Streetwise Professor

February 21, 2012

Portrait of A President As A Young Thug

Filed under: Politics,Russia — The Professor @ 8:14 pm

I’ve often commented how Putin has a gansta’s obsessions with respect. It comes out in particular when he talks about the United States and Khodorkovsky.  I’m convinced that Khodorkovsky sealed his fate when he gave a public presentation accusing Putin’s inner circle–and by implication Putin–with corruption, and thereby disrespected the don.

This excerpt from a forthcoming biography of Putin by Masha Gessen makes it plain that Putin’s gangsta obsession dates from his childhood.  It is his chosen identity, one that he has built-cultivated, really-for five decades.  It is not an act.  It is him.

Very revealing. And very disturbing.

Choices Are Far More Revealing Than Words

Filed under: Politics,Russia — The Professor @ 7:51 pm

Russia, the home of the world’s largest population of addicts,  has vented loud and long at the flow of Afghan heroin reaching Russian veins, and placed blame squarely on the United States and NATO and their war in Afghanistan.  Russia wants the US to eradicate the Afghan crop; the US and NATO refuse to do so, on the belief that this would strengthen the Taliban.

The US has proposed instead to create task forces in the former Soviet ‘Stans that would coordinate with local authorities to attempt to stem the flow of heroin using law enforcement means.  The Russians have blocked this initiative.  The reason?  In brief, the Russians view the ‘Stans as theirs and theirs alone, and don’t want any Americans mucking about:

“Kommersant” quoted an unnamed Russian official in Vienna as saying, “Why create something new if Collective Security Treaty Organization [CSTO] structures are already in force in these countries? Why does [the United States] insist on bilateral dialogues with the Central Asian republics, demonstratively ignoring Russia’s interests in the region?”

The CSTO is a regional security alliance that includes Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan, but is dominated by Russia. Analysts say the United States and NATO are hesitant to work solely through the body due to that controlling influence.

The newspaper said another unnamed Russian official called the U.S. plan “a new tool of infiltration into Central Asia [and] a method of strengthening the military-political influence of the United States in the region.”

So when push comes to shove, a few hundred Americans interacting directly with governments in Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan trumps the “30,000 to 40,000 drug-related deaths in the country annually.”

Very revealing about priorities, no? Duly noted.

February 20, 2012

Did You Follow My Advice? I Should Have!

Filed under: Commodities,Derivatives,Economics,Exchanges,Regulation — The Professor @ 12:41 pm

Last March I noted that in my two previous trips to teach in Geneva, there had been squeezes in the coffee market, and I said I was going to buy coffee spreads before my next trip.  Well, that trip is coming up in about 3 weeks, but somebody in the market (perhaps the Noble Group, according to the FT) beat me to the punch: there is a good squeeze underway in the robusta market, with spreads going from contango to a $182/ton backwardation.  That ain’t a hill of beans.

Note to self: put on the trade earlier next year.

When I was in Geneva last year the Li(e)bor story came to life after having faded from view for several years.  That story has now exploded into prominence, with numerous disclosures over the past several weeks.

Indeed, the story has taken a major turn.  Whereas suspicions as to motive originally focused on the idea that banks were attempting to make themselves look sounder than they were by exaggerating their ability to borrow unsecured, the new stories claim that there is evidence that some traders were manipulating rates specifically to influence the value of derivatives positions tied to Libor.  This is a major development because specific intent to manipulate the price of a derivative is a necessary element of a manipulation case under the Commodity Exchange Act.  If confirmed, these allegations regarding motive dramatically increase the legal stakes for the banks.

Putin’s Arms Race

Filed under: Economics,Military,Politics,Russia — The Professor @ 11:04 am

In the immediate aftermath of the Duma election, I predicted Putin would do the following:

  1. Even more populism, with lavish promises regarding pensions, state investments, limitations on increases in utility tariffs.
  2. Nationalist appeals, complete with dark tales about foreign conspiracies to destroy Russia.
  3. Relatedly, even more truculence in foreign policy, e.g., Syria, BMD, the Near Abroad.

