Monday, March 30, 2009

Who is your Propane or Heating Oil Expert?

The Jim Cramer - John Stewart debate has lit up the national discourse on a good topic - the value of an expert. Jim Cramer is an expert to a section of the stock buying public - but his advice hasn't worked out so well of late. There are only a few folks that have done well in this market, and those investors are to busy counting their money to do a TV show.

But this does highlight a few valid questions - How do we choose the people we trust? And what qualities make a person an expert?

Last week, Nicholas Kristof wrote an excellent op-ed piece in the NY Times. It was on the "Dr. Fox effect." The whole article is worth a read, the following is an excerpt:

The best example of the awe that an “expert” inspires is the “Dr. Fox effect.” It’s named for a pioneering series of psychology experiments in which an actor was paid to give a meaningless presentation to professional educators.

The actor was introduced as “Dr. Myron L. Fox” (no such real person existed) and was described as an eminent authority on the application of mathematics to human behavior. He then delivered a lecture on “mathematical game theory as applied to physician education” — except that by design it had no point and was completely devoid of substance. However, it was warmly delivered and full of jokes and interesting neologisms.

Afterward, those in attendance were given questionnaires and asked to rate “Dr. Fox.” They were mostly impressed. “Excellent presentation, enjoyed listening,” wrote one. Another protested: “Too intellectual a presentation.”
Scary, huh? A good presenter = an expert. Or maybe an "engaging talking head" = an expert (Jim Cramer, maybe?).

Ben Stein goes further to put this in perspective in another NY Times editorial:
Humans can’t consistently pick the right stocks or call markets, foretell political or geopolitical events or successfully predict changes in interest rates or commodity prices.

Life is far too complex and baffling for the minds of mortals to understand it as it happens, let alone to predict it accurately. (I am mindful of how Professor Friedman, a true supernova of brilliance, said of economic forecasting, “If you’re going to predict, predict often.”) Some humans shine like dazzling stars when their predictions turn out to be true, but those same humans can’t ever be counted on to replicate the feats regularly.

Yet, we cry out for someone to tell us the future, like children who want to hear the end of the story. When Mr. Cramer tries to satisfy that need, he is doing no more than answering a deep human wish. But he — and everyone else in a similar situation — should make it clear that these are no more than opinions and guesses, which could easily be wrong and often are.

This is not just boilerplate. This is life. The way it is.
So where does this leave us in our search for market wisdom? What is a retailer to do when he or she realizes that no one can predict the future with consistency and that "the folks that know aren't talking?"

Reevaluate who you trust. What questions do they ask? Do they understand your balance sheet, your customer base, and your business processes? If they don't, they might be a "Dr. Fox" - a false expert.

The value of a market expert is not in helping you make only good decisions. The value of a market expert is to help you understand - in advance - the impact of a bad decision, and then to assist you in steering your business clear of the kind of mistake that it cannot afford.

Before you make your next risk management decision, consider the trader's axiom "The market can remain illogical far longer than individuals can remain solvent." If your purchase decision can withstand the clarity granted by this statement, then it is probably a hedge. If not, you might wind up as frustrated with your "expert" advisor as Stewart was with Cramer.

Tuesday, March 24, 2009

The Emotions of the Market: Hope

In the 1930's, the economist John Maynard Keynes used the term "animal spirits" to describe human emotion in the marketplace. In the last 10 years, the Nobel Prize has been awarded to economists from the University of Chicago School of Business that have pioneered in the field of Behavioral Finance.

Emotion is not to be discounted in the market. And it plays a huge role in the decision to enter a fixed price contract. There are three main emotions that effect the buying decision, and they work in coordination with each other to help create a poor decision. These are the emotions of Greed, Hope, and Fear. They are not your friends, and when you detect them in your mind they should be dispatched with extreme prejudice. I would venture to guess that HOPE is an emotion that is at play in your mind today.

