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Sticky Fingers

6 Nov

The always progressive CFTC has come forward with a new effort to initiate position limits in a number of “key” commodity futures markets. This new rule, if enacted, would limit position sizes in a number of markets like: Crude, Wheat, PGM’s, Copper and others. Driven by pressure from end users, these rules will ostensibly diminish any upward price pressure on prices (forget the fact that large players can short as well).  We wonder why the CFTC is not more concerned with the HFT activity in these markets , but that is a whole different discussion for another day. We also have to wonder  if end users have fully thought out the possible implications of rules that might force players into alternative vehicles, namely the physical markets. It is not difficult to imagine an environment in which several large players choose to express their particular views on a specific commodity via the physical markets,  as opposed to the futures markets. In a market with tight supply,  no limits on physical holdings, and no real ease of  entry and exit, end users could be looking at a significant amount of available supply held in much stickier hands than before.

Be Careful What You Wish For

24 Oct

Back in February, the CEO of UC Rusal expressed his desire to see financial players play a diminished role in the aluminum market. He stated that “capital flows driven by index investors and hedge funds in particular, have distorted the supply/demand equilibrium, sending the wrong signal for players in the market”. The recent LME proposal to eliminate some of the load out delays that exist at accepted LME warehouses has him singing quite a different tune however. Mr. Deripaska recently penned a letter to said LME ,regarding the proposal, which stands in sharp contrast to his earlier stance.  In this letter, Mr. Deripaska states that the LME proposal is an unprecedented intervention and one that Rusal strongly objects to”.  We suspect that Mr. Deripaska’s earlier statements were made in an effort to see some rationalization in production come to the aluminum market. However, the reality is that the structural, persistent contango (aided by LME rules) has led to a sustained  high levels of premiums for Rusal and others.  We also suspect that any changes to the LME delivery rules will most likely result in a flood of metal released unto the market eliminating most of the premiums that exist today. Any changes to the existing LME rules has to be looked at as a long term positive for the market.  However,  the self serving attitudes exhibited by Alcoa and Rusal in response to these changes, have the potential to inflict long term damage on the reputation of the marketplace itself.

Can you hear me now?

28 Aug

A recent mining conference in South Africa was quite instructive as to the level of communication, or non-communication, between those in the mining world and those in the political realm. A study was presented to the conference by an independent survey company which laid out some disturbing comments from major mining executives as it relates to  their future involvement in South Africa.  One of the comments that struck out from this survey was that some executives thought ” Both South Africa and Zimbabwe are driving social experiments not driven by logic and economy but by ideology. In the absence of reason, primary industries become the cash cows to fund the unfundable.”  This conference is taking place against the backdrop of new wage talks among both platinum and gold miners in which both are asking for high double digit rate increases  in the context of falling precious metal prices.  However, the comments from the government were most telling.  The Deputy President proceeded to inform the conference that “the mining industry, supported by discriminatory legislation, has developed methods of making super-profits by relying on the super-exploitation of unskilled workers”.  The most confusing comments from government however were made by the Finance minister Pravin Gordhan who stated that “South Africa is not going to become competitive by all of us sitting on our laurels”.  I am not sure what laurels he is speaking of, when the industry has a workforce that is 25% less productive than it was 10 years ago and a cost structure that is hampered by excessive power costs rendering at least 60% of most platinum companies unprofitable at current price levels.

U store it

25 Jul

We were subject to congressional hearings this week on the appropriateness of bank owned physical commodity infrastructure. We have spoken of the criticism by industry regarding the holding of captive physical stocks of metal in LME warehouses. Industrial end users have complained loudly at the cash premiums they must pay in order to get prompt metal, a premium they say is inflated due to the persistent steep contango in metals such as aluminum and zinc. Congress is seeking to crack down on ownership of LME warehouses by banks such as JP Morgan and Goldman Sachs,  just as these very firms seek to divest themselves of their ownership interests. We suspect that this divestiture has less to do with congressional oversight, and more to do with the eventual narrowing of the contango. Owning a warehouse is only lucrative to the extent that physical holders are paid to store the metal. What made these hearings interesting was what was not discussed, namely the involvement of ETF’s into these commodity markets. While there was much discussion of the role of banks in the skewing of fundamental pricing, there was not much talk of the involvement of the public (via ETF’s) into what has heretofore been the purview of traditional producers/consumers. The influence of these ETF’s was seen throughout the year in the gold market where massive liquidation by the gold ETF has exacerbated any and every selloff.

