Streetwise Professor

November 17, 2018

Read Financial Journalism For the Facts, Not the Analysis

Filed under: Commodities,Derivatives,Economics,Energy — cpirrong @ 7:19 pm

One of the annoying things about journalism is its predilection to jam every story into an au courant narrative.  Case in point, this Bloomberg story attributing a fall in bulk shipping rates (as measured by the Baltic Freight Index) to the trade war.  Leading the story is the fact that iron ore and coal charter rates have fallen about 40 percent since August. The connection between these segments in particular to the trade war is hard to fathom, and the article really doesn’t try to make the case, beyond quoting a shipping industry flack.

An earlier version of the story included a few paragraphs (deleted in the version now online) about grain shipping, stating that grain charter rates had also fallen, since the decline in shipments from the US to China had depressed the rates for smaller ships.  It was not clear from the unclear writing whether the smaller ships referred to just means that smaller vessels are used to carry grain than ore or coal, or whether it means that among grain carriers, the smaller ones have been hit hardest.  If the former, it’s by no means clear that the trade war should reduce shipping rates for most grain carriers.  Indeed, by disrupting logistics through reducing shipments out of the US, Chinese restrictions on US oilseed imports has forced longer, less efficient voyages, which effectively reduces shipping supply and is bullish for rates.  If the latter, yes, it is possible that the demand for smaller ships that normally operate from the USWC to China has fallen, but this can hardly explain a fall in the Baltic Index, which is based on Capesize, Panamax, and Supramax voyages, not (as of March, 2018) of Handymax let alone Handy-sized vessels.  (Perhaps this is why the paragraphs disappeared.)

Bulk shipping rates are used as an indicator of world economic activity: Lutz Kilian pioneered the use of freight rates as a proxy for world economic conditions.  Thus, it’s more likely that the decline in the BFI is a harbinger of slowing global growth–and growth in China in particular.  There are other indications that this is happening.

Yes, the trade war may be impacting the Chinese economy, but it is more likely that it is just the icing on the cake, with the main ingredients of any Chinese decline (which is indicated by weakening asset prices and lower official GDP numbers, though those always must be taken with mines of salt) being structural and financial imbalances.

If you are going to look to freight markets for evidence of the impact of the trade war, it would be better to look at container rates, which have actually been increasing robustly while bulk rates have declined.

While I’m on the subject of pet peeves relating to journalism, another Bloomberg story comes to mind.  This one is about oil hedging:

The plunge in oil prices may finally make oil producers’ hedging contracts into a financial winner for 2018.

After more than a year of surging prices made the contracts a drag on profits, the slide in West Texas Intermediate crude to around $55 a barrel this month means some of the hedges are edging toward profitability, said Anastacia Dialynas, a Bloomberg NEF analyst.

Uhm, that’s not the point.  Just as this article misses the point:

There’s a downside to oil prices being up that could cost the industry more than $7 billion.

When crude markets slumped, explorers used hedging contracts to lock in payments for future barrels to ride out prices that fell as low as $27 a barrel in 2016. Now, as global tensions and OPEC supply cuts drive prices toward $70 in New York, those financial insurance policies have become a drag on profits, limiting some companies from cashing in on the rally.

Even the title of this week’s article is idiotic: “Hedging Bets.”  What would those be, exactly?  “Hedging bet” (as distinguished from “hedging your bets”) is pretty much an oxymoron.  If hedge is any kind of bet, it is a bet on the basis–but that’s not what these articles are talking about.  They focus on flat prices.

The point of these contracts is to reduce exposure to flat prices, and to reduce the sensitivity of revenue to price fluctuations.  The hedger gives up the upside during high price environments to pay for a cushion on the downside in low price environments.  Thus, if anything, these articles shows hedges are performing as expected.  They are in the money in low price environments, and out in high price ones, thereby offsetting the vicissitudes of revenues from oil production.

The problem with journalism regarding hedging (and these articles are just the latest installments in a large line of clueless pieces) is that it doesn’t view things holistically.  It views the derivatives in isolation, which is exactly the wrong thing to do.

Journalists are not the only ones to commit this error.  Some financial analysts hammer companies that show big accounting losses on hedge positions.  “The company would have made $XXX more if it hadn’t hedged.  Dumb management!” Er, this requires the ability to predict prices, and if you can do this, you wouldn’t be hedging–and if it’s so easy, you shouldn’t be a financial analyst, but a fabulously wealthy trader living large on a yacht that would make a Russian oligarch jealous.

Derivatives losses deserve scrutiny when they are not (approximately) offset by gains elsewhere.  This can occur if the positions are actually speculative, or when there is a big move in the basis.  In the latter case, the relevant question is whether the hedge was poorly designed, and involved more basis risk than necessary, or whether the story should be filed under “stuff happens.”

Which brings me to a recommendation regarding consumption of most financial journalism.  Look at it as a source of factual information that you can analyze using solid economics, NOT as a source of insightful analysis.  Because too many financial journalists wouldn’t know solid economics if it was dropped on them from a great height.

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