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Wednesday, December 21, 2011

Gas Price Reversals

On an earlier post I was commenting on a disconnect between oil and gasoline prices. Oil was falling but gasoline was staying up...

Well guess what...? The very opposite is happening now... Take a look

In the last 3 months, gasoline prices have dropped from $3.55 to $3.20  while oil has fluctuated between a low of $75 per barrel to a current $100.

How long does it take to clear oil inventories? Or is it simply noise from day traders?

Tuesday, December 20, 2011

The cheaper it gets, the less I want it

Great intuitive commentary in the Financial Times yesterday about the effects of really low rates on the banking industry and the economy.

Pimco's Bill Gross argues that low rates could entice less borrowing instead of more.

Good read for students and practitioners

Wednesday, October 26, 2011

Is Pure Expectations Hypothesis useful?

Does Pure Expectations Hypothesis provide good estimates of future rates?

Does PEH matter?

Most finance students at one point or another have the Pure Expectations Hypothesis. The professor will show term structure data, and then say something like…

“If PEH holds (big if) we can use today’s data to calculate what the market expectations are for next year’s rates. “

How good are these predictions?

Based on 2010’s daily term structure data, I calculated the PEH expectations for 2011. Take a look for yourself. The chart below shows the prediction and the real outcome.

Will they come closer?

Friday, October 21, 2011

Soccer and Efficient Market Hypothesis

I always enjoy showing my students live examples of how EMH works in reality. I usually use an online earnings call while looking at the stock prices, tick by tick. This week for instance, I shared the afterhours drop in the price of Apple after their earnings miss. Students are generally impressed by this market wisdom and by how quickly prices incorporate information.

But every now and there are some situations that leave me speechless.

Coincidentally this week I witness one such moment. Please bear with me.

My favorite Chilean soccer club: Universidad de Chile (not related to any university), like many others in Chile is a publicly traded company trading under the mnemonic AZUL AZUL. Yes, imagine the Patriots, Cowboys, Sox and Yankees trading in the NYSE.

My team’s share price went up this Friday. A lot! It went up so much that the bourse had to stop trading when it had literally doubled in value.  After trading was re-started it settled for a67% gain. This on top of a 28% gain on Thursday.

The reason? On Wednesday the team had a superlative performance (4-0) against Flamengo a Brazilian team in a South-American tournament.

You can watch the beautiful 4th goal here.

I am buying some AZUL AZUL!!!

Is the Nikkei that bad?

Japanese stocks have performed badly since, ... well since what seems forever. Looking from a long term buy-and-hope strategy, had you invested in the NIKKEI in 1984 your returns would be around nada. No matter how much we complain about our financial markets and their crises, had you invested in the S&P500 you would be sitting in a 600-700% return.

 From a shorter term perspective, say after the dotcom bubble, results are similar. Japanese stocks underperform US equities. Does this mean that investors should avoid Japanese stocks? Not really. Look in the same chart how the JPY/USD is doing.

Oversimplifying calculations, and assuming that an American investor put 10,000 USD (around 1,333,333 JPY) in the Nikkei in 2002, he/she would be sitting on a20%equity loss. Today he/she would only have 1,066,666 JPY, which at the current exchange rate (75 JPY/USD) would be 14,222USD…

I don’t know about you… but I would take it.

Is the Nikkei that bad? Not if you are an American.

Wednesday, October 12, 2011

Slovakia and the Kentucky Derby

Slovakia and the Kentucky Derby.

An old mentor of mine once told me... "Son... you don't put a mule in the Kentucky Derby"

At first, I thought the old man was funny but crazy. In time, I have learnt to appreciate those words of wisdom.

In fact it is exactly what Slovakia is arguing in their resistance to approve a bailout package for Greece.

Why help a country that is broke? Why throw good money after bad?
I totally agree with them

That is not the whole story, there are two moral issues that needs to be explored.

1) Should one of the poorest countries in the EU have to pay for the rescue of a richer one? Should Slovakia, a model of good governance and responsibility have to pay for the irresponsibility and corruption of Greece?

