Tuesday, December 02, 2008

Commodities Are a Joke

Welcome to the new month....it's the same as the old month!

Frankly, Macro Man isn't sure what to make of yesterday's price action. A week of low-volume aggressive rally is followed by a day of moderate-volume, aggressive sell-off. As he noted last week, it's difficult to discern any forecasting edge for short-term price action.

What we can say is that the bear market remains alive and well. Yesterday's shellacking made it onto Macro Man's list of top 15 worst market days since the end of the first world war. As a public service, he has created a "league table" of bad days, which he will endeavour to maintain on the right side of the website.

Somewhat ominously, Macro Man's preferred (proprietary) measure of risk aversion has started heading lower again, having consolidated in the second half of November at levels suggesting that markets were merely "very" risk averse, rather than the prior shotgun-and-canned-goods of aversion prevailing in October. It doesn't exactly augur for a quiet end to the year.
Yesterday was notable for a couple of other reasons, as well. The NBER has finally acknowledged that the US economy is in a recession; there is no word yet on a likely timetable for announcing the start of the depression. Ben Bernanke, meanwhile, sketched out a roadmap for further policy easing, a game plan that includes the outright purchases of long-term Treasuries to "spur aggregate demand."

As always, however, large government actions carry unintended consequences. While lower long-term rates may be seen as a boon to spending, they also substantially increase the net present value of pension fund liabilities. Coming at a time when declining asset performance has left a hole in pension funds' balance sheets, lower long term rates make the asset-liability mismatch even worse. Among those funds most adversely affected include, quelle surprise, the defined-benefit plans of the Big 3, who themselves are lobbying for fresh government bailouts.
Whether it's pension funds scrambling for duration or exotics desks scrambling for hedges, the performance of the 30 year swap in the US has been truly awe-inspiring. While 30 year swap spreads are off their lows, they still remain sharply negative; the latest print on Macro Man's screen is - 43 bps. Intriguingly, 30 year rates are going so low that asymptotic considerations may soon come into play. Assuming that LIBOR rates do not go negative (and they didn't for any observable period in Japan), your max loss from paying these swaps should be the nominal rate in any one year time horizon. So if you pay it in, say, $10k/bp, you won't lose more than $2.78 mio per year. You won't necessarily make that much per annum either, but Macro Man would argue that this trade is approaching a very high likelihood of ultimate success. Food for thought....
Elsewhere, one of the stories of 2008, when the history is finally written, will be the implosion of the "commodities as an asset class" investment theme. If the pension fund portfolio return chart above had included a 5% allocation to commodities, the returns would look even worse.

One of the silver linings of the commodity market implosion, however, has been the opportunities afforded to people of Macro Man's vintage to indulge in what can only be called "dad jokes".

Macro Man's colleagues cringe whenever commodities edge lower, as he is apt to come up with "gems" like the following:

* Oil is getting drilled
* Oil isn't looking too slick
* Nat gas is getting burned
* Gold has lost its luster
* Silver's looking tarnished
* Copper's getting smelted
* Wheat's getting scythed down
* Sugar ain't looking too sweet
* Coffee's getting roasted
* Cotton's getting put through the mill
* Soybeans have been crushed
* Cocoa isn't too hot

All in good fun, of course, and readers are invited to submit their own efforts. For anyone or any fund who bought into the hype in the first half of this year, however, the performance of commodities is no laughing matter.


Anonymous said...

Tin's roofing


Anonymous said...

ps I appreciate that makes more sense in a bull market but, bof

Macro Man said...

In the meantime.....tin's getting canned? Nickel ain't worth a dime?

Anonymous said...

lean hogs are getting slaughtered?

Anonymous said...

pork bellies are getting stuffed

NordicDude said...

OK, brace yourselves:

* Lumber's getting nailed
* Milk's getting creamed
* London potatoes got mashed
* Lean hogs are starting to stink
* Electricity has lost it's spark
* Orange juice market is getting squeezed
* Coal's gone up in smoke
* The cashew market is nuts
* Frozen shrimps are getting battered
* The rubber market failed to bounce

Anonymous said...


what is the politics around starting this, why and who in the ecb want to sink the pound

Brian said...

corn got popped

"Cassandra" said...

Oats are getting rolled
Scrap steel is getting crushed
Freight-futures are getting deep-sixed
Heating-oil is ummm errrr .... tanking?

Anonymous said...

macro man you've created a monster...
anon @ 11.29, it's probably the illuminati or else the new world order.. unless its the rosacrucians or opus dei of course.. maybe the "world's best newspaper" will run a follow-up tomorrow

Macro Man said...

Bravo, Nordic Dude...well done. You obviously have kids to make that many bad jokes. Cannot believe I forgot hogs get slaughtered!

Macro Man said...

