Summer 2018

Dr. Jian Yang, Ph.D., CFA provides an update on the JPMCC’s research activities and future plans. As the J.P. Morgan Endowed Research Chair, Dr. Yang is the JPMCC’s Research Director. His three goals for the JPMCC are (1) for the center to become globally known for its innovative research in the commodity arena, (2) for the JPMCC to become a leading educator of cutting-edge knowledge in the commodities space, and (3) for the center to become a major participant in the exchange of knowledge amongst commodity thought leaders. Towards the latter goal, Dr. Yang is organizing the JPMCC’s second international commodities symposium, which will take place in August 2018 and which will include many top commodities scholars.

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The fifth issue of the Global Commodities Applied Research Digest (GCARD) draws from the JPMCC’s varied expertise across academia and industry. The Summer 2018 issue includes a special focus on the JPMCC’s inaugural international commodity symposium that took place in August 2017. The current issue also examines the prospects for commodities in light of geopolitical tensions and trade war concerns. In addition, the present edition examines various futures trading strategies, including momentum trading, positioning analysis, pairs trading, and volatility analysis. Finally, members of the GCARD’s Editorial Advisory Board have contributed articles on the fundamental developments in the crude oil market as well as on the considerations in evaluating renewable energy contracts. We welcome reader feedback on this issue.

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By Bluford Putnam, Ph.D., Chief Economist, CME Group and Member of the JPMCC’s Research Council

The biggest current threat to global growth is a trade war. There are other risks. The US Federal Reserve is unwinding quantitative easing and raising rates, but making the policy shifts very gradually with careful market guidance. Governments are focused on whether they need to cut taxes, not raise them, so there would be no growth risks from fiscal policy. Consumer confidence is relatively high around the world, from mature industrial countries to young emerging market countries. Equity market valuation may appear high to some, but stock market corrections do not cause recessions unless there is a financial panic – and systematic risks from financial institutions are much lower than when the last crisis occurred in 2008. After considering the other risks, we stand by our analysis that if the current synchronized global economic expansion is derailed, the most likely cause will be a trade war. Yet, we are optimistic. So far, the actions taken earn only the terminology of “Skirmishes,” but if they escalate to “Battles” and then a “Trade War,” we will need to reassess the risks. This article provides a review of the issues and challenges of trade protectionism.

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By Brock Mosovsky, Ph.D., Director of Operations and Analytics, cQuant.io and Lance Titus, Managing Director, Uniper Global Commodities and Member of both the JPMCC’s Research Council and the GCARD’s Editorial Advisory Board

Renewable power purchase agreements (PPAs) have long been important enablers of renewable energy development. They are a means to providing the revenue certainty that project developers need to secure financing for capital-intensive wind and solar projects, and they also give renewable energy buyers access to the renewable energy they desire without upfront capital outlay or the need for development expertise. However, these agreements are complex long-term financial contracts and should be treated as such within any buyer’s broader business portfolio. In this first article of a two-part series on renewable PPA analytics, we illustrate how nuanced interactions between intermittent generation and electricity market prices can significantly impact PPA value. Without proper value tracking and active management, adverse market moves can erode PPA value over time and potentially require the buyer to make settlement payments each month to cover losses on the contract. In the second article of the series, to appear in the Winter 2018 edition of the GCARD, we will elaborate on the mechanics of risk mitigation strategies.

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By Kaifeng (Kevin) Chen, Ph.D., Chief Strategist, Hywin Capital Management, LLC and Member of the GCARD’s Editorial Advisory Board; Keith Black, Ph.D., CFA, CAIA, Managing Director, Curriculum and Exams, Chartered Alternative Investment Analyst Association and Member of the GCARD’s Editorial Advisory Board; and Lena Gerber, Senior Marketing Professional, University of Colorado Denver Business School

Over 80 international commodities researchers and practitioners attended the J.P. Morgan Center for Commodities’ (JPMCC’s) inaugural “New Directions in Commodities Research” international symposium in August 2017 to discuss critical thinking and new research related to commodities. The 2017 symposium took the place of the JPMCC’s annual Research Council meeting. The conference’s lead sponsor was the CME Group Foundation. The 2017 symposium included speakers and participants from a broad set of industries, regulatory agencies, and research institutions, including oil and natural gas companies, automobile manufacturers, renewable energy companies, U.S. national laboratories, universities, the Federal Reserve Bank of Dallas, the Commodity Futures Trading Commission, financial institutions, exchanges, and market research institutions. The broad range of topics covered by the conference included renewable energy finance, raw materials, shipping finance, macroeconomics, and China’s economic supply side reform. This article summarizes four of the presentations from the August 2017 conference.

