GalaTime

• Asia Times: India revels in hot commodities

India’s commodity exchange markets, where trading volume has ballooned 50-fold in barely five years, could shrug off a recent drop in business and almost double in size within the next two years, according to a report.

The market, which has grown to US$858 billion in 2007 from $16.9 billion in 2002, could expand to $1.8 trillion by 2010.

Three large exchanges - MCX, the National Commodity and Derivative Exchange (NCDEX) in Mumbai, and Ahmedabad-based National Multi Commodity Exchange of India - now lead a sector revival after a ban on futures trading in most commodities was lifted in 2003.

• Bloomberg: China’s Reserves Fit Harvard Linguist’s Law

Statistically speaking, there’s nothing `normal,’ or bell-shaped, about the way $6 trillion in foreign-exchange reserves is distributed around the world. The top five holders control more than half of these assets, with China alone accounting for 24% of the total.

Mathematician Benoit Mandelbrot, who discovered such a relationship for U.S. cotton prices in 1963, used it as a building block of a new “fractal” theory of financial markets.

Sumlinski has now extended the analysis to foreign reserves, and he finds that Zipf’s rule, when applied to the distribution of as much as 90% of worldwide official assets, fits the data very well.

• Financial Times: Why the Baltic Dry Index matters

As the key measure of global prices for shipping dry bulk commodities such as iron ore and coal, the BDI is the window on what CLSA’s Christopher Wood described in his client newsletter Greed & Fear last November as a “supreme cyclical indicator”.

The recent collapse of the index is a strong signal that the boom in agricultural commodity prices is about to come to an end . . .

A recent theory doing the rounds of the shipping and commodities world lays blame for the slide in dry bulk shipping rates - and consequently the BDI - on a single Taiwanese shipping magnate: Nobu Su, whose privately held Taiwan Maritime Transport is the largest participant in shipping futures markets

• Calculated Risk: Options Theory and Mortgage Pricing

Residential real estate sales and mortgage loans do not, actually, literally, have puts and calls in them. If you buy a home today, you assume the risk that its price may fall in the future. Your contract does not include an option for you to sell the house at the price you paid for it. Nor does the seller of the house have a “call”; the seller cannot force you to sell the house back to him at the original price if its value rises.

The “implied put” in a mortgage contract is the borrower’s ability to default . . . We do not, generally, consider “distress” . . . as an “implied put.” Some borrowers will fall on hard times and be unable to fulfill their mortgage contracts. This is a matter of “credit risk” and it is, analytically, a different matter of mortgage contract valuation. The “implied put” analysis is trying to capture the possible cost to the lender/investor of what we call the “ruthless” borrower. “Ruthless” . . . is in fact the term we use to describe borrowers who can pay their debts but choose not to, because there is a greater financial return to that borrower in defaulting as opposed to not defaulting. It is “ruthless” precisely because there is not a contractual option to do this: the only way you can exercise the “implied put” is to default on your contract.

Long, but informative.

• Forbes: Experience

Schloss has a laid-back approach that fast-money traders couldn’t comprehend. He has never owned a computer and gets his prices from the morning newspaper. A lot of his financial data come from company reports delivered to him by mail, or from hand-me-down copies of Value Line, the stock information service.

Schloss screens for companies ideally trading at discounts to book value, with no or low debt, and managements that own enough company stock to make them want to do the right thing by shareholders. If he likes what he sees, he buys a little and calls the company for financial statements and proxies. He reads these documents, paying special attention to footnotes. One question he tries to answer from the numbers: Is management honest (meaning not overly greedy)? That matters to him more than smarts.

“There’re too many people with money running around who have read Graham,”

• Bloomberg: FBI Probing 14 Companies in Subprime Lending Crisis

The Federal Bureau of Investigation is investigating 14 corporations for possible accounting fraud and other crimes related to the subprime lending crisis . . .

The probes include reviews of subprime lenders, housing developers and Wall Street firms that package loans as securities . . .

“We’re looking at the accounting fraud that goes through the securitization of these loans.”

The Andersen/Enron/Worldcoms of the 2003-2007 bull market?

• John Mauldin’s Investors Insight: The Dash To Trash And The Grab For Growth

The growth universe appears to be made up of two kinds of stocks. Firstly, the ones we would expect to find within this universe - the Googles, Apples and RIMMs of the world. These stocks have extraordinary cash flow growth embedded within their market price (in excess of 40% p.a. over the next 10 years) - surely madness. The second sort of stock in the growth universe are cyclicals masquerading as growth stocks. Some of the general industrials and the miners are priced for quite incredible long-term growth.