2)  According to the EU budget, between 2007 and 2013, Slovakia will receive 11 billion Euros in net transfers, or 2,039 Euros per capita. Greece... they will receive 25 billion (2,238 per capita). Should Slovakia have the right to renege on this?

Sunday, October 9, 2011

What is ahead?

According to intrade here is what to expect for 2012

Romney to be the Republican Candidate (62% chance), and the DOW below 12,000 (60% chance).
Republicans will control the senate (67% chance) with a 50% chance of going into recession


... and the winner is...

Just a few more hours to find out who will be the next Nobel Prize in Economics. The WSJ has an article showing various candidates...

I have mine:
Richard Thaler.
One of the founding fathers of behavioural economics. Yes, that "science" that questions the omnipresence of the EMH.

His work is vital, well understood by the lay person, mostly ignored by others. The best part is that he has not written a book or article about the crisis.

Betting against France

James Mackinstosh from the Financial Times has a great article on a strategy many hedge funds seem to be taking.

Long Italy - short France... and not because Italy is better shape... No way... The point is simply the spreads

According to the spreads (against the Deutsche Bund) here is how closely they stack (in basis points)

Italy 350

France 70

Is Italy really 5 times riskier than France?
So something is got to give. F
a) Things get bad, ECB intervenes to stop a run on Italy, France gets infected increasing its spread to level it to that of Italy, or
b) Things get better, Italy's spread goes down to match France's
There is always c) ECB dumps the PIIGS (Italy included) and let everybody fend for him/herself...

Just for the fun here is where the PIGS stand

Portugal 995

Ireland 575

Greece 2,227

Spain 298

And Belgium, courtesy of Dexia 195

To me, it seems like these spreads are priced as if there was no correlation between debtors, just as the CDOs were before 2008. The problem is that given that one country goes belly up, the probability of the next one going under is much higher.

Friday, October 7, 2011

Reshoring and the CNY

In a great piece at the HBR blog, Hal Sirkin from the BCG argues that increasing productivity in the US and increasing labor costs in China are making some US companies reshore their operations back the US.

Further, an article by Peter Marsh from the FT explains how US consumers and companies are beginning to value the "Made in the USA" noting that the cost advantage is not that great.

Brazil's Embraer chose Florida, while Germany's Volkswagen chose Tennessee. American workers are up to 3 times more productive than their Chinese counterparts...

According to Mr. Sirkin, up to 3 million re-shoring jobs could be created by 2020

Can you imagine how many more would be created with a 20% revaluation of the CNY?

Wednesday, September 28, 2011

A great take on the Euro crisis

After so many not so good pieces comes this one from BBC's Paul Mason. kudos to him.

Take a look for yourself

A loose canon

Sunday, September 25, 2011

Debt to GDP does not matter

Debt to GDP does not matter

For too long we have focused on a simple and simplistic indicator to say that the PIIGS (Portugal, Ireland, Italy, Greece and Spain) and everybody else are doomed. Further, these countries can't grow their GDPs so the logic conclusion is that they will never pay...

My personal Debt to GDP ratio is about 250% and nobody seems to care... My bank does not, neither do I. My mortgage payment is only 20% of my income. I comfortably fulfill my obligations with my current income level.

The tricks are these:

I did not buy my house using my credit card, rather a 30 year fixed rate mortgage.
My house is collateral

I am pretty sure that my case is rather ordinary, so if millions of people can afford leverage 3 times their incomes, why can't a country?

Debt terms are as relevant as debt levels, why don't journalist bring this up?

The real question then is
Can a country pledge collateral?

Could Jack Welch or Warren Buffet be better presidents?

Not unlike Americans, Chileans were disenchanted with the political class 2 years ago. In the last election Mr. Sebastian Pinera, a very successful entrepreneur run and won the highest office with the promise of managing the country as a corporation. Better administration. Less waste, more flexible decision making, more efficiency... what is not to like?

Could a Jack Welch or Warren Buffet be better for the US than a professional politician?

The Chilean experience seems to say no. Chile boasts the highest growth rate post recession in LATAM and very low unemployment.

Mr. Pinera's approval rate... under 30%.