All is  going according to form.  Insofar as the truculence and nationalism is concerned, Putin’s promises of a lavish binge on weapons procurement fits right in.  The latest of his mind-numbingly long articles on his future plans focuses on defense.  He promises $770 billion in expenditures on weapons over the next 10 years-an increase of $120 billion over and above what had been mooted last year.

Putin gives two rationales for this binge.  The first is that the defense industry can be the catalyst for a revitalization of technologically advanced industries in Russia.  This is a common assertion, and one that has little basis in reality.

The second is that Russia is under siege:

“New regional and local wars are being sparked before our eyes,” Mr. Putin wrote. “There are attempts to provoke such conflicts in the immediate vicinity of Russia’s borders.”

Note the phrasing: “attempts to provoke conflicts.”  Only the truly dim will not understand the code and fail to identify whom Putin believes it he provocateur.

Several quick comments.

First, when Kudrin was sacked for criticizing Medvedev’s lavish defense spending plans-a mere $600 billion or so-I said that Kudrin was really attacking Putin, because Putin was the driver behind increased defense spending.  It is now clear that this was definitely the case: Kudrin’s (admittedly guarded) move to opposition provides further evidence.

Second, this plan is technologically fantastical given the actual performance in Russian weapons programs in recent years.

Third, Putin completely misdiagnoses the real source of Russia’s military weakness. It is a software problem, not a hardware problem.  Just where are all the soldiers, sailors and airmen needed to operate these new weapons going to come from?

Fourth, Putin warned defense contractors against price gouging on new contracts.  Hahahahahahahaha! What a card! Good luck with that! Especially given Putin’s own policy of consolidating Russian defense contractors into a few huge politically connected behemoths.

Fifth, this is fiscal insanity. This is especially true as there is little prospect for raising additional revenues from the energy industry.  Indeed, the opposite is likely true (h/t R):

Russia’s 12-year oil boom is nearing its peak, forcing the next president to decide whether to cut taxes and revive production or use the windfall from $100 oil to boost public spending and quell mounting unrest.

As Vladimir Putin campaigns for a second stint in the Kremlin, the nation’s existing fields are losing pressure and oil companies OAO Rosneft, OAO Lukoil and TNK-BP (BP/) say production taxes give little incentive to invest. Since Putin first became president in 2000, crude output has grown 57 percent to 10 million barrels a day, surpassing Saudi Arabia and flooding the state treasury.

“The cream has been skimmed off the top,” said Leonid Fedun, the billionaire deputy chief executive officer of Lukoil, Russia’s second-largest oil company. “Further steps require taxes based on different principles,” or production will start falling within three years, he said.

Any cuts in the oil and gas industry’s 5.64 trillion rubles ($190 billion) in taxes mean less cash to combat the biggest anti-government protests since the 1990s. Deputy Energy Minister Sergey Kudryashov said Feb. 2 the need to strike a balance between revenue and oil output levels is one of the most difficult questions facing the state.

To which I would add that future competitive threats to Gazprom will put additional pressures on revenue in the medium-to-long term.  (Note that Gazprom has already given price cuts of around 10 percent to big European and Turkish customers.  The pressure on pricing will only increase in the next several years, certainly within the 10 year defense budget horizon Putin discussed.)

Sixth, the need for revenues to pay for such outlandish promises makes the Retroactive Oligarch Tax all the more attractive.  And we can see that Putin gave a very clear hint at how Putin might propose that this tax be paid: he lavished praise on TNK and Surgutneftgas for paying  for the continued operation of a submarine base in 2002.  We can expect Putin to extract similar “contributions” from other big companies to pay for his defense splurge.  (As a too funny sidebar, Prokhorov said that the oligarchs should decide themselves how much they will pay.  Good luck with that!  And I’m pretty sure that was the real Prokhorov who said that, not @fake_prokhorov.)

