Weekend Link Summaries - 5/17/05

Below are the weekly link summaries for the usual groups: commodities, derivatives, hedge funds, private equity, quantitative finance and financial engineering, and trading. Hopefully you find some articles that you may have passed over, but might be interested in reading. Have a good week.

Commodities

Limited trading gains dampen corporate wheat purchases
Harish Damodaran - Business Line
* There is a cutback in demand for wheat from India this year as many companies got burned when the price of wheat did not keep rising, and sold off quickly. Many corporations in India that use wheat have large stockpiles left over from the previous year.

Soaring freight costs add to price of basics
Javier Blas - Financial Times
* Freight cost for basic commodities are rising as the Blatic Dry Index rose to an all-time high, increasing inflationary pressures on countries importing natural resources, in particular India and China. One of the main reasons is a surge in demand for iron ore in China, but consumption is high for nearly all commodities. Analysts are finding that there are not enough new vessels entering the market to match the increases in demand. Port delays are also rising across the globe, adding another element to drive shipping prices higher.

European Coal Rises to Record on Limited Supply, Power Demand
Alistair Holloway - Bloomberg
* Interesting article on how coal for delivery in Europe has rose to record levels as global supplies become limited. Demand from India and elsewhere is increasing as these countries need coal for new coal-fired power stations being built across the globe. Of particular interest is the quote: "We are in a long-term pattern because the world is building a massive amount of coal-fired generation. Current supply is definitely running under global demand.'' The need for coal is also strong in the European Union, where the 27 nations in the union use coal for about 30% of their power. Given that a lot of the coal comes from the U.S. and elsewhere, hauling costs are currently accounting for as much as half the price of delivered coal.

Bears begin to separate the wheat prices from the corn
Javier Blas - Financial Times
* A discussion of how wheat and corn prices, which have at times risen together, have been diverging in price as corn continues to increase in price, while wheat prices decrease. Analysts expect them to begin tracking each other at some point. The key is to determine whether it will be wheat going back up, or corn correcting and selling off. Given that there have been record harvests of wheat in the Northern hemisphere, wheat is expected to continue to fall in price. Nonetheless, the amount of corn in the ground, on a percentage basis, is still below average levels, suggesting that prices will not selling off.

Derivatives

Libor Alternatives Used for Liffe Futures Contracts
Nandini Sukumar - Bloomberg
* Problems with Libor are causing some to look for alternatives. As it turns out, the NYSE Euronext's Liffe derivatives market will begin trading contracts on alternatives to the Libor. The Liffe's contracts include futures based on the euro overnight interbank average, a borrowing rate calculated by the European Central Bank, along with contracts on the sterling overnight interbank average, calculated by the Wholesale Markets Brokers' Association. ICAP Plc is also planning a U.S. alternative to Libor called the New York Funding Rate, based on an anonymous daily survey of at least 24 banks.

Futures suspension fails to trim commodity prices
The Economic Times
* The government of India has suspended futures trading in soy oil, chick peas, potatoes and rubber for at least four months. Last year India banned futures trading in rice and wheat, each in an effort to reduce inflation. Critics feel the ban will simply make the problem worse by shutting down the market-pricing mechanisms, essentially encouraging traders into the country's unregulated black market, further reducing tax receipts and causing even more unpredictability in prices.

Swaption Volatility Rises Amid Risk of Higher Revision in Libor
Liz Capo McCormick - Bloomberg
* The volatility on options for U.S. interest rate swaps increased as investors became worried that the benchmark for borrowing costs may be adjusted higher, causing an increase in hedges against changes in rates. Swaption volatility tracks options on interest rate swaps with maturities of 1 to 10 years. The increase in volatility is due in part to the current issue with the Libor rate, increasing the number of people interested in using swaptions to hedge interest rate risk. The swap spread has contracted about 27 basis points since it reached 112.56 basis points on March 7, the biggest contraction since November 1988, reflecting an improvement in the opinion of the interest rate market as to where the U.S. economy is going. Interestingly, the spreads have contracted also in part as fixed-rate corporate bond issuance increased, given that there has been more corporations using bond issuance to raise capital. Much of this fixed rate paper gets swapped back to Libor. The increase in fixed-to-floating swapping has caused tightening of the swap spread.

China to Develop Currency Derivatives This Year, Official Says
Li Yanping and Judy Chen - Bloomberg
* China has announced that it will continue with its plan to develop existing currency derivatives this year. The derivative products are being produced to help exporters and importers within China hedge their currency risks. The yuan, foreign exchange swaps, and forwards are already being traded.

Hedge Funds

A Commodity Hedge Fund in Every Pot
Paul Kedrosky - Seekingalpha.com
* Click on the link to the article to see the growth rate of commodity hedge funds. It will not continue forever (as humorously mentioned by the author), but does show the recent growth in such funds. Not sure if this is a sign of a top or not.