Be careful what you wish for...

See The limits of a superman by John Paul Rathbone for more on the topic

Tuesday, September 20, 2011

A Lesson to the US on Infrastructure

As we are reminded by our authorities over and over, the US is in great need to upgrade its infrastructure. The choices we are given are taxes or "no" (as in we will just not do it).

With the World Cup (soccer) and the Olympics around the corner, Brazil's needs are so much greater than the problems we face. How will they do it? Rousneff should be jealous of Obama's problems.

Not quite.

Brazilians are much more pragmatic. They have just auctioned the rights to build and operate new "Sao Goncalo do Amarante" airport. A Brazil-Argentine consortium has 3 years to build an airport and then 25 years to operate it. Read article here.

How much will Brazilian tax payers pay for this?
Nothing, the consortium actually paid the government for the rights.

Are Brazilian unique?
Not quite, Argentina and Chile have had privately operated major airports and ports for many years. In Mexico, consortiums that operate roads are publicly traded companies

Who pays? Those who use airports and roads and ports.

Imagine the possibilities.

Friday, September 16, 2011

A bonus for Adoboli?

In the next days, Mr. Adoboli will undoubtedly be portrayed as a villain by his former bosses and the press. Regardless of his role in this debacle, I wonder what would have happened if Adoboli had been right? He takes on unauthorized or un-scrutinized positions at the prop desk and he makes 2b in profits. I posed this question to my students who agreed that he would have gotten a promotion, big bonus and a genius status.
So the difference between villain and genius is random
I think they are right.

Wednesday, September 14, 2011

Gasoline versus oil

According to Gasbuddy, around May 1st (Labor day in most countries) crude oil reached $113/barrel. A week later it was down 14% to around 97. See chart below.  By mid August, a barrel of oil was trading around $79, a 30% drop since May.  Not bad.

Gasoline prices however have not followed. On average, we were paying $3.97 per gallon in early May while $3.58 in mid August, for a drop of merely 10%.

Someone is making money

Friday, September 2, 2011

CAPM and Ouija Board

How am I going to use the CAPM now?

Gillian Tett from the Financial Times rightfully argues that we have arrived to a world without a risk-free rate. Yes, no rf. In fact she points to Credit Default Swaps being more expensive to the US government than 70 American companies. It is not an issue where to find rf, but whether if it is relevant. Does rf exist? We may come to the conclusion that there no such thing as rf. To make things more complicated, another pivotal assumption in the field: market efficiency has a shrinking following.  

It is time for academia to rethink its teaching of finance. Personally I will have a hard time teaching the CAPM this year.

Adieu CAPM, welcome the Ouija board

Monday, August 22, 2011

Chile (like many other) is a country of contradictions. The latest is this.

Since the return to democracy, (1989),  4 left wing governments have cheerfully followed the most conservative (free markets) of economic policies . The results speak for themselves, look at per capita income growth and poverty reduction rates.

During the left presidencies, (Aylwin, Frei, Lagos and Bachelet) people seemed to be happy. No government mistake (see transantiago) or corruption scandal created any significant anger. People seemed content.

In the first years of Pinera’s government and despite a devastating earthquake, people have come to the streets. To demand everything from clean energy to free education. There are crowded events and marches almost every week.

The irony is that Pinera has been more populist than any government in the left. See for example the proposed maternity leave or bonus payments.

Thursday, August 4, 2011

Growing old

Every chance I get I tell my students that they will be the first generation with a bimodal death age. Those who are wealthy, take care of themselves eat well and exercise will live to 120 (I would stress wealth and eating habits)  and those who don’t… well… diabetes, cholesterol will make sure they die at 50 – 60. I finally run across a piece that provides evidence of it. It is related to retirement,  but worth reading.

I challenge my students to think about career paths when they will have to work 100 years. It becomes important to do something that you enjoy.  Who could stand to be a lawyer or banker for 80 years?  Who could be good at some trade for so long?

 I also challenge my students to think about graduate school l when they are not 30 but 55 or 65.