Consider the market context that we have recently experienced.
  • In July, prices were sitting at all time highs ($147/bbl on NYMEX crude)
  • But by November they had fallen to $37 - $40/bbl MORE than even the most bearish observer thought they could
  • The brutality of the fall caused folks all over the industry to examine their existing positions closely, they needed to make sure their positions were flat. Additionally, there were margin calls to work through. This period of time was very busy, as folks were attending to pressing business that could not be put off.
  • However, it was also (in retrospect) the best time to lock in some product. The wholesale price that was available in the market at this time was one that could be used as a base for a 2009-2010 fixed price program. A margin could be added, and the retail customer would have been interested. A large segment of marketers passed on this opportunity, just wasn't a good time for them to make that leap.
  • Propane prices are now 30 cents above the price that was available in November.
  • Over the last month or so, folks have been thinking about layering into a piece of prebuy. Seasonally, it makes sense to do so as the market often trades on its annual lows in the first quarter.
  • Last week, an unexpected fundamental (news of the Treasury's plan to buy $1.0 trillion is debt) caused historic weakness in the dollar, and therefore spiked commodity prices across the board (energy prices included).
  • Those folks that were still waiting to lock in a piece of fixed price product find themselves in a state of shell shock, confused by the market's fluctuations and not knowing what to do.
  • Here is where the HOPE sets in:
It becomes the natural human reaction to wait for a while before pulling the trigger on a contract. Marketers in this situation are HOPING that the price moves lower and that they are able to get the price they could have gotten previously. They may wind up HOPING in that way for several months, as the price continues to move higher.

Whether you should buy now or wait is really a question that is dependent upon your unique business, customer base, and target margin structure. No one should ever give a blanket purchase recommendation to customers, although there are consultants that do so.

However, what an independent third party can do is offer perspective and encourage a balance between emotional and rational. Is there too much HOPE in your program? If so, consider buying the piece you might have missed out on last week.

Monday, March 23, 2009

Wednesday, March 18, 2009

Wachovia MLP Primer

100 pages of information - a very thorough review - can be found here.

Tuesday, March 17, 2009

OPEC Oil Market Report for February

Hear it HERE. (~2 minutes)

Campbells Soup Reports Hedges as a Drag on Earnings

Just to demonstrate that folks in other industries "guess wrong" too...

CHICAGO (Reuters) - Consumers looking for relief from rising food prices are not likely to see any price cuts soon from Campbell Soup Co (CPB), which is still dealing with high commodity costs under previously set contracts.

Sales of the world's largest soup maker have been helped by consumers eating more at home, and the company sees little need to cut prices, especially while margins remain under pressure, CEO Douglas Conant said at the Reuters Food and Agriculture Summit in Chicago.

"Quite frankly, sales are growing, our marketplace presence is growing, consumer purchases are actually growing faster than sales," Conant said. "Clearly we're having a good year, we've had the best year in soup that I've experienced in my nine years here."

"So it's not likely we're going to be reducing prices in the near term."

But Conant also said that strategy could change if commodity prices come down and margins improve.

Like many food companies, Campbell locks in some costs for grains and other ingredients through commodity hedges. The company hedged some commodities when prices were at historic highs last year and those hedges run until July, Conant said.

"As those hedges come off and if our margins start to turn around, then we'll reconsider that, but that's premature to talk about," Conant said about the possibility of lowering prices.

"We're hopeful our margins will improve in the second half but for the full year, at best they'll be flat," Conant said. "So we won't recover everything we lost in the first half."

But do you see the concept of sticky margins in action?

Hat tip to DealBreaker.

Monday, March 16, 2009

4+1 Market Commentary

It has been a while since I last posted a 4+1 market commentary - a posting that is meant to tie together and make sense of the different postings on this site. Truth be told, it isn't because I didn't have stuff to write about. I can always come up with something to talk about (ask my wife).

Instead, I had a technology problem. At the end of the last 4+1 I mentioned that my next 4+1 post would be a video blog posting. That was the goal. But it was "all hat and no cattle." I didn't have my technology worked out, and trying to install the audio and video technology cause a devastating error on my computer. It was called a "kernel stack" error. Being a finance guy, I really don't know what a kernel stack is. Nor do I quite understand why kernels would need to be stacked. But I do know if your kernels are not stacked you won't be happy with the outcome.

I was minding my own business and stringing the USB cord one minute, and the next I was looking at the "blue screen of death" and contemplating the complete system restore. Wow, what a mess! I was out of commission for three days. If I could offer the readers of this site just one humble piece of advice, I would recommend you make sure all kernels are stacked appropriately at all times. The video post is coming...after I restack my kernels, and do whatever I need to do to make sure that what happened NEVER happens again.

Now...on to business. I will touch on 4 important market factors, as well as one thing that does not matter at all.

1) The Changing Face of OPEC
Russia is an observer, and Brazil was entreated to join but refused. Economies that rely on petrodollars as a significant economic driver are aligning together. OPEC becomes even more important in the future for these economies, because petrodollars lubricate the wheels of government. Petroeconomies are typically run by petro-dictators, and dictatorship (or autocracy) is easiest in a climate of economic plenty. The lower classes are happy with the government when there are petrodollars to go around - and they are more unsettled when they do not have jobs or when the economies have to cut back on building projects or social projects.

