 5, 2015
Oil and the Saudi budget
POST NUMBER 5 - Oil and the Saudi budget
The name of this blog is The Commodity Strategist, so I plan to concentrate on longer term issues instead of reacting to news coming off the tape. However, there were a few pieces of news on the oil front that that do have longer term implications. So here's my take:
There's a widespread view in the oil markets that Saudi Arabia is playing a game of chicken with various higher cost oil producers, especially the US shale industry. The theory is that the Saudis will overproduce to keep the price low enough that shale goes broke and then raise the price again. And if the low price hurts Russia and Iran, so much the better.
This really underestimates the Saudis. They have been in the oil business for a long time and have seen many cycles. I'm sure they realize that they cannot keep the price of oil above its long run supply cost for very long. If they do, it winds up crashing, just like a year ago. If OTOH they cut production unilaterally to support the price, world production will continue to increase. In the limit, their production goes to zero. Not good!
So I'll bet that they see sub $75 prices as a steady state. This should be enough to curtail a lot of high cost production - as it has already. They do have a major problem though. In the last few years, Saudi government spending has exploded. That's what happens when the government is taking in a gazillion dollars per year with $100 oil.
Saudi Government Breakeven Oil Price
2010 $69 / bbl.
2014 $106 / bbl.
The increase in government spending was pretty much broadly distributed: education, social services, government payrolls, defense, air conditioned soccer stadia, gold plated Mercedes, etc.
The information we have gotten recently is that they are getting serious about reducing spending. The 2015 budget was originally set at $229 billion. With that level the IMF is forecasting a $107 billion deficit. So far the Saudis have said they plan to cut investment by 10% (that includes the stadia and gold plated Mercedes) and to borrow another $27 billion.
All parties know that this won't be enough to stabilize the financial situation. The good news for them is that there are some almost painless cuts that can be made. Most obvious is the subsidy for gasoline. The UAE has recently eliminated this. It's easy to do with oil prices already low enough that it won't result in a huge extra cost to consumers. Some commentators have said that cutting back on payrolls and social services will make the population restless, but I see no actual evidence of that.
The budget path the Saudis take has long run implications for oil. If they continue on the path of right sizing their government spending, it means we are in for a long period of oil price stability at around these levels. In this scenario my feeling is that the price will slowly climb to maybe $65 in 2015 dollars, but it won't be quick enough to make a trade. This is bullish for most world economies since they will not have the price instability to upset planning.
OTOH, if they do not do this, there will be trouble down the road. They can finance things as is by drawing down reserves and foreign assets. They can also ramp up their borrowing; I'm sure the long-only geniuses who bought the subprime paper will gladly buy their's also. The result: wildly fluctuating oil prices, an eventual default and probably a turn for the worse in the middle east (yes, that is possible).
NEXT POST - Who's the Sucker Now?
The name of this blog is The Commodity Strategist, so I plan to concentrate on longer term issues instead of reacting to news coming off the tape. However, there were a few pieces of news on the oil front that that do have longer term implications. So here's my take:
There's a widespread view in the oil markets that Saudi Arabia is playing a game of chicken with various higher cost oil producers, especially the US shale industry. The theory is that the Saudis will overproduce to keep the price low enough that shale goes broke and then raise the price again. And if the low price hurts Russia and Iran, so much the better.
This really underestimates the Saudis. They have been in the oil business for a long time and have seen many cycles. I'm sure they realize that they cannot keep the price of oil above its long run supply cost for very long. If they do, it winds up crashing, just like a year ago. If OTOH they cut production unilaterally to support the price, world production will continue to increase. In the limit, their production goes to zero. Not good!
So I'll bet that they see sub $75 prices as a steady state. This should be enough to curtail a lot of high cost production - as it has already. They do have a major problem though. In the last few years, Saudi government spending has exploded. That's what happens when the government is taking in a gazillion dollars per year with $100 oil.
Saudi Government Breakeven Oil Price
2010 $69 / bbl.
2014 $106 / bbl.
The increase in government spending was pretty much broadly distributed: education, social services, government payrolls, defense, air conditioned soccer stadia, gold plated Mercedes, etc.
The information we have gotten recently is that they are getting serious about reducing spending. The 2015 budget was originally set at $229 billion. With that level the IMF is forecasting a $107 billion deficit. So far the Saudis have said they plan to cut investment by 10% (that includes the stadia and gold plated Mercedes) and to borrow another $27 billion.
All parties know that this won't be enough to stabilize the financial situation. The good news for them is that there are some almost painless cuts that can be made. Most obvious is the subsidy for gasoline. The UAE has recently eliminated this. It's easy to do with oil prices already low enough that it won't result in a huge extra cost to consumers. Some commentators have said that cutting back on payrolls and social services will make the population restless, but I see no actual evidence of that.
The budget path the Saudis take has long run implications for oil. If they continue on the path of right sizing their government spending, it means we are in for a long period of oil price stability at around these levels. In this scenario my feeling is that the price will slowly climb to maybe $65 in 2015 dollars, but it won't be quick enough to make a trade. This is bullish for most world economies since they will not have the price instability to upset planning.
OTOH, if they do not do this, there will be trouble down the road. They can finance things as is by drawing down reserves and foreign assets. They can also ramp up their borrowing; I'm sure the long-only geniuses who bought the subprime paper will gladly buy their's also. The result: wildly fluctuating oil prices, an eventual default and probably a turn for the worse in the middle east (yes, that is possible).
NEXT POST - Who's the Sucker Now?
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