Spring 2017

In this letter, Dr. Rohan Christie-David, the new dean of the University of Colorado Denver Business School, welcomes GCARD readers to the third issue of the commodities digest. Dean Christie-David notes that his goal is to build the J.P. Morgan Center for Commodities (JPMCC) into a global leader in both commodities education and thought leadership. Future issues of the GCARD will discuss the JPMCC’s progress toward that goal.

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The GCARD  team is proud to present the Spring 2017 issue of the Global Commodities Applied Research Digest.

In this issue, members of both the J. P. Morgan Center for Commodities’ (JPMCC’s) Research Council and the GCARD’s Editorial Advisory Board have generously contributed the lion’s share of articles, demonstrating the deep pool of talent within the JPMCC. This issue also discusses the upcoming International Commodities Symposium, which will take place at the JPMCC in August of this year and will include a panel from the GCARD’s Editorial Advisory Board. Like the GCARD, the symposium is supported by a grant from the CME Group Foundation.

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

Gold may see some extra volatility in 2017 as several driving forces are converging. Gold bears no interest, so in a rising rates environment its value may be challenged. Improved risk management and technological enhancements may also play a role in the continued expansion of production, even if prices fall. Central banks have been buying gold for the last few years, but will they continue? China appears to be decelerating further, and it has been a big buyer of gold. Taking each of these factors into consideration, this could be quite a volatile year for the shiny metal.

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By Ehud I. Ronn, Ph.D., Professor of Finance, McCombs School of Business, University of Texas at Austin and Member of the JPMCC’s Research Council

Financial markets in general, and energy finance markets in particular, are highly informative. The challenge is always in interpreting what exactly the message is from the markets. We address this issue in the crude oil markets with an examination of the level of spot prices and the implied volatility of crude oil futures prices.  Professor Ronn’s Encana Distinguished Lecture at the JPMCC on March 9, 2017 was closely related to this topic.

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In this issue of the GCARD, the Contributing Editor covers the commodity derivatives markets from a broadly conceptual perspective. Specifically, this section’s collection of articles reviews (a) the potentially persistent sources of return in the commodity futures markets; (b) the differing risk-management priorities for commercial versus speculative commodity enterprises; and (c) the economic role of commodity market participants.

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By Hilary Till, Solich Scholar, J.P. Morgan Center for Commodities, University of Colorado Denver Business School

This digest article describes potentially persistent sources of return in the commodity futures markets due to (1) hedge pressure, (2) scarcity, and (3) weather-fear premia. But the article also notes that active commodity futures strategies can be limited in scalability and can potentially lose their potency due to structural breaks or popularization.

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By Hilary Till, Solich Scholar, J.P. Morgan Center for Commodities, University of Colorado Denver Business School

This digest article discusses how risk management in commodity futures trading takes two different forms, depending on whether trading is done for a commercial or a purely speculative enterprise. The paper discusses that for commercial enterprises, the most important aspects of risk management are in (a) adhering to regulatory rules and laws, and in (b) establishing strict operational policies and procedures over every facet of risk-taking activity. In contrast, for a purely speculative participant, the emphasis is almost entirely on market risk-management.

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By Hilary Till, Solich Scholar, J.P. Morgan Center for Commodities, University of Colorado Denver Business School

This article notes how the terms, “hedging” and “speculation,” are not precise. What futures markets accomplish is the specialization of risk-taking rather than the elimination of risk. In addition, this paper discusses how there is some empirical evidence to support the theory that speculative involvement actually reduces price volatility. This article also explains that even when commodity futures markets are viewed as “hedging” markets, there is still a vital role for speculators because there will not always be an even balance of short hedgers and long hedgers at any one time: speculators are needed to balance the market.

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By Charoula Daskalaki, Department of Banking and Financial Management, University of Piraeus, Greece; George Skiadopoulos, Department of Banking and Financial Management, University of Piraeus, Greece, and School of Economics and Finance, Queen Mary, University of London; and Nikolas Topaloglou, Department of International and European Economic Studies, Athens University of Economics and Business, Greece

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

This paper revisits the question of whether it is worthwhile for investors to include commodities in their equity and bond portfolios. In studying this question, the authors use a statistical methodology that circumvents the need to make assumptions on investors’ preferences and the distribution of asset returns. The authors find in both in-sample and out-of-sample tests that commodities provide diversification benefits, especially, for second- and third-generation commodity indices. Of note, the authors of the comprehensive article were recipients of a Commodities Research Fellowship Award at the J.P. Morgan Center for Commodities. This fellowship, in turn, was generously funded by the CME Group Foundation.

