April 2008 Archives

Adam Warner over at Daily Options Report discusses how volatility collapses after earnings reports and how that affects options pricing. That is, you might have purchased puts expecting a drop in a stock price. You were correct in that the stock price did fall; however, you lost on your puts because the volatility collapsed. It usually just takes one or two experiences to learn this painful, but powerful lesson.

Knowing that volatility collapses after an earnings release, you can use that information to determine how much the stock is expected to move. You know the prior volatility before the earnings run up. You know the current volatility. In his article Serious Yahoo, Adam walks you through how to estimate an earnings move in the stock price.

If you use options at all, you need to understand how earnings announcements affect volatility.

My photograph of the Banff with Cascade Mountain in the background is hosted at Flickr. This picture was taken at the end of Banff Avenue near the Administration Building. If you click on the picture, you will be taken to my Flickr account where you can see more pictures.

In my last post Still Believe In The Commodities Bull Markets, I discussed Barron's article Commodities: Who's Behind the Boom? (subscription required), where Gene Epstein provided a compelling argument that the commodities bubble is about to burst. I further wrote that I am a commodities bull and referenced Jim Rogers. As luck would have it, Lawrence C. Strauss wrote a feature article in this week's Barron's Light-Years Ahead of the Crowd: Interview With James B. Rogers, Private Investor (subscription required).

Below is an excerpt from the article where Jim Rogers comments on the recent Barron's commodities article.

Our colleague Gene Epstein argued in a recent Barron's cover story that there is a huge speculative element pushing up commodities prices.

But where is the oil coming from that's going to drive down prices and keep them down? We are going to have corrections, as was the case in 2001 after 9/11. Is there speculation in commodities? Of course. Whenever you have a bull market, it draws money. If the fundamentals are right, investors make money and they want to make more. But people were buying commodities for 20 years in the 1980s and 1990s and nothing happened, because the fundamentals weren't right yet. Now that the fundamentals are right, more money is going into commodities. It will end in a bubble and hysteria. But in 2018, or whenever this bubble finally starts to peak, if I'm lucky you will call me up and I'll say it's time to sell commodities.

So you expect commodities prices to keep running up.

Absolutely. Look, if somebody discovers a gigantic oil field in Chicago or Berlin, then we will maybe have to start reassessing. But remember that all the great oil fields are in decline, including those in Alaska, Mexico and the North Sea. And I'm not just talking about oil. You can't go into your garage, snap your fingers and bring a new zinc mine to market. It takes on average 10 years to bring on any new mine.

Again, as mentioned in my prior post, if you look at the graphs of the commodities indexes on Bloomberg's website, you will note that, while commodities have become more volatile recently, they are still up on the year. In fact, the various indexes have essentially recovered from their prior swoon two weeks ago. Oil prices remain near record highs at about $110 per barrel. Not so very long ago, we wondered when oil would break the one hundred dollar barrier. Now the question is, will oil hit $120 per barrel this summer? Natural gas remains strong, along with agricultural products. You may wish to view my prior article, referenced near the top of this article, for links to gold and silver charts.

Last Friday certainly was an interesting day with the earnings release of GE). I bought some GE near the bottom as a trade. While I think GE is an outstanding company, I am uncertain as to how deep and now long this recession will be. Initially, I did not expect this much damage. While I was aware of the housing bubble, I did not anticipate this much fallout. And according to some, we might be early in the game.

That said, I am not sure how much further down we could go. Are we vulnerable to a much further drop? While I hope not, I am far from certain. Reality is, like most investors, I am waiting and watching events unfold. As the earnings season progresses, we should gain more clarity. However, the companies themselves might not be well positioned to offer much insight, because they too are waiting and watching. Does the housing problem continue to spiral downward and spread throughout more of the economy, or do we begin to stabilize?

I have not made many trades recently. For the most part, I am content to watch my positions. I remain biased to commodities, with particular emphasis on oil, gold, and silver. Outside of commodities, I continue to have a well diversified portfolio, including some stocks that are being hit. We will just wait and see how events unfold.

My photograph of the Rocky Mountains Seen From Calgary is hosted at Flickr. This picture was taken from the western edge of Calgary looking west. If you click on the picture, you will be taken to my Flickr account where you can see more pictures.

In this weekend's Barron's magazine article Commodities: Who's Behind the Boom? (subscription required), Gene Epstein provides a compelling argument that the commodities bubble is, indeed, a bubble and that it is about to burst. And the price action in today's markets certainly seems to support that thesis. All that said, I disagree.

Jim Rogers in his book Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market indicated that during commodity bull markets, there are periodic corrections that are sometimes severe. I believe we are simply experiencing a pullback, nothing more.

If you look at the graphs of the commodities indexes on Bloomberg's website, you will note that, while commodities have become more volatile recently, they are still up on the year. Oil prices remain near record highs, natural gas is strong, along with agricultural products. If you visit Kitco's five year gold chart or Kitco's five year silver chart, you will again note that prices are still up substantially compared to recent history.

In the Barron's article, we are told that it is speculation that is driving commodities far beyond reasonable valuations. My response is that, if prices are so far beyond reasonable valuations, then why are the physical producers not taking advantage of this situation by dramatically increasing their production? The answer is, of course, because they cannot do so. They simply do not have the ability to find more readily available cheap oil. Finding gold and silver are similarly difficult. Natural gas is somewhat different because a lot of previously stranded natural gas is being converted to liquid natural gas (LNG) and imported to the U.S. I do not follow farm products, so I am more cautious about my comments. From my weak knowledge of the ethanol boondoggle, some artificial forces that are creating a distortion. The point is, many commodities remain in short supply and difficult to produce more quickly.

Until I see the commodity suppliers threaten and have the ability to carry out their threat of substantially more production, then I will remain steadfast in my outlook. At present, I do not significant additional sources of production coming on stream. Does that mean that prices can grow to the sky? The answer is clearly no. Prices are constrained by customers' ability to pay. While some argue that the U.S. recession is now removing the customers' ability to pay, I am in the camp that says world growth is still growing and thus commodities are still in demand.

In summary, while I acknowledge that the commodities markets are volatile, I continue to believe that the bull markets in commodities will continue. And while the U.S. recession might temporarily damp the price of commodities, I expect that external demand to be a moderating force. The demand for commodities continues to grow and the ability to produce more commodities cheaply is not keeping pace with the increased demand.

My photograph of the Bow River in Banff National Park is hosted at Flickr. This picture was taken from bridge on Banff Avenue looking west. If you click on the picture, you will be taken to my Flickr account where you can see other similar pictures.