Monthly Archives: April 2013

Smooth Talk About Gold

Bruce Bartlett used his New York Times Economix blog post today to argue that “Gold’s Declining Price Is a Reversion to the Mean”. He buttresses his argument by pointing out that,

In a recent paper, the economists Claude B. Erb and Campbell R. Harvey present strong evidence that the gold market was severely overbought. The increase in gold prices did not represent a change in the trend of inflation. As the chart indicates, even with the sell-off, the price of gold is still high and has a long ways to fall to get back to the “golden constant” that gold-standard advocates cite as proof that the dollar should be pegged to gold.

Bartlett Harvey

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CSI: prop trading investigation squad.

Does JP Morgan’s derivative portfolio hedge its other lines of business? This picture says ‘no’.

Does JP Morgan’s use derivatives to make prop trade bets on interest rates. This picture suggests ‘yes.’


Piazzesi et al.

Let me explain.

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Can Hedging Save Cyprus?

Lenos Trigeorgis has a piece in the Financial Times’ Economists’ Forum advocating the use of GDP-linked bonds for Cyprus.

Suppose that its steady-state GDP growth is 4 per cent and that fixed interest on EU rescue loans is 3% per cent Instead of the fixed rate loan, Cyprus could issue bonds paying interest at its GDP growth minus 1% (the difference between the average growth rate and the EU bailout rate). If GDP growth next year is 0 per cent, lenders would pay the Cypriot government 1%, providing Cyprus with some relief in hard times. But if after, say, 10 years GDP growth is 7 per cent, lenders would instead receive 6 per cent. In essence, during recession EU lenders will provide insurance and interest subsidy to troubled Eurozone members, helping them pull themselves up, in exchange for higher growth returns during good times. Increased interest bills in good times might also discourage governments from sliding back into bad habits.

As we’ve written in a couple of earlier posts, this is easier said than done. But it’s certainly thinking along the right lines.

Gold’s Random Walk

A number of journalists are helping to broadcast Goldman Sachs’ latest prediction for gold prices. Goldman’s press agents planted the story in the Wall Street Journal, the Financial Times and the New York Times, among other places.

This is silly. There’s plenty of scientific evidence that the gold price is a random walk. Here’s an old reference: Eduardo Schwartz’s Presidential Address to the American Finance Association back in 1996. There are older and more recent papers finding the same.

Last week I wrote a post in which I mentioned that the time series of commodity spot prices are often mean reverting. They contain an element of predictability. Gold, however, is the exception. Gold is very, very, very cheap to store. And it is widely held purely as a store of value without any use value. Consequently, the spot price of gold quickly incorporates changing market views about future supply availability and any other fundamentals like those itemized in the Goldman report. For all intents and purposes, a physical investment in gold is a financial security, which means that the spot price is a martingale. The distinction I made in my last post between the spot price series for a commodity and the time series for a specific futures price is a meaningless distinction for gold.

Games with Risk Controls

FT Alphaville has been running a series of blog posts digging in to items raised in the investigation of the fiasco at JP Morgan’s Chief Investment Office. The series is called The Belly of the Whale.

Today’s entry is a must read for anyone who has tried to “control” traders using quantitative risk measures. It’s all about gaming government capital rules. But shouldn’t any corporate officer who has to manage teams of traders have to worry about similar games being played?


Margins, Liquidity and the Cost of Hedging


Our paper on end-users and the cost of margins is now out in Morgan Stanley’s Journal of Applied Corporate Finance.

Dynamic Hedging or Futile Speculation?


Chesapeake still thinks it can time the market.

On Tuesday management held its Conference Call to update to investors and stock analysts. Steve Dixon, the acting CEO, said “We’ve also taken advantage of the recent surge in natural gas prices to lock in additional price protection in 2013, and we have begun to hedge natural gas production in 2014 at prices well above $4, a level the market has not seen for some time.”

The company has had problems in the past from its foolish attempts to time natural gas prices. Last time prices were falling and the company took off its hedges. This time prices are rising and its putting on hedges. But the mindset is the same.

Behind this dynamic hedging strategy is a common misunderstanding about mean reversion in natural gas prices. The same misunderstanding applies to other commodities as well.

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