Seventh, the centerpiece of Putin’s plans are the building of 400 MIRVed ICBMs.  This is occurring when the Obama administration is mulling a unilateral cut in US nuclear warheads-perhaps to as low as 300.  It will be quite interesting to see whether Putin’s announcement makes the slightest dent in these dreamy plans.  Sadly, I believe that is unlikely to be the case, given (a) Obama’s bizarre strategic views, and (b) his obsession with the Reset.

I Don’t Give a Flying F*** About Contraception (Policy)*

Filed under: Economics,Politics — The Professor @ 10:29 am

If you need a graphic illustration of the degraded and delusional state of American politics, you only need to observe the fact that the issue that has dominated the political headlines in the past weeks is contraception.  Really.

Yes, the administration presents a fantastical budget, one which acknowledges that the nation’s fiscal situation is unsustainable.  The Senate hasn’t passed a budget in years.  Many states-including most of the largest ones-are on the fiscal precipice, and the nation as a whole is not far behind.  Entitlement spending is metastasizing.  As for growing our way out-please.  Despite all the Happy Days Are Here Again rhetoric emanating from the White House-duly echoed and amplified in the media-growth is anemic, and far below what is needed to right the fiscal ship.  The unemployment rate is falling-but the employment rate is at multi-decade lows, as many are dropping out of the labor force.  And it’s not due to an aging population.  The employment rate among those in their 20s has fallen most, which is a catastrophe, as that is the period when people should be building the experience and human capital that can only be obtained by working-learning by doing-and that generates returns for a lifetime. And it’s not like we’re lacking for examples of what can happen when fiscal problems fully ripen. We see the consequences of fiscal profligacy playing out in Greece and Europe generally playing out right before our very eyes.

But we’re hung up on contraception.

Why?  I can think of several reasons.  One is that when faced by an overwhelming problem, people deny and avoid, and concentrate their efforts on something smaller-trivial often-and more easily managed.  The fiscal situation is daunting, so the impulse to avoid and deny is particularly strong.  Another reason is that it is very convenient for Obama to distract attention from his Achilles’ heels, of which the looming fiscal crisis is the most vulnerable.  Of course, the media is quite willing to play along, and the Republicans are living up to their reputation as the Stupid Party by falling right into the trap.

The only reason that the contraception issue should matter at all is that it provides a very clearcut demonstration of a progressive administration’s willingness to run roughshod over the Constitution and and private property (by compelling private companies to provide a good or service for free).  But this isn’t news.  By word and deed, Obama has repeatedly demonstrated that he is a committed progressive, with all that entails.  Since the Progressive Era at the beginning of the 20th century progressives have heaped disdain on the Constitution and the constraints it imposes on the ability of the government to order us all about. Do we really need another example to make the point?

The candidates of even A Slightly Less Stupid Party would focus on the impending fiscal train wreck and put Obama on the defensive.  Little chance of that.

(And for those who are about to fire off a comment saying-“See-you should support Ron Paul because he’s the only one who cares about government spending and the Constitution”: spare me.  Paul punts completely on the most pressing medium- and long-term spending issue: entitlements.  Moreover, his proposals to cut a trillion dollars tomorrow are, like most Paulian ideas, political fantasies.)

Right now it looks like that the main obstacle to a second Obama term is $5 or $6 gasoline over the summer.  Which would be wickedly ironic, because he and his policies have little effect on the price of energy in the short run (though his policies are a complete cluster**** in the medium-to-long run).

But it’s truly come to that.  Due to a complete lack of seriousness and courage in the political class, a transformational election hinges on something completely unrelated to the transformational issues, and completely out of control of any of those participating in it.

* SeekingAlpha often changes the titles of my posts.  I wonder if they’ll change this one?

February 18, 2012

A Bad Metaphor That Puts Your Financial Health At Risk

Eric Posner and E. Glen Weyl have attracted a lot of attention for their proposal to create an agency that would approve trading of new financial products, in the same way the FDA must approve new drug entities before they can be sold to the public.  Their initiative is fundamentally flawed, both in its diagnosis and its prescription.

