April 25, 2014

There is an interesting trend in the commodities market:

As Barclays Plc, JPMorgan Chase & Co. and Morgan Stanley leave parts of the business, prices of commodities are moving more independently of stocks. The correlation between U.S. equities and corn, cattle and wheat fell to less than 0.05 in January, compared with almost 0.3 in 2008, an analysis by David Bicchetti and Nicolas Maystre, economic affairs officers at the UN Conference on Trade and Development in Geneva, shows.

Banks, hedge funds and other financial institutions piled into physical commodities and derivatives over the past 12 years, amplifying a run-up in prices for everything from copper to oil, in short supply before the 2008 global recession, the UN found in a 2011 study. The exodus is nudging futures markets back toward their original function, as a way for farmers, miners and other companies in the commodities business to hedge against price swings.

I’m not sure, but I think the study Bloomberg refers to above is by David Bicchetti and Nicolas Maystre, titled The synchronized and long-lasting structural change on commodity markets: evidence from high frequency data:

This paper analyses the intraday co-movements between returns on several commodity markets and on the stock market in the United States over the 1997- 2011 period. By exploiting a new high frequency database, we compute various rolling correlations at (i) 1-hour, (ii) 5-minute, (iii) 10-second, and (iv) 1-second frequencies. Using this database, we document a synchronized structural break, characterized by a departure from zero, which starts in the course of 2008 and continues thereafter. This is consistent with the idea that recent financial innovations on commodity futures exchanges, in particular the high frequency trading activities and algorithm strategies have an impact on these correlations.

This paper documented striking similarities in the evolution of the rolling correlations between the returns on several commodity futures and the ones on the US stock market, computed at high frequencies. It also highlighted a structural change that took place recently in these markets. Prior to 2008, high-frequency co-movements between commodity and equity markets did not usually differ from zero over a long lasting period at such high frequencies. In the course of 2008, these correlations departed from zero and became strongly positive after the collapse of Lehman Brothers.

In our view, this finding adds to the growing empirical evidence supporting the idea that the financialization of commodity markets has an impact on the price determination process. Indeed, the recent price movements of commodities are hardly justified on the basis of changes of their own supply and demand. In fact, the strong correlations between different commodities and the S&P 500 at very high frequency are really unlikely to reflect economic fundamentals since these indicators do not vary at such speed. Moreover, given the large selection of commodities we analyse, we would expect to have different behaviours due to their seasonality, fundamentals and specific physical market dynamics. Yet, we do not observe these differences at any frequency. In addition, the fact that these correlations at high frequencies started during the financial shocks provides additional support for financial-based factors behind this structural change. Therefore, the very existence of cross-market correlations at high frequencies favours the presence of automated trading strategies operated by robots on multiple assets. Our analysis suggests that commodity markets are more and more prone to events in global financial markets and likely to deviate from their fundamentals.

It seems odd to me that the authors don’t spend much time discussing monetary policy. The links between commodity financialization and monetary policy were highlighted on PrefBlog on November 11, 2010 and in the post QE2 and Inflation.

Econbrowser is prominent in the above links, and the blog also hosts a recent piece titled Guest Contribution: Commodity-Price Comovement and Global Economic Activity:

Our approach to understanding the drivers of the comovement in commodity prices uses a theoretical model in which the prices of commodities are determined by two sets of forces. First, there are the forces that affect commodity prices directly, by which we mean forces which alter the supply or demand for commodities even for a fixed level of global economic activity. For example, we classify a technological improvement in the production of commodities as such a force, because it would increase the supply of commodities even in the absence of any subsequent effects on global economic activity. Of course, to the extent that these forces change commodity prices, they ultimately alter the level of global economic activity and feed back into commodity prices through general-equilibrium effects. But the key to identifying these forces is that they affect commodity prices even absent any endogenous response of global activity. By contrast, the second set of forces are those that affect commodity prices only through the changes that they induce in the level of global economic activity, i.e. “indirectly”. Changes in government spending, variation in the desired markups for the production of consumer goods, or improvements in the technology used to produce final goods are all examples of such forces. The composition of all such forces is summarized by the indirect factor. These two drivers are common to all commodity prices. The model also permits there to be idiosyncratic forces specific to individual commodities.

Looks like Abenomics is working on the data but not on embedded expectations:

Tokyo’s consumer prices rose 2.7 percent in April from a year earlier, the biggest jump since 1992, pumped up by a sales-tax increase and a year of unprecedented stimulus from the Bank of Japan.

Inflation excluding fresh food accelerated from 1 percent in the previous month, while nationally the same price gauge rose 1.3 percent in March from a year earlier, statistics bureau data showed today. The Tokyo price gains compared to a 2.8 percent median forecast in a Bloomberg News.

The Tokyo data provide a first look at the effects of the April 1 tax increase that’s damping consumer demand and is projected to tip the economy into a one-quarter contraction. Investors are assessing prospects for extra monetary easing, with Bank of Japan Governor Haruhiko Kuroda’s board set to meet on April 30 to review policy and release updated forecasts for inflation and growth.

