Posts Tagged ‘Economics’

Commodities Investing: Demand, Supply and Speculation

July 24, 2011 2 comments

First published on BBeyond Magazine blog – an ultra niche publisher that caters exclusively for the global UNHW market and community:

An unsophisticated forecaster uses statistics as a drunken man uses lampposts –
for support rather than for illumination.

– Andrew Lang

The price of a commodity is determined by demand and supply. At least that is what most of us are taught in ‘Economics 101’. The relationship between supply and demand forms the cornerstone of economic models. The most fundamental concept in economics – price – is therefore a reflection of supply and demand. Or is it? Ask anyone who has traded Brent Crude or Light Sweet Crude (WTI) oil contracts and they will tell you the oil market is driven as much by speculation and momentum as it is by demand and supply. To put it in perspective, the CFTC (Commodity Futures Trading Commission) recently revealed that almost 95% of US crude oil futures volume is generated by day trading and OPEC president Mohammad Aliabadi noted futures contract trade an astonishing 18 times higher than the volume of daily traded physical crude.

The world’s population currently stands at 6.93 billion (and counting). It is expected to surpass nine billion by 2050. As such, there has been a lot of brouhaha about our capacity to accommodate the rising demand. The rise of emerging economies like BRIC (Brazil, Russia, India, China) has pushed the prices of commodities to new highs. In the post-2007 credit crunch economic climate, despite the possibility of prolonged spells of slow growth in the developed world, demand is expected to be robust. Chinese GDP per capita alone more than doubled from $3600 in 2001 to $7600 in 2011 and is forecast to surpass $12,000 by 2016. This is a large demand explosion and the question is: How quickly can supply response to that? The prices of commodities will thus be determined using supply-side fundamentals.

In India, 60% of farmers’ produce spoils before it reaches the market. The problem therefore is not supply per se, but infrastructure (which constricts the supply chain).  New technologies can lower production costs while increasing the supply of the commodity. A technology is classified as ‘disruptive’ when it significantly lowers the supply-demand equilibrium price while it simultaneously causes a surge in production capacity. For example, the natural gas market was hit by a disruptive technology in the form of horizontal drilling. Each horizontal rig can surge production by 5-10x the previous capability of vertically drilled wells. In the past, natural gas needed to trade near $6–$7 per mmbtu (million British thermal unit) to encourage new production. Now natural gas is expected to remain under $5.50 per mmbtu for the foreseeable future. The key to successful commodities investing is to spot these disruptive technologies in the wings.

The ideas in this blog post stem from a panel discussion on Commodities Investing the author recently attended at JP Morgan, London. Chartered Alternative Investment Analyst Association sponsored the event.



Is Dubai’s economy built on sand?

December 3, 2009 Leave a comment

Last week saw plenty of fear and lots of noise in the markets but little hard news as Dubai stayed on the front pages of the newspapers for its economical crisis. Holidays in the US (Thanksgiving) and Dubai meant that the financial market was startled for a few days before the scale of the problem became known; not a lot of information was available beyond the short statement from Sheikh Al-Maktoum. This, to my mind, simply fails to answer any of the questions the market is asking, so everyone will speculate about whether the request to re-schedule debt will succeed or lead to default, what other Dubai-based entities could suffer a similar fate, whether it could prove more widely contagious and which banks globally are most exposed. My first impressions of the Dubai crisis have not changed materially. I suspect this is an attempt at a managed, voluntary debt re-scheduling rather than a default. The sums involved are potentially large but are spread widely around the financial system if only because the Dubai ‘story’ was so heavily marketed and widely understood. There is a risk of ‘psychological contagion’ but Dubai was a one-off bubble. Nowhere else has there been so much extravagant construction. The longer-term damage is to the notion of an ‘assumed’ state guarantee. It was taken for granted that Dubai would stand behind its commercial enterprises and that Abu Dhabi would stand behind Dubai. Those kinds of assumptions are fairly reasonable to make when times are good, but in troubled times they are tested.

DWTC says: no matter how deep your pockets (or oil wells) are, throwing money at projects in a hope that it will ‘stick’ is somewhat akin to throwing cement in the sand in a hope that it will become a building. It may work but the chances are very very very slim, and you are going to need a lot more luck than money or cement in the long run.


Categories: Economics Tags: , ,

The Financial Crisis Explained !!!

November 20, 2009 Leave a comment

Here is one of the best explanations of the financial crisis I’ve come across.

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her loyal customers – most of whom are unemployed alcoholics – to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of customers flood into Heidi’s bar.

Taking advantage of her customers’ freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognises these customer debts as valuable future assets and increases Heidi’s borrowing limit.

He sees no reason for undue concern since he has the debts of the alcoholics as collateral.

At the bank’s corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items.

One day, although the prices are still climbing, a risk manager (subsequently of course fired due to his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi’s bar.

However, they cannot pay back the debts.

Heidi thus cannot fulfil her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95%. PUKEBOND performs better, stabilising in price after dropping by 80%.

The suppliers of Heidi’s bar, having granted her generous payment due dates and having invested in the securities, are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the government following dramatic round-the-clock consultations by leaders from the governing political parties.

The funds required for this purpose are obtained by a tax levied on the non-drinkers.

Source: Unknown (landed in my email inbox)


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