While we understand that the growth of ETF’s and the financialization of commodities is something we all must live with, we do question the introduction of these products into markets which are very thin and highly fragmented. Much like congress however, we fully expect that regulatory scrutiny of “inappropriate” ETF’s will appear only after some kind unforeseen market event.

Contangoed

26 Jun

An article in the FT highlighted a recent complaint by the Beer Institute regarding the premiums currently being demanded in the aluminum market. Their complaint lies with the LME and the artificially high contango that exists, driven primarily by LME rules which effectively lock up metal in financing deals for overly extended periods. This complaint should not be taken lightly by the LME, as well as other exchanges whose rules regarding position size and nuances of delivery, favor non-commercial users. It is easy to envision a world in which commercial end users contract directly with producers (several most likely) within some contract pricing mechanism derived off- exchange. This should be of upmost concern to the exchanges as they desperately need the underlying producer output as it is critical to the entire pricing/delivery process.It will be interesting to see how these disputes between commercial and non-commercial commodity participants play out, particularly within the context of a rising rate environment.

Pay no attention to the man behind the curtain

16 May

This title really says it all when it comes to the recent action in capital markets. Market excess is not hard to find in any part of the capital markets as they exist today: high yield, government bonds, equities, leveraged loans, etc.. But, when it comes to Central Banks, the phrase ” ask and yee shall receive” has never been more true. However, just like the great and wonderful Oz, it is important that markets not delve too deeply behind the curtain because such exploration would suggest that the benefits of Central Bank actions have mostly been psychological in nature, with very little proven outcomes to date. We understand the talking points quite well, nearly 5 years into this grand experiment, Low rates: boost corporate profits, equity prices, perceived consumer wealth, spur hiring, etc.. However, this experiment in yield curve support, has morphed into a feeling by all investors in all disparate parts of the capital markets that the man behind the curtain has things covered. We were blown away by a recent article in the NYT in which Bernanke (remarking on the possible bubbles in todays environment) stated ” Microsoft ‘s stock is worth well more than it was some time ago, and it could still prove to be a bubble” He chooses Microsoft as an example? It is interesting to note that he did not use the high yield market as an example, particularly since spreads over treasuries are below where we were pre-2008. The Fed is de-facto encouraging not only a reach for yield, but a completely reckless reach for yield. No doubt, this type of behavior always ends badly, however in this latest episode the blame (as it should be) will be placed squarely on the Fed. Their ability to, once again, “save the day”  will be severely hampered under such a scenario. Forget the short term oriented deflationary chatter: BUY STUFF, SELL PAPER.

Nationalization Lite Revisited

14 May

The decision by Anglo American Platinum to revise the restructuring plan they had set out originally in January sets a bad precedent for all of industry operating in South Africa. We have mentioned in past blogs that private companies must be allowed to rationalize their cost structures, even if that rationalization means job cuts. While we understand that employers must be sensitive to local employment conditions, governments must reciprocate with a sensitivity to the reality that companies must operate at a profit. The president of Anglo stated that the shift reflected a commitment to our role in ” addressing the social economic challenges facing the country, while recognizing that we need to take actions to return the company to profitability”.  The markets were paying attention to this governmental meddling, with the yields on corporate bonds in the platinum sector skyrocketing over 80 basis points in a single day ( The Rand sold off sharply after this announcement as well).  While nationalization has always been a concern when dealing with foreign governments, companies must now deal with what we call nationalization lite. This type of intrusive behavior however, does not involve overt takeover of private assets, but rather involves a governmental co-opting of private decision making. The swift response on the part of investors  has sent a message to the governments of South Africa and others, that such heavy handed political moves will have immediate real world consequences.