There are a variety of problems.  The most basic is their false dichotomy between contracts that are used for speculative purposes, and those that are used for hedging.  In fact, speculation and hedging are highly complementary functions.  The most important function of derivatives markets is to facilitate risk transfer.  This risk transfer often involves a hedger on one side of a transaction, and a speculator on the other.  The speculator may be, as Posner and Weyl claim, trading on the basis of incorrect beliefs.  So be it.  His existence allows the hedger to reduce risk, and makes both parties subjectively better off, although Posner and Weyl seem to suggest that it would be possible to determine objectively that the speculator is acting irrationally.

In other words, much speculation in financial markets facilitates hedging.  To suggest that these activities are antithetical, or unrelated, as Posner-Weyl do, is highly misleading.

Posner and Weyl use mutual funds as an example of a salutary financial innovation.  No disagreement here.  But these can be used for activities that are commonly and properly considered “speculative.”  Moreover, equity and bond futures are widely used to speculate on broad movements in stock and interest rate changes.  But they are also used by pension funds and institutional investors to achieve the same type of objectives as mutual fund investments. So what, really, is the difference between mutual funds and derivatives?

There are indeed well-known problems with speculation.  Much of it (including excessive acquisition of costly information, the development of faster ways to trade) is properly understood as rent seeking.  But these problems are not uniquely associated with particular kinds of instruments, as Posner-Weyl insinuate.  There can be inefficient acquisition of information for speculative purposes in derivatives that are widely used for hedging–including the agricultural futures that Posner-Weyl consider to be salutary. (Although it does not speak highly of their understanding of these markets that they use farmer hedging as their justification of ag futures, though that is hardly the primary hedging use of these instruments.)

Other possible problems highlighted by Posner-Weyl include the use of derivatives for tax avoidance or regulatory arbitrage.  I say “possible problems” because the real problem can be with inefficient regulations or taxes, not the means that are used to mitigate these inefficiencies.  But even abstracting from this difficulty, there is also a fundamental problem distinguishing “bad” derivatives that are used for tax or regulatory avoidance, and “good” derivatives that are used to hedge.

Back in the 1970s and 1980s, simple plain vanilla futures contracts were widely used in a tax reduction strategy called “tax straddles” involving a spread trade (buying one future, selling another with a different delivery day).  The trader would liquidate the losing leg of the trade to generate losses to offset against other gains, or to convert ordinary income into capital gains.  This strategy was eventually disallowed in 1981: the instruments themselves were not banned because they could be used to avoid taxes.

In sum, hedging and speculation are complementary; speculation is not always inefficient;  and inefficient forms of speculation are not confined to specific instruments.  Therefore, regulations designed to impede speculation by requiring the approval of specific products are misguided because impeding speculation interferes with efficient transfer of risk, and because the inefficient uses of derivatives cannot be reduced reliably by preventing the marketing of particular instruments.

This means that charging some financial FDA with the responsibility of choosing which innovations to permit and which to proscribe, based on the goal of eliminating speculation, is basically hopeless.  Such an agency’s choices will be plagued by Type I and Type II errors.

Not to mention that whereas the effects of a drug can be determined with some (though incomplete) precision in clinical trials, there is no comparable way of determining how financial innovations will be used, the volume of their use, or their economic effects (in part because these effects depend on the scale of adoption, and the interaction of these products with other products in the market).  All of these things depend on the choices of myriad individuals, and these choices can change over time: who would have envisioned, in the 19th century when wheat and corn futures were first traded in Chicago, that they would one day be used by index funds to offer diversification opportunities to pension funds?

Drugs are taken by individuals and their effects can be understood by studying individuals who take them: the systemic effects are just the sum of individual effects. Things are very different in financial markets.  The introduction of financial products can lead to very complex responses in the entire system that cannot be understood or quantified in any clinical trial.