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By Lutz Kilian, Ph.D., Professor of Economics, University of Michigan, Ann Arbor and Member of the JPMCC’s Research Council and Xiaoqing Zhou, Ph.D., Senior Economist, Bank of Canada

Between June 2014 and March 2016, the inflation-adjusted price of oil dropped by 66%. This price decline was one of the largest in history, yet average U.S. economic growth accelerated only slightly from 1.8% at annual rates before the oil price decline to 2.2% after the oil price decline. The absence of an economic boom in response to falling oil prices has puzzled some observers, given that higher oil prices in the past have been blamed for major economic recessions. That said, it is well documented that the consumption stimulus from lower oil prices is only modest, and the recent episode is no exception. What had not been fully appreciated is that the oil investment response does not depend so much on the magnitude of the oil price decline, but rather on how far the expected oil price declines relative to the break-even point. Hence, oil investment may change disproportionately, as oil price expectations change. This fact may hold the key to understanding the macroeconomic consequences of oil price shocks in countries with a sizable oil sector such as the United States. Professor Kilian presented on this article’s topic during his keynote speech at the JPMCC’s August 2017 international commodities symposium.

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By Martin Stuermer, Ph.D., Senior Research Economist, Federal Reserve Bank of Dallas

Demand shocks due to rapid industrialization have driven commodity price booms throughout history. As periods of industrialization lose steam and supply catches up, busts follow after about 10 years. A new dataset of price and production levels of 12 commodities provides evidence of this behavior from 1870 to 2013. Dr. Stuermer presented on this article’s topic at the JPMCC’s August 2017 international commodities symposium.

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By Adrian Fernandez-Perez, Ph.D., Auckland University of Technology, New Zealand; Ana-Maria Fuertes, Ph.D., Cass Business School, City, University of London, U.K.; and Joëlle Miffre, Ph.D., Audencia Business School, Nantes, France

As summarized by Ana-Maria Fuertes, Ph.D., Professor in Finance and Econometrics, Cass Business School, City, University of London, U.K. and Member of the GCARD’s Editorial Advisory Board

This digest article summarizes a flexible investment framework that nests standalone styles and integrations thereof and can be applied in a long-short, long- or short-only fashion to any asset class in zero net supply. Motivated by the unsettled debate on how to best model commodity risk premia, the usefulness of integration is demonstrated in the context of a “universe” of eleven long-short commodity styles. The findings hold after trading costs, variants of the sophisticated integrations, sub-period analysis and data snooping tests.

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By Robert Bianchi, Ph.D., Griffith University, Australia; Michael Drew, Ph.D., Griffith University, Australia; and John Hua Fan, Ph.D., Griffith University, Australia

As summarized by Ana-Maria Fuertes, Ph.D., Professor in Finance and Econometrics, Cass Business School, City, University of London, U.K. and Member of the GCARD’s Editorial Advisory Board

This article investigates the 52-week-high momentum trading strategy in commodity futures markets. The paper’s empirical analysis suggests that this behavioral-finance-motivated strategy generates significant profits after accounting for transaction costs, and outperforms the conventional momentum strategy. They further demonstrate that the 52-week-high momentum returns are significantly linked not only to the term structure and hedging pressure risk factors that reflect the inexorable contango and backwardation cycle but also to the TED spread that proxies for global liquidity risk.

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By Ioannis Psaradellis, Ph.D., University of St Andrews, U.K.; Jason Laws, Ph.D., University of Liverpool, U.K.; Athanasios Pantelous, Ph.D., Monash University, Australia; and Georgios Sermpinis, Ph.D., University of Glasgow, U.K.

As summarized by Ana-Maria Fuertes, Ph.D., Professor in Finance and Econometrics, Cass Business School, City, University of London, U.K. and Member of the GCARD’s Editorial Advisory Board

This article examines the performance of technical rules applied to the pairs-trading strategy using daily data from 1990 to 2016. The main finding is that while the performance of pairs-trading based on technical analysis exhibits a downward trend over the sample period, the opportunity for significant pairs-trading excess profitability remains.

