Stephen’s Posterous

Hedge fund Universa Investments L.P. is planning to launch the Black Swan Protection Protocol-Inflation fund according to the Wall Street Journal. The fund is based on a premise of hyperflation as a result of the massive stimulus efforts of governments around the world.

Universa Investments is known for its connection to Nassim Nicholas Taleb, author of the 2007 bestseller The Black Swan.

The Wall Street Journal said that Universa Investments is trying to capitalize on a wave of investor demand for its products. The fund will invest in options tied to commodities such as corn, crude oil and copper, as well as options on stocks such as oil drillers and gold miners. The fund will also bet against Treasury bonds.

FINalternatives said that the fund is the brainchild of Mark Spitznagel, a longtime collaborator of Taleb who owns and manages Universa. Mr. Taleb himself has no ownership stake in the Santa Monica, Calif.-based firm, but is a major investor and adviser.

There are risks involved when investing in this fund. Some believe that deflation may be much more or a risk than inflation. Others believe that inflation may not take hold for awhile. As written in the Wall Street Journal:

David Rosenberg, chief economist at Gluskin Sheff, a Toronto wealth-management firm, believes inflation won't take hold until consumer spending rebounds, which he thinks could take years. Says Mr. Rosenberg: "Not until the household sector expands its balance sheets are we likely to see the re-emergence of inflation on a sustained basis."

The minimum investment in the firm's other funds has been $25 million, but the company rarely accepts investments less than $100 million

The Financial Times reported that oil prices rose above $60 a barrel for the first time in six months on May 12, 2009. Oil prices have jumped 85 percent from a five year low of $32 a barrel set in February 2009.

Other raw material prices also increased. Sugar rose to a three-year high. Wheat reached its highest price since January 2009. Tin hit a six-month peak.

The leading global commodity index, S&P GSCI, soared to its highest level since November 2008 and is up 20 per cent this year. The Financial Times article said that traders put the reason at China, which revealed a large increase in raw materials imports, reflecting in part the economic recovery but also Beijing’s attempt to take advantage of lower prices to stockpile commodities.

Iron ore and copper imports reached a record in April 2009, while crude oil imports hit their second-best month at the same time. Traders and bankers have reported a return of hedge fund money into the market and said big institutional investors such as pensions funds were making inquiries about commodities.

Corn prices hit a four-month high. However, Cocoa futures lost 3.9% as early speculative buying vanished and selling interest tied to falling demand gripped traders. Cocoa for nearby May delivery fell $96 to settle at $2,353 a metric ton on ICE Futures U.S. in New York as reported by the Wall Street Journal. Most-active July lost $93 to settle at $2,377 a ton.

The International Cocoa Organization on May 11, 2009, said demand for cocoa is expected to see its largest yearly decline in 50 years due to the global economic recession. U.S. cocoa import data drove that bearish point home, said Jack Scoville, analyst and vice president at Price Futures Group.

U.S. cocoa imports fell 30.6% in March 2009, from February, and were down 36.5% from one year ago, the Commerce Department said on May 12.  Global cocoa bean grindings, a demand signal, are expected to fall 6% in the year to September 2009, the ICCO said. Its previous forecast had estimated just a 2.1% fall. Despite waning demand, the ICCO still estimates a world cocoa deficit of 80,000 to 90,000 tons, as production declines.

Weather in top-grower Ivory Coast has been mostly beneficial for the crop, though concerns are beginning to mount over recent heavy rain and a lack of sunshine.

Commodities Throw a Curveball by Liam Denning, WSJ.com

Despite big swings this week, oil prices have been stable, bobbing around the $50-a-barrel mark, plus or minus 10%. This is remarkable when you consider that fundamental supply and demand data have been bearish.

This month, the International Energy Agency raised the specter of early 1980s-style demand destruction. In terms of days of supply, commercial-oil inventories in the industrialized world are higher than in 1998, when crude crashed to $10.

Some take hope from the upward slope of the oil-futures curve, known as contango, interpreting it as indicating higher prices ahead. This view is misguided. Indeed, the extreme steepness of the current contango, with oil a year out trading 20% above the May 2009 contract, points to a more complex situation.

Energy economist Phil Verleger makes a robust case for the market impact of speculators, although not in the way you might think. Contrary to the widely held viewpoint that speculators were to blame for the spike in oil prices last year, movements in the price of oil and many other raw materials display virtually zero direct correlation with flows into and out of commodity funds.

This money, much of it passive, does, however, affect the shape of the forward curve. An upward-sloping curve is indicative of there being a surplus of oil relative to real demand. Funds buying oil futures push up forward prices, steepening the curve's upward slope.

