February 26, 2005
Technical Analysts on a Downwave
The world's biggest financial services firm last week dismissed its entire stock market technical analysis team, including longtime analyst Louise Yamada, group leader who had been with the bank for nearly a quarter of a century.
Citigroup stated that the firing of Yamada and her team is part of an effort to control expenses, and the company is planning to eliminate up to 1,000 jobs from its global corporate and investment banking division:
Citigroup Eliminates Stock Technical Analysis Group
Naturally this released yet another barage of the customary anti-technical analysis invective which seems to emerge at every opportunity:
Technical analysis--you're fired! Is there any value to this controversial stock picking method?
I'm sure TA techniques could be used to spot just such denigrating opportunities!
However, I think it important to highlight the fact that Citigroup never claimed that TA doesn't work. The action simply implies that their customers just aren't buying the analysis that the company is producing. Instead they choose to focus their remaining analytical resources on fundamental analysis. Let's face it, with its roots firmly planted in facts and figures - the average investor finds this much easier to comprehend.
But for a trader, whilst the analysis of fundamentals plays a part and should never be ignored, it's importance for short term trading, day trading, swing trading, etc. is much less pronounced.
For example, we know that the markets can move dramatically at the time of fundamental announcements. Depending upon individual trading style, this will tell us either to keep out of the markets altogether at these times, or be prepared to act quickly upon specific signals. The news release of fundamental announcements are a time for skilled traders to make huge gains when positions are correctly managed.
So that's fine - people have voted with their feet and market forces have done their work - nothing changes - which is why TA is such a useful trading tool!
Posted by Tony at 08:04 PM | Comments (0)
February 23, 2005
Oil and Dollar Relations
So, the price of crude is again on the ascendant, and, guess what? - that's right! - the dollar's falling back from its recent highs. Nothing new there. And as active market traders, don't we just love this level of volatility!
In a former (one of several) life, I worked in the petroleum industry - and there was nothing better than to see a rise in the price of crude. It meant more exploration, more drilling ... more, yes - a word we don't here too often these days ... INVESTMENT.
And all of this was great too for the then ailing UK economy, which still relies heavily upon North Sea oil revenues - a huge proportion of the price of petrol (gasoline) at the pumps is actually tax. It also meant more jobs in the (also ailing, and indeed disappearing) construction and fabrication industries. So, all in all, oil price rises, in a nation accustomed to petroleum prices at 4 times or more higher than those in the US, could be considered as, well ... beneficial (although not generally appreciated to be such by the typical consumer). But, in any event, the impact of a dollar or two ... or even 10 ... on the price per barrel was not a mega-burdon.
Clearly this is not so at the other side of the Atlantic. And, let's face it, the United Kingdom doesn't exactly have a "UK Dream" to support.
But let's take a closer look at the relation between oil and dollar prices:
Briton L Ryle, Chief Trading Strategist at Money-Flow Matrix Trader has this to say:
"Crude futures jumped back over the US$50 mark today. And as you might guess, stocks and the US dollar went lower. There are rumblings that oil exporters and Russia are converting dollars into euros and that’s pressuring the dollar. But should that have an effect on crude?
Actually, yes.
It seems that anytime oil rises, the dollar falls. If you superimpose a US dollar chart over a crude chart, you’ll clearly see the relationship. But it’s important to understand that the relationship is not casual. Like gold, oil should rise when the dollar drops.
That’s because crude oil is denominated in US dollars. Forget supply and demand dynamics for a minute. Forget China’s insatiable appetite for crude. Ignore the financial media’s fixation on weather reports for the Northeastern United States and what that means for heating oil.
The single biggest force on the price of oil is the US dollar. And that’s because the price of oil represents the real buying power of the dollar. It’s not a fixed peg that implies a benefit, such as can be found with the US trade deficit.
Since 2000, the US dollar has lost around half its value. Crude oil consistently traded below US$20 a barrel during the late 1990’s. And it wasn’t until OPEC adopted the US$22-to-US$28 price band on March 28, 2000, that crude prices got above US$20 a barrel for good.
Stocks are down today because of the appearance of that US$50-a-barrel price on the tape. But if the stock market was going to crash because of high oil prices, it would have done so already. The fact is, US GDP growth is largely immune to higher oil prices, as we’ve seen.
The US economy grew at a 3.1% rate in the fourth quarter. Crude prices ran between US$45 and US$55 during that same period. Low interest rates and rising income will keep US consumers spending enough to maintain US GDP growth at 3% to 3.5% - regardless of whether crude futures are trading for US$40 or US$50 a barrel.
Most oil analysts expect flat to lower prices for the remainder of the year. And yet nobody is willing to go on record and predict a rally for the US dollar. But, interestingly, one of the biggest dollar bears in the world over the last few years, George Soros, isn’t forecasting more declines for the US dollar. Rather, he’s linked its fate to crude prices.
Now, a guy like Soros can always be expected to talk his position. If he wants to cover a dollar short, he’ll say publicly that the dollar is going down. So in light of his apparent candor, I can only assume that Soros currently has no position in the US dollar. Maybe he’s long the euro.
