CHINA AND ITS OIL FUTURES
There are two significant events that have recently transpired. Spurred by
rumors of speculation in the oil markets Washington (Gary Gensler’s CFTC)
is reviewing its futures market regulatory stance. New CFTC Chief Gary
Gensler promises an increase in regulation. Because Mr. Gensler is a
Goldman Alum, we think any serious re-regulation is unlikely. We have
always been fans of the options (not the futures market) here at Disocvery
Investing.com. Cash settlement in the futures market leaves us cold – just
as it did during the massive equity market decline of October 1987.
Will we ever learn?
How many OTC derivative and futures-induced bubbles must burst before
we properly design our derivative contracts (position limits, margin
requirements, no cash settlement, etc.) and regulate naked shorting – which
is nothing more than stealing from honest shareholders. Birch Mountain is
the most painful example of naked shorting, in my opinion.
And in academe, teaching CAPM, Value at Risk, Black/ Scholes and Binomial
option pricing as the major risk discounting vehicles on which base risk
analysis and valuation of the markets is naïve. In reality it has become
mark-to-model in all markets. Assuming the world is Normally
distributed (Gaussian) in its risk profile is a simplifying yet failed assumption.
Mathematics as the driving force is out. Perhaps Pimco’s Bill Gross is correct
there is a New Normal – fat tails and Black Swans anyone?
We do not agree with all the talk in New York and Washington, especially
from the naive meanderings of the Obama capital market people, on the
evils of speculation. Simply design a fair and transparent listed options
contract and then establish the framework to run the options markets properly.
Because we can print cash, according to the Federal Reserve’s Bernanke,
unbridled cash settlement of futures is a no, no.
Never mind, the big players have been lifted from the muck and mire by
the “too big to fail” label and the egregious violation of Moral Hazard.
Really what does risk taking mean anymore to any large institution?
Perhaps this is China’s concern.
A fair, listed and transparent derivative market cannot be beyond the reach
of today’s capital and futures market thinkers. Goldman Sachs and JPM
could take the lead here. Citizens, investors and legislators need to become
self-educated and must demand no less.
The second issue of importance is China’s recent threat (See China Economic
Review September 2, 2009) to walk away from some of its futures contracts
in the oil market. More important is the rumor that China has made the long
side of the gold and silver futures market for the likes of Bear Stearns,
JP Morgan, HSBC and other shorts.
Should China walk away from its gold and MORNING NOTESsilver positions
all hell will break loose. Ted Butler, the most well known and prescient silver
analyst, in the world, has recently written on the potential of this.
Twenty two years ago (early October 1987), I presented at the Citigroup Asian
Country Head seminar run by Harvard University in Singapore. At that time I
forecast the great market collapse of 1987 reasoning that the equity futures
market would be undone by the futures market. I reasoned that portfolio
insurance (another can’t-fail futures product of Wall Street) would crash the
market. Following that I spent a good deal of time in the next decade in Asia.
In 1995 I was invited to present my analysis of China’s nascent T-Bond Futures
market. I presented to the CSRC (the equivalent of the US SEC) in both Beijing
and Shanghai. It was a wonderful experience. Most of the terminology did not
exist in the Chinese language at the time (simultaneous translation). In any event,
after I finished and described the effects of the 1987 equity market demise they
abruptly shut the futures market down. It reopened only a few years ago. This
AM I sent this email to my good friend Chris Tibbs who had invited me on behalf
of CitiGroup and China to speak.
“Chris,
We said all these things (position limits, margin, cash settlement, etc.) about the futures
market in 1995 while in China. The case study of the1987 portfolio insurance debacle
should have been enough. What we did not mention then were fast trading strategies,
unlisted derivatives and the morality of the other side. I am amazed that China is threatening to walk away from some of its oil futures positions. They would not do this if they did not know much more than they are reporting. Sure, they lost money on their oil futures but they made a contract. Based on our experiences I assume no one twisted their arms to buy.
What do they know about their losses that have them angry enough to threaten so publicly to walk on futures contracts? The particular issue here is the hundreds of millions of dollars that Chinese SOE’s lost on their oil futures positions.
The next issue of interest may be the gold and silver futures markets – JPM and HSBC (up to four firms according to Ted Butler via his excellent analysis of the COT) recently established the largest commercial short position ever – on silver. China has encouraged its citizens to buy silver in up to 5 kilogram bars – which could make Revett and Quaterra much more valuable. But with commercial silver shorts at record high levels would China also walk from its silver and gold futures contracts? What might happen?
Would new CFTC Chief Gary Gensler (a Goldman Sachs alum) re-regulate and modify the oil futures market / contracts and not the gold and silver futures market? Unlikely.
I think Ted Butler has it right on – this AM we have gold over $1000 – let’s see what happens by 11 AM on the COMEX.
I emphasize this because I remember so well your comments, Chris, that when Chinese authorities act they act very quickly – as per our futures market presentations to the CSRC in 1995 in Shanghai and Beijing and the subsequent shut down of their futures market for years. Personal experiences!
Perhaps China would actually like to see gold and silver prices fall so dollars could be swapped more economically for the precious metals. Interesting times – the shoe may most definitely be on the other foot now. Maybe it is simply a message from China as there have been so many lately.
http://www.chinaeconomicreview.com/dailybriefing/2009_09_02/SASAC_clarifies_
statement_on_derivatives_contracts.html”
It will be a most interesting time for gold and silver investors as we move forward.
Please be sure to have a core discovery position in gold and silver.
2. DISCOVERY INVESTING TUTORIAL
Finally I have completed a University style lecture on Discovery Investing. I would be
most interested in feedback that you may have, good, bad or indifferent as long as it is
constructive. This is an introductory seminar. I plan to present several amore which
will be more detailed and focus on specific topics; the 10 point grid, the 8 point discovery process and risk analysis. We will also present three case studies (both winners and losers) to help in the teaching of the technique. The video is about 30 minutes in duration so I do not think it will be a waste of time. I am available to present these topics at any live conferences that you may be attending.
….read more HERE.
3. PRINCETON CLUB SEMINAR SEPTEMBER 10TH 4:30 PM
PLEASE JOIN US !!!
QUATERRA RESOURCES
Dr. Michael Berry will open with a discussion “Where Are We Headed in the Economy?”
followed by Dr. Thomas Patton, CEO, Quaterra Resources “The Bright Future of Quaterra.”
Quaterra’s silver exposure in Mexico is one critical aspect of his discussion
Thursday, September 10, 2009
4:30 PM to 6:30 PM
Cocktails 4:30 PM Presentation promptly at 5:15 PM
You can sign up for Dr. Berry’s free Morning Notes HERE.
Michael Berry has been a portfolio manager for both Heartland Advisors and Kemper Scudder where he successfully managed small and mid cap value portfolios. Dr. Berry has specialized in the study of behavioral strategies for investing and has been published in a number of academic and practitioner journals. His definitive work on earnings surprise, with David Dreman, was published in 1995 in the Financial Analysts Journal.
Previously, Dr. Berry was a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia and has also held the Wheat First Endowed Chair at James Madison University.
Dr. Berry is a respected and dynamic speaker. He regularly presents around the world on topics such as value investing, the role of Austrian Economics in investment management, behavioral investing strategies and is a specialist in developing case studies to teach investors how to invest. While a professor, he published a case book, Managing Investments: A Case Approach.