Research Approach To Investment_1

S.Venkataraghavan Vice President –Research www.altostrade.com

Research Approach to investment in commodity markets

! There is a risk of loss when trading in derivatives.

! Investment in derivatives bears considerable risk-reward tradeoffs.

! Altos Advisory Services Ltd., altostrade.com, Ten Ford Rich Ventures Ltd., Gibraltar, Spain – the companies that I represent are not responsible for any desired or undesired outcome of this presentation.

! The views expressed in this presentation are personal. They are not a solicitation to buy or sell instruments.

Disclaimer

Proprietary Positions Family and Friends Clients Other Conflicts

No Yes Yes Maybe

Investments: Commodities & Derivatives.

Disclosure

Dedicated to the Greatest Cartoonist of all times R.K.Lakshman

We are in a secular bull market for Commodities silver, gold, and many other metals here is an explanation for the recent sell offs, In Spain there is a game with the bull "MATADOR " an average guys who tries to ride the bull typically last only about 5 seconds before getting bucked off. That's the job of a bull, to buck off those who attempt to ride it. Bulls also gore people with their horns, and use their horns to throw those bull riders into the air. The spike you see on the gold and silver price charts that looks is a bull's horn. It just gored and killed all those who tried to use borrowed money to try to take advantage of the bull.

In Spain a very interesting sport of valor is played the MATADOR here I try to draw an analogy from that sport to the recent moves in financial markets.

IS there an asset bubble ?

Equity markets at 9 % Volatility ?

housing and real estate asset market is it over valued ?

Investor buying is one factor that has added upside to commodity markets. Asset diversification as a concept a must ‘just being reinforced’ Inspite of the Recent Falls, The Commodity Indices like Roger Index an out performer year to date. However of greater significance are the fundamental factors that will support higher commodities prices over the rest of this decade:

Commodity Markets- Role of investor buying outweighed by fundamentals……

GEO POLITICAL

CLIMATIC

Electricity

Meats & Live Stocks

Fibers : cotton & wool

Grains Wheat & Corn

Soybean,Rapeseed oil

Softs: Cocoa,coffee,Sugar Orange Juice

Energy Products: Crude Oil,Gasoline,Heating Oil

Forestry Products : Rubber,Lead& Paper Pulp

Base Metals: Al ,Cu,Zn,Pb,Tin

Precious Metals: Gold Silver Platinum Palladium

MONETARY MACRO ECONOMICS

LOCAL

Fundamental Factors that influences commodity prices.

Example of Monetary Factors -Precious Metals Prices

Example of Geo political & Macro Economic Factors Iran tension drives markets whereas India's nuclear Plans to drive the ‘Economy’ back ?

Example of Geo political – ‘The terror premium’

Example of Climatic Factors

Example of Disruptive Demand Shift – Fuels to Bio Fuels

Example of Local Factors-Bird flu and Mad Cow on Meat Prices & soy feed

Skeptics who say commodities demand drive in China Exaggerated?

Don’t know whether to call this monetary,macro economic or geo political or Local!~~!

• Chinese industrialization, urbanization and income growth as a key driver. • Below-trend growth in supply • lack of investment, increased environmental & political risks, &lack of large mineral deposits and very low levels of spare crude oil and refining capacity. • Low inventory levels • commodity prices are fundamentally justified as stocks are near “critically-low”levels. Weaker US dollar • Resource misallocation risk is small • Unlike the tech. bubble of the late 1990s high commodity prices are required to encourage much needed investment to take place.

Above-trend growth in raw materials demand

I want to make more money I want to diversify my assets I don’t want to watch saas bhi kabhi bahu thi and I prefer to sit in front of a trading screen in the evenings

55% 40% 5%

In an honest survey of ‘new entrants’ to trading in commodity markets

• Arbitrageurs

• Investor & Financiers. • Speculators/traders • Hedgers

Research Approach of Participants in the commodity markets

Total Yield for Investors ( futures) = Increase or Decrease in value of his positions in futures + Collateralized yield-cost of roll over.