I want to challenge Universities about the same. At a time when many schools are rethinking themselves,  are we ready to attract and receive the new mature-adult student? Do we know what they need to know?

Can we learn from the nonprofit sector?

As I emerge from my summer break, I wanted to share something that a little out of the scope of this blog, but close to my heart and research.

Many suggest that the nonprofit sector is plagued witth inefficiencies , lack of technology and know how. My research and that of other academics suggests otherwise, for this reason I want to bring your attention to Mother Teresa, CEO by Bose and Faust. They suggest we can...

Tuesday, June 21, 2011

Australian Dollar and IRP

My students frequently ask me about Interest Rate Parity in what they call “the real world”. They are eager to know if this arbitrage blah blah can help them make money. The Australian dollar is on fire, needless to mention its New Zealand cousin. Take a look at the following chart (from yahoo finance). For the last 3 months the AUD and NZD have risen 6 and 12 percent respectively against the dollar. (Nice return!) During the same time frame an investment in the SP&500 would have lost value (2 percent), while the Euro was barely above 0.

According to the interest rate in Australia has been 4.75% since November 2010 while the FED has set the rate in the US at 0.25% since December of 2008. Tempting… isn’t it? One should borrow in the USD and deposit (lend) that money in AUD.

So what if a student had borrowed $1,000,000 and used the money to buy AUD back in March 2011?

On March 21st the student would have borrowed $1,000,000 at 0.25% and bought Aussies at the going exchange rate. According to Oanda, the bid /ask rates were 1.0037/47 AUD to get 1 USD. Therefore USD1,000,000 would have bought AUD1,003,700. The student would have the deposited the money in an Australian Bank earning 4.75%. At the end of the 3 months this is what we have.

a)      Owed to American Bank: USD 1,000,000 x (1+(0.0025/4))=$1,000,625, this needs to be paid on June 21st .(today)

b)      To be received from Australian Bank: AUD1,003,700 x (1+(0.0475/4))=AUD1,015,618.94, which would have to be exchanged at today’s rate. Again, according to Oanda, the bid /ask rates are 0.9465/67 AUD per 1 USD. Our student would get a total of  resulting in a total of USD1,072,799.13

Our student would now pay the loan to US bank and clear USD72,174 in profit. Not bad... I don't even want to do the numbers for the NZD. Not bad but not riskless either.
Here is when I break the news. Our student spent 3 months with a long open position on the AUD. It could have gone either way. To lock the exit of the position we must have bought a forward contract to purchase the USD back... and that is the end of the profit.

Wednesday, June 15, 2011

Too small to fail and foreign exchange


I grew up listening to the following saying… When the US economy catches a cold, the developing world catches pneumonia. Forget about that. It is the reverse what holds.

Forget about the behemoth corporations so big and influential that their demise could compromise the entire financial system of the planet.
How about too small to fail? How is it possible that the world markets are so obsessed with one country; Greece which represents a mere 0.44% of the world’s GDP? Even if we add Portugal and Ireland we only get 1.06% of the world’s GDP…

You may be thinking, well the markets are really worried about Spain, the big daddy of the PIGS… Let’s add it and we reach a still minuscule 3.07% of world’s GDP.

When was the last time that Australia (same size as Spain) threatened to derail world's financial system.
  According to reports, today between 20- 40 thousand protesters took the street s of Athens and clashed against the police. These protesters have immense power over 7 billion fellow human beings.

Think about it. Too small to fail is the new too big to fail.

The only difference… the Euro and its artificial imbalances. Forex market would have corrected this issue long time ago.

Tuesday, June 14, 2011

The Quimera of Latin American Unity

Quimera is the Spanish word for illusion. For centuries LATAM politicians have promoted unity saying that a continent of brothers with one voice will be a strong force against the evils of a capitalist world that simply wants to strip its natural resources. Dozen of organizations with lofty goals have been created all of them with little practical achievements.

LATAM is now presented with a unique opportunity. It can offer a united front in the race for managing director at the IMF. So far most LATAM countries have jumped onboard. Why does and Argentina, Brazil, and Chile (ABCs) do not offer support for Agustin Carstens’ bid? What are they waiting for? What small political gain or loss is preventing them?