For the traders selling the contracts to them, this presents an incentive to buy cheaper physical barrels and put them in storage for delivery at higher prices down the road, hence high inventories. This removes some oil from the market, putting a floor under spot prices. Supply cuts by the Organization of Petroleum Exporting Countries help in this regard, too.

Relying on investor optimism and cartel cohesion to maintain stable prices even as global economic forecasts worsen, however, requires nerves of steel. If faith in peak oil crumbles further, or financing tightens again, lower demand for futures would reduce the steepness of the forward curve. That, in turn, would erode profits on the oil-carry trade, leading speculators to liquidate inventories, likely hammering prices.

Optimism regarding industrial metals rests on similarly fragile foundations. Bellwether copper is up 43% since late February 2009. This head fake comes courtesy of China cannily stockpiling inventories of raw materials like copper and iron ore even as demand contracts virtually everywhere else.

Stockpiling, however, isn't consumption. The surge in Chinese imports hasn't been matched by increases in industrial production, suggesting metals are going into warehouses, not factories. Oddly, despite the country's apparently insatiable demand for iron ore, big price cuts are expected this year. Like the oil overhang, when those inventories get "mined," prices will likely suffer, transforming the head fake into a major headache.

Source.

It has been a great week for commodities. But has the price rally got ahead of itself? Although demand has improved relative to the dismal conditions of late last year, analysts and traders warn that conditions have yet to perk up sufficiently to warrant an across the board price rally beyond current levels.

“The market is ignoring near-term bearish fundamentals,” says Adam Robinson, director of commodities at Armored Wolf, a California hedge fund. The poor prospects have not discouraged investors, fearful that the Federal Reserve’s action to buy US government debt will stoke growth at the cost of higher inflation.

Some banks are also beginning to see value in the asset class. Goldman Sachs, Wall Street’s largest commodities dealer, on Friday increased its recommended allocation for commodities to “neutral” from “underweight”.

The benchmark S&P GSCI index rose 8 per cent this week. Some commodities gained more than 10 per cent. That strong performance has brought talk among investors about a revival of the asset class, after the carnage of last year. Money flows, particularly exchange traded funds, have picked up. Most analysts are less enthusiastic than investors.

James Steel, a commodities analyst at HSBC in New York, says given that the genesis of the wider commodity rally appears to be the shift in policy by the Federal Reserve and not a sudden change in underlying supply and demand balances, “it is unclear whether higher commodity prices can be sustained.”

Barclays Capital says that a fall in freight costs, a steep decline in Chinese domestic steel prices, both good indicators of industrial activity and commodities demand, and the steady increase in inventories in some raw materials “all suggest fundamental conditions in several markets are still very weak and price recoveries [would] likely prove fragile.”

Goldman warns that it would need to “see demand stabilise before going overweight” in commodities.

Some analysts, such as Daniel P. Ahn, director of macroeconomic research at Louis Capital Markets in New York, question how much central bank quantitative easing, in which central banks inject large amounts of cash into the system in an attempt to bring down long-term interest rates, by itself will help stimulate demand.

“Japan’s example in the 1990s, though not a perfect analogy, shows how massive quantitative easing can co-exist with continued deflation in the absence of structural reforms and proper fiscal stimuli,” Mr Ahn says.

Even if the world’s central banks are successful in quick-starting the economy, it will be months, probably a year, before a pick-up in activity lifts demand for commodities and drags inventories down.

There are some bright spots. Commodities producers’ output cuts, such as by Opec in the oil market, have been in place for long enough and represent a sufficient amount of production to begin to offset demand destruction. This is supporting prices. Merrill Lynch and JPMorgan on Friday raised their oil forecasts for the second half of the year.

“Against our initial expectations, Opec production cutbacks have been very significant,” says Francisco Blanch, commodities strategist at Merrill Lynch.

Other supportive factors for commodities are the Chinese and US fiscal stimulus programmes, which involve large outlays on infrastructure. There are limiting factors. Oddly the pick up in prices is the critical one. Higher prices could lure some producers, from Opec countries to miners, to bring back output capacity even if final demand has yet to recover, opening the door for oversupply and lower prices.

The cycle of higher prices leading to more output and eventually to lower prices is exactly what has happened in the steel sector in China, where a rebound in prices in January, due to traders stockpiling, prompted steel makers to bring back production capacity. As soon as the stockpiling ended, it became clear that final demand was not there and prices fell sharply again.

The influence of speculative money is also likely to be smaller than last year, potentially capping the rally. Hedge funds, for example, have far less firepower than last year as the credit crunch has reduced their capacity to leverage. Regulators appear ready to intervene in the commodities market if they perceive that speculators are driving raw materials prices higher, particularly if oil and food prices are being pushed up.

One way to avoid getting caught out, say analysts, is to pick commodities with supportive fundamentals such as sugar and corn and avoid those with poor ones, base metals and natural gas are typically blacklisted, while also avoiding baskets of raw materials that mix good and bad picks together. The market is divided about the prospects for oil.

Some commodity hedge funds are betting on relative value strategies, gambling that the price of forward contracts, such as for delivery in 2010 and later, will increase relative to spot prices.

The question for investors is whether the economy is strong enough in the short-term to justify the gains. The International Monetary Fund, which forecast that economic growth would fall this year for the first time in 60 years, has a clear view. “Commodity prices are unlikely to recover while global activity is slowing,” it says.

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Basic materials has been a treacherous stock sector as of late after the bloom came off the multiyear rally in commodities. Witness the 47.8% plunge at ICON Materials Fund (ticker: ICBMX) for 2008. But even with that precipitous dive, the fund is ranked by Lipper as the top basic-materials fund for five-year returns.

The future could be much brighter for the sector as well. ICON Materials fund manager and quant-analyst Zach Jonson sees 20% to 25% of upside for basic-materials stocks in 2009 alone. He expects the steel subsector to grow 30% with one company rising as much as a whopping 50%.

Barrons.com: Does the Obama administration change your outlook for the year or not, based on your methodology?

Jonson: I use a quantitative-value-based industry rotation methodology. So being that we are quantitative, that is going to be reflected in our model instantaneously, in the underlying valuations. But we are not going to make any guesstimates about what the new administration is going to be doing.

Currently within the materials sector, using that quantitative methodology, we see about 20% to 25% of upside moving forward [for 2009]; that isn't really a stagnant number, it is going to move over time. If we see spreads narrow within the marketplace within yields out there, we might actually see more value come to fruition.

Q: What industries in materials are you seeing as leaders right now, and what are your favorite stocks in there?

A: Steel is going to be the first one that I'm going to highlight. Currently we see steel has about a 30% upside, so it is a little bit higher than the sector average. Specifically we are going after some of the larger-cap names within that, for example, U.S. Steel (X). We see a downgrade in near-term earnings per share, but their long-term rate still is maintaining over 10% growth. U.S. Steel we actually see conceivably 50% upside.

Q: The typical steel-sector darling is Nucor (NUE). But you see U.S. Steel as having more of an upside play?

A: Correct. We have not seen as much value in that name, but we still see upside in that name. I still have a holding in Nucor, but I'm not quite as bullish on it; I haven't overweighted it nearly as much.

Q: What else are you seeing as leading subsectors?

A: Fertilizers and agricultural chemicals have been a big holding of the materials fund for quite some time. It is, on an absolute basis, the largest percentage holding within the [materials] sector and makes up just over 22% of the portfolio. Names in that include Monsanto (MON), Potash Corp. of Saskatchewan (POT) and Syngenta (SYT), and we've held a pretty big allocation in those for quite some time.

Those earnings estimates have looked very solid going forward; they're actually not taking as big of a hit as the majority of industries out there in the whole domestic universe, not to mention materials. We are seeing their earnings grow going forward. Potash actually came out with an excellent earnings report, and we are seeing approximately 20% of upside within that industry.

Q: Do you see Monsanto having as much upside as U.S. Steel?

A: Monsanto no; actually we don't at this point. Historically we have. We have seen Monsanto have one of the highest upside potential. But currently it is a little bit less. But on a relative basis, as I mentioned, we do have a higher overweight in U.S. Steel than we do in Monsanto as far as portfolio construction goes. Monsanto is approximately 15% of the benchmark, so it is a huge name in that benchmark. We do like both names, and we see approximately 15% to 20% of upside within Monsanto as well. When we dive down on these individuals, we kind of mask a little bit of what we do -- which is, we look at the overall industry basis. So when I'm talking about steel and fertilizers and agricultural chemicals, we're taking a look at how to allocate money within that on the industry basis. When we are looking, we take an overweight position in both fertilizers and steel -- in doing that, we are definitely taking our bets there.

Q: Are you still adding to Dow Chemical (DOW) and DuPont (DD) positions?

A: No, we are basically holding those at where they are. Dow and DuPont we basically hold about equal to the benchmark. I think we are a little underweight within DuPont. But diversified chemicals is not an area that we are looking to add at this time.

Q: Can you tell me what industries and names you've been trimming your positions on?

A: We did trim a little bit in commodity chemicals, specifically in Spartech (SEH). And in diversified chemicals, PPG Industries (PPG); we've trimmed back in that as well.

Q: Thanks for your time.

Source. Subscribe to Barron's. ICON Materials Fund.