There’s one thing that all the hand wringing about the dollar and oil proves - there is an abundance of fear in the market right now. This despite the fact that the economy is on pace for 3% to 3.5% growth, the forward P/E for the S&P 500 is moderate at around 20, fourth-quarter earnings were above expectations, and economic data is coming in mostly as expected."
You can find the latest data on oil and gasoline prices, presented graphically, here: Crude Oil & Gasoline Prices
As I said at the beginning - great news for traders!
Posted by Tony at 02:02 PM | Comments (0)
February 13, 2005
Trading: Don't be Married to your Position
People who constantly change their minds are often thought of as flighty, inconsistent, even unreliable.
Nassim Nicholas Taleb, in a recent article published in The Daily Reckoning, wants to prove that theory wrong and show that those who start each day with a clean slate and new ideas make the most rational investors.
He claims that in today’s world, self-contradiction is considered culturally to be shameful, and goes on to quote from Proust, whose novel A la Recherche du Temps Perdu ("In Search of Lost Time") features a semi-retired diplomat, the Marquis de Norpois, who, like all diplomats before the advent of the fax machine, was a socialite who spent considerable time in salons. The narrator of the novel sees the Marquis openly contradicting himself on some issue (a pre-war rapprochement between France and Germany). But when reminded of his previous position, he did not seem to recall it. Proust reviles him:
"Monsieur de Norpois was not lying. He had just forgotten. One forgets rather quickly what one has not thought about with depth, what has been dictated to you by imitation, by the passions surrounding you. These change, and with them so do your memories. Even more than diplomats, politicians do not remember opinions they had at some point in their lives and their fibbings are more attributable to an excess of ambition than a lack of memory."
The Marquis is made to be ashamed of the fact that he expressed a different opinion. Proust did not consider that the diplomat might have changed his mind. We are supposed to be faithful to our opinions or be considered a traitor!
It should be mentioned at this point that Taleb is a trader and professor of mathematics, specializing in the risks of unpredicted rare events ("black swans"), who has held senior trading positions in New York and London, before founding Empirica, a trading firm and risk research laboratory.
And Taleb believes that the Marquis would also have made a good trader. However, he considers that the public person most visibly endowed with such a trait to be George Soros, one of whose strengths being the facility to revise his opinion rapidly, without the slightest embarrassment. He goes on to provide an anecdote perfectly illustrating Soros' ability to reverse his opinion in a flash:
The French playboy trader Jean-Manuel Rozan discusses the following episode in his autobiography (disguised as a novel in order to avoid legal bills). The protagonist (Rozan) used to play tennis in the Hamptons on Long Island with Georgi Saulos, an "older man with a funny accent," and sometimes engage in discussions about the market, not initially knowing how important and influential Saulos truly was. One weekend, Saulos exhibited in his discussion a large amount of bearishness, with a complicated series of arguments that the narrator could not follow. He was obviously short the market. A few days later, the market rallied violently, making record highs. The protagonist worried about Saulos, and asked him at their subsequent tennis encounter if he was hurt. "We made a killing," Saulos said. "I changed my mind. We covered and went very long."
What characterizes real speculators like Soros, differentiating them from the rest is that their activities are devoid of path-dependence. They are totally free from their past actions. Every day is a clean slate. Quoting from Taleb:
"There is a simple test to define path-dependence of beliefs (economists have a manifestation of it called the endowment effect). Say you own a painting you bought for $20,000, and owing to rosy conditions in the art market, it is now worth $40,000. If you owned no painting, would you still acquire it at the current price? If you would not, then you are said to be married to your position. There is no rational reason to keep a painting you would not buy at its current market rate – it is an emotional investment. Many people get married to their ideas all the way to the grave. Beliefs are said to be path-dependent if the sequence of ideas is such that the first one dominates.
There are reasons to believe that, for evolutionary purposes, we may be programmed to build a loyalty to ideas in which we have invested time. Think about the consequences of being a good trader outside of the market activity, and deciding every morning at 8 a.m. whether to keep the spouse or part with him or her for a better emotional investment elsewhere. Or think of a politician who is so rational that, during a campaign, he changes his mind on a given matter because of fresh evidence and abruptly switches political parties. That would make rational investors who evaluate trades in a proper way a genetic oddity - perhaps a rare mutation. Researchers found that purely rational behavior on the part of humans can come from a defect in the amygdala that blocks the emotions of attachment, meaning that the subject is, literally, a psychopath. Could Soros have a genetic flaw that makes him rational as a decision maker?
Such trait of absence of marriage to ideas is indeed rare among humans. Just as we do with children, we support those in whom we have a heavy investment of food and time until they are able to propagate our genes, so we do with ideas. An academic who became famous for espousing an opinion is not going to voice anything that can possibly devalue his own past work and kill years of investment. People who switch parties become traitors, renegades, or, worst of all, apostates - those who abandoned their religion were punishable by death."
You can read the full article here: Spotless Minds
Taleb's interests lie at the intersection of philosophy, mathematics, finance, literature and cognitive science, but he has stayed extremely close to the ground, thanks to an uninterrupted two-decade career as a mathematical trader.
