Commodities coming down? Gotta love the free market.

[Guest VAL9000]

My intention was to follow up on a conversation we had going about commodity prices.  The original thread ("Market Correction Soon?" ?) appears to have been deleted (this time I was a real contributor, so I'm a bit miffed about that).  Regardless, at one point there was a good discussion going about the obnoxious price of silver and what would happen with pricey oil and pricey commodities in general.

 

I just saw this article on Bloomberg and I find the implications fascinating:

 

http://www.bloomberg.com/news/2011-05-11/crude-oil-falls-for-first-day-in-three-on-projected-gain-in-u-s-supplies.html

 

I absolutely *love* that a country like the US, a country that has leveraged so much of its growth and prosperity through cheap oil, is able to adapt this way.  A measurable reduction in gasoline use during the traditional spring-time run-up is pretty significant.  I genuinely hope that this run-up in price was caused by irresponsible speculators and that they lose their shirts over the disconnect between the futures market and the real market.  To my friends here invested in E&P or other facets of the oil industry, this isn't a shot at you.  Oil scarcity is a real problem and responding to it deserves real returns.  Betting on the price of oil, however, is something I think of as financially irresponsible.

 

That's it, I just wanted to offer kudos to the free market system and further propose that it's adaptability like this that makes me confident that we're in for a long positive run for the US and all other free market economies / democracies.

 

[cashisking]

I found this from Alphaville to be very interesting. It goes on to explain how commodity etf growth is a function of the need to offload commodity exposure by the large financials. Sort of like creation of CDOs was driven by the need to offload housing exposure and desire to short the whole thing by opportunistic hf managers. Of course the retail public ends up holding the bag yet again...

 

ETFs have been a useful tool to allow banks to move risk off balance sheet. When a bank takes on risk through lending to or financing a big commodity player, say for an acquisition, there is a need to hedge potentially huge commodity exposure — so as sell to lock in the commodity price, and you couldn’t sell that volume easily into the terminal market; although you could transfer a large amount of exposure to investors through an ETF more easily. The only way this used to be done is by the bank taking proprietary risk, but they now have other risk issues and aren’t prepared to carry that sort of exposure.

 

Using ETFs becomes a mutuality of interest, with everyone moving to launch products to investors – retail and institutional – so that they can carry the risk instead. It’s all about de-risking your book. And you saw it in the dot com bust when investment banks pushed dotcoms, but offloaded the risk to investors. When the NASDAQ crashed the investors carried the bulk of the exposure.It all has similarities to the Abacus CDO. If you want to short the market you have to create the demand, like Paulson did. If you are an institutional advisor you can do that by hyping the commodity.

 

The rest can be found here http://ftalphaville.ft.com/blog/2011/05/11/565941/if-we-build-it-they-will-come/

[Smazz]

genuinely hope that this run-up in price was caused by irresponsible speculators and that they lose their shirts over the disconnect between the futures market and the real market.

I agree however the free market seemed to work for those taking the avg joes hostage. Nothing free about that. Something needs to change there.

Why such swift action on Silver?  I dont know, commodities are not my gig but you know how much $ has been taken out of the avg working persons wallet by this "free" system?

 

Not impressed.

[ubuy2wron]

I have been short silver and Osama's death has been a bit of a black swan for commodity investors. The silver mkt started falling minutes after his death was announced. A lot of long term good things can pass from his demise not the least of which may be the ending of two very costly wars which have been largely responsible for a big portion of the build up inthe pre crash debt in the USA.(Remember Clintons Peace dividend) An awful lot of money has been long commodities short the dollar for a long time the Precious metal players particularly the silver players Where CERTAIN that this time is different that US was going to undergo a currency collapse and silver would resume its rightful place as currency. At the same time this has been going on it has come to the mind of a lot of investors that Europes problems are not going away in fact are going to get a lot worse. Greece will be dealt with next week only because the short term fixes to stave off default restructuring are not that expensive. Ireland is not fixable in my opinion to ask the Irish citizenary to pay for the bail out of the Irish banking system is not going to work in my opinion. The amts are too large and the beneficiaries are in London not Dublin the Irish will soon figure out its in there interest to say piss off to the Brits and there goes the Euro IMO. So if any currency is going to crash its prolly the Euro and not the US dollar. If the Euro falls apart an awfull lot of money gets destroyed which I think is deflationary

[alertmeipp]

There is real demand for things like oil and copper.

not sure about Gold and silver tho.

[Myth465]

Kudos Val, perhaps more people are also thinking on the subway then I thought lol. Didnt think oil was so elastic. I am sort of disappointed in myself, I and most here knew oil was frothy, but I didnt take enough off the table. I guess in a pullback though its never enough. Most of my producers are hedging so this swings shouldnt have too big of an impact, but the share prices really are wiping around.

 

Between margin changes, attacks on big oil subsidies (probably the right thing to do and I am glad its limited to 5 companies none of which I own), and the macro / geopolitical picture - things should be interesting going into summer.