As for the Daily Express article...I wish you hadn't posted that, anon. I was eating my lunch, and seeing the leering visage of Mandelson was almost more than I could take. I am close to convinced that that guy is Nosferatu or some other sinister creature of the underworld, and there is very little that I would put past him.

That having been said, the Daily Express is about as trustworthy as the Weekly World News when it comes to...err...news.

Macro Man said...

Cassie...surely freight is sinking?

SD said...

MM - Still sportin' the receiver on the DI rates? (hope so anyways!) Trade of week seemms to be receive DI, buy USDBRL for better risk/return... what u think of that?

Macro Man said...

SD, yes...though I am looking to roll, and finding that the bid/ask on vol in that market is as wide as the Grand Canyon. It seems like once you have a position, you need to give it a wedding ring, because you are married to it, such is the disparity in bid/ask.

Anonymous said...

Mandelson should be drowned in guacamole...sorry, mushy peas.

Anonymous said...

Wool is unraveling

Arcturus said...

Macro Man,

In the section where you discussed the 30yr swap spreads, were you saying that risking $10k/bp your max downside on that trade is $2.78 million? Sorry, was just confused if mio was a misprint. Thanks.

Christian said...

Sterling is err... disappearing?

Anonymous said...

Arcturus, he is correct - the picture shows 30yr trading at 2.78, hence at 10k/bp (assuming libor can go no lower than 0) that's a max loss of 2.78mm.

Trying to move your dad jokes to the FX space...
Cable's been chopped?

Darth Trader said...

Was the market not down 8.93% on Monday, thus putting the down day into the top 10 post war?

Steve said...

Speaking of commodities and uhm China, MM have you noticed the yuan over the past two days?

Still trying to eek out a decent month...and this seems like the way to do it. I can't trade the yuan, or even the Chinese stock market, but I'm looking for the knock-on effects. Seems to me that oil could actually benefit (despite the initial reaction) since the stimulus to the Chinese economy will probably offset the higher cost of fuel, which is at any rate fixed by the govt.

Any interest? Thoughts?

Anonymous said...

Macro man

correct me if i'm wrong but concerning the 30y US swap, your max drawdown on this trade (paying 10kUSD/bp)could be much bigger than 2.78M per annum...

I think you forgot the convexity effect : if yields were to collapse, the sensitivity of your position will dramatically increase (for example, for an immediate fall of 100bps of the whole curve structure, the sensi will increase from 10K to 13K), so each marginal bp fall will increase your loss...
In that case, you won't lose 1M USD but 1.1 M USD
and if yields were to fall by 200bps, you wouldn't lose 2M but 2.6M...

That's the convexity effect : you need 5M USD nominal for 10KUSD/bp when yields are at 2.78, but the same nominal won't have the same sensi if yiels move significantly (and that won't be so much surprising given the current volatility !!!)

Macro Man said...

Anon, yeah, you're right, I foolishly didn't account for convexity. I do think the issue of the zero bound is an important one...at some point the risk/reward will just look too good for me to pass up.

Steve, I think it's a bit of a leap to go from China letting the currency weakening to a concomitant demand-driven bid for oil. There are a lot of intermediate steps (and time) that will have to occur before that chain can make an appreciable impact on the price, IMHO.

Darth, I use logarithmic rather than arithmetic returns.....hence my somewhat different figures.

Steve said...

MM I have to agree the impact if any would not be immediate and in fact oil is making new lows. I wonder though if Asia can give a bid hand to Team 850. I have been right with you in the bear equity trenches but am now playing from the (small) long side thinking that for krissakes is there no pony in this room full of road apples?? TARP and all the rest, oil below $50m 30-year mortgages dropping 90bp IN ONE DAY...

Sold some Gilts at the close too, went from medium long to small short, "we'll see how THAT works out..."

Anonymous said...

Corn came a cropper.
Oranges got squeezed.
The egg dropped.
Beef got pounded.
Beer went flat.
Tomatoes went splat.
Potatoes were fried.
Spices burned.
Cement is cracking.
Rubber was vulcanized.
Uranium got nuked.
Coal came off the mountain top.

Anonymous said...

rubber melted
palm oil spread

sorry trying to get exotic here..no i do not want to rec 30y ...swaps

love ur blog

Pizza Dude said...

Well if you look at commodities overall... one could only conclude that they all

" Tossed their cookies "

And are now praying to the porcelain "god" and gonna have a bad hangover for a couple years

Anonymous said...

Hi Macro Man,

Your proprietary risk indicators show good correlation with market tops and bottoms. (vs SPX Index)

It is probably difficult to judge the direction over the next few weeks.

We are currently 2 Standard Devi's away from normal range, but we might just remain here, hey?

Anonymous said...

Surely sterling should now be called "Ugly Betty"?

Ray said...

damn macro man im afraid to bother u ur so busy!! but very nice work with the site, very well written

Anonymous said...

in FX world..
long overnight brazillian straddle..