His book Fooled by Randomness, into its second edition in 2004, has been published in 14 languages, and the author's ideas on sceptical empiricism have been covered by hundreds of articles around the world. In it he examines what randomness means in business and in life and why human beings are so prone to mistake dumb luck for consummate skill.
Posted by Tony at 07:52 PM | Comments (1)
February 11, 2005
Oil & Stocks: Is There Really Any Connection?
Every day, you hear that “high energy prices are bad for the stock market.” You may be shocked to learn, however, that financial “experts” were saying exactly the opposite five years ago.
So which is it – are high oil prices good or bad for stocks?
I recently came across a research paper which appeared in the Special Section of the August 2004 Elliott Wave Theorist, Robert Prechter’s monthly market analysis publication:
OIL AND STOCKS: A CRUDE CONNECTION
by Tom Denham
For decades, people have fixated on some economic indicator du jour as the key driver of stock prices. This idea is seductive because, as Robert Prechter has noted many times, it helps investors “explain” otherwise mysterious market phenomena. In the 1980s, it was the weekly money supply report. Then it was the bond market and, off and on, inflation. Later it was the near-term trend of the U.S. dollar, and for a while, it was consumer confidence levels.
Each indicator came into vogue for a period of time and during that period was accepted without question. This acceptance occurred despite the fact that any decent historical analysis would have proved that the supposed correlation did not exist at all.
Current Conventional Wisdom
If you have been keeping up with conventional wisdom, you know that the indicator of the moment is the price of crude oil. Prominent market analysts claim that oil prices and stocks are inversely related, i.e. that rising oil prices are bearish for stocks and falling oil prices are bullish for stocks. Financial newspapers are replete with comments like these:
• “…historically high oil prices…pose a threat to global economic growth and the prospects for stock markets.” (29 May 2004)
• “The fall in oil prices…may bring some relief to financial markets.” (4 June 2004)
• “US stocks turn lower as oil price jumps.” (14 July 2004)
This is not the first time we have been told that oil prices are an indicator of stock trends. Before we investigate whether oil prices actually do correlate inversely with the price of stocks, we have two questions to explore.
1) Are Oil Prices Actually “Historically High”?
Speaking of “high oil prices” prompts the question, “What is high?” In December 1998, oil sold at $10.35/barrel. After seven months, in July 1999, it was 100% higher at $21.12. After 15 months, in March 2000, oil was 200% higher at $34.20. After nearly five and a half years, in June 2004, oil was 300% higher at $42.38. So when did oil become “too expensive”? At $20? $30? $40? If oil was not too high after climbing 100% or 200%, what makes oil suddenly too high after crossing 300%? Sticker shock at $40 oil is primarily a psychological event. How do we know this? Because real oil prices are actually substantially lower now than at several previous peaks. As Paivi Munter points out in “Bond Jury Out on Effects of Oil” (FT.com, 25 May 2004), “In 1979 to 1984, average annual prices in today’s money exceeded $50 a barrel for four consecutive years, reaching $72 in 1980.” Yet in the eyes of many, the issue of “high oil prices” now is bigger than ever. Apparently, perception of “historically high” oil prices is due as much to psychology as to actuality. We hasten to add that we are perhaps the most extreme bears on the planet with respect to stocks (for details, see Conquer the Crash), but the trend of “historically high” oil prices has nothing to do with our analysis, nor should it, as we are about to see.
2) If a Simultaneous Correlation Exists, Would It Be Valuable?
A prominent stock analyst recently asserted, “If crude oil extends today’s reaction, stock markets are likely to stage another technical rally. Conversely, if crude rallies, share indices will be under further pressure.” Fine. So what do investors know about next week? Answer: nothing. Even if we were to accept the analyst’s premise that oil prices drive stocks, unless he also tells us where oil prices are heading, his “forecast” is really no forecast at all. It tells us nothing about the path ahead for stocks. “It is not good enough to say, for instance, that stocks will go up as long as earnings increase,” Prechter wrote in The Wave Principle of Human Social Behavior. “You must predict earnings to arrive at a payoff. To do that, you need an indicator of earnings. And so on; the cycle is endless” when making external-cause claims.
Surprise, Surprise: There Is No Correlation
As with all external-cause claims relating to financial markets, there is a more serious problem with this supposed correlation between stocks and oil: It doesn’t actually exist.
People naturally default to the “external cause” model, borrowed from physics, when analyzing markets. This case, in which the price of oil is supposedly pushing stocks around, is no exception. But as Prechter explained and demonstrated in the May and June issues of The Elliott Wave Theorist, the laws of physics are not useful in describing or forecasting market behavior. Let’s take a moment to test the facts about the purported “obviously sensible” correlation between oil and stock prices.
The Standard Contradiction
If you were to perform a quick survey of Financial Times market-related headlines from 1999 to the present, you might be amazed to discover that the polarity of the presumed correlation had changed to suit circumstances. Prior to 2000, the newspaper cited rising oil prices as a reason stocks were heading up, but once stocks topped in 2000, it blamed rising oil prices as a reason stocks were moving down.