 

These swings are getting nuts. I think the fair price for oil is between $80 - $90. We seem to be dancing around so much. Also who keeps deleting threads?

[Granitepost]

Hi Myth:  The "Market Correction Coming" thread was started by Bronco on May 4. 

[alertmeipp]

I too knew the oil correction but didn't know it will bring SD all the way to 10 bucks. I think part of the SD is Tom is again being aggressive on drilling. Market hates uncertainty and Tom just introduce one - the funding gap. Last few days sucks, but I love the price though.

[Myth465]

I too knew the oil correction but didn't know it will bring SD all the way to 10 bucks. I think part of the SD is Tom is again being aggressive on drilling. Market hates uncertainty and Tom just introduce one - the funding gap. Last few days sucks, but I love the price though.

 

Ya its rough. Would have been nice to sell leaps at $13 and buyback at $10...  Tom is smart and I now view this as an owner manager. Him and the new CFO appear to know exactly what the market wants. The CFO is address debt and trying to get it to the right metric, and Tom and trying to get SD to where ATPG will be come year end - self funded. They closed the 2011 gap in record time, and now want to get the 2012 one closed. I believe they said they will have enough cash flow in 2013 to self fund.

 

I like that he was hedging all the way out, which helped me hold most of my leaps, and really like the fact that they want to monetize and pull drilling forward. Hopefully they sell, JV, or Trust 250,000 acres and drill baby drill. What would kill me, and the share price is more equity, converts, or debt (in that order). If we avoid those 3 things, then I think we will be rewarded for holding.

 

ATPG is a whole other story. Its like the little company that could. I think that catalyst is right around the corner. Just have to finish these next 2 wells, and put out 1 good cashflow number. After that I think we are set. Though been saying that for a year.

 

-----

 

Thanks Granitepost, that makes sense. Hopefully he comes back.....

[link01]

I found this from Alphaville to be very interesting. It goes on to explain how commodity etf growth is a function of the need to offload commodity exposure by the large financials. Sort of like creation of CDOs was driven by the need to offload housing exposure and desire to short the whole thing by opportunistic hf managers. Of course the retail public ends up holding the bag yet again...

 

ETFs have been a useful tool to allow banks to move risk off balance sheet. When a bank takes on risk through lending to or financing a big commodity player, say for an acquisition, there is a need to hedge potentially huge commodity exposure — so as sell to lock in the commodity price, and you couldn’t sell that volume easily into the terminal market; although you could transfer a large amount of exposure to investors through an ETF more easily. The only way this used to be done is by the bank taking proprietary risk, but they now have other risk issues and aren’t prepared to carry that sort of exposure.

 

The rest can be found here http://ftalphaville.ft.com/blog/2011/05/11/565941/if-we-build-it-they-will-come/

 

wow, thats quite the eye opener, thx

[Guest VAL9000]

Myth, I think we collaborated on the right answer around oil - namely that there's x% inelastic (systematic?) demand, and (1-x%) elastic demand.  Seeing this kind of softness in the market just indicates that the elastic bit starts to kick in somewhere between 90 and 120 / barrel, which gives us a good price floor on which to value oil companies.

 

That being said, the future need for E&P is indisputable..  We will likely see good long-term value creation with companies like SD, PBN, and ATPG.  All that's required is the patience to wait out these market foibles.  A run up like oil has had is bound to result in some disgruntled consumers..  hopefully we'll see more reasonable and measured price increases going forward (although I'm not counting on it).

 

Cashisking: good find on the commodity ETFs article.  I've already brought this up in three conversations today :)  I can't think my way through how the ETFs transfer the risk to consumers..  The consumer buys the ETF, which I assume is like buying the commodity...  is the idea that they're buying it from the bank?  But the bank doesn't own the actual commodity, just the risk around financing the company with the commodity?  This is already getting a bit complicated! Help?

 

 

[cashisking]

 

Cashisking: good find on the commodity ETFs article.  I've already brought this up in three conversations today :)  I can't think my way through how the ETFs transfer the risk to consumers..  The consumer buys the ETF, which I assume is like buying the commodity...  is the idea that they're buying it from the bank?  But the bank doesn't own the actual commodity, just the risk around financing the company with the commodity?  This is already getting a bit complicated! Help?

 

 

I am certainly no expert and just dabbling here, but I would think from the entire "system" point of view that etfs are convenient retail products that create demand for commodity derivatives and in some cases actual physical. The marketing machine ramps up and is aided by recent positive returns. Creators of etfs (asset managers) get product fees that offset losses from some of the traditional sources of fees. To this point - I think profitability of the good old money market fund is now a big negative and is a pain in the ass for the manager - "How do i get rid of these mmf folks without losing their mutual fund assets?". And of course the broker hoards of these asset managers need to be employed and a new hot product brings the fees. The big banks benefit from the m&a fees... Everyone feeds. Check out the franchise Sprott built.