Compliance is a big thing, because OPEC saying it will cut and OPEC actually cutting production are really two different things. However, the most recent round of cuts has actually gone better (from a compliance standpoint) than I had expected. To put this in perspective, right now OPEC members are receiving about a quarter of the oil revenues that they received this summer, due to the falling price of crude and the production cuts that have been announced. When you think about it this way, it makes Oman and the UAE sound a bit like Las Vegas - having taken a massive cut in the revenue source that the economy was built upon.

OPEC's ability to constrain supply is bullish. Maybe not now - but when it begins to matter again.

2) Demand is Driving
Domestic gasoline demand is UP year over year. The mainstream media might want you hold yourself up in a tornado shelter because Armageddon is nigh...but it is not. Folks are driving more this year than they did last year. And we must remember that, due to EPA regulations, there have been no new refineries built in the US in 30 years. There is a supply/demand imbalance regarding domestic refining capacity - and that imbalance will show itself again this summer. Look for the crack spreads to widen, and potentially apply upward pressure to the crude complex, as the marketplace finds itself in the driving season.

Strong demand for finished products is bullish to the market.

3) The Least Worst Sovereign Currency
Democracy and Capitalism are the perfect parlay - I will bet on the resilience of both of them. When the government exercises restraint and does not attempt to meddle or socially engineer solutions, the independent American businessman solves problems. He/She allocates capital efficiently and grows his/her business. Growth in business means growth in economic value - and growth in economic value is the way we get out of the recessionary funk in which we currently find ourselves mired.

Other countries don't exactly work like that. Government tries, but one or one hundred bureaucrats cannot allocate capital as efficiently as businessmen like you and me. China is trying, of course. But this op-ed piece from the India Times eloquently states my point - when the world economy is stressed, look to America to lead the recovery - due to the resilience of the American businessperson.

Due to this resilience, the dollar index should maintain its strength against other currencies. A strong dollar makes crude and other commodities priced in dollars cheaper (because a dollar goes further when buying some). This is neutral to bearish for energy prices.

4) Oil on a Fulcrum
The incremental cost of production for the next barrel is somewhere above $60/bbl. So when the cash price is below $60, no new production cash flows. More importantly, plans get mothballed, exploration ships get dry docked, and crews get sent home. Major oil projects take years to plan and develop in good economies. But allowing all the assembled physical assets, inertia, and human capital to disburse back to their home bases mean that the supply will no be there when it is needed, and it will take years to bring these hydrocarbons to market. Therefore, the more time the market spends below the $60-$65 threshold, the more violent and pronounced the spike will be.

China knows. They are on a buying spree, grabbing commodity assets throughout eastern Asia and the Pacific rim. Billions are being spent so that China is secure and well positioned for further worldwide demand-based uncertainty.

Are we at peak oil? Personally, I don't think so. However, demand is increasing as economies modernize. And it takes a whole lot of infrastructure to slake the world's energy thirst. I my mind, the move to $147 can be repeated, and may just be an opening act for the volatility and price moves to come, as the new Asian middle class develops a liking for the hydrocarbon intensive goods and services (corn, cars, plastic stuff, etc.)

Crude oil being below the cost of production is bullish for energy prices.

+1) The one thing folks should be ignoring: Banks and Credit
The credit market is healing, and the Federal Reserve has demonstrated a willingness to print money to insure the solvency of the system. Markets are looking more positive in a number of ways. And each day that goes by gives the large financial institutions more time to de-leverage and heal themselves. Sure, there are pockets of the domestic market that will take a long time to heal (California, Phoenix, coastal Florida) but in a year, our market will be focusing on a new problem - it will most likely not be the credit markets.

Daily news headlines regarding banks and credit markets should not a reason for the energy markets to lose 10% or more in a day (like has happened in the last few months).
If you like or dislike this stuff - my analysis - feel free to leave an anonymous post comment.

Wednesday, March 11, 2009

What Do Bananas and Fixed Price Positions Have In Common?

Have you been to Sam's Club or Costco lately to buy bananas? They try to sell you a bunch - no pun intended. At least twice if not three times as much as the typical bundle size in the local shopping center. Some times, my family "goes long" bananas from Costco...and man, do we eat them. We have to be committed to eating them. Bananas on our shredded wheat, bananas in school lunches, bananas suspended in green jello...We just hate to waste them. Of course, if we can't muscle through our banana storage position, there is always the Hancock family equivalent of the ripcord on an emergency parachute...baking banana bread - where completely brown, ripe bananas can still be used as an ingredient.