How could this possibly be? It’s quite natural, really. As Prechter states in The Wave Principle of Human Social Behavior, “[A] duality of meaning holds for all [such presumed external-cause] relationships.”(p.376) In the case of oil, one can convincingly argue, “Rising oil prices hurt transportation and electric utility companies and are therefore bad for the economy.” On the other hand, it is quite reasonable to assert, “A healthily expanding economy requires more energy consumption, which naturally leads to higher oil prices. What else would you expect?” As always, “fundamental” arguments (1) always appear sensible, (2) can be utterly contradicted by another sensible argument and (3) never explain the data. Refer to the following figure for a few examples relating to oil and the stock market:
Is There Any Consistent Correlation?
If the price of oil were a key driver of the stock market, we would see a consistent relationship between the prices of oil and stocks over time. Here’s a chart of the S&P Composite index and crude oil for the past 20 years. Notice that when oil peaked at $41.15 in 1990, the S&P was part-way along a two-decade rally. At crude’s next peak at $37.80 in 2000, the S&P was near a top. Then when oil spiked to $39.99 in 2003, the S&P was near a low. Likewise, oil’s four major lows during this time came at very different points in the trends for stocks. So anecdotally, at least, it appears that no relationship exists. But what about statistically?
Let’s take a look at the statistical correlation of the S&P Index and crude oil in 10-week segments. If these markets were truly correlated on this timeframe, we would see a flattish line somewhere near the “100” line in either the upper or lower panel. Instead, what we find is that the correlation swings erratically from positive to negative. Sometimes oil and stocks advance or decline together, sending the correlation into positive territory, and sometimes oil and stocks move inversely to each other, sending the correlation into negative territory. So statistically, there is no consistent relationship between the prices of oil and stocks on this timeframe.
Even on a longer term basis the swings are just as erratic. What’s more, the polarity of the relationship can change at any point; reversals sometimes occur at relative extremes and sometimes not.
Denham goes on to consider even longer time frames, reviewing ten notable swings in the price of oil over the past 20 years and tracks what happened in the S&P during those moves. In event #1, oil declined 70% into April 1986 while stocks rallied 56%. In event #2, oil rallied 322% into 1990, and stocks rallied 20%. In event #3, oil declined 67% into 1993, and stocks rallied 60%, a near inverse. But oil and stocks then trended together in event #4 into 1996, when crude oil rallied 95% and stocks rallied 52%. And so on. Of the ten significant oil swings in this list, five coincide with a stock move in the opposite direction, and five coincide with a move in the same direction. (Event #2 turns current conventional wisdom on its head, as it was oil’s biggest rise of all yet accompanied a substantial advance in stocks.) So we find negative correlation half the time and positive correlation the other half, which is no correlation at all.
The DAX, too
The lack of correlation is just as dramatic when we compare oil prices to the German DAX stock index, as demonstrated in the latest issue of The European Financial Forecast. Rest assured — with the socionomic insight as a guide — that you are unlikely to find any stock index that consistently tracks the price of oil.
Conclusion
To say it plainly, the data show no consistent relationship between oil and stocks of the type that conventional wisdom purports to be causally sensible. As we have already shown, even if there were, it wouldn’t help you predict stocks. Therefore, paying attention to stock forecasts based on the price of oil is a waste of time. Worse, they are setups for bad investment decisions. Shorting stocks on an oil spike (presuming you even knew that it was a peak, which you wouldn’t) or buying stocks at an oil trough may seem like a reasonable decision, but as this study shows, it’s simply a blind gamble, and rolling the dice is not an investment strategy.
As far as we can see, there is no consistent leading or lagging relationship between these two sets of data either.
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Posted by Tony at 02:35 PM | Comments (0)
February 10, 2005
Real Big Mac Value
Looking to invest globally? Let the Big Mac be your guide.
The Big Mac index is an informal way of measuring whether one currency is at the theoretically correct exchange rate with another currency. The measure assumes that the theory of purchasing power parity (PPP) holds.
The main tenet of PPP is that the exchange rate between two currencies should naturally adjust so that the cost of a sample basket of goods should cost the same in one currency. In the Big Mac index, the "basket" in question is considered to be a single Big Mac as sold by McDonald's. The Big Mac was chosen because it is available to a common specification in many countries around the world, with local McDonald's franchisees having significant responsibility for negotiating input prices. For these reasons, the index allows for meaningful comparison between many countries' currencies.
The Big Mac PPP exchange rate between two countries is obtained by dividing the cost of a Big Mac in one country (in its own currency) by that of a Big Mac in another country (likewise in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued compared with the second, and conversely, if it is higher, then the first currency is over-valued.
For example, suppose a Big Mac costs £2.00 in the United Kingdom and $2.50 in the United States; thus, the PPP rate is 2.00/2.50 = 0.8. If, in fact, the dollar buys £0.55, then the pound is over-valued with the respect to the dollar.
The Big Mac index was introduced by The Economist newspaper in 1986 and has been published by them regularly since then. The index also gave rise to the word Burgernomics.
To get the latest Big Mac data, you can find it on the Economist site here:
In January 2004, The Economist introduced another index, the Tall Latte Index. The idea is the same, except that the Big Mac is replaced by a cup of Starbucks coffee, acknowledging the global spread of that chain in recent years. In a similar vein, in 1997, they created a Coca-Cola map that showed a strong positive correlation between the amount of Coke consumed per capita in a country and that country's wealth.