When I originally heard of the Posner-Weyl paper, I thought they would focus on how particular instruments can be systemically risky.  They in fact pay very little attention to this issue.  In this regard, it should be noted that the FDA/clinical trial model is completely inapposite.  You cannot study the systemic effect of a financial innovation in an isolated trial: you have to see how it interacts with, and affects, the entire system.

And to try to understand these effects a priori is certainly futile.  The system is too complex, and there is no way to understand how a particular innovation will fare in the market, and how it will affect the entire system.  As a concrete example, no one truly understood the consequences of CDOs on subprime ex ante, just based on the characteristics of the instrument themselves.  The risks embedded in the instruments were not well understood when they were first created, and these risks depended on the scale of their use, which was impossible to predict at the time they were first created.  In the end, there were risks that were not widely understood at the time of introduction, and these risks had systemic import only because these instruments proved very popular and grew to massive proportions completely unanticipated when they were first introduced.

We actually have historical experience with ex ante entry regulations on financial innovation.  Until the 1990s, no exchange could introduce a futures contract unless the CFTC approved it.  The approval was contingent on a CFTC finding that the proposed contract passed an “economic purpose” test, and was designed in a way that would permit it to achieve this purpose.  In some ways, the economic purpose test was analogous to what Posner and Weyl propose today.

This system was costly and reduced competition.  Like many entry barriers, it was exploited by incumbents to hamstring competitors. I am not familiar with any dangerous product that was kept off the market through this procedure, and the introduction of good products was delayed.  All pain, no gain.  Why would we want to repeat that experience.

Maybe Posner and Weyl would disagree with my appraisal of the CFTC precedent.  They don’t seem to be aware of it, in fact.  Before making such sweeping proposals perhaps they should have performed an analysis of a similar system that operated for decades.

Being a Sam Peltzman student, I was never all that impressed with the FDA model in the first place, even in pharmaceuticals.  I am even less impressed with the FDA as a model for the regulation of products that are fundamentally different from drugs.  Especially when those advocating this model make basic errors about the instruments that they believe should be regulated, and the uses to which they are put.

Great. Like They Needed Something Else to Fight Over

Filed under: Commodities,Derivatives,Economics,Exchanges,History,Politics,Regulation — The Professor @ 9:09 am

Walter Russell Mead’s excellent blog recently discussed the conflicts over massive natural gas deposits in the eastern Mediterranean:

Naturally, the race to get the gas has reinvigorated old arguments (Cyprus-Turkey) and added fuel to newer disagreements (Israel-Turkey). Israel and Cyprus have been fastest off the blocks, agreeing their common maritime border in 2010 and contracting exploration work to Noble Energy. Turkey, on the other hand, has been slow to react and increasingly confrontational, holding naval exercises and trying to prevent Cyprus from accessing gas that Turkey says belong to Northern Cyprus, which only Ankara recognizes as a country. The confrontation also threatens to further destabilize Israeli relations with Turkey, which appeared to be on the uptick this week when an Israeli delegation arrived in Turkey’s quake-hit Van Province with aid supplies; “You are our true friends” said Van’s vice governor.

The gas reserves in the Levant Basin may be large enough to make Cyprus self-sufficient in energy and turn Israel into a major gas exporter for the next several decades. That, and Israel’s new tilt toward Greece as a way of countering the cold wind in its relations with Turkey, is opening a new era in Israel-Cyprus relations. Netanyahu is on his way to Nicosia this week (the first ever visit of an Israeli PM to the island), and Israel is expected to formally ask to station fighter jets at a southern Cypriot airbase.

Oh joy. Another reason for conflict in a region of the world that counts conflict and strife as its most important export.

Unmentioned in Mead’s post is Russia, the country which has a huge economic stake in the development of a major gas resource right next to its major western European customers.  Eastern Med supplies would far closer to Europe–especially big consumers like Italy–than Russia, and these supplies wouldn’t be subject to the Russian-Ukrainian Punch and Judy routine every winter, or the vicissitudes of Russian domestic considerations.  Meaning that if these resources were developed to their full potential, Gazprom (and Russia) would suffer substantially.  Very substantially.

