Friday, April 22, 2016

Global Macro: There Are Many Ways To Approach It, Here's A Good One

A couple weeks ago I emailed a friend:
Re: posts on money
Years ago one of the mentors said you can approach macro from a lot of starting points, for him it was bonds, he had internalized the price/interest rate teeter-totter to the point that if the other parts of the matrix, currencies or metals or equities, whatever, didn't fit the paradigm he'd know he was looking at either danger or opportunity.
I can't go so far as to say they are all fungible but along with empirically derived lead/lag times, grit in the gears/slippage inefficiencies and leverage it's a close enough first approximation to use as a mental model.
The key is to have enough exposure to your subject that your understanding is innate, that you don't have to consciously think "Now when interest rates go down, bonds go up". When you've achieved this level of mastery you immediately sense when the presented facts aren't conforming to the mental model and may be worth further scrutiny.

Another way in to global macro is commodities and if this is your choice it helps to internalize curves to the point the dangers/opportunities pop when you look at them.

Permit me to present Izabella Kaminska, writing at FT Alphaville:

Bringing balance to the commodity force, not leaving it in surplus
Commodity curve purists insist that long-term futures prices must not be confused with market forecasts.

People who do that are deemed commodity dummies because long-term futures are said to reflect the price at which market participants are prepared to buy or sell commodities in the future today. That generally means prices that make sense for them right now, but not necessarily those they expect in the future.

As a result, certain assumptions can be made about curve structures.

If long-dated futures are very much higher than spot prices, the market is offering premiums to those who have the capacity to take delivery today and store the oil until the future. It’s a dynamic that indicates an abundance of oil in the spot market today, rather than an expectation that prices will be higher tomorrow. It’s known as a contango market and is generally a bearish signal.

To the contrary, if spot prices are very much higher than futures prices, the market is offering premiums to those who have the capacity to deliver commodities today and make up for the lost sums with increased production. This dynamic reflects a shortage of oil in the spot market today, not an expectation that prices will be lower tomorrow. More commonly, it’s known as a backwardated market and it’s generally assumed to be a bullish signal.

And yet, in recent times, these long-standing assumptions — based on the sound logic that it’s always the spot market which leads the curve, not the other way around — are being tested. A flattening or backwardated market, for example, is increasingly looking like a scenario in which the reluctance of financial participants to fund the long-term storage of commodities is leading the spot price to a lower clearing price, not the other way around.

This, of course, reflects the need for a long-term rebalancing in the market, linked to a permanent elimination of active production rather than just a temporary wind-down.

As Goldman Sachs’ commodities team depicts on Friday, the anatomy of a typical commodity futures curve must now account for the phenomenon of short-cycle production:...MUCH MORE