Does any of that sound familiar? Or am I bananas? (Pun intended.) I hope you can relate. Fixed price positions are similar. They have a "shelf-life," too. Without discipline to use them quickly (either to manage front month margin risk or to offset heating season fixed price program risk) they can wind up turning brown on you, as the market turns lower and starts eroding any equity previously garnered by your position. When that happens, bad things (like compressed operating margins and supplier margin calls) can result. And those bad things adversely affect the performance of your most important asset, your business.

Before you enter a fixed price deal, make your decision can pass the following litmus test. Does my purchase fill an immediate consumption need (like eating a banana for breakfast)?

Alternatively, if the purchase does not fill an immediate consumption need, then does my business have an outlet for the inventory I am taking on (like pulling the ripcord and processing old bananas into banana bread)?

If you can't answer a hearty "Yes!" to either one of these questions, then your position is a speculation and unnecessary. It is just the siren's song of the market tempting you into wanting to take a position, just like the sirens of myth tried to lure the Argonauts to the rocks.

Many folks like to layer into positions over time. But layering in to positions involves risk. As you think about your next purchase think about your business's banana inventory.

One can eat only so much banana bread. After my recent trip to Costco, you can take my word for it!

Monday, March 9, 2009

Reality and Retrenchment

Is the current slowdown the end of capitalism? Probably not...Just like it wasn't over when the Germans Bombed Pearl Harbor.

However, the economic environment that we are currently in is a challenging one, featuring seismic changes in consumption driven primarily by a vaccum of consumer confidence. Here are three internet finds that help illuminate these shifts, along with some quotes and video from the sources themselves:

1) A New York Times Article on Conspicuous Consumption
In just the seven months since the stock market began to plummet, the recession has aimed its death ray not just at the credit market, the Dow and Detroit, but at the very ethos of conspicuous consumption. Even those with a regular income are reassessing their spending habits, perhaps for the long term. They are shopping their closets, downscaling their vacations and holding off on trading in their cars. If the race to have the latest fashions and gadgets was like an endless, ever-faster video game, then someone has pushed the reset button.

2) The Text of a Brooking's Institute Presentation Given Today by Christina Romer
The fourth lesson we can draw from the recovery of the 1930s is that financial recovery and real recovery go together. When Roosevelt took office, his immediate actions were largely focused on stabilizing a collapsing financial system. He declared a national Bank Holiday two days after his inauguration, effectively shutting every bank in the country for a week while the books were checked. This 1930s version of a “stress test” led to the permanent closure of more than 10% of the nation’s banks, but improved confidence in the ones that remained.22 As I discussed before, Roosevelt temporarily suspended the gold standard, before going back on gold at a lower value for the dollar, paving the way for increases in the money supply. In June 1933, Congress passed legislation establishing deposit insurance through the FDIC and helping homeowners through the Home Owners Loan Corporation.23 The actual rehabilitation of financial institutions, obviously took much longer. Indeed, much of the hard work of recapitalizing banks and dealing with distressed homeowners and farmers was spread out over 1934 and 1935.
Nevertheless, the immediate actions to stabilize the financial system had dramatic short-run effects on financial markets. Real stock prices rose over 40% from March to May 1933, commodity prices soared, and interest-rate spreads shrank.24 And, the actions surely contributed to the economy’s rapid growth after 1933, as wealth rose, confidence improved, and bank failures and home foreclosures declined.

3) A 3-hour interview with the The Snowball, Warren Buffett. CNBC has the interview on its website. It has been cut up into 7-10 minute segments, and is well worth your time. The last segment is here.

B of A Chairman Ken Lewis Speaks Out

Here is a link to an op-ed piece from the Wall Street Journal that was penned by Ken Lewis, Chairman from Bank of America. Of course, Bank of America has a vested interest in what happens from here - with its shares currently trading at $3.75. Even still, Mr. Lewis attempts to put a glass-is-half-full spin on things and dispel the rumors that the market takes for reality.

Mr. Lewis debunks six widely held myths in his letter. Here are my favorite three:
- The banks aren't lending. This claim is simply not true. Yes, banks have tightened lending standards after a period in which standards were too lax. But, according to Federal Reserve data, bank credit has actually increased over the course of this recession, and business lending is trending up modestly so far in 2009. Also, mortgage finance volume is booming as a result of low interest rates. What's gone from the system is the easy credit that got us into this mess, as unregulated nonbank lenders have disappeared, and the market for many asset-backed securities has all but dried up. Most banks are making as many loans as we responsibly can, given the recessionary environment.