Which gives Russia a tremendous incentive to foment instability in the region.  Not like that is very hard, either.

It has two major levers in this endeavor.  The first is Cyprus, which is deeply enmeshed with Russia financially and politically.  Russia has been Greek Cyprus’s financial savior, extending it substantial amounts of credit to keep the country from plunging into Greece-like catastrophe.  Even more importantly, Cyprus is the destination or conduit of dirty Russian money, and the location of choice for Russians setting up dodgy shell companies.  (Oh, how entertaining it would be if Cyprus were the target of an invasion by an army of forensic accountants!) (Also recall that the SVR agent who was the money man for the Anna Chapman spy ring miraculously disappeared in Cyprus after being arrested there.)

The second is . . . Syria.  I do not suggest that this is the only for Russian intransigence in that country: that behavior is overdetermined.  But stoking conflict–or standing in the way of resolution of conflict–in Syria does promote Russian interests in the gas business.  Indeed, the economic stakes here are far greater than the oft-cited Russian commercial interests in Syria: some rather shambolic business and infrastructure projects, and arms sales (which appear never to be paid for, at least fully).

Just saying.

Saint? Warren Ain’t

Filed under: Commodities,Derivatives,Economics — The Professor @ 8:24 am

I have long been nauseated by the hagiography surrounding Warren Buffett.  The veneration of St. Warren has reached a peak of late, as he is Obama’s go to guru, providing protection against accusations that the president is anti-business, and giving cover to Obama’s plans to jack up taxes on the wealthy.  After all, if a man richer than God is on your side, how can you possibly be a class warrior?

My cynicism about the saintly Buffett dates from almost exactly 14 years ago. There is substantial evidence that in February, 1998, Buffett cornered the silver market.

I repeat: there is substantial evidence that Warren Buffett cornered the silver market.  Cornered, as in manipulated.

Yes, Saint Warren was almost certainly a manipulator.

The story in a broad outline. Beginning on 25 July, 1997, Buffett began to accumulate large quantities of silver via Phibro, a subsidiary of Salomon Brothers, an investment bank in which Buffett had a big stake, and which he had saved from extinction when Salomon traders cornered the Two Year Treasury note market in 1991.  He eventually acquired nearly 130 million ounces of silver.

He stood for big deliveries in February, 1998.  The market went nuts.  All of the inidicia of a corner were present.  Nearby prices skyrocketed relative to prices for delivery in the spring.  The following chart depicts the spread between the March, 1998 COMEX silver price, and the prices for May and July. 

Note that the spread blows out when Buffett stood for delivery, during the first week of February, with the March-July spread going from -.2 cents/oz on 1/29/98 to 20 cents/oz on 2/5/98.  The March 98 price went up a dizzying $1.25/oz (about 20 percent) during that week.

The loco London lease market for silver also showed acute signs of a squeeze.  (The lease rate is the cost of borrowing metal.  If you need silver in a hurry to make delivery, you are willing to pay a big premium for nearby delivery, that is, you are willing to pay a lot to borrow/lease silver.  Formally, the forward price of silver is the spot price times one plus the interest rate minus the lease rate.  If the lease rate is very high, the forward price will be below the spot price: that is, the market is in backwardation.)

This depicts the one month lease rate for silver.  Note it skyrocketing right around the time of the deliveries.  In early February, the lease rate was quoted as much as 75 percent annualized (some press reports say 80 percent).