The burger methodology has limitations in its estimates of the PPP. For example, local taxes, rates, levels of competition, and import duties for burgers may not be representative of the country's economy as a whole. Nevertheless, the Big Mac index has become widely cited by economists.
However, a major problem with such indices is that they completely omit to take into account historical differences. i.e. convenience food in many parts of Europe has a higher “perceived value” than in the USA – indeed the same applies to many items sold in shops (possibly related to the different values nations place upon labor).
So, for example, the typical difference (specifically, the median) has been for Big Macs in Britain to be 19% more expensive than in the States. So the fact that a Big Mac costs 20% more in the UK right now doesn't mean Britain's pound is 20% overvalued. It's about in line with history - which is NOT what most experts would tell you right now!
And yet --
Latest data published by The Economist indicates that the cheapest burger is in China, at $1.26, compared with an average American price of $3. This implies that the yuan is 58% undervalued relative to its Big Mac dollar-PPP. On the same basis, the euro is 25% overvalued, the yen 17% undervalued.
I'll leave you to draw your own conclusions!
Posted by Tony at 03:19 PM | Comments (0) | TrackBack
February 09, 2005
Curves, Peaks, Dips & Geophysics
I was going to make an "educational" post today on the subject of the "Big Mac Index" -- everyone knows what that is don't they! -- but the following article just came onto my desk. It's a follow-on from a previous article on oil demand. This article, again from the Rude Awakening newsletter, takes a look at the other side of the equation, oil supply:
By Eric J. Fry
Curves, Peaks and Dips
"Hubbert's Curve" is NOT part of the female anatomy...
But it is, nevertheless, a thing of beauty to long-term
crude oil investors.
Back in the 1950s, Shell Oil geophysicist, M. King Hubbert,
discovered a phenomenon he dubbed, "Hubbert's Curve."
The Shell geophysicist theorized that oil production from a
new field would tend to rise until about half the
recoverable oil had been produced, then peak and fall off
sharply, all along a classic bell-shaped curve.
Furthermore, Hubbert understood that in the real world of
crude oil production, the "second half" of the
theoretically recoverable reserves would be relatively more
difficult - and expensive - to extract, which would prompt
oil companies to abandon fields before extracting all
"recoverable" reserves.
Based on his theories, therefore, Hubbert predicted in 1956
that U.S. oil production would peak in the 1970s. Most of
his contemporaries scoffed at the notion. But his
prediction turned out to be surprisingly accurate. U.S.
production did indeed peak in 1970.
"Using the same model," writes Jeremy Rifkin, author of the
The Hydrogen Economy, "Hubbert estimated in 1971 that the
middle 80 percent of global oil production will be produced
within fifty-eight to sixty-four years, or less than one
lifetime."
In other words, 80% of the world's oil would have been
produced by 2035...at the latest.
"If M. King Hubbert is proven right once again, the world
has either reached or will soon reach peak global
production," observes Steve Belmont in a new report
entitled, "The Death of Cheap Oil." (Belmont is the Senior
Market Strategist for the Rutsen Meier Belmont Group LLC in
Chicago).
"Hubbert's predictions for exploration are also proving to
be true," Belmont continues. "Now that all the cheap
sources of oil have been found, oil companies are cutting
spending for new exploration. The windfall profits
generated by the 3-year run-up in crude prices are not
being spent on finding new oil, but on share-buybacks,
dividends and/or efforts to purchase already-discovered
reserves. Exploration is decreasing because today's
smaller, harder-to-drill fields provide less bang for the
exploration buck."
"Most geologists agree that there is still plenty of oil
left to be discovered," Belmont admits, "but given the cost
of extraction, it is not economically feasible at current
prices. The world may not be running out of oil. It is,
however, running out of cheap oil."
Even the world's largest oil producer may be running low on
"cheap oil"...or any kind of oil, for that matter. Saudi
Arabia pumps 13% of the world's oil and is responsible for
23% of the globe's reserves, making it the most important
player on the supply side, followed by Iran with 11% of the
world's reserves and Iraq with 9%.
"According to official Saudi state calculations," says
Belmont, "Saudi Arabia could produce at current levels of
10 to 11 million barrels per day for 50 years. However, we
view that number with a certain degree of skepticism.
Matthew Simmons, chairman of Simmons and Company
International - an investment bank specializing in the oil
industry says the official Saudi numbers are too high and
that Saudi fields are aging much faster...According to Mr.
Simmons, the Saudis need to strip water out of nearly every
well and this is a sign that Saudi fields are aging much
faster than the industry has planned for.
"Almost every oil field sits on top of water," Belmont
explains. "New oil wells draw up the crude first and have
almost no water content. As a field ages, more and more
water gets mixed with the crude oil. Wells that are almost
dead will reach a 'water cut' of 40%. According to Nasen
Saleri, manager, reservoir management at Saudi Aramco, the
'water cut' for Saudi wells in 2003 was 27%."
In other words, most of the easy-to-get stuff is gone and
only the hard-to-get stuff remains.