The ABCs decision is ironic (at best) when even Spain has declared support for the Mexican candidate.

Monday, June 13, 2011

What can Greece learn from Chile and Argentina?

A Lesson for Greece from the South

By the south I mean south America.  Northern European countries could use a little economic history from two not so distant currency, debt and financial crises in LATAM. In 1982 Chile abandoned an unsustainable peg of the dollar. The USD went from 39 pesos to 46 over night. Many Chilean firms and Small Enterprises (including my father’s) had borrowed in USD. You can imagine the composite effect. As the country came to a halt and unemployment reached 30%, the debt burden of firms rose sharply simply by currency exchange. The banking system (which was also indebted in USD but receiving pesos from its customers) soon collapsed. Instead of fiddling around with temporary measures, Chilean authorities bought all the bad debt from banks. Chile did not default. Yes, the government assumed the debt of private banks and gave them a clean balance sheet and repayment terms that banks could afford.  A few months into the devaluation, out of 41 banks, 16 were bankrupt, and 6 were intervened.   Private banks now had a debt with the government. Large privatizations followed to pay for this debt. The impact on the economy was very, very strong. In 1981, Chile’s GDP was 32 billion USD, in 1985 a mere 16 USD Billion, it was not until 1990, almost 8 years later that Chile’s GDP returned to the pre-crisis levels. Chile’s GDP in 2000 was USD75 billion and USD170 in 2010. Perhaps the most dramatic illustration is the following chart. Before the Crisis in 1982 the government debt was about 30$ of the total debt, by 1988 it was 70% and by 2010, it was 6.1%.

Chilean Foreign Debt by year, Banco Central de Chile

Argentina in 2001 also had to end a currency board arrangement and impose severe limitations to capital outflows.  The economy had been faltering and debt mounting since 1999, invertors demanded ever greater returns from Argentine bonds to compensate them for their risks. Pressures from the IMF (much like the ones are being made on Portugal and Greece) pointed to austere policies like those applied in Chile. Nestor Kirchner decided he would not submit his countrymen to such a treatment. The barber of Buenos Aires decided to default and repudiate the debt. In 2001 Argentina’s GDP was around USD270 Billion, (almost 4 times that of Chile). By 2002, after the haircut, it had fallen to USD102 Billion. (Yes these figures are correct). In 2007 Argentina had recuperated its pre-crisis GDP.

In the end Chile and Argentina seemed to have solved their problems.


1) No easy way out. There will be a lot of suffering, for a long time, expect 50% - 70% decrease in GDP. Expect very high unemployment and very high poverty levels. Default is no cheaper that the bad tasting medicine.

2) It will pass, so plan for the Greece of 2030.

Wednesday, June 8, 2011

In the aftermath of earthquakes: The limits to creative destruction

By Andrés Ramírez and Nezih Altay

Though it is difficult to imagine anything positive arising from the devastation and loss of life caused by intense earthquakes in China, Haiti, Chile and now Japan, massive destruction caused by such natural disasters can lead to innovation.

Such a statement may seem counterintuitive in the wake of the human toll these disasters take. But our five-plus years of research on the topic has found support for creative destruction.

In 1942 Joseph Schumpeter argued that “the fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.”

Businesses that by all measures appear to have lost everything – buildings, equipment, employees, customers – in fact have gained a unique opportunity to change or improve their assets and technology and adapt in ways that Schumpeter says keeps economic engines in motion.

Take businesses in Chile as an example, where an earthquake of magnitude 8.8 struck on February 2010. Before the quake, some businesses in this developing country employed basic technologies such as basin flood irrigation for farming or land lines for communications. In the aftermath, as they rebuild, Chilean businesses have an incentive to adopt the next level of technology -- perhaps drip irrigation and wifi. Chilean wineries could adopt new technologies – from bottling equipment to inventory software.  Such innovations induce a large jump in productivity. These increases are then reflected in higher stock market valuation.