- The banks are insolvent. In the past 18 months, we've seen fewer than 50 bank failures. That compares to about 2,000 failures or closings of commercial banks or savings institutions between 1986 and 1991. There may be more to come, but the vast majority of banks will weather this economic storm.

- Taxpayers have given the banks billions and won't get their money back. TARP funds are not charity. Banks that received TARP funds will make about $13 billion in dividend payments to the U.S. Treasury this year. TARP funds are loans yielding anywhere from 5% to 8% interest. This is a win-win: Banks are getting the capital they need, and taxpayers are getting a strong return on their investment.

Sunday, March 8, 2009

Brainstorming on Banking

Impressionism In the Energy Markets

I wish I knew more about art. I have been exposed to very little in my life, and have never studied the different movements. However, I know what I like to look at. I find impressionist paintings very interesting and pleasing to my eye. And I didn't realize it till this weekend, but there is a significant similarity between markets and impressionism.

The unique thing about impressionism is that paintings done in this manner are meant to create different impressions upon people based upon their viewing distances. Up close a painting will look different than it might from a moderate distance or a very long distance. The viewers perception of the work will change dependent upon the proximity to it.

And it is the same with commodity markets. When heating oil inventories were swelling last summer, an employee in New York harbor might have thought "Price must go down, we have too much of this stuff." What that employee did not know is that there were electric and nuclear energy generation problems in Europe, and that China was buying heating oil to replace the coal-fired generation capacity that the nation intentionally shuttered prior to the Olympics. This additional demand caused the NYMEX market price to surge over $1.00 in just a matter of days.

Each step from an impressionist painting reveals a nuance or unique characteristic that was not discernible from a previous vantage point. Likewise, it is always important to take a step back from the markets to appreciate the fundamental drivers.

In the current energy markets, I offer the following three vantage points from which to view the market. Each tells a unique story.

1) Short Term: Domestic and world economies are faltering simultaneously and in significant magnitude. (In case you hadn't noticed.) But Americans are still consuming gasoline - and year over year demand is actually higher in unleaded gasoline.

2) Intermediate Term: Sooner or later, the aggressive steps taken to increase the monetary base will result in an economic turn around, both here and abroad. While this demand is re-forming, producers are cutting production, because spot prices are below the incremental cost of production.

3) Long Term: 2 billion cars by 2020. Thank you, Tata. Economic liberalization and growth in pacific rim countries and China and India will continue to tax the worlds natural resources (all commodities and even clean air and fresh water).

My impression? Prices might remain depressed for even 2 years, as the world regroups and shakes off the funk of economic malaise. But prices for most all energy commodities must gravitate higher due to global demand growth and the increasing cost of new production.

Monday, March 2, 2009

Buying the Crude ETF - The Worst Idea I Hear all the Time

Most of the people in my life know I do "something in the market." And they are always excited to either: A) ask me what gas prices are going to do, or B) tell me they want to buy a crude ETF at these levels. Since I am on pace to drive about 6000 miles (to work and back) this year I really don't care about "A". This post focuses on "B"...and maybe the most under-appreciated market dynamic in commodities - the forward price curve.

Have you noticed the steepness associated with the price curve? The current contract - April - is trading at an $8.00 discount to the December (which expires on November 30th). It is a 20% change in price in about 2/3rd's of a year. If price froze right here and only time could pass and the monthly price spreads rolled my position from month to month, I would neither make money or lose money. But at Thanksgiving time my position would be struck at almost $50/bbl. In my mind, $50 is less of a compelling buy than $38 or $40.

So one must ask before entering a position going long crude oil - "At what price will I enter and how long will I hold." If one deems the position as a long-term type opportunity, then the one clearly feels that the price will be materially higher than $50/bbl since December 1 - since $50/bbl represents the breakeven for the trade. It is kind of like going to Vegas and giving a huge vig to the don't make money until AFTER the house makes its money.

Consider shorting crude instead. Contango aids short positions, with each roll crediting the position and making the buyer short at a higher price. If you believe that the price is not destined to rally more than 20% by Thanksgiving, shorting the front month and rolling it forward is the best decision.

Note that the passive ETF that attempts to mirror crude trades the front month. So based on the logic above, a better trade than buying the ETF is selling the ETF. In that way, investors are making the contango structure of the market work for them.

Clearly, the worst idea I hear all the time is to go long crude in an ETF.