"Consequently," Belmont's report concludes, "we may have
entered an era of perpetual shock where supply and demand
are balanced so precariously that the slightest disruption
could send prices soaring. The world is currently using 98
percent of its producing capacity; OPEC was pumping flat
out in 2004 yet prices remained stubbornly high. This was
unprecedented in the short history of crude oil."
So there you have it, folks; demand is climbing and
supplies are dwindling...At least CHEAP supplies are
dwindling. So what's the far-sighted investor to do?
Belmont recommends call options on crude oil futures.
That's his business, of course. Steve is not a stockbroker;
he's an options broker on commodity futures. So naturally,
he prefers this medium as a way of capitalizing on the
crude oil rally he anticipates.
"Most investors think of energy stocks first," says
Belmont. "However, if you own the more well-known stocks
you also know that they haven't kept pace with crude oil
itself. History has proven that an investment in energy
stocks is not necessarily an investment in crude oil. In
fact, in the recent bull market, traditional energy stocks
have not returned anywhere near an investment in crude oil
itself - not by a long shot."
To illustrate his point, Belmont presents the nearby chart
showing "the relative performance of crude oil [versus]
Chevron Texaco since early 2002, a period that encompasses
most of the bull market. As of late December 2004, crude
oil had gained 157%. Chevron Texaco had gained only 16%.
There are numerous other examples of the same phenomenon."
Why not play crude oil directly, Belmont asks?
"NYMEX crude oil futures and options allow investors to
make bets on the movements of crude oil directly," he says,
"offering the cleanest possible play on this most essential
of all commodities. Crude oil futures are extremely
volatile, so we would not recommend trading them directly
for most investors. Crude oil call options are another
story. Crude oil call options trade on the New York
Mercantile Exchange or NYMEX...
"Each NYMEX crude oil call option," Belmont explains,
"gives the buyer of the call the right but not the
obligation to be long a futures contract covering 1,000
barrels of light, sweet West Texas Intermediate grade crude
oil at a specific price known in option jargon as the
'strike price.'...For example, as we write this report, the
spot (front) contract West Texas Intermediate crude oil
futures are trading at roughly $45 per barrel. Long-dated,
December 2006 $50 crude oil call options are going for
roughly $2.30. Multiply times the 1,000-barrel contract
size to get a total cost of $2,300 per option.
"At $60 per barrel, a $50 call would be worth at least
$10,000. Why? Because the holder of a $50 call could simply
exercise the right to be long at $50 per barrel and then
turn right around and sell his 1,000 barrels into the
market for the going rate of $60 per barrel. Multiplying
the $10 per barrel difference times the contract size of
1,000 barrels yields a gross profit of $10,000 per option.
Since our hypothetical option holder paid a premium of
$2,300 for the right to be long, the net profit on this
position would be the $10,000 gain minus $2,300 or $7,700."
Of course, options buyers should not forget that a DROP in
the oil price would render a $50 call option worthless.
Your editors at the Rude Awakening are prohibited from
revealing the exact option Belmont recommends currently.
But we can share his rules for buying options on crude oil:
1) Buy NYMEX calls with at least 15 months until
expiration.
2) Buy calls with strike prices no higher than 10% above
the spot crude price.
3) Pay no more than $2,500 for each option.
Lastly, Belmont advises, "Consider buying NYMEX crude calls
in multiples of two, holding one for the long term and
using the other as a trading position."
Your New York editor contacted Steve yesterday to find out
how Rude Awakening readers could reach him, in the event
that they wished to do so. "Well, I'll be skiing this
week," Steve said sheepishly. "So they should contact my
colleague in Chicago, Sue Rutsen, at 800-345-7026."
"Thanks, Steve."
Now that's what I call an "educational" post - not only educational but immediately "useful"!
The Rude Awakening is published daily alongside it's parent publication The Daily Reckoning
Posted by Tony at 04:24 PM | Comments (0) | TrackBack
February 08, 2005
In Memoriam: Cheap Oil
An article from today's Rude Awakening newsletter, which takes a look at oil supply and demand:
By Eric J. Fry
The world will not run out of oil any time soon...just
CHEAP oil...
So says a fascinating report that bears the title: "The
Death of Cheap Oil." The report's author, Steve Belmont,
Senior Market Strategist for the Rutsen Meier Belmont Group
LLC in Chicago, lays out a compelling - and somewhat
frightening - case for much higher oil prices.
Admittedly, oil prices might retreat a bit over the near
term, as evidenced by yesterday's $1.20 slide to $45.28 a
barrel, but Belmont believes the price of crude oil will be
much higher by the end of 2006 than it is today. He bases
his bullish call on the inevitable - he believes - clash
between shrinking supplies and soaring demand. To preview
his conclusion: Buy long-dated call options on crude oil.
In Today's Rude Awakening we highlight the first half of
Belmont's argument: oil demand. Tomorrow we'll examine the
supply side, while also revealing Belmont's suggested
course of action.
"Oil prices are vulnerable to a perpetual state of shock,"
Belmont's report begins, due to a 'new era' of soaring
demand, depleting supplies and semi-permanent geo-political
tension, especially in the Middle East. "The $40 per barrel
peaks of the past decade could easily become the floor of
the next," Belmont predicts. "$70, $80 or even $100 per
barrel oil is not only possible, but probable in the coming
decade."