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By Hilary Till, Solich Scholar, J.P. Morgan Center for Commodities, University of Colorado Denver Business School; and Principal, Premia Research LLC

The Winter 2017 issue of the Global Commodities Applied Research Digest (GCARD) provided a case study on the MF Global bankruptcy. In this issue of the GCARD, we cover another debacle: the Amaranth (commodity) hedge fund debacle. While the lessons from the MF Global bankruptcy can best be understood in terms of due diligence principles, the Amaranth blowup can best be understood in terms of market-risk principles.

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By Hilary Till, Solich Scholar, J.P. Morgan Center for Commodities, University of Colorado Denver Business School; and Principal, Premia Research LLC

This digest article covers examples of successful contracts that responded to new large-scale commercial risks over the past 170 years. The article explains the new commercial circumstances that ushered in the intense need for hedging instruments, spanning the grain, financial, crude oil, and natural gas markets. This digest article is excerpted from a seminar that was prepared by the author for staff at the Shanghai Futures Exchange.

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By Daniel Murray, Deputy CIO and Global Head of Research, EFG Asset Management (U.K.) and Member of the GCARD’s Editorial Advisory Board

We live in a world of heightened geopolitical risk where developed countries are reliant on less politically stable countries for the supply of many commodities. Yet there is little academic literature that investigates these relationships. This paper presents such an analysis using a new index of geopolitical risk. An initial simple event analysis is performed comparing spikes in geopolitical risk with the performance of various financial markets. The results are ambiguous: the relationships vary enormously over time and across financial indices. A vector autoregressive analysis is performed to examine the relationships more closely. Granger causality from commodity prices to geopolitical risk is shown to have existed before the global financial crisis but not subsequently. Impulse response analysis generally shows a weak response both from commodities to geopolitical risk as well as in the other direction. This is in contrast with commonly held views about the impact of geopolitical risk on commodity prices.

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By Jan-Hein Jesse, Founder, JOSCO Energy Finance and Strategy Consultancy (Amsterdam) and Member of the GCARD’s Editorial Advisory Board

This article is the second in a two-part series. This series provides insights into the complex dynamics of oil price formation from 2014 onwards. Part 1 focused on the events influencing the oil markets from 2014 through 2015 while Part 2 covers (a) oil-market-moving events from 2016 through the present and near future and (b) JOSCO Energy Finance and Strategy’s field-by-field oil production analysis through 2025.

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By Mark Keenan, Managing Director, Global Commodities Strategist and Head of Research for Asia Pacific, Société Générale Corporate & Investment Bank (Singapore) and Member of the GCARD’s Editorial Advisory Board

In recent years, positioning has become a key driver of commodity prices and a principal factor in shaping sentiment and behavior. Published in January 2018, the book, “Positioning Analysis in Commodity Markets,” defines and establishes “Positioning Analysis” as an area of research that provides a powerful framework to better understand price dynamics, risk, sentiment and behavior in commodities. The article highlights key areas of the book, explaining how certain types of positioning patterns, in the context of changes in a variety of variables, can be used to develop different models, indicators, analyses and trading signals.

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By Vito Turitto, Manager, Quantitative Analysis, S&P Global Platts (U.K.)

Market risk and hedging strategies have, particularly over the last few years, helped many market participants mitigate crude oil market fluctuations. The implementation of efficient energy hedging strategies has often made the difference between business success and bankruptcy. An indispensable element of hedging is the estimation of volatility. This article explains how a study of volatility fluctuations can be used to build efficient hedging strategies and to understand market sentiment. The key features of this analysis focus on volatility asymmetry and volatility’s mean-reversion propensity. The article finds a negative link between implied volatility, extracted from average price options, and swap prices in both the Brent and WTI markets, implying an asymmetric volatility response to changes in the underlying price. The mean-reversion propensity of volatility is also found to be rather strong in both crude grades under examination.

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Interview by Hilary Till, Contributing Editor, Global Commodities Applied Research Digest

In the Summer 2018 issue of the GCARD, we are delighted to interview Dr. James Hamilton, Professor of Economics, University of California, San Diego and Co-Chair of the JPMCC’s Research Council. Professor Hamilton also serves as the JPMCC’s Distinguished Visiting Fellow. In this issue’s interview, Professor Hamilton explains what originally spurred his interest in the impact of oil price increases on the economy, followed by what he currently sees as important research issues. He also touches upon what encouraged him to become involved with the JPMCC and its Research Council, noting some of his goals for the Research Council and its international commodity symposia. The interview concludes with Professor Hamilton discussing both the potential impact the JPMCC could have on the commodity industry and his recommendations for future topics in the GCARD.

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