. . . there are two major flaws in the decoupling arguments. Firstly, people always forget lags at the turning points in cycles. So if the US housing bubble bursting brings down the US consumer, it is ludicrous to assume that highly export-dependent nations will be able to withstand a demand drought. Secondly, the decoupling arguments reek of cognitive dissonance - the desire to hold two contradictory viewpoints simultaneously. Those who now speak of decoupling used to talk of globalisation. This is oxymoronic, you can believe in one or the other but not both.

• Bloomberg: Death of VaR Evoked as Risk-Taking Vim Meets Taleb’s Black Swan

Value at risk, the measure banks use to calculate the maximum their trades can lose each day, failed to detect the scope of the U.S. subprime mortgage market’s collapse as it triggered more than $130 billion of losses since June.

Lehman uses four years of historical data to calculate VaR, with a higher weighting given to more recent time periods, while Morgan Stanley provides VaR calculations using both four years and one year of market data.

All of the risk-measurement tools failed to prepare Merrill for the unforeseen declines on triple-A rated securities backed by subprime mortgages . . .

Talk about timing - Taleb’s ‘The Black Swan’ is practically selling itself! Wonder how widely VaR is (ab)used in India.

• Psychology Today: 10 Ways We Get the Odds Wrong

The human brain is exquisitely adapted to respond to risk—uncertainty about the outcome of actions. Faced with a precipice or a predator, the brain is biased to make certain decisions. Our biases reflect the choices that kept our ancestors alive. But we have yet to evolve similarly effective responses to statistics, media coverage, and fear-mongering politicians. For most of human existence, 24-hour news channels didn’t exist, so we don’t have cognitive shortcuts to deal with novel uncertainties.

The physiological consequences of overestimating the dangers in the world—and revving our anxiety into overdrive—are another reason risk perception matters. It’s impossible to live a risk-free life: Everything we do increases some risks while lowering others. But if we understand our innate biases in the way we manage risks, we can adjust for them and genuinely stay safer—without freaking out over every leaf of lettuce.

• Bloomberg: Stock Market Decline Delays Highest Number of IPOs in 10 Years

Tumbling equity markets prompted 24 companies this month to halt plans for initial public offerings, the most in at least a decade.

The Bloomberg IPO Index, which tracks new stocks in their first year of trading, dropped 9% in the past year, while the Standard & Poor’s 500 Index declined 6.4%.

• TraderFeed: From Trader to Hedge Fund

. . . few traders end up making the leap to funds, even when they have talent. The reason is that most hedge funds are looking for multifaceted portfolio managers, not directional traders of single asset classes.

. . . being a successful trader and being a successful portfolio manager are different skill sets. A trader knows his or her market in depth–particularly at a short time frame–and masters particular strategies or setups. A portfolio manager has to know multiple markets and trade multiple strategies often across multiple time frames.

• Business Standard: The ultimate crisis machine - Sebi`s risk management

Our concern is with index futures — for the US markets, the margin to contract value ratio is around 6 to 7%; for India, 10 to 15% and on January 24, it was a whopping 17.3% for Nifty futures.

. . . the increasing frequency of sharp moves in a few minutes of opening (the P-notes crisis in October 2007, and other crises in May 2006, May 2004, and so on) is not due to the market being too far up, or excessive speculation, or even the erroneous assumption of low margins required for trading. It is due primarily to the dud system of margining that we in India have adopted. As always, we have instituted a policy “in the name of the aam aadmi”; and as always, the policy hurts them the most.

. . . margins for a Nifty futures contract rose by 50 per cent between January 18 (Rs 29,955) and January 24 (Rs 45,000).

• Knowledge@Wharton: Beneath India’s Choppy Stock Markets, Index Funds Gain in Strength

Passive index funds are gaining popularity as Indian mutual funds, including active funds, grew by 80% to $140 billion (Rs. 556,730 crore) between October 2006 and October 2007.

. . . in the past two years, passively managed, low-cost index funds returned nearly 46% annually, while their counterparts in active, diversified equity funds averaged close to 45%.

Yay!

• ViewsWire, Economist: India economy: Consume now, pay later

. . . at current prices, subsidising various fuels–petrol, diesel, kerosene, LPG–may cost the equivalent of 1% of India’s GDP in the 2007/08 fiscal year (April-March).

