Weekend Link Summaries - 6/1/08

Below are the weekly link summaries for the usual topics, with energy added. As usual, hopefully you find some interesting articles that you may have passed over.

Commodities and Energy

S&P launches new commodities and natural resources indices
Hedgeweek
* Standard & Poor's has launched two new indices, the S&P Global Natural Resource Index (with contributions from 60 large energy, agribusiness, metals, and mining companies), and the S&P PMI Commodities and Resources Index (similar sectors, but with 160 stocks for broader exposure). The indices can be invested in and are available for benchmarking. Often, but not always, this kind of activity begins to mark the top, or at least short-term peak, in a sector or market. Time will tell.

Why Cap-And-Trade Won't Work
Paul Cicio - Forbes
* An opinion article in Forbes about the problems with the proposed cap-and-trade legislation. Beyond the pros and cons of whether cap-and-trade will actually help reduce carbon emissions, of interest is the effect on clean energy. Low carbon alternatives, such as natural gas, should see an increase in price as companies look for ways around new mandates. Nuclear is another carbon-free option for power generation, but given its own regulatory issues, and the 10-20 year backlog for reactor domes and other critical components, it is likely that natural gas will be the only viable short-term alternative. If the legislation is passed, expect natural gas prices and electricity prices (natural gas plants currently set the marginal price) to increase.

Joy Global Mines Money From Commodities Boom
Melinda Peer - Forbes
* As usual, look for and consider the "consequence" or periphery plays when investing in sector booms. As for commodities, mining equipment makers Joy Global and Bucyrus International are doing well, very well. Downturns in these and other similar companies may give an early indication of changes in the commodity landscape. Often it is the pick equipment makers, and not those selling the gold, that make the most money during the rush.

Coal seam gas seen as Asia's next hot energy play
Reuters
* Interesting article from Reuters talking about how some countries are using coalbed methane (CBM) as an energy source to power cars and electricity plants, among with things. Methane stores in Asia are estimated at 2,100 trillion cubic feet. As LNG prices continue to rise, CBM is hoped to be a viable alternative for both developing and developed countries with large coal deposits. Storage is still a problem for some counties as they retool existing plants. Coal seam gas also has a lower heating value compare to natural gas, but is able to be blended with LPG (liquefied petroleum gas). The gas does have a low sulfur and carbon content, allowing it to burn cleaner.

Derivatives

Banks launch central clearer for derivatives
Hal Weitzman - Financial Times
* To mitigate some of the risk of privately negotiated credit derivatives, 11 of the world's biggest banks announced the creation of the first central clearer for derivatives, in particular credit derivatives. The clearer will use funds contributed by traders to guarantee against counterparty default. The clearing will be run by The Clearing Corporation, a Chicago-based institution backed by the banks.

Canada's emissions-trading market open for business
Boyd Erman - Globe and Mail
* Short article about a new emission-trading market, called the Montreal Climate Exchange, from the TSX Group. The exchange will allow companies (AKA "polluters" in the article) to buy and sell carbon credits. Look for emissions trading to continue to be a big business going forward. It will be of interest to see if these markets allow for "greener" companies to develop and survive. Since carbon credits can be traded from non-polluters to polluters, a green company could sell its carbon credits to the polluters, essentially making the polluting companies subsidize part of their business. In fact, just about any business, with or without environmental intentions, could do this. I guess it depends on how the credits are distributed, but the system may leave itself open for gaming and profit opportunities.

Climate-Bond Plan by UN Official Aims to Boost Energy Investing
Alex Morales - Bloomberg
* Why should Canada have all the fun? The United Nations is considering a new climate bond that would be sold to investors in developing countries as a way to spur investment in green projects. How would they work? Mature bonds, after they have been used to finance green projects, could be exchanged for credits that allow industrial plants to emit a certain amount of carbon gases. How are they funded and priced? The amount of money generated would depend on the level of emissions-reduction targets set in the current round of UN climate talks. I guess if you need more funds, you could raise emission targets. As with the Canadian system, the effort is noble in intentions, but has the potential to kill the goose that laid the golden egg (or provides the revenues in this case), while not really solving the problem. Hopefully safeguards will be put in place to prevent abuse. In its current form it is also not clear that overall emissions will actually be reduced. Time will tell.

US and European debt markets flash new warning signals
Ambrose Evans-Pritchard - Telegraph (London)
* The cost of insuring against default on bonds of Lehman Brothers, Merrill Lynch, and others has increased in the last few weeks, as debt markets are signaling fears that the global credit problems are still here, and could be entering another phase of write-downs. Inter-bank Libor and Euribor spreads are back to near record levels, with Lehman Brothers debt credit default swaps rising from 130 to 247 in a little over one month. Merrill Lynch debt has spiked to 196. As reported by Willem Sels, a credit analyst at Dresdner Kleinwort, ".... banks are beginning to face waves of defaults on credit card, car loans, and now corporate loans. We believe we're entering Phase II. The liquidity crisis has eased a little, but the real credit losses are accelerating. The worst is yet to come." It is also felt that the increase in corporate bankruptcies is not yet being seen by the usual indicators, which tend to lag the market.