There were physical distortions characteristic of a squeeze.  People around the world scrambled to get silver and transport it to London–often by plane.  The silver market in India, a major consumer, almost shut down:

But in the past two months, work at the refinery has slowed–because of one man half a world away. Until a few days ago, most Indians had never heard of Warren Buffett. They even say his name wrong, confusing it with buffet. No matter. Since last October, when Buffett began buying silver, imports into India have nearly stalled as Indians decided that the metal costs too much. Today, more and more Indians are selling their dishes and jewelry made of silver, which now fetches $7.25 an ounce, 20% above the normal $6. That makes for an interesting match-up: 960 million Indian sellers vs. one billionaire buyer from Omaha. “Tell [Buffett] he can’t last,” thunders dealer and refiner Mukul Sonawala. “Indians say the price is too high. They’re saying: `Mr. Buffett, have your buffet, we’ll wait till the price drops. Good-bye.”‘

There were backlogs processing the silver flooding into London: the official weighers couldn’t keep up.  The London Bullion Market Association responded to the bottleneck by extending the normal 5 day delivery period to 15 days.

There was plenty of silver in New York, but Buffett didn’t buy it there, even though it was cheaper there (more on this below).  Instead, silver was shipped from NY to London, by airfreight(!) mainly, where it had to be re-assayed because the assay marks were from a firm no longer in existence.  This created yet another bottleneck.

As soon as the deliveries were completed, prices, spreads and lease rates collapsed: by 27 February, the London price had fallen 22.5 percent off its peak, and lease rates were down to where they’d been before the frenzy began in the immediate aftermath of a Buffett press release (see below).  These price and price relation changes are also symptomatic of a corner.  They are the manifestations of what is often referred to as “burying the corpse”–a phrase I’ve been accused of coining.*

What did Buffett have to say?  This (on February 3, 1998):

During 1998, Berkshire has accepted delivery of 87,510,000 ounces in accordance with the terms of the purchase contracts and the remaining contracts for 42,200,000 ounces call for delivery at varied dates until March 6, 1998. To date, all deliveries have been made on schedule. If any seller should have trouble making timely delivery, Berkshire is willing to defer delivery for a reasonable period upon payment of a modest fee.

Over 30 years ago, Warren Buffett, CEO of Berkshire Hathaway, made his first purchase of silver in anticipation of the metal’s demonetization by the U.S. Government. Since that time he has followed silver’s fundamentals but no entity he manages has owned it. In recent years, widely-published reports have shown that bullion inventories have fallen very materially, because of an excess of user-demand over mine production and reclamation. Therefore, last summer Mr. Buffett and Mr. Munger, Vice Chairman of Berkshire, concluded that equilibrium between supply and demand was only likely to be established by a somewhat higher price.

On which I call Bull!

If it was a long term investment, why did Buffett take delivery at a huge premium over deferred prices? If he was betting on the long term fundamentals, why not sell nearby silver at its huge premium, and buy silver at a much lower price for delivery in July, say?  If he was right about the fundamentals, the July price would rise as the “equilibrium [was] established.”

Taking delivery at a premium price was actually foolish, if long term investment was the actual goal.  Buffett paid a premium of about 45 cents/oz to get silver in early-February.  He was buying high and selling low. If he wasn’t manipulating, and his trading wasn’t causing the price distortions, he could have sold spot silver, bought silver for delivery in a month, and picked up 45 cents/oz by doing so (instead of standing for delivery).  Warren Buffett did not get that rich by being that stupid.  No, the evidence clearly shows he had another, very short-term objective in mind.

Put differently, if Buffett had been acting purely as a long term investor, why would he have needed people around the world–as far away as India–to scrape up all the silver they could find, put it on planes, fly it to London to get in the customs queue to be delivered in a five day window (later extended to 15 days)?  Why did Mr. Long Term need silver on those 5 (15) days? What was the big hurry, if he was taking the long view?

And why did he need it in London? This chart depicts the difference between the London silver fix and the COMEX March futures price.  Note the spike when Buffet was taking deliveries in early February.  At the margin, he paid a premium of 56 cents/oz–representing almost 8 percent of the NY price–to get silver in London in early February rather than getting it in NY.  Note too that the premium crashed after the bottleneck cleared.

