In a recently published research paper in the Journal of Applied Corporate Finance, Tim Adam (from the MIT Sloan School of Management) and Chitru Fernando (from the University of Oklahoma Michael F. Price College of Business) report in their research paper "Can Companies Use Hedging Programs to Profit from the Market? Evidence from Gold Producers" that during the 10 year period of 1989-1999, the gold derivatives market was characterized by a positive risk premium that resulted in short forward positions generating positive cash flows. The authors found that the gold mining companies that hedged their production during this time realized an average cash flow gain of $11 million, or $24 per ounce of hedged gold per year, compared on average to an annual net income of only $3.5 million without hedging. Of interest is that as a result of the positive risk premium that resulted from a positive spread between the forward price and the realized future spot price, short derivatives positions did not result in significant losses, even when the price of gold increased. In summary, hedging helped increase profits.

Also of interest in the article was the finding that there was also a significant level of volatility in corporate hedge ratios, implying that some managers were incorporating market timing into their hedging strategies (no surprise, as hedgers will sometimes begin to speculate). The authors found that attempts to time the market by "selective hedging" were futile and unprofitable, even causing the company to consistently lag the markets as they attempted with little success to successfully adjust their hedge ratios in response to expectations regarding market direction.

In summary, hedging helped profits, but the benefits were from hedging, and not from the risk managers ability to predict price moves as they set their hedge ratios. Therefore, one can expect, at least for the gold mining companies, that while earnings and profits may remain volatile, those investors holding longer-term investments should see higher returns from companies that successfully implement and execute a defined hedging program that do not try to engage in market timing. While it is difficult to know when any company that you are investing in begins to move from hedging to market timing, at least knowing that a company is hedging will give you the potential for higher returns as long as you can weather a few up or down moves that may temporarily reduce profit margins.

The CNBC Santelli Housing Bailout Rant

Posted by Bull Bear Trader | 2/20/2009 07:12:00 AM | , , , | 0 comments »

In case you have not seen it, Rick Santelli, reporting for CNBC from the floor of the Chicago Board of Trade, gives his two cents regarding the recent housing bailout (CNBC video here). I would not be surprised to see future bailouts, and subsequent rants, get worse going forward. Given that housing often leads us into and out of recessions, there is no doubt that the housing problem needs to start being resolved before people will begin believing that the economy will recover. Unfortunately, there is no easy answer. Just about any of the proposed solutions that has the slightest chance of speeding up the recovery seems to reward bad behavior, while at the same time further penalizing those that acted responsibly. Do we continue bailouts, or simply let the chips of capitalism fall where they may? Santelli, as well as many others, seem to have already chosen sides.

Although the DJIA and S&P 500 were each down over 10 percent in January, the Credit Suisse / Tremont Hedge Fund Index was up 1.09 percent (also see Investment News article). The January returns were the first time the index was up since May 2008. Top strategies for the month were convertible arbitrage (returning 5.72 percent), dedicated short bias - no surprise (up 3.69 percent), multi-strategy (up 3.35 percent), and global macro (up 2.33 percent). Managed futures took the biggest hit for the month, falling 0.56 percent.

T. Boone Pickens, who as of last November had holdings in 26 energy companies within his BP Capital Management, now holds shares in nine companies as of its latest filing (see Bloomberg article). The fund fell an astonishing 97 percent during the final three months of 2008, declining from $1.29 billion to around $40 million. As for individual holdings, BP Capital reduced exposure to Occidental Petroleum, Transocean, and Suncor Energy, while selling all of its holdings in Schlumberger and Halliburton. The fund added shares of Chesapeake Energy and Peabody Energy.