So what about Japan? In the last months several experts have offered largely contradicting predictions about its future. For a developed country such as Japan, which already uses the latest technology to produce high-value-added products and services, the gains will be marginal. In fact firms Japanese firms are likely to experience a reduction in cash flows. Toyota can rebuild its damaged plants but it is unlikely that productivity will increase dramatically because they already had cutting edge technology before the earthquake. The same can be said about Fujitsu or Sony. For these companies, the costs (even after insurance payments) will greatly exceed the benefits. The only good news for a developed open economy such as Japan’s is that its multinational firms will fare better; they will experience a lower decrease in cash flows compared to domestic firms.

Our research is based on an analysis of 299 earthquakes between 1990 and 2004 and their impact on almost 150,000 companies in 50 countries. Among our findings:

-      A business will experience increases in market capitalizations even three years after an earthquake hits its country. A closer look, however, reveals that this result is valid only for companies in less developed countries, particularly those from non-G8 countries.

-      Regarding operational cash flows, businesses in Latin America and Asia – the two regions most prone to earthquakes – see an increase in cash flows; companies in other regions see a decline.

-      Earthquake damage generates a great deal of uncertainty about the future to which companies respond by increasing their cash holdings, even three years after the event. This cash hoarding can be detrimental to reconstruction efforts.

 Disaster damage is not a straightforward measure, and research on the impact of natural disasters on companies and corporations is in its infancy. We can focus on economic losses, lives lost, people affected. But in terms of creative destruction, what we do know is this: It is limited to the developing economies.

Andrés Ramírez is a professor in the Department of Finance at Bryant University, Smithfield, R.I. Nezih Altay is a professor in the Department of Management at DePaul University, Chicago.

Wednesday, May 25, 2011

The Barber of Athens

The late Nestor Kirchner, also known as the Barber of Buenos Aires must be bewildered in his resting.

The Argentina he inherited in 2000 looks so much better than the current moribund Greece.  Public Debt over GDP in Argentina before the hair cut was a mere 45% compared with 143% for Greece. The interest rate that brought Argentina down was an 8.7%, compared to the current 25% Greece pays for 2 year notes. Furthermore, GDP prospects are weak for Greece while Argentina’s were positive. One thing both countries share was the lack of monetary policy. Argentina had a currency board while Greece is part of the Euro. The big difference; Greece has Germany, Argentina had nobody.

The question is not if or when Greece will default. The question is what shape it will take.

Monday, May 16, 2011

Commodities topping... ?

The press is constantly telling us that the commodity bull market hit the real economy. Everyone from General Mills (breakfast cereal) to Aeropostale (cotton jeans) is suffering...

is this old news?.... It may be...

At least we may be witnessing an inflexion point.

Look at the chart below... Food returns (FUD, blue line) has decreased by 4%, while corn (CORN, green line) and sugar (SGG, red line) are down more than 6% and 8% respectively.

Monday, April 25, 2011

Gold Rush or Dollar Hold Up

Much has been said about the current gold rush. Unlike the one in California, 21st century 49ers can be found in any corner of the world.

According to in the last 52 weeks (April 25th, 2010 - 2011), gold has risen 32.67%. A nice return for an American investors, however, for a Swiss investor this is not quite true. Gold has risen a mere 8.84% indicating a 23.83% loss of value from the USD. 

As you can see from the table below is a combination between a rush and a hold up!

Gold Price Change April 25th 2010 - 2011 in local currency
Gold Rush 8.84% 14.68% 15.76% 23.52% 26.30%
USD Hold Up 23.83% 17.99% 16.91% 9.15% 6.37%

Tuesday, April 12, 2011

Got MILA ?

Later this month the integration of the stock markets of Chile, Peru and Colombia will begin.
What does this mean?  A new trans-national stock market is created; MILA (Mercado Integrado Latinoamericano). Investors from these countries will be able to freely invest in each other.
How big of a deal is it? Well it will have 564 companies listed in it. Compare that to 406 in Mexico or 386 in Brazil

There is even talks about inviting Mexico to participate.

What do you think?  Got MILA now?

Thursday, March 31, 2011

BRICs or BICs or nothing?