Bonds Insuring Next Hurricane Hugo Beat Subprime
Erik Holm - Bloomberg
* As hurricane season begins, investors are clamoring once again for catastrophe bonds, the market of which as tripled over the past three years to more than $13 billion. Some of these bonds yield near 15%, with the average around 11% - assuming that we don't get another Rita, Katrina, or Hugo. One attraction to the bonds is their lack of correlation with the stock and bond markets. The key here is weather or natural disasters, and not credit. Given the problems with mortgages and subprime, hurricanes and earthquakes seem like a safer alternative for some - but it is still possible to lose your entire cat bond investment if the big one does occur. What I find interesting is how the whole market is somewhat circular. Cat bonds are often offered by insurance companies as a form of reinsurance to protect themselves if a catastrophe does occur and they are forced to pay out. Who buys the bonds? We do, through pension funds, hedge funds, and less so through individual investments. We are essentially taking out insurance with the insurance companies to protect against an event happening, and then buying bonds against the event actually happening. On the other hand, insurance companies are selling us the insurance to protect us in case the event does happen, betting themselves that it won't, and then selling us bonds to protect themselves in case it does. Confused? Ah, you have to love the markets. Who are the big reinsurance companies? Swiss Re, Munich Re, and General Re (Warren Buffett's Berkshire Hathaway's reinsurance company).

Hedge Funds

Hedgeweek Comment: Going with the flow
Hedgeweek
* There was been a lot of talk about hedge funds looking for investment in Asia, but not as much action as the talk (although some investments). It appears that now some funds are entering Asia, and not just for opportunity (which they can take advantage of stationed nearly anywhere). Instead, funds are opening in Asia to take advantage of liquidity and capital that is not as available in the west, as in the past.

Prime Brokerage Will Make $11B in ’08: Study
Christopher Glynn - HedgeFundfont>.net
* Prime brokerages are expected to receive $11 billion in hedge fund money in 2008, a 15% increase over the 2008 value. Goldman Sachs, Morgan Stanley, and JP Morgan, who own the majority of prime brokerage market share, are expected to be the biggest beneficiaries.

Private Equity

Morgan Stanley, Citigroupfont> Bankers Leave as LBOsfont> Slow
Pierre Pauldenfont> and Jonathan Keehnerfont> - Bloombergfont>
* Top bankers are leaving larger firms, such as Morgan Stanley and Citigroupfont>, as the LBOfont> market grinds to a near-halt, compared to recent years. Many banks are still trying to clear out old loans that they are unable to get off their books. Banks have traditionally made money twice, once on the deal, and once when they sell the debt to others. Many banks are now being forced to hang on to the bad debt that in the past they were able to push off on other investors. Some of this debt is now selling for less than 70 cents on the dollar, making it difficult unload without taking a huge loss.

FT REPORT - CORPORATE FINANCE 2008: Public life after private equity
Chris Hughes - Financial Times
* Interesting case study of one company, now public after it was floated on the stock market by a private equity group, is now having difficult dealing with current high energy and raw material cost after taking on previous private equity debt. Companies with high leverage can do well in boom times, but suffer more in downturns given that their fixed cost per unit begin to rise rapidly as sales decrease. The effect on the bottom line is intensified as variable cost increase, as they have for many companies highly dependent on raw materials and energy. We often hear about the slowdown and problems with private equity investors, but often forget about the companies that are now dealing with the debt issues directly.

An unlikely financier
Janet Morrisseyfont> - Investment News
* Yes, you too can start you own private equity firm. Interesting story of Malonfont> Wilkusfont>, a college dropout that started his own private equity firm, American Capital Strategies, with a focus on middle-market companies. So far the fund has delivered annual compound returns of 18%, including an average dividend yield of nearly 10%. Not bad, although last year the firm was down 22% with other financial stocks.

Quantitative Finance, Financial Engineering, and Trading

Prospectors join Canada's electronic gold rush
Melanie Wold - Financial News
* Not a specific trading strategy article, but does highlight to impact of the recent commodity boom on trading, at least in Canada. Given the rise and interest in trading in the commodity-rich country, investors are taking an increased interest in the Canadian markets. As such, market technology vendors and investors are increasing, providing numerous alternative trading systems, platforms, and trade crossing networks, causing Canadian regulators to implement institutional trade matching, settlement framework, and best practice guidelines. This looks very similar to the buildup of ECNsfont> and exchanges in the late 1990s during the U.S. technology dot-com boom. Hopefully it does not end the same way for the Canadian market.

China rebukes west’s lack of regulation
Jamil Anderlinint> - Financial Times
* Interesting perspective from Liaont> Min, the head of the China Banking Regulatory Commission, about how western governments must strengthen oversight of their financial markets. There argument is that by giving the market too much leeway, problems such as the subpriment> crisis were allowed to develop. It is believed that tight regulation has made it nearly impossible for exotic financial instruments to be developed in China. Of interest from the regulator is worries regarding the increased flow of money into their market, as a result of investors abandoning the dollar and U.S. markets (argued as being due to our regulation-lacking induced problems). This shift in funds is causing a potential asset bubble and rising inflation in the Chinese market. As a result, China is considering advocating new international laws and regulations for providing timely and accurate information during crisis. Even so, as international economies develop and mature, and the flow of money into the "new" economies slows down, I would not be surprised to see their use of derivatives increase (in order to internally reallocate capital), regardless of current perspectives.

Three ETF-of-ETFsnt> are launched
David Hoffman - Investment News
* Admit it. You knew it was going to happen. It was just a matter of time. Invescont> PowerSharesnt> Capital Management has launched three new ETFsnt> that invest in ...... what you say ..... other ETFsnt>. While providing investment advisers more choice, especially those that are not investment strategists, many advisers are not happy. Why, the ETFsnt> of ETFsnt> (ETFsnt> squared anyone - you heard it here first, I think) reduce the fees that advisers receive for recommending and selling products to investor. Why get one fee when you can get three by selling three different ETFsnt>. Even worse, some investors may realize that they don't even need an adviser, and can just invest in a diversified exchange traded pool of diversified asset classes. Then again, some investors probably will not know what that means, so the advisers job is probably safe. Now, if we only had derivatives on ETF-squares. Ah, Wall Street can dream.