Market Quants; Kill or Cure?

This brilliant VPRO documentary on Quants should be required viewing for all involved in markets.

The problem with heckling from the cheap seats is that the rest of the audience can get bored pretty quickly and stop listening. Then you get thrown out. It’s the old ‘cry wolf,’ thing. I kind of feel like that about shouting from my soapbox about quants and all they have spawned in markets from HFT’s, trading Algo’s, to derivative and structured product modelling. I’ve watched their growth from all the way back when index arb models lit the fire that turned into a market conflagration in 1987 to the subprime CDO models that did so much to destabalise the financial system in 08 through to the occasional flash crashes we see today.

The simple fact is that very few managers and certainly no boards have the first clue about what the quant ecosystem that plumbs their banks together is capable of. Nor do they understand the assumptions made in those models or how vulnerable the models are to human error or abuse, either internally or externally. The video clip above is very well worth watching. It is a very straight forward reality check; a reality check from the practitioners themselves; ‘it is clear that a major rethink is desperately required if the world is to avoid a mathematically led meltdown.’

Glencore; Meltdown or Death Spiral?

While the UK markets attention has been dominated by the Rate Debate and Volkswagen, we have a rather serious problem brewing on our own doorstep. Glencore is in meltdown and with its 5 year CDS trading on Friday either side of 600bps it is a wisp away from a death spiral. That’s the point when, ‘get me out I’m not having this in my portfolio when it goes down,’ PM’s jump ship and their numbers outweigh the bargain hunters. Investors who subscribed to the recent rights issue, and wouldn’t I love to see the crib sheet and FAQ sheet written for the salesmen by corporate finance for that one, will be feeling that maybe ‘cheap,’ wasn’t quite the right word to be banded around at 125p.

Whatever valuations analysts put on Glencore, equity investors may be about to be reminded that equity is at the bottom of the capital structure. Following the announcement earlier this month of the company’s $10bn recapitalisation plan through a rights issue, dividend suspension, asset sales, capex cut and production cut; Moody’s put the company on negative watch on its Baa2 rating, (just above junk). The market is beginning to question if the $10bn recap is sufficient to guarantee the survivability of the company and the whole asset structure is consequently having convulsions.

The problem becomes acute if Glencore is downgraded to junk. At that point we have a potential Lehman / AIG scenario in the commodity space. While Glencore is the biggest listed leveraged bet on the price of copper and the Chinese economy through its mining operations, it is also one of the world’s biggest commodity trading firms. A downgrade to junk could trigger forced selling from PM’s not able to hold junk paper, collateral liquidations and market counter parties slamming the doors shut. The complex daisy chain of OTC derivative contracts have an unquantifiable market risk. At the minimum, fear of a bad thing happening is enough in this fragile environment to unsettle the broader market. Risk managers and regulators must surely have Glencore front and centre on their radar this weekend.

Goldman have suggested in a recent note that it would take only a further 5% drop in commodity prices to tip Glencore over the edge. Bernstein meanwhile apparently think it is cheap.  Sure, the company will announce asset sales, like its agri business, and the shares may enjoy big % temporary spikes. My view however, is investors have no business touching this stock unless they have a near term blue sky view for copper and Chinese growth to which it has a high sensitivity. As neither are likely to be forthcoming investors should take a wide berth. Better to catch the turn in the commodity cycle when it comes with companies who are ahead of the game rather than behind it and examine Glencore only when it recovers its rating and financial health. Better to pay more for something with longevity than to bet at the roulette table in a casino on fire, which is exactly what an investment in the company is now.

Greek Crisis; "Our Guys Did What?"

Some readers may only have a passing interest in financial news and perhaps none at all when it comes to esoteric instruments like CDS's  on Greek Goverment bonds, (In simple terms, this is like buying an insurance policy on Greek bonds, or any bonds for that matter, in case they default.) No matter, stick with me on this one.

You'll be aware that the Greek economy has recently been exhibiting all the characteristics of an ill fated passenger liner that set sail from Southampton in 1912. European Union ministers meet this week to try and hammer out a support package otherwise the Greeks may go to the IMF. No need to get bogged down with the quite complex geopolitics at play here but in the run up to this meeting the Greek government has been virulent in it's attacks on "speculators," who they blame for creating the crisis.

Prime Minister George Papandreou is among the global leaders that have been pushing for increased financial market supervision of CDS and a crackdown on market manipulation. In fact, he threatened to spit in the face of anyone who bought them and the silliness extended to the Spanish and Greek secret services saying they would spy on CDS traders in New York and London.

“We are in a state of war, in a battle against special interests, both at home and outside Greece. It is a battle against speculators and for transparency, so that markets are at the service of the people, not the other way around.”

No George my fine furry friend, idle tax dodging Greeks are the cause of the crisis, not the people who are highlighting the symptoms like only four citizens paid tax on earnings of over 1m euros last year.

Still with me because this is the good bit? Greek daily Kathimerini has uncovered that the biggest speculator, holding 15%, or $1.2bn of the total $8bn in Greek notional CDS is a firm which is about 600 yards from the Greek parliament in Athens............ the state owned Hellenic Post Bank (TT).

"With a position totalling 950 million euros, or 1.2 billion dollars, TT had the ability to shape momentum in the speculative derivatives market which the Greek government wants to be controlled."

Good to know we're not the only ones with an incompetent Prime Minister................... ho hum!