Are the BRICS falling out of favor? It looks like it in the next chart.  Returns for the last 6 months of several ETFs are plotted.
PEK=China, INDY=India, RSX Russia, EWZ=Brazil, GSPC= S&P500... Only Russia outperforms...
Do they really?


The next chart shows what happened with exchange rates for the last 6 months...

Russia greatly underperforms, taking all the gains away

BRICs or BICs or nothing?

Tuesday, March 29, 2011

Mantega and the BRICs

Guido Mantega, the finance minister of Brazil became famous when he stated in September of 2010 that "We’re in the midst of an international currency war". This statement was aiming at how countries were manipulating their currencies (lowering) to acquire a competitive advantage in international markets.
What has happened since then?

QE1 and QE2

What has been the effect on the BRICs?

The USD has lost value amongst all BRIC currencies, specially the RUB and BRL.

Was Mantega right?

Sunday, March 27, 2011


Codelco, the state owned copper producer is huge. With 2010 sales of $16 billion, it represents almost 10% of Chile’s GDP ($160 billion in 2009). What should Chile do with it? One thing is to keep it, run it and benefit from it. This alternative forces Chile to deal with commodity price risk. Does Chile really want to bear this risk?
Another alternative is to sell it. How much? Well… P/E ratios in the industry range from 9 -15 times. If we take a conservative 10, then Codelco's $5.8 billion in earnings would turn to $52 to 87 billion valuation. Not bad? People tend to get greedy. According to a study made by Goldman Sachs in 2005 Chile would have been happy to get $26 billion for it. Looking at the price of copper it looks hard to find a better time to sell. If you think the price of copper will go higher, then sell only 10% of Codelco.

Chile spends $10 billion per year in education.  How different would Chile’s future be if we could increase spending by 50% for the next 20 years? 
It is my opinion that investment in education is the only way to break into the developed world.

Wednesday, March 23, 2011

The real unemployment

Unemployment is particularly hard to measure. What to do with those who are unemployed but not looking for a job? Are they "resting" or simply gave up looking after trying so hard?
How about those who are working a job they don't want (perhaps waitresses and bartenders) but need the money? How do we count those who are working part time but would like more hours?
The official un-employment figure, around 9 percent, simply ignores them

The latest Gallup poll published in IBD shows a more comprehensive picture. If we include them, unemployment is closer to 20% than to 9%.

Thursday, March 10, 2011

Gadaffi: Good of bad for oil?

I made this chart based on intrade figures and oil prices (iPath S&P GSCI Crude Oil TR Index ETN ).

As the chances of Gadaffi being ousted are decreasing, oil prices are not. It tells me in the early stages of the crisis, the colonel staying was a solution, now Gadaffi's staying in power is becoming a liability.

Thursday, March 3, 2011

On tainted money

The Financial Times just announced that Sir Howard Davies resigned as the director of the London School of Economics on a donation of £300,000 made by Seif al-Islam Gaddafi, the son of Muammar.

Is that money tainted? Is it immoral to use tainted money for a good cause? Should tobacco companies be banned from making charity donations?

Tuesday, March 1, 2011

Carry trades

With Central banks around the world scrambling to fight commodity price driven inflation, it is a good time to review an old FX trading strategy.

Carry trade is a trade in which a speculator borrows money in a country (and currency) that has a low interest rate and invests it in another country that has a high rate.

Current rates show that an investor could borrow in Japan at 0.1% per year and lend in Brazil at 11.25%.

What should happen?  Interest rate parity suggests that our investor would not benefit because the  the difference in interest rates between two countries should equal the rate at which investors expect the YEN to rise against the BRL.

What has happened?

According to Bloomberg, in 2010, the carry trade of borrowing in dollars and selling the greenback to buy the currencies of Australia, Norway, New Zealand and Brazil returned 11.5 %. That compares with a loss of 2.8 percent using the yen as a so-called funding currency. Interestingly these results have reversed in 2011, with carry trades using the yen gaining 23.8 percent, compared with 2.8 percent in dollar-funded trades.

Friday, February 25, 2011

On oil

According to Deutsche Bank, a $10 increase in oil prices translates into roughly a 25 cent increase in retail gasoline prices.