BOJ officials are increasingly concerned the nation’s bond market is failing to reflect emerging inflation, raising the risk of a sudden surge in yields, according to people familiar with the matter. Officials hope yields will rise gradually, in line with developments in the economy and prices, the people said. Benchmark 10-year government bonds yesterday yielded 0.615 percent, little changed from March 2013.

There’s one good aspect to the federal Target Date pension plans I’ve been complaining about recently:

Meanwhile Denis Lemelin, president of the Canadian Union of Postal Workers, said he fears the government will eliminate defined benefit plans for employees at Canada Post and other Crown corporations. “We’re really worried about this announcement,” he said.

Hey, that’s a good justification right there! Bring it on!

Assiduous Reader MG writes in about Target Date Pension Plans and says:

Hi James, thanks for including my response yesterday. Not to prolong the discussion but I just wanted to make on additional point regarding the pooling. Your last paragraph yesterday stated:

Well, OK. But pooling of longevity risk can be accomplished with an annuity. The basic problem is familiar; I wrote an article about it some time ago in another context and now can’t remember the article: risk cannot be destroyed. It can only be passed on or changed in form. And while I seem some risk-pooling for the beneficiaries here, I see no indication that the company bears any; therefore, it’s a DC plan with bells and whistles.

The issue with defined contribution plans is that you need to make decisions at the point of retirement which would not be required under target benefit plans. If you annuitize at the point of retirement, you are making a call on the timing of accumulated savings, i.e. if your investment went down prior to retirement you may be annuitizing a lower capital. You are also captive of the level of long term interest rates at the point of annuitization. If they were 18% (like when I started in the business), it is not an issue. If they are at 3.5%, it is a problem. A target benefit plan would likely be invested in such a way that there is some continuity, i.e. no call on timing of markets and long term rates when benefits start. In a defined contribution plan, you do not need to annuitize but then you have a lot of uncertainty due to unknown longevity, so there is a temptation to get it over with and just get whatever you get through an annuity purchase.

All of this may be a moot point, as I have seen similar arrangements proposed by the federal or provincial governments. Typically these have not been a success for a variety of reasons. In this situation, TB plans would only apply to federally regulated companies, unless provinces do the same. Federally regulated companies would include banks and transportation including CN and CP. Historically many of these already have defined benefit plans, so the only potential would be among employees of much smaller companies.

OK, fair enough. A DC plan member can transfer the value to a Locked-In Retirement Income Fund which – presumably – will have all the continuity he wants, but does not address mortality risk. So a Target-Date will pool the mortality risk for the participants, which is a benefit – it will be able to pay out more aggressively than a self-managed investment portfolio. On the other hand, this pooling occurs in the context of an active pension plan, while leaving the investment risk with the employee (on a pooled basis, of course). This might not be a good thing, depending on the risk characteristics of the pool vs. the risk characteristics of the client.

I will leave it to an actuary to comment on how risks taken by the Target Benefit plan on behalf of the entire pool impact on the risk sustained by the individual retirees! But now I’m wondering if the big insurers could offer such a thing for DC beneficiaries when they cash out. Offer mortality pooling in a mutual fund-like vehicle (but with investments irrevocably locked in!) with an actuarially blessed monthly pay-out, charge a fat fee …

S&P downgraded Russia:

  • •In our view, the large capital outflows from Russia in the first quarter of 2014 heighten the risk of a marked deterioration in external financing, either through a significant shift in foreign direct investments or portfolio equity investments. We see this as a risk to Russia’s economic growth prospects.
  • •We are therefore lowering our foreign currency ratings on Russia to ‘BBB-/A-3’ from ‘BBB/A-2’, lowering our local-currency long-term rating to ‘BBB’ from ‘BBB+’, and affirming our local-currency short-term rating at ‘A-2’.
  • •The outlook on both the foreign and local currency ratings remains negative. If we perceived increased risks to Russia’s creditworthiness stemming from much weaker medium-term economic growth or due to reduced monetary policy flexibility, we could lower our sovereign ratings on Russia further. We could also lower our ratings on Russia if tighter sanctions were to result in additional weakening of Russia’s net external position.

The CMHC is fiddling around with mortgage insurance eligibility rules again:

Canada Mortgage and Housing Corp. is voluntarily tightening up the types of mortgage insurance it will offer.

The Crown corporation said Friday that it is going to stop offering mortgage insurance on second homes. It will also stop offering mortgage insurance to self-employed people whose income cannot be validated through traditional means. The changes on second homes also mean that anyone who has an insured mortgage will not be eligible to act as a co-borrower on another insured mortgage.

CMHC says that its second home program and its self-employed-without-third-party-income-validation programs combined account for less than 3 per cent of its insurance business volumes in terms of the numbers of mortgages insured.

“Given the limited use of these products, their discontinuation is not expected to have a material impact on the housing market,” it stated in a press release.

More smoke and mirrors. Fiddling with the rules keeps the voters happy, but leaving the spigots open for plain vanilla insurance keeps the banks happy.

