On Crude Oil And Mistaken Notions About Bonds

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On Crude Oil And Mistaken Notions About Bonds
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On Crude Oil And Mistaken Notions About Bonds by David Merkel, CFA of The Aleph Blog

I’ve been busier than ever of late — not much time to blog. Thus, a few notes:

1) Often the rate of change in a price can tell you something, particularly if the good in question is widely traded/held by a wide number of parties with different interests.  In this case, I am talking about crude oil prices, and the related set of prices that are cousins.

Overall demand for crude hasn’t shifted, and neither has supply.  Yes, there has been some buildup of inventories, and some key global players refuse to cut production in response to lower prices.  But the sharpness of the price move feels more like some large player(s) who were relying on a higher oil price finally hit their “stop loss” point, and their risk control desk is closing out the trade.

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I could be wrong here, but paper barrels of oil trade more rapidly than physical shifts in net demand, and risk control and margin desks will force moves that are non-economic.  Wait.  Surviving is economic, even at the cost of forgoing potential profits.

We’ll see how this shakes out over the next few months.  There’s a lot of pain for pure play producers, and those that aid them.  I particularly wonder at governments that rely on crude exports to support their budgets… they may not cut, but what will they do, if they don’t have reserves?  Cuts will have to come from economic players initially.  It make take a revolt to affect non-economic governmental entities.

All that said, sharp price moves tend to mean-revert, slow moves tend to persist, so be wary of too much bearishness here.

2) An article in yesterday’s Wall Street Journal was entitled Bond Funds Load Up on Cash.  This qualifies for the “Dog Bites Man” award, as it puts forth the conventional wisdom that interest rates must rise soon.

That drum has been banged so frequently that it is wearing out.  We’re not seeing the pickup in lending necessary to convince us that the economy needs higher real interest rates so that more savings would be available to be lent out.

Also, some managers may be running a barbell, holding more cash and long debt, and not so many intermediate securities.  This would be logical, because a barbelled portfolio does better in volatile markets — it’s ready for inflation and deflation, while giving up yield should times remain stable.

All for now.  Maybe when my busy time is done, I’ll write about it.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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