Posts filed under “Really, really bad calls”
Last night’s 60 Minutes had a story on Oil Speculation. Its not that they said anything that was factually wrong per se, its more that they told 10% of the story of the rise and fall of energy prices. The entire report was surprisingly thin, and avoided discussing all of the many other factors that had been impacting energy prices during the 7 year rise and subsequent collapse (60 Minutes video here).
Very often, major bull market moves begin on fundamentals, but shift towards the end of its life into a speculative frenzy. These always end in a price surge (i.e., a blowoff top), which is followed by a collapse. But note that it is in the end game where speculation dominates, not the first 7 or 8 innings. That was true as much for Housing in 2005-06 as it was for dot com stocks in 1999-2000.
Hot markets always attract hot money.
But merely claiming that the run up in Oil prices was due to unprecedented speculation misses the big picture of what actually occurred. And, it reflects a lack of understanding of how markets work, and the psychology of booms, bubbles and busts.
Here are a few factors that I believe the folks at 60 Minutes either misunderstood or overlooked completely during the run up from $20 to $100:
1. Oil is priced in US Dollars. Since 2001, the Dollar fell 40% (from 120 to 72); Oil rise nearly 5 fold over the same period. And Oil’s collapse occurred over a period when the dollar formed a short term bottom; it has certainly had its most significant rally in years (72 to 88).
2. Over the same period that Oil prices were rising, the US was fighting two major wars in the Middle East, Iraq and Afghanistan. These impact prices via psychology and risk of supply disruption — especially at a time when producers were running flat out.
3. Energy prices rose during a global economic expansion (fueled by low rates and cheap money); Oil fell during a period that marked the beginning of the US recession and the start of a global slowdown.
4. Since 2001, Commodities of all sorts rose significantly: Steel, aluminum, cement, cotton, soy, livestocks, foodstuffs, precious metals, etc. Were they all driven by speculation, or was something else going on?
5. Since the 1% Fed funds rate of 2002-03, inflation has had a dramatic impact on ALL prices — from medical costs to insurance to education to health care to transportation to housing to food and energy. That 60 Minutes failed to even mention inflation in a piece on Oil prices is a terrible oversight on their part.
6. Throughout the 1990s and 2000s, cars were increasingly replaced with SUVs and trucks in the United States. Not only did these get appreciably worse gas mileage, that fleet transition took place as the total US miles driven rose. Over the past 20 years, people have lived increasingly further away from their jobs. Hence, increased US demand for energy accompanied (and increased prices).
7. Since gas prices hit $4 a gallon and the recession began, total US miles driven fell significantly, by several billion miles. As expected,t he drop in driving was followed by a fall in prices.
8. 60 Minutes interviewed Mike Masters, a hedge fund manager who had testified before Congress that speculation was driving prices. They omitted to mention he was talking his book. His holdings in energy sensitive stocks — with large positions, the vast majority in call options, in AMR Corp (AMR), the parent of American Airlines, Delta Air Lines (DAL), General Motors (GM), UAL Corp (UAUA) and US Airways (LCC) — were responsible for his fund losing 35% of its value before the Fall 2008 market collapse..
9. China boomed~! More and more global manufacturing outsourcing saw factories being built throughout China. They also went through a wild process building out the nation in preparation for the 2008 Olympics held there. Oh, and China, like the US, also began filling its Strategic Petroleum Reserves. Another small country, India, was booming over this period also.
10. The rise of extremist terrorist groups like al-Quada, the hostility of Iran towards the West, supply and political disruptions in places like Nigeria, and overt hostility to the US by oil producers like Venezuela President Hugo Chavez also contributed to drive prices up. The political factors were also omitted.
There’s a lot more, but the bottom line is this: Higher energy prices were caused many many factors over the past 8 years. Certainly, speculation played a part at the end of the run — but it always does. Oil fell more precipitously than it rose, but don’t all markets do that? Didn’t the S&P just plummet nearly 50% in a year, after a 5 year run?
Speculation is merely one aspect of what happened. 60 Minutes missed the other 59 elements . . .
The Costanza Energy Policy: 25 Ways to Drive Oil to $150 (May 29th, 2008)
Clarifying CNBC Oil Comments (December 22nd, 200)
Did Speculation Fuel Oil Price Swings?