As the Asian economies continue industrializing, the report
points out, demand for oil will soar...or at least it
should. "Total global demand for crude oil is currently 80
million barrels per day (MBD)," says Belmont. "Of those 80
million barrels per day, America's population of 293
million people consume roughly 22 MBD. Meanwhile, Asia's
3.6 billion people - well over 12 times the size of the
U.S. population - consumed just 20 MBD. Should Asian per-
capita-consumption rise from its measly 7% of U.S. per-
capita demand to a mere 14%, the market would have to
supply an additional 20 million barrels of oil per day.
This is one-fourth of today's entire global demand...
"Let's look at it another way," says Belmont. "U.S.
consumption of crude oil is roughly 28 barrels per person
per year. South Korea's annual per capita consumption is
17 barrels and so is Japan's. These are both developed
Asian nations. China is rapidly becoming a developed Asian
nation, yet its per capita consumption of crude oil is only
1.7 barrels per year." But Chinese demand is racing to
catch up. Crude oil imports to China jumped a whopping 33%
last year.
But, says Belmont, the bull case for oil does not rest
entirely on the magnitude of demand, but also on the
rapidly changing structure of demand. Now that the Chinese
are maneuvering to secure long-term oil supplies, for
example, future supplies available to other buyers will be
reduced.
The Chinese are actively negotiating to secure long-term
supplies from countries as geographically and politically
diverse as Canada, Saudi Arabia, Iran and Russia. Indeed,
the Chinese and the Russians have embraced one another in a
kind of petro-political bear hug. "When it comes to the
classic relationship between a natural resource producer
and a natural resource consumer," says Belmont, "no two
nations appear more perfectly matched than Russia and
China. Russia produces far more oil that it consumes.
China consumes far more oil than it produces. Both share a
Communist past, a long border complete with road and rail
links, and a history of uneasy relationships with the
world's largest oil consumer: America."
This commercial relationship is spilling over into the
political sphere. For the first time ever, the Russians
recently agreed to hold a large military exercise together
with China on Chinese territory. The exercise will take
place in the second half of the year and will include
'state-of-the-art weapons', according to Russian Defense
Minister, Sergei Ivanov.
As these former Cold War allies draw closer politically and
militarily, they will also draw closer commercially - a
trend that is likely to divert a growing share of Russia's
vast oil supplies away from world markets toward the
thirsty Chinese economy. "Now the China has entered the
game," says Belmont, "America will find itself competing
for shrinking supplies at every level. Over the long haul
that can only mean one thing - higher prices."
Meanwhile, as China and the rest of the world ramp up their
oil consumption, oil production is peaking. The world has
consumed an estimated 1 trillion barrels of oil since the
drilling of the first well in the mid-1800s - almost half
of known recoverable supplies. And no new giant oil fields
have been discovered recently. In fact, discoveries of new
oil reserves peaked in the 1960s and have been declining
rapidly ever since. U.S. oil production peaked in 1970;
North Sea oil production peaked in 1999.
"Given the likelihood that world crude oil production
cannot rise much above 90 million barrels a day," observes
Kevin Kerr, the man behind the Resource Trader Alert, "and
the fact that world demand will easily reach 90 million
barrels per day by the end of 2007, there is little chance
of cheap oil returning. It is unwise to count on sustained
oil prices below $35 to $45 per barrel to ever return
again. You're far more likely to see $100 oil than $35 oil
again."
The Rude Awakening is published daily alongside it's parent publication The Daily Reckoning
Posted by Tony at 08:42 PM | Comments (0) | TrackBack
The EWI Stable Currency Benchmark
Bob Prechter, President of Elliott Wave International and author of books such as "Conquer the Crash", unveiled the EWI Stable Currency Benchmark in his November 2004 Elliott Wave Theorist.
If you don't know about Elliott Wave analysis, now would be a good time to start learning. You can find out more about it here: Elliott Wave Theory
Here's Bob Prechter's reasoning behind the new benchmark, in his own words:
"It's time to divorce our measures of value from individually (mis)managed currencies. Currency yardsticks are made of such elastic rubber that when one perceives change of value in something measured in currency units, nine times out of ten it is a change not in the thing measured but in the yardstick itself. The values of the U.S. dollar, the yen, the euro and every currency on earth fluctuate wildly all the time. Gold is the truest universal value benchmark, but it is impractical for use as an investment benchmark because fund managers cannot move their assets in and out of gold; the costs are prohibitive. Therefore, I have devised a new benchmark that is designed to be a stable representation of global purchasing power. EWI's new Stable Currency BenchmarkTM (SCB) comprises equal-value portions of the Swiss franc, the Singapore dollar, the New Zealand dollar and the U.S. dollar. Each currency is the most attractive one within its global quadrant – Europe, Asia, Oceania and the Americas – from the standpoint of political and fiscal stability. Three of these issuing countries have been politically neutral for a long time, a major advantage in wartime. Some of these countries have more political than fiscal stability, and vice versa, but in my judgment these are the ones whose currencies are most likely to withstand the pressures of a global depression and the social upheavals that will accompany it.