Even after the imminent mini-hike, petrol will be sold at a loss of at least Rs5 per litre and diesel will be sold at a loss of at least Rs9 per litre.

. . . the state-owned oil companies are likely to be hit with an estimated revenue loss of Rs190bn in 2007/08.
The consolidated fiscal deficit (federal plus states) will have fallen from around 10% of GDP ten years ago to around 6%. But total off-budget liabilities–such as oil bonds, food, fertiliser and power subsidies, which could reach an estimated 2% of GDP–will not be included.

• McKinsey: India’s rising middle class wants a better life
  

• DNA: Insurers change ULIP pitch

The recent stock market volatility has had life insurers take a hard look at their fastest moving product, the investment-related unit linked plan (ULIP).

And the companies are tactically changing their pitch. Most will now play up the flexibility of free switches offered by Ulips, rather than promotes possible stock market gains.

ULIPs, largely market-driven, comprise almost 80-85% of new business premium of the companies.

More BS from the purveyors of the worst investment product out there.

• Yahoo: Quantum launches gold exchange-traded fund

Quantum Asset Management Co Pvt Ltd said on Wednesday it will launch its gold exchange-traded fund on Thursday with a listing likely in March.

. . . this fund has no entry load, our unit size will be half a gram.”

Yet another gold ETF - there are now 5 choices for Indian investors!

• Zeal LLC: SPX Secular Bears

With almost 8 years of sideways trading, and general valuations shrinking relentlessly, there is just no doubt we are in the second half of a Long Valuation Wave. The “second half of an LVW” is just a synonym for a secular bear market. The problem is these secular bears tend to run for 17 years in duration and we are merely starting to approach the half-way point today.

If the US stock markets continue trading sideways on balance until 2016, at which point stocks will be a once-in-a-trading-lifetime bargain at 7x earnings, are we now due for a cyclical bear to keep the SPX within its secular trading range?

Shares the same outlook (single-digit returns for the next 5-10 years) as other US ‘bears’ - Hussman, Grantham et al.

• Big Picture: Fed’s Folly: Fooled by Flawed Futures?

. . . it took only 2 days to learn just how ill-considered the Fed’s emergency market rescue plan was: To wit, a fraudulent series of losses led to a major European bank unwinding a huge trade: Societe Generale Reports EU4.9 Billion Trading Loss.

SG’s $7.1Billion dollar unwinding led to panicked futures selling on Monday and Tuesday.

Hence, we quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices. Their panicky rate cute were not to insure the smooth functioning of the markets, but rather, to guarantee prices.

Whoa! So that 20% drop in 2 days was for nothing? Do we see 20k+ on the Sensex soon? And here we were debating valutions, FII flows, margin calls & such!

• Seeking Alpha: WisdomTree Launches Broad-Based India Earnings ETF

In early February, WisdomTree Investments plans to launch the WisdomTree India Earnings ETF.

The ETF’s benchmark includes 150 locally listed companies. That compares to around 62 companies the MSCI Index tied to the iPath uses, . . .

The WisdomTree India Earnings Index also screens for profitability as a criteria. “We only include Indian companies that’ve been profitable in the last reported 12 months,” Lavine said.

Stocks are weighted in the index by “their contribution to the earnings stream of corporate India,” he added. “We look at trailing net income and work with S&P in those calculations.” The rival ETN is market-cap size weighted.

• Business Line: FIIs betting on reverse-arbitrage?

If you go by the SEBI figures for recent FII investments, then you may conclude that they are net sellers in the Indian equities. But it’s deceptive, say brokers and overseas fund managers.

“Foreign investors, particularly participatory notes holders, have adoted a reverse arbitrage strategy for 2 to 3% additional spread available because of dip in the futures prices compared with that in the cash segment.

. . . all the big investment outfits, who have large inventories of participatory notes, have been strong net sellers in the cash market in the last five sessions. However, as their trade figures in the derivatives market do not indicate whether they are ‘buy’ or ‘sell’, this strategy of reverse arbitrage is not in the public domain. Since the settlement is round the corner, the new investment tactic is likely to pay off huge dividend . . .

This is why first-level analysis of daily FII flows is usually insufficient. Simpliy looking at the SEBI net purchasese/sales by FIIs can lead to incorrect conclusions.