Gas Deposit Lures Hedge Funds
Eric Baum - WSJ
* A discussion of how hedge funds are betting on the three companies, Chesapeake Energy, Petrohawk Energy, and Goodrich Petroleum, buying land and drilling for natural gas in parts of Arkansas, eastern Texas, and northwest Louisiana. Some funds are placing bets on all three companies as each scrambles for land and mineral rights, while others are placing their bets (and investment dollars) on the two smaller companies, and not the larger Chesapeake, assuming the smaller companies will be able to get more bang for their buck if the estimated reserves come anywhere close to being realized.

Private Equity

Clawback Rule Takes a Bite
Peter Lattman - Deal Journal, WSJ
* Interesting article about clawbacks. In short, a clawback is an investor protection that prevents a company from performance fees and forces them to refund already booked performance fees to investors when unrealized investments fall in price below the stated minimum return. The firm can recover fees if the firm earns positive profits on future deals, essentially digging itself out of a hole by clawing back, causing the clawback accural to disappear.

Fears of private equity talent vacuum
Martin Arnold and Lina Saigol - Financial Times
* A discussion of how some of the largest banks in the world are getting rid of their private equity groups, which is causing some concern that there will not be the proper expertise available regarding financing on leveraged buy-outs when the market eventually corrects. While financing LBOs for private equity is very profitable for banks, many feel that it will be a number of years before a profitable level returns, therefore they are timing staff in the meantime.

ICICI Seeks $3 Billion for India Private Equity, Property Funds
Sumit Sharma - Bloomberg
* ICICI Bank, which is the second biggest lender in India, plans to raise up to $3 billion for two private equity funds as it competes with U.S. firms. ICICI joins Blackstone in seeking opportunity in India. Private equity fund investments in India were seven times more than that investment in China in Q1 of this year.

Why U.S. Highways Are Falling Into Private Equity Hands
Heidi N. Moore - Deal Journal, WSJ
* An article about private equity bidding for transportation assets, including KKR's recent bid for assets in Pennslyania. If you don't like toll roads - too bad. You are likely to see more of them in your future.

Quantitative Finance and Financial Engineering

Amaranth Founder Maounis to Start New Multistrategy Hedge Fund
Katherine Burton - Bloomberg
* Nicholas Maounis, whose hedge fund Amaranth Advisors collapsed after a $6.6 billion loss in 2006, is developing a new fund. The fund, called Verition (Latin for truth), will initially utilize three strategies: quantitative (uses computer models to pick trades), bonds and loans, and special situations (focusing on convertible bonds issued by companies going through corporate events). Maybe the talk I have been hearing about the death of my beloved quantitative funds is true. Just kidding. Really.

Trading

Is A Low VIX A Short Trigger?
Quantifiable Edges
* Interesting analysis of using the VIX as a short trigger. From the blog Quantifiable Edges: "Over the last 10 years, owning the S&P 500 when the VIX was more than 10% below its 10-day moving average was significantly more profitable on average than owning it when it wasn’t. Let me repeat that. Owning the S&P 500 when the VIX was more than 10% below its 10-day moving average was significantly more profitable on average than owning it when it wasn’t. To illustrate I ran a study: Short the VIX on a cross of the lower 10% envelope of the 10-day moving average. Cover when it moved back above this envelope. From 5/98 until now there were 87 such trades. The average lasted just over 3 days. The S&P actually GAINED 91.09 points in the 272 days that this was in effect. That is an average of about 0.33 points per day. In the other 2,379 days the market only managed to gain 184.22 points – about 0.08 points per day. In other words, the market actually performed over 4 times BETTER when the VIX was stretched more than 10% below its 10-day moving average. Also, when this VIX-stretch was active the S&P made nearly 1/3 of its total gains in only 9% of the time." Interesting indeed. This follows a comment by Adam Warner at the Daily Options Report blog stating that: “Also, oversold VIX does not provide as good an indicator as overbought. Outright fear tends to lead to big turns, outright disinterest can just linger.”

Pension Funds `Diversify' Into Commodity Bubble: Caroline Baum
Commentary by Caroline Baum - Bloomberg
* Interesting second half of the article regarding the way pension funds and others are getting around the position limits for speculators. As mention in the article, the CFTC - Commodity Futures Trading Commission, has historically reported the futures positions of hedgers (called commercials, and engaged in the cash market) and speculators (called non-commercials, not engaged in selling the commodity) in its Commitment of Traders report. Speculators, pension funds in this example, can use total return index swaps to get around current positions limits. From the article: "Let's say a pension fund, like the California Public Employees Retirement System, wants to increase its exposure to commodities. Calpers, a speculator according to the CFTC, does a total-return swap with Goldman Sachs Group Inc., a hedger. Goldman promises to pay Calpers the total return on the Goldman Sachs Commodity Index and hedges the swap by buying futures contracts. Calpers's speculative bet on commodities gets recorded as Goldman's hedging in the COT report. In so doing, investors circumvent the position limits on non-commercials." Beyond the regulator issues, the practice causes problems with the reporting of the Commitment of Traders number. Research shows that the swap index positions account for over 41% of the total market capitalization, much more than the positions held by both non-index hedgers and regular speculators.