Pembina Pipelines, proud issuer of PPL.PR.A, PPL.PR.C and PPL.PR.E, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Issuer Rating and Senior Unsecured Notes of Pembina Pipeline Corporation (Pembina or the Company) at BBB, and the Preferred Shares at Pfd-3. The trends remain Stable. The confirmation largely reflects DBRS’s view that the Company’s exposure to fractionation spreads and seasonal pricing differentials has lowered considerably while its financial profile has improved over the past 24 months (since the April 2, 2012, closing of the Provident acquisition (the Acquisition)). The confirmation also reflects DBRS’s expectation that: (1) further improvement of the business risk profile will be achieved once the Company substantially completes all of its current expansion projects; and (2) Pembina will continue to finance its expansion with appropriate debt and equity to maintain its debt-to-capital structure in the range of below 40% and cash flow-to-debt ratio at least 25%.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts and FixedResets both gaining 8bp, while DeemedRetractibles were off 2bp. Volatility was totally nonexistent yet again. Volume was below average.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.2746 % 2,409.5
FixedFloater 4.65 % 3.88 % 33,014 17.74 1 0.1470 % 3,694.3
Floater 3.03 % 3.15 % 50,876 19.35 4 0.2746 % 2,601.6
OpRet 4.35 % -8.98 % 34,259 0.10 2 0.1936 % 2,701.5
SplitShare 4.81 % 4.34 % 63,115 4.21 5 0.0238 % 3,088.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1936 % 2,470.3
Perpetual-Premium 5.54 % -7.17 % 103,012 0.08 13 0.0423 % 2,389.2
Perpetual-Discount 5.38 % 5.39 % 111,181 14.61 23 0.0762 % 2,503.9
FixedReset 4.65 % 3.53 % 198,190 4.17 80 0.0799 % 2,542.1
Deemed-Retractible 5.02 % -2.10 % 145,556 0.16 42 -0.0220 % 2,500.4
FloatingReset 2.66 % 2.41 % 168,101 4.07 5 0.0398 % 2,482.1
Performance Highlights
Issue Index Change Notes
No individual gains or losses exceeding 1%!
Volume Highlights
Issue Index Shares
BMO.PR.S FixedReset 72,760 Recent new issue.
Maturity Type : Call
Maturity Date : 2019-05-25
Maturity Price : 25.00
Evaluated at bid price : 25.47
Bid-YTW : 3.61 %
RY.PR.Z FixedReset 47,625 Nesbitt crossed 20,000 at 25.70.
Maturity Type : Call
Maturity Date : 2019-05-24
Maturity Price : 25.00
Evaluated at bid price : 25.74
Bid-YTW : 3.31 %
RY.PR.I FixedReset 42,961 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2019-02-24
Maturity Price : 25.00
Evaluated at bid price : 25.77
Bid-YTW : 2.78 %
MFC.PR.L FixedReset 40,080 Scotia bought 13,300 rom Nesbitt at 24.96.
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.97
Bid-YTW : 3.99 %
BNS.PR.R FixedReset 32,775 Scotia bought 13,300 from TD at 26.05.
Maturity Type : Call
Maturity Date : 2019-01-26
Maturity Price : 25.00
Evaluated at bid price : 25.93
Bid-YTW : 2.99 %
RY.PR.Y FixedReset 29,950 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-11-24
Maturity Price : 25.00
Evaluated at bid price : 25.60
Bid-YTW : 1.11 %
There were 25 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
TRP.PR.E FixedReset Quote: 25.54 – 25.98
Spot Rate : 0.4400
Average : 0.2669

Maturity Type : Call
Maturity Date : 2019-10-30
Maturity Price : 25.00
Evaluated at bid price : 25.54
Bid-YTW : 3.82 %

ELF.PR.G Perpetual-Discount Quote: 21.56 – 21.98
Spot Rate : 0.4200
Average : 0.2578

Maturity Type : Limit Maturity
Maturity Date : 2044-04-25
Maturity Price : 21.56
Evaluated at bid price : 21.56
Bid-YTW : 5.55 %

PWF.PR.A Floater Quote: 19.40 – 19.99
Spot Rate : 0.5900
Average : 0.4539

Maturity Type : Limit Maturity
Maturity Date : 2044-04-25
Maturity Price : 19.40
Evaluated at bid price : 19.40
Bid-YTW : 2.70 %

POW.PR.C Perpetual-Premium Quote: 25.31 – 25.53
Spot Rate : 0.2200
Average : 0.1338

Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 25.31
Bid-YTW : -7.17 %

BAM.PR.G FixedFloater Quote: 20.44 – 20.69
Spot Rate : 0.2500
Average : 0.1674

Maturity Type : Limit Maturity
Maturity Date : 2044-04-25
Maturity Price : 21.29
Evaluated at bid price : 20.44
Bid-YTW : 3.88 %

PWF.PR.K Perpetual-Discount Quote: 23.48 – 23.68
Spot Rate : 0.2000
Average : 0.1288

Maturity Type : Limit Maturity
Maturity Date : 2044-04-25
Maturity Price : 23.18
Evaluated at bid price : 23.48
Bid-YTW : 5.28 %

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