The answer to these questions: demanding delivery in a short time window in a single location had nothing to do with a long term view on silver.  It was a corner, pure and simple, exploiting the frictions involved in bringing large quantities of silver to London on short notice. That made it very costly to deliver, allowing Buffett to loan out silver very profitably at the inflated lease rate.  He created an artificial shortage, and likely profited accordingly.  An investor acquiring silver based on a long-term view would attempt to minimize cost by purchasing in the cheapest locations and dates.  Buffett bought a lot of silver at the most expensive location and the most expensive date.

And note well the little insult that Buffett added to economic injury:

If any seller should have trouble making timely delivery, Berkshire is willing to defer delivery for a reasonable period upon payment of a modest fee.

A reasonable period.  A modest fee.  How saintly.  Note well again: the market rate for deferring delivery by as little a month was as high as 75 percent on an annualized basis.  In dollar terms, about 45 cents/oz (6 percent of the price) to defer delivery by one month.  Does that sound “modest” to you? Not to me.  Does it sound like the actions of a purely long term investor, who shouldn’t need to get the silver RIGHT NOW? Couldn’t a long term investor wait a month? Wouldn’t a long term investor want to buy at the cheapest location, not the most expensive?

The lease rate tells you exactly what that “modest fee” was.  Deferring delivery for one month cost 75 percent annualized–over 6 percent per month.  That’s not even that modest for loan sharks.

No, the market showed acute signs of shortage, and that shortage had one cause: Buffett standing for huge deliveries.

So keep this in mind when you hear Buffett praised to the heavens.  He is more than willing to play smash mouth to add to his fortune.  He is also very willing to lie about it, and to claim sanctimoniously that he is doing those he is smashing a favor.

That doesn’t sound too saintly to me.

* I wish.  Actually, the phrase originates with P. D. Armour, a famous Chicago grain and meat magnate in the 19th and early-20th centuries.  (You might have had Armour chili–same company.)  He was asked whether it was easy to corner the market.  He responded that it was like a murder: ” to commit murder is very simple, the trouble is to bury the corpse”, the corpse being the excessive quantities of the commodity delivered to the market, that the cornerer had to unload later at a loss.

February 13, 2012

You Make the Call

Filed under: Military,Politics,Russia — The Professor @ 10:18 pm

Russian FM Sergei Lavrov claims there is “no proof” Assad is using artillery against opposition forces in Syria.

The US State Department posts satellite images of Syrian artillery “deployed in support of security operations.”

They Lied. How Shocking.

Filed under: Military,Politics,Russia — The Professor @ 2:56 pm

In the aftermath of the fire aboard the Delta-IV class SSBN Yekaterinburg, Russian officials–including Rogozin the Ridiculous–claimed that the sub had no weapons on board, and in particular, had no nuclear weapons.

Another non-operative explanation, apparently:

A fire at a drydocked Russian nuclear submarine in December could have sparked a radiation disaster because it was carrying nuclear-tipped ballistic missiles and other weapons, despite official statements to the contrary, a Russian news magazine reported Monday.

The respected Kommersant Vlast said the fire aboard the Yekaterinburg could have triggered powerful explosions that would have destroyed the submarine and scattered radioactive material around a large area.

When the fire erupted on Dec. 29, Russia’s Defense Ministry said all weapons had been unloaded before the submarine was moved to a drydock for repairs at the Roslyakovo shipyard in the Murmansk region.

. . . .

The magazine said that an explosion of torpedoes, each carrying 660 pounds (300 kilograms) of TNT would likely have destroyed the bow and could have triggered a blast of nuclear-tipped missiles in the midsection and the vessel’s two nuclear reactors.

“Russia was a step away from the largest catastrophe since Chernobyl,” Komersant Vlast said, referring to the 1986 explosion at a nuclear power plant in then-Soviet Ukraine.

The magazine said that weapons are normally removed from submarines before repairs, but the navy wanted to save time on a lengthy procedure to unload the missiles and torpedoes. It said the repairs were supposed to be relatively minor and the Northern Fleet wanted the Yekaterinburg to be quickly back to service [emphasis added].

Cutting corners with nuclear weapons.  Always a comforting thought.

Cutting corners with the truth.  SOP.

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