• An Investor has committed ‘x’ amount of money with an intention of pulling out ‘x’+Delta ‘x’ , he has the capacity to hold since he believes that an intrinsic value of any commodity cannot become zero. • He never takes unlimited risks in the market and as a rule is never leveraged and is wholly collateralized.(meaning in futures as margin and remaining value of asset as T-bills or bank sweeps)

Research Approach of Investors

(*) Assuming Margin to be 5 % on futures

Financiers commitment = 30*15295+5% 30*16725 Total Yield for financier = 430/16131.25 =2.66 % or annualized 15.96 % Risk Free

financier earns= 430* 30= Rs. 12,900

Differential = Rs. 430

Eg.(on 14th June 2006) MCX 05 JUL 2006 SILVER Rs. 15295 per Kg 30 Kgs Contract 05 SEP 2006 SILVER Rs. 15725 per Kg 30 Kgs Contract

The ‘Cash’ Financier in a contango situation Buys Current/Spot " Takes delivery (demat a more transparent option) Simultaneously sells futures" Enjoys this cost of financing the contango market.

•

Research Approach of The Financier

•

Financiers commitment = Stock Total Yield for financier = Infinite since money committed into transaction is zero and it is only as stock.

this futures position)

Stock financier earns # Rs. 276 on the difference + risk free rate on 95% of the money he has got by giving delivery for a month(since about 5% would go for margin on

Enjoys this cost of loaning his stock to the market. Eg 14th June URAD MCX 20 JUN 2006 URAD 3151 Rs. 18 AUGUST URAD 2875 Rs.

The ‘Stock’ financier in backwerdation. Sells Current/Spot " Gives delivery (demat a more transparent option) Simultaneously Buy futures" Takes delivery

Research Approach of The Financier Contd

•

•

•

•

•

•

•

Hedging Defined When two risks offset each other, one is said to be a hedge for the other. A hedged position has less risk than its separate components. A Commodity Hedging Example A farmer who has wheat in the ground risks that the price of wheat will fall before the July harvest. A baker who must buy flour in July risks that the price of wheat will rise before July. A natural hedge appears possible because these two risks are complementary. The Hedge If the baker buys a wheat futures contract from the farmer, both will reduce their net risk exposure. Although the futures contract by itself may be very risky, when used in these hedges, it reduces overall risk. The contract need not be delivered.

Research Approach of Hedgers

If wheat prices fall, the farmer loses on her harvest but gains on her futures position, and vice versa. (What if hail destroys her crop?) • The Baker’s Hedge The baker hedges his short position (must buy flour) with a long position in wheat futures. If wheat prices rise, the baker loses on his flour purchase but gains on his futures position, and vice versa. (What if he loses a contract to deliver bread in July?). • Hedging Summary : Hedging involves the exchange of risks but not necessarily assets. • Many futures, swaps, and options contracts have been developed to facilitate hedgers

• The Farmer’s Hedge :The farmer hedges her long position (wheat in the ground) with a short position in wheat futures.

• Arbitrageurs use fundamental and technical models to estimate relative differences in fundamental values. • They trade when the relation between two (or more) prices differs from the relation predicted by their models. • The effect of their trading is to remove these differences.

Research Approach of Arbitrageurs

•

•

•

Forecast cash flows. Analyze discount rates. Value-motivated traders must be very disciplined about their assumptions. Organizations that pursue value-motivated strategies tend to be shaped like pyramids.

News traders follow news carefully. They trade on events that they expect to change prices. News traders must act quickly. Organizations that pursue news trading strategies tend to be flat.

– – – – –

Informational efficient prices should not have forecast able changes. Technical traders try to forecast prices from past prices and other market data. Their trading removes predictable price patterns. Technical traders profit when other traders make mistakes. They scavenge for the tidbits that other traders leave on the table.

Technical traders try to identify price patterns that are inconsistent with prices that reflect fundamental values.

– – – –

News traders estimate changes in fundamental values.

– – – –

Value-motivated traders estimate fundamental values.Value-motivated traders use economic models to estimate security values.

Research Approach of Traders

• Informed traders compete to acquire and profit from expensive information. • Informed traders enter and exit. • Only efficient informed traders make profits. • Price informative ness depends on the costs of acquiring information.

Speculators

Google.com Cagle.slate.msn.com for all the cartoons. Reuters –RTC for commodities Active 8- Telerate. My Research department for their support and analysts at altos for their consensus estimate. • MATS

• • • • •

Acknowledgements