60 Minutes: Speculation Affected Oil Price Swings More Than Supply And Demand
CBS, Jan. 11, 2009
Fisking Michael Masters
NakedShorts, June 26, 2008
The Treasury Department TARP/Bailout plan has been an utter disaster. It has been mishandled from day one — poorly planned, poorly executed. Both Hank Paulson and Congress for passing such a shoddy piece of legislation should be ashamed of themselves for their horrific judgment and egregious failures. It is hard to see a single thing…Read More
Over at Marketwatch, Paul Farrell sifts through a book (sitting on my shelf) and pulls out these embarrassing quotes. 15 reminders of how happy talk misled us a decade ago October 1999: James Glassman, author “Dow 36,000.” “What is dangerous is for Americans not to be in the market. We’re going to reach a point…Read More
Alternative Title: David Lereah: Even More Full of Shit Than Previously Believed > Of all the various parties who contributed to the boom and bust in housing and credit, none have escaped more unscathed than the National Association of Realtors, and their former Baghdad-Bob-in-Chief, David Lereah. The NAR turned a blind eye to fraud amongst…Read More
Here is another excerpt — part II — of the all consuming OpEd of the Sunday New York Times by Michael Lewis and David Einhorn: Excerpt: When Bear Stearns failed, the government induced JPMorgan Chase to buy it by offering a knockdown price and guaranteeing Bear Stearns’s shakiest assets. Bear Stearns bondholders were made whole…Read More
The entire OpEd section of the Sunday New York Times has been taken over by an article jointly written by Michael Lewis and David Einhorn, titled The End of the Financial World As We Know It. Its this morning’s must read piece . . . Excerpt: “OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required…Read More
Terrific l o n g article in the Sunday Times Magazine by Joe Nocera, titled Risk Mismanagement. Its all about how Wall Street developed and still uses VaR — Value at Risk.
The application of VaR remains hotly debated today. Did it contribute to the credit crisis — or was it ignored/misapplied/distorted, and THATS what was a key factor.
Risk managers use VaR to quantify their firm’s risk positions to their board. In the late 1990s, as the use of derivatives was exploding, the Securities and Exchange Commission ruled that firms had to include a quantitative disclosure of market risks in their financial statements for the convenience of investors, and VaR became the main tool for doing so. Around the same time, an important international rule-making body, the Basel Committee on Banking Supervision, went even further to validate VaR by saying that firms and banks could rely on their own internal VaR calculations to set their capital requirements. So long as their VaR was reasonably low, the amount of money they had to set aside to cover risks that might go bad could also be low.
Given the calamity that has since occurred, there has been a great deal of talk, even in quant circles, that this widespread institutional reliance on VaR was a terrible mistake. At the very least, the risks that VaR measured did not include the biggest risk of all: the possibility of a financial meltdown. “Risk modeling didn’t help as much as it should have,” says Aaron Brown, a former risk manager at Morgan Stanley who now works at AQR, a big quant-oriented hedge fund. A risk consultant named Marc Groz says, “VaR is a very limited tool.” David Einhorn, who founded Greenlight Capital, a prominent hedge fund, wrote not long ago that VaR was “relatively useless as a risk-management tool and potentially catastrophic when its use creates a false sense of security among senior managers and watchdogs. This is like an air bag that works all the time, except when you have a car accident.” Nassim Nicholas Taleb, the best-selling author of “The Black Swan,” has crusaded against VaR for more than a decade. He calls it, flatly, “a fraud.” . . .
What will cause you to lose billions instead of millions? Something rare, something you’ve never considered a possibility. Taleb calls these events “fat tails” or “black swans,” and he is convinced that they take place far more frequently than most human beings are willing to contemplate. Groz has his own way of illustrating the problem: he showed me a slide he made of a curve with the letters “T.B.D.” at the extreme ends of the curve. I thought the letters stood for “To Be Determined,” but that wasn’t what Groz meant. “T.B.D. stands for ‘There Be Dragons,’ ” he told me.
Best line in the article: “When Wall Street stopped looking for dragons, nothing was going to save it.”
I particularly loved the graphics and illustrations that were part of it:
Paul Krugman asks: Unusually, I’m having a vocabulary problem. There has to be some word for the kind of person who considers his mild discomfort the equivalent of torture, crippling injury, or death for other people. But I can’t think of it. What brings this to mind is this from Alberto Gonzales: I consider myself…Read More
Special Schadenfreude edition: In case you missed it, here is our updated collections of the worst predictions for how 2008 would turn out: • The 10 Worst Predictions for 2008 (Foreign Policy) • The Worst Predictions About 2008 (Businessweek) • 2008 Investment Guides Are HILARIOUS (New York Magazine) • Famous Last Words (CNBC) • The…Read More
Via New York Magazine, comes this amusing collection of bad forecasts for the 2008 year: • Jon Birger, senior writer, Fortune Investors Guide 2008 Smart investors should buy [Merrill Lynch] stock before everyone else comes to their senses.” Merrill’s shares plummeted 77 percent. • Elaine Garzarelli, president of Garzarelli Capital, Business Week’s Investment Outlook 2008…Read More