Working Issue (fall 2016)

My colleagues and I are happy to present the Fall 2016 issue of the Global Commodities Applied Research Digest (GCARD) to you. For the benefit of GCARD’s practitioner readership, we have pulled together insights from the following J.P. Morgan Center for Commodities’ (JPMCC’s) sources: (a) its Research Council members; (b) the Center’s past Research Council meetings; (c) the JPMCC’s Global Commodity Issues [Editor’s Choice] e-Journal; and from (d) the GCARD’s Editorial Advisory Board. The expertise and diversity of these sources result in the GCARD being able to further the JPMCC’s goal in becoming the focal point for highly relevant commodities thought-leadership.

This article discusses the shift of weather patterns from El Niño 2015 (warmer waters along the east equatorial Pacific Ocean) to the potential La Niña 2017 (colder waters along the east equatorial Pacific Ocean) and the effects this shift could plausibly have on energy and agricultural markets.

As of July 29th, 2016, US GDP estimates confirmed that the US economy was in a broad and sustaining slump. Blacklight Research had previously identified this decline and termed it, “The Great Suppression.” This article explains the five main suppressants that drive the Great Suppression: climate policy, FOMC monetary policy, US crude export policy, OPEC production policy and international policy toward the Syrian crisis.

The Contributing Editor’s collection of four articles covers issues that are relevant to the agricultural, metals, and energy markets, reflecting the J.P. Morgan Center for Commodities’ commitment to include all commodity sectors in both its applied research and educational efforts.

This digest article covers how to further distill returns in the commodity markets beyond that which is available through passive exposures to various commodity sectors. A manager can potentially do so through the use of well-chosen entry and exit rules, trade construction, and downside risk management. In addition, an actively managed commodity portfolio will tend to have dynamic exposures to the various commodity sectors, given the seasonal nature of a number of commodity trading opportunities.

This digest article discusses the practical issues involved in applying a disciplined risk management methodology to commodity futures trading. Accordingly, the paper shows how to apply methodologies derived from both conventional asset management and hedge fund management to futures trading. The article also discusses some of the risk management issues that are unique to leveraged futures trading.

The GCARD’s Spring 2016 “Contributing Editor’s Collection” of articles included an article on “Brief Case Studies on Futures Contract Successes and Failures.” That article noted that even though the U.S. futures markets have evolved in a trial-and-error fashion, one can nonetheless identify the key elements that determined whether particular futures contracts succeeded or failed. In this issue, we extend this past analysis by examining why a particular metals futures contract has not succeeded thus far: the uranium futures contract. Such an analysis, as in this article, may be valuable for new financial centers as they build successful futures markets.

Should an investor enter into long-term positions in oil futures contracts? In answering this question, this paper covers the following three considerations: (1) whether crude oil inventories are scarce or not; (2) how to avoid the risk of oil prices crashing; and (3) the use of financial assets for diversification purposes. The paper concludes that positions in crude oil futures contracts should (a) not only be actively timed, but (b) must also be twinned with financial assets in order to hedge against both the possibility of deflationary conditions and/or periodic oil-market-share price wars.

As summarized by Dr. Keith Black, Ph.D., CFA, CAIA, Managing Director, Curriculum & Exams, CAIA Association

Investors and suppliers have long sought to understand and predict commodity prices using supply and demand analyses. Historically, commodity demand was measured by the quantity of commodities consumed through food or industrial uses. After the Chinese Property Law was enacted in October 2007, an increasing amount of industrial metals have been placed into storage and used as collateral for loans. Including these warehouse stocks in demand estimates, especially in copper, seem to overestimate the demand for industrial metals in the Chinese market. Investors and suppliers of industrial metals should adjust their supply and demand models to account for the risk of the unwinding of these inventories.

At the JPMCC’s December 2015 Research Council meeting, Professor Forest Reinhardt of Harvard Business School (HBS) led a discussion on an HBS case study on Olam International, which Professor Reinhardt had co-authored. This digest article summarizes Professor Reinhardt’s case study lecture.

At the JPMCC’s December 2015 Research Council meeting, Professor James Hamilton of the University of California, San Diego, discussed why it turned out that oil priced at $100 did not hold, starting in 2014. Dr. Bluford Putnam of the CME Group and Professor Yosef Bonaparte of the University of Colorado Denver discussed Professor Hamilton’s research from both practitioner and academic perspectives, respectively. This digest article summarizes Professor Hamilton’s panel session.

The article begins with the classic definition of a swing producer and notes that North American tight oil (shale) producers would not normally fit this strict definition. The paper then argues that advances in well-production estimation techniques naturally led to an explosion of creative financing solutions for investing in shale. As a result, the appetite of credit markets for taking on shale-production risk became a key driver for the outlook for North American oil production. Next the article proposes that we might be able to refer to shale producers as swing producers as long as we loosen the definition of swing producer to be one in which there are fairly uniform production decisions that take place over up to a 12-month timeframe. The paper then notes that at some point, geological constraints (much more than the credit cycle) could come back into play and the baton would thereby pass back to the Middle East Gulf oil producers as the undisputed swing producers. Lastly, the paper returns to a shorter-term perspective, describing how the capital markets will likely be much more cautious in investing in shale oil production, even with a continuation in the recovery of the price of oil.

In the Fall issue of the GCARD, we interview Dr. Margaret E. Slade, Ph.D., Co-Chair of the J.P. Morgan Center for Commodities’ (JPMCC’s) Research Council. In this interview, Dr. Slade discusses her motivation for becoming the Co-Chair of the Research Council and notes that there are no other academic centers like it. She also provides highlights of the 2015 Research Council meetings and details her goals for the Council. In addition, Dr. Slade discusses how she became involved in the commodity markets. She then notes key findings of her recently published work. Lastly, Dr. Slade also provides feedback on the GCARD, regarding the types of topics that should be covered, given its practitioner focus.

The J.P. Morgan Center for Commodities also produces the Global Commodity Issues (GCI) [Editor’s Choice] e-Journal, which is edited by Professor Marcelle Arak of the University of Colorado Denver Business School. The GCI [Editor’s Choice] distributes working papers and abstracts of accepted papers in commodities, including agricultural, minerals/mining, and energy-related commodities worldwide.

The commodities sector (oil, minerals/metals and energy) are a critical sector of the economy. However, they are generally underserved in terms of knowledge and skill enhancement opportunities. The J.P. Morgan Center for Commodities is uniquely positioned to fill this gap through its offer of 1-3 days courses on commodities with CE credits.

Guided by veteran industry practitioners, and utilizing one of the most user-friendly statistics packages on the market, students gain a core practical competency in econometrics and price modeling for the commodity markets. Students become familiar with not only the dominant methods for modeling forward curve dynamics, but also advanced methods employed by the most sophisticated market participants.

In the Spring 2017 Professional Education offering, attendees gain a high level of understanding of the commodities industry from physical aspects (supply chain, fundamentals, asset monetization) to the financial (market structure, spreads, futures and derivatives). Risk management and regulation compliance are covered at a high level. The goal of this course is to educate professionals on the foundational concepts of commodities in the physical and financial arenas including key terms and concepts, underlying principles, market structure, futures and derivatives, risk management, and regulation. This course provides an affordable and accelerated curriculum for new hires in commodity-related businesses.