Undoubtedly with sentiment toward the U.S. dollar near an all-time low, some people will complain that the dollar should not be in the mix. This is one reason why it should be in the mix. Most investors and advisors get bearish after a 3-year decline, not before. They load up on foreign currencies just when their own is ready to recover. Three years ago, people would have complained that there were not enough dollars in the mix. The whole point of holding funds in the SCB is to stabilize one's global purchasing power. When one currency is weak, the others are usually strong. The fluctuations tend to cancel out, leaving a stable benchmark of value in a worldwide setting. The accompanying charts show the SCB as the benchmark against which individual currencies fluctuate. Figures 9 and 10 show the SCB against its components on two time-frames, and Figures 11 and 12 shows it against some other major currencies. Needless to say, most minor currencies have been downhill against the SCB.
One must refrain from making judgments about the individual currencies in the SCB based on their value histories from 1971, the year that currencies were freed to float. Beginning in 1978, or 1988 as you can see in Figure 10, gives a whole different look to the U.S. dollar and the Swiss franc. Beginning in 1992 would give a new perspective on the New Zealand dollar. Finally, the past is not the future, and my judgment on these selections is based as much on expectations as on past performance.
The benchmark will be adjusted on a quarterly basis to ensure that there are equal-value portions of the four currencies in the mix. The basis for adjustment will be their value in terms of gold. The SCB, as long as its components remain under the purview of sober governments, should be “as good as gold” in terms of maintaining value and better than gold in terms of cost and liquidity.
You may think of the benchmark as a new currency. You can measure anything in the world against it, thereby sidestepping wild individual currency fluctuations. The diversification inherent in the SCB mitigates the risk of choosing to hold your assets in one currency if that one were to get hammered during a global meltdown. It also gives you a consistent measure to value the price of goods, services, stock indexes or anything else. If you own stocks in a foreign country because its stock market is rising, you might lose the value of the gain in a depreciating currency. The SCB gives you a way to value all the world's investment indexes with a stable benchmark, which will thereby reveal if it is truly in a bull or bear market in terms of global purchasing power. Figure 13 shows the DJIA, the Nikkei and the FTSE indexes against the SCB, which factors out local currency fluctuations to give you truly comparative values. I am personally intrigued by the clarity of the five-wave decline in the DJIA from its all-time high, a pattern masked by the nominal Dow's denominator of depreciating dollars from 2001 to the present.
Whether you are a global fund manager or a sophisticated, globally oriented investor, I hope you will find this benchmark useful in coming years..."
Get full details about it here: The Stable Currency Benchmark by Robert Prechter.
Keep up with the benchmark at this new site dedicated to the benchmark: www.stablecurrencybenchmark.com
Posted by Tony at 02:34 PM | Comments (0) | TrackBack
February 07, 2005
On with the motley!
Hello! My name is Tony Wood and I’d like to welcome you to the Trading Systems Blog. The idea behind this blog is to provide not only reviews of trading strategies and systems, but also to comment on and (try to) explain the goings-on in the world which are responsible for market movements. To make sense of all the data in all its combinations is a mammoth task, so I’ll be looking at snapshots of particular sectors, seeing what influences are at work and then taking out the crystal ball to try and predict what lies ahead.
What’s this I hear you say – a day trader looking at market fundamentals? Seems to be a contradiction there. Surely us traders just look at charts, patterns, signals, retracements … yeah, sure we do! But doesn’t coming to grips with the fundamentals make it just that much more interesting? Of course it does – that way we need never switch off … every time we see a 1c increase in the price of gasoline at the pumps, it’ll be a reminder to check whose pumping how much oil where and its effect on commodity prices, and the knock-on effect to prices in the stores, labor rates … … the dollar … gold … climate change … all these interactions, which seem to go full circle.
Incidentally, did I tell you about the Midas Trader Club? No? OK, here’s the deal --- I’d highly recommend you go and sign up for it now. You can do it here: http://www.online-trading-systems.net/invitation.html
You’ve got nothing to lose and everything to gain. As a member you’ll be getting the inside info on the new systems I’m regularly trying out, plus access to lots of free resources, reports, software, etc, as I come across it. Much of it you won’t easily find elsewhere. So go on, sign up now … then come back and continue reading !!!
Now then, where was I? Oh yes, the global markets. If you’re going to be a well-rounded citizen and a credit to society, you owe it to yourself --- and the rest of mankind --- to know what’s going on around you, globally speaking.
And just so you know, I’m **warning** you now – so don’t say I didn’t tell you! I could be classed as something of a sceptic, a cynnic, and certainly a contrarian. Or should that be “contrary”? Quite possibly. Anyway, if you want to learn the **truth** behind the latest news reports in the popular media; find out whose **really** responsible for the decline of the greenback; like to know the best place to stash those gold dubloons you’ve been hoarding for years; or simply want to hear the latest **conspiracy** theory – you’ll get it all here.
I’m not asking you to agree with me – in fact I’d **hate** that. But come along for the ride – I’m sure we’ll have some great debate.
Now - on with the motley!
Posted by Tony at 06:52 PM | Comments (0) | TrackBack