That is about how much oil went up this week.

Is the sky falling? The following chart showing the S&P500 (GSPC), Brazilian Bovespa (BVSP) and oil returns (USO) certainly suggests so. We shoulc be buying oil!

However, if we take a longer view, perhaps a 5-year view, the picture looks much different...

Even after the financial crisis, Brazil and the S&P 500 overperformed oil.

Thursday, February 24, 2011

Can the war on drugs be won?

I keep reading articles about the violence in Mexico. I read about outrage in the US. I read about efforts to fight the cartels and the North to South weapons traffic. I read nothing about consumption. I have come to conclude that to fight drugs could be as dangerous as to consume it. Think about this: in 2010 in Mexico alone a study reports that over 15,000 people were killed because of the war on drugs. To this number we should add the hard to quantify figures of drug related homicides in the US. As for the harm… in the US, about 16,000 people die for illegal drug usage.
Compare these figures to those of the legal drugs, 430,000 deaths for tobacco or 110,000 for alcohol.
The war is useless unless consumption decreases. A victory by Mexico, (imagine drug trafficking comes down to zero) would only imply an increase in prices in the streets of US cities. Very quickly, the same market forces that moved textile factories to Asia will move drug trafficking to the next country, say Costa Rica or Canada, soon supply will increase again, prices drop, everyone happy.
This is what happened when Colombia defeated (or controlled) the FARCs.
In an agency world where politicians care only about their gains, the Mexican government should simply help cartels in their move to another country. Instead of fighting them, help them. Up to 2009 the war was costing Mexico 0.3% of its GDP or 2.6 billion per year. Why not create an annuity and make annual payments to cartels contingent on them moving operations to another country? The government could even tax them on that money.
Could cartels be trusted?

Saturday, February 19, 2011

Some perspective on China’s impact on US

Let’s think of the following scenario… CNY goes up by 20% (similar to the 2007 move) and that inflation pressures in wages and commodities make up for another 10% increase in total costs of manufacturing in China… what would happen in the US? A sure catastrophe?
Let’s look…
The GDP of the US is about $15 trillion. Every year we import goods worth about USD2 trillion, so imports are only 14% of our economy. In other words, despite the rhetoric, our country is a relatively closed economy.  Compare this figure to 48% in Denmark, 41% in Germany or 89% in Ireland. Which countries are more likely to suffer from Currency wars?
You may think that everything we buy comes from China, but in 2010 we imported only (I guess this is a relative word) 365 billion. So imports from China represent around 2.5% of GDP. 
A 30% increase in costs from China would surely impact us. However, if this increase is limited to China alone, MNCs will likely shift manufacturing to other low cost locations such as Vietnam, Thailand or Malaysia, or even Africa or Latin America.

Friday, February 18, 2011

China's buying spree, the answer to the CNY?

Latin trade pubished a series of articles on Chinas recent interest in the region.

Foreign Direct investment in developing countries would be a good use of the currency reserves that the People's Bank of China holds. It will be interesting to see how and if any of these partnerships could provide an escape valve for the CNY.

Currently 67% of FDI goes to Asian countries and 25% to Latin America

The problem is that China has too much free cash flow and I believe the agency costs will start to kick in...

China’s Buying Spree: Chile – In Search of a Strategy for Emerging Trade Behemoth

Thursday, February 17, 2011

Why inflation is not a big deal yet

At least in developed countries...
Did you know that if wheat prices go up 100%, this will only translate into a 30% increase in the price of flour and a much lower 10% increase in the price of bread...


100 / 30 / 10

Wednesday, February 16, 2011

A rational incentive to do the wrong thing

Politiians now have evidence to back their mishandling of fiscal policy.

A new study made by Joachim Voth an economist at Chile's Central Bank shows evidence of something that we all have assumed. There is a positive significant correlation between tightening fiscal policy and civil unrest...
At least in Latin America

On how FX quotes work for real

Students get frustrated when they attempt to go from the book to the real world.

Finance textbooks tend to use fraction notations for a direct quotation like USD/JPY = 0