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

As summarized by Ana-Maria Fuertes, 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 nexus between idiosyncratic volatility and returns in commodity futures markets. The authors find that the seemingly abnormal performance of active strategies that systematically exploit idiosyncratic volatility turns out to be a fallacy associated with the use of an inappropriate benchmark. Instead, suitable benchmarks reveal that idiosyncratic volatility cannot be a specifically rewarded risk factor since it can be diversified away.

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By Thorvin Anderson, CFA, Content Director, “Foundations for Commodities” Professional Education Program, JPMCC, University of Colorado Denver Business School and Member of the JPMCC’s Research Council

As discussed at the JPMCC’s September 2016 Research Council meeting, recent developments in battery technology have given rise to energy storage devices targeting not just wholesale or grid support operations, but residential buyers as well. While several manufacturers compete in this space, it is Tesla, with its Powerwall, that has commanded the majority of media attention. Billed as a complement to residential rooftop solar installations, the Powerwall offers homeowners the allure of some measure of energy independence, reliability, and cost savings, all with not-too-subtle intimations that use of this storage technology is associated with superior environmental stewardship. This paper examines the Powerwall product, and by implication its competitors, in the context of today’s electricity markets to consider the validity of these claims and the prospect of retail electricity storage significantly impacting the electric market.

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By Nikos Nomikos, Ph.D., Professor of Shipping Risk Management, Faculty of Finance, Cass Business School, City, University of London, U.K. and Member of the JPMCC’s Research Council

As discussed at the JPMCC’s September 2016 Research Council meeting, the shipping industry plays an important role in the world economy since about 90% of the world trade is carried by sea. One of its sectors is the dry bulk market that involves the transportation of homogeneous bulk commodities, typically raw materials such as iron ore, grains, coking and thermal coal, bauxite and alumina, on non-scheduled routes, mainly on a ‘one ship-one cargo’ basis. The dry bulk sector is important in its own right, as it represents by far the largest shipping segment in terms of both cargo carrying capacity and quantity transported. This digest article describes the statistical properties of both dry-bulk shipping demand and supply and does so as well for shipping earnings and vessel prices.

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By Sven Streitmayer, Senior Commodity Risk Manager, Robert Bosch GmbH (Germany) and Member of the JPMCC’s Research Council

As similarly discussed at the JPMCC’s September 2016 Research Council meeting, this article delivers insights into the different risk-management approaches employed by the German-based Bosch Group. The Bosch Group is a leading global supplier of technology and services whose operations are divided into four business sectors: mobility solutions, industrial technology, consumer goods, and energy and building technology. The article also provides specific examples of challenges for commodity risk managers such as the recent changes in financial market regulation, the handling of non-exchange traded commodities, and the potential involvement in newly launched derivative markets and instruments.

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By Hilary Till, Contributing Editor, and Joseph Eagleeye, Editorial Advisory Board Member, GCARD

One typically finds that institutionally-scaled futures programs employ trend-following algorithms. Here, the key is employing such algorithms across numerous and diverse markets such that the overall portfolio volatility is dampened. On the other end of the spectrum are calendar-spread strategies. These strategies typically have limited scalability but individually can potentially have quite consistent returns.

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By Ebele Kemery, Portfolio Manager, Head of Energy Investing at J.P. Morgan Asset Management and Editorial Advisory Board Member, GCARD

American onshore oil companies have evolved over the last three years: they are more disciplined about leverage, capital deployment and acreage. Weak companies have collapsed or been acquired, leaving the sector much stronger than seen in decades. This article discusses the current shape of American shale producers as they emerge from one of the most dramatic oil price collapses in modern history.

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By Fergal O’Connor, Ph.D., Senior Lecturer in Finance, University of York, U.K. and Editorial Advisory Board Member, GCARD

This digest article examines whether gold can hedge an investor’s inflation risk over the long term. Though many studies do find that a long-run equilibrium relationship exists between gold and inflation in various countries, these results may not be relevant for the outcomes that real investors would have experienced. This article examines the results of saving an ounce of gold a year for a U.S. dollar-based investor over 25 to 40 years, as someone saving for a pension would, over a 200-year period. Perhaps somewhat surprisingly, in the majority of cases, saving in gold would not have compensated these investors for inflation when they came to draw down their funds at retirement. The paper concludes that there may be good reasons for an investor to hold gold, including portfolio diversification benefits and acting as a safe haven during major market crashes, but reliable inflation hedging properties does not appear to be one of them.

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By Peter O’Neill, CFA, Chief Risk Officer and Head of Finance, Uniper Global Commodities North America, a wholly-owned subsidiary of E.ON and Editorial Advisory Board Member, GCARD

In the power markets, prices can move rapidly at quite inopportune times. This article highlights one such event in the Texas power market and describes what led up to and contributed to this extreme market price move, followed by what happened as the market went into settlement. The article concludes with lessons learned on how to manage the price risk around such an event.

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By Anne-Sophie Corbeau, Research Fellow, KAPSARC (Saudi Arabia)

The Liquefied Natural Gas (LNG) industry is going through the largest increase in LNG capacity ever, equivalent to twice the LNG export capacity of Qatar. These new supplies are arriving in a market environment significantly different in terms of supply, demand and prices from what the industry anticipated when investment decisions were taken. Slower than expected LNG demand growth is forcing sellers to look for new, more riskier markets. But a potential market squeeze beyond 2020 is currently the greatest worry of investors and buyers alike, as very few projects have been sanctioned since mid-2015. Buyers have become more demanding about what they are ready to accept in terms of contractual conditions. Their demands focus on three different aspects: pricing mechanisms, flexibility and final destination clauses. Sellers have become increasingly worried on how far negotiations could be pushed and that the sanctity of long-term contacts could become under threat.

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By Andy Hecht, Subject Matter Expert, “Foundations for Commodities” Professional Education Program, J.P. Morgan Center for Commodities, University of Colorado Denver Business School

This brief article outlines the changes in the political and economic landscape that one might expect with the new U.S. administration. The article also argues that the changing regulatory environment twinned with the potential for energy independence could lead to vast changes in the commodity markets. The article concludes with exploring the growing potential for some commodity merchant businesses to return to the shores of the U.S. over the months and years ahead.

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

In the Spring 2017 issue of the GCARD, we are honored to interview Dr. Vince Kaminski, Ph.D., Professor in the Practice of Energy Management, Rice University and an inaugural member of the JPMCC’s Research Council. In this issue’s interview, Professor Kaminski discusses his motivation for joining the Research Council and the value that the JPMCC can bring to commodity market participants. He also elaborates on his metaphor of comparing the various parts of the commodity complex to a Rubik’s Cube, which he had proposed at the JPMCC’s April 2015 Research Council meeting. In addition, Dr. Kaminski generously summarizes his September 2016 Research Council presentation on the involvement of financial institutions in the commodity markets. Dr. Kaminski’s interview also includes how he came to specialize in the commodity markets, and he offers advice to students and young professionals whom are interested in potential careers in the commodity markets. His interview also covers his newly published and updated reference textbook, Managing Energy Price Risk, which is now in its 4th Edition at Risk Books, and he concludes with suggestions on what topics should be covered in future issues of the GCARD.

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By Ajeyo Banerjee, Ph.D., CMA, Executive & Faculty Director, J.P. Morgan Center for Commodities, University of Colorado Denver Business School

The “New Directions in Commodities Research” conference is an international commodities symposium, which is being organized at the J.P. Morgan Center for Commodities, University of Colorado Denver on August 10-11, 2017. The symposium will bring together global thought-leaders and prominent stakeholders in commodities to discuss new research related to commodities.

The conference organizers are Ajeyo Banerjee, Ph.D., Associate Professor of Finance and Risk Management, Executive & Faculty Director, JPMCC and Graham Davis, Ph.D., Professor of Economics, Colorado School of Mines and Member of the JPMCC’s Research Council. The technical committee for the symposium is drawn from the membership of the JPMCC’s Research Council.

The conference is being sponsored by the CME Group Foundation and by the Payne Institute for Earth Resources.

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