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Power Hedge is an independent international investor with a passion for macro- and microeconomic analysis. Power Hedge focuses his research primarily on dividend-paying, international companies of all sizes with sustainable competitive advantages. Power Hedge is neither a permabear nor a... More
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  • Book Review: Oil's Endless Bid
    I found Oil's Endless Bid to be a thoroughly interesting and engrossing book. This book was written by veteran NYMEX oil futures trader turned energy markets analyst Dan Dicker and published by Wiley Finance. Dicker leverages his experience throughout this book to provide unique insider insight into why oil (and other commodities) futures markets have become much more volatile and unpredictable over the past decades. Dicker also offers his own prescription for reform of the futures market.
     
    Dicker believes that the recent evolution of oil into an investment or asset class has led to higher prices and more price instability in the markets. This leads to higher gas prices at the pump for consumers, less stability and predictability in revenues and profits for oil companies, and makes virtually all kinds of business planning more difficult. Thus he believes that the transformation of the oil futures market into “just another capital market” has greatly hurt economies, businesses, and consumers around the world. This puts him at odds with many other energy and commodities analysts who believe that the overall impact of speculation on the oil markets is minimal.
     
    The book opens up by discussing how the futures markets operated during the beginning of the author’s career; this period includes the 1980s and 1990s, and lasted until 2001 or so. There were many interesting characters on the trading floors in those days and many of them were gamblers. By far, the biggest players in the oil futures markets were Exxon (XOM), BP (BP), Chevron (CVX), and other major oil companies. This is in stark contrast to today where the biggest players are Morgan Stanley (MS), Goldman Sachs (GS), commodity index funds, and other financial players that have no interest in physical crude oil. This is a problem, Dicker explains, because the futures markets were never designed to handle this kind of financial interest.
     
    The change in the futures market, that from a market composed primarily of hedgers with a legitimate business interest in physical oil to one made up of people interested more in betting on oil prices, is a central focus of the book. Dicker devotes a lot of space to discussing this progression. It is a very good read, though. The author is in a unique position to offer insight into these changes as he was trading oil contracts on the floor of the NYMEX while this evolution was taking place. There are few other authors or analysts that have this sort of experience to draw on.
     
    The banks, hedge funds, indexers, and pension funds are not the only financial players to have gotten into the act. In one section of the book, Dicker discusses an interview that he had with Coastal Oil in 1994. This Texas oil company had been fantastically successful at handling physical oil but several executives were concerned that the company could not keep pace with all the new oil derivatives hitting the market. The company had been successful at trading with the other oil companies but the financial players eventually ate their lunch. Coastal ultimately went out of business due to trading losses and not due to any problems with their core business of finding, processing, and selling oil. The same thing has happened to other smaller independent oil companies. This is intended to serve as an example of how concerned the oil producers and users have become about the increasing focus on trading, especially that by parties that have no interest in the physical product. Others may have believed that their proximity to the physical markets gave them an advantage in the oil trade; this belief may have been true at one time but it no longer is today.
     
    Dicker concludes with a discussion on how the markets can be reformed to bring back their proper functioning. He notes that the amount of investment money currently in the futures markets has inhibited their price discovery feature which is an essential role of any properly functioning market. The author thus clearly believes that any effective reform will need to substantially reduce the role of purely financial players without imposing undue burdens on legitimate hedgers. He does not believe that any current proposal by regulators will accomplish this. Here are the commonly proposed reforms and why this twenty-year industry veteran does not believe that they will be successful.
     
    • Increasing Margin Requirements: The increasing volatility of the oil markets over the past decade has been consistently met with higher margin requirements. So far, the speculative money has been the least affected by this. In fact, the number of hedge funds, ETFs, managed futures accounts, index funds, and oil trading shops have increased at the same time that margin requirements have increased. While increased margin requirements may help, the levels that are needed to clean up the futures market will risk destroying it entirely.
    • Imposing Position Limits: Futures exchanges have always had fairly strict position limits. The problem, as Dicker sees it, is not one participant amassing huge positions in oil. The problem has been an influx of a huge number of participants. A large number of investors or speculators, all going long, are overwhelming the futures market. Additionally, if one single player wanted to take a larger position than what is allowed, they could simply go to the unregulated OTC market to acquire a position. Even if this option did not exist, it would still be possible to set up a network of seemingly unrelated accounts all over the globe and have each of them bid up to the position limits. This would allow the limits to be bypassed if all accounts are owned by the same entity.
     
    Dicker does offer some suggestions about what effective reform would entail. These include:
    • Moving all oil futures trades onto regulated exchanges and abolishing the OTC market entirely.
    • Outlaw oil futures ETFs and index funds. He suggests that it is far too easy to trade futures in today’s world of discount online brokerages.
     
    All in all, Oil’s Endless Bid was a book that I found myself completely unable to put down. The author does an excellent job of explaining in plain language how the transformation of oil into another financial asset has led to higher and more volatile pricing for all. I highly recommend this book to anyone with an interest in oil markets, futures and commodities trading, or with an interest in obtaining an insider’s perspective into the NYMEX. I also recommend it for anyone who wonders why it costs $40 to fill up your gas tank one year and $80 the next.

    Tags: GS, MS, XOM, BP, CVX, USO, OIL, Book Reviews
    Sep 10 11:45 PM | Link | Comment!
  • Book Review: The Demise of the Dollar
    I recently finished reading The Demise of the Dollar by Addison Wiggin and published by Agora Financial. Wiggin was a coauthor on the last book that I reviewed, The New Empire of Debt, also published by Agora Financial. You can read my review of that book here.
    One of my criticisms of Wiggin’s other book is that it offered no solutions for how investors can protect themselves or even turn an opportunistic profit from what Wiggin has identified as an “epic financial bubble.” The author rectified that in this book. In this book, Wiggin identifies a few hedges and profit opportunities amongst a dire outlook for the U.S. dollar.
    I will admit that reading this book brought back memories of reading my finance texts in college. The book is not an overly technical read but it is certainly not as easy of a read as the previous book that I reviewed by this author. There were a few sections that felt quite wordy, almost as though Wiggin was stating the same point over and over again. I think that he could have effectively made the case for a long-term decline of the dollar in about half the length that he actually took. With that said, Wiggin does effectively make a strong macroeconomic case for a progressive, long-term decline in the value of the U.S. dollar.
    The author is clearly troubled by the massive growth in consumer debt over the past few decades. He describes this as “pathological consumption” and he states that this is one reason that the dollar will necessarily decline in value. The reason is that this debt-fueled consumption is driving a massive trade deficit. American factories have been progressively moving overseas since the late 1970s. As these factories leave, the jobs that formerly existed at these factories leave with them. This is causing a labor shift from high-paying manufacturing jobs into low-paying jobs in other sectors. Consumers, however, increased their spending despite the loss of income. They accomplished this with debt. Since the products that consumers are buying are constructed in factories overseas, Americans have effectively been borrowing money to ship to other countries. According to the author, America has been “selling its factories and financial assets to pay for consumption.” This cannot go on forever and it is a major and growing stain on the value of the dollar.
    Wiggin also states that the Federal budget deficit will drag down the value of the dollar over the long-term. He is particularly concerned about how the budget deficit has become institutionalized. According to Wiggin, “we cannot continue the exponential expansion of debt without a catastrophic economic outcome.” He also points out that the debt is actually much larger than the stated levels; this is due to the obligations of Social Security and Medicare. These obligations have not been funded. As with the author’s other book, Wiggin is very apolitical when it comes to the causes of the burgeoning national debt. Wiggin lays the blame squarely on both the Republicans and the Democrats. He also debunks the Republican theory that lowering taxes will fix everything. The author seems to be pessimistic that our deficit problem can be resolved and he offers no solutions that I could see to this problem on a national level. He does offer advice that individual investors can use to protect themselves though.
    Wiggin devotes the final chapter of the book to the thing that I suspect every investor is most interested in: profiting off the dollar’s decline. Here are a few of his suggestions:
    1. Long-term puts on mortgage securities and subprime mortgages. Considering that this book was written in 2005, this was a very prescient call. It also proved to be a very correct one. An investor who goes long a put option is essentially going short the security. During the most recent recession, a short on mortgages, especially subprime ones, was a very profitable investment to make.
    2. Oil. This was another correct, if volatile, investment to own since 2005. Wiggin’s thesis is based on the long-term growth in oil demand. The author states, and I agree, that over the long-term demand for oil will grow more rapidly than the supply will. Basic economic principles tell us that this will cause prices to rise. Investors who own assets that will benefit from an increase in oil prices should profit from this.
    3. Foreign investments. Wiggin’s suggestions are limited to commodity companies located in areas that will benefit by profitably providing resources to a growing and hungry China. His suggestion is Australia. I agree with him that Australia does have some promising qualities and it would have been a great long-term play at the time that the book was written. Wiggin did not expand on the foreign investment theme like I would have liked though.
    4. Gold. Anyone who bought gold in 2005 at the author’s suggestion can tell you how good of a call this was! Wiggin makes the case for gold at numerous points throughout the book. There were times when I got the feeling that I was reading a very thorough investment thesis for gold. I think that gold is Wiggin’s strongest recommendation for an investor looking to navigate the coming dollar devaluation.
    Overall, I found The Demise of the Dollar to make a very convincing if somewhat wordy case for the continued decline in the value of the U.S. dollar looking forward. The author seemingly tries to aim the book at investors and readers of all experience levels but it may be easier to follow if you have at least some knowledge of macroeconomics before you begin reading. The profit opportunities chapter does offer more suggestions than what I have detailed here and has strategies for both beginning and advanced investors. All in all, the book was a success at what it set out to do!
    Tags: GLD, Book Review
    Apr 23 8:02 PM | Link | Comment!
  • Poor Retirement Readiness Will Act as a Drag on Employment

    Wells Fargo released a study earlier today that shows how poorly the average American is prepared for retirement.

    • 72 percent of Americans aged 25 to 69 expect to work through their golden years.
    • Most people surveyed believe that they need $300,000 to retire. They have, on average, 20,000 saved.
    • The median amount of savings for people aged 50-59 is $29,000. This is not nearly enough to support them in retirement, even with a massive economic boom.
    Most of the fifty-somethings also believe that they will have enough saved up to support their lifestyle in retirement. There is no way, barring a large savings boom that these people will be able to save up to even the $300,000 figure (and this number is not nearly enough to retire for an average middle class family). If that savings boom comes, then it will act to curtail the demand for goods and services in the American economy. After all, money that is used to be saved cannot be spent. Given the reliance of the U.S. economy on consumer spending, this could act as a significant economic drag.

    I believe that it is more likely that these poor savers will simply continue to work and never retire. This will create a drag on employment. With less attrition in firms, there will be less need for companies to hire people to replace those workers who retire.

    Dec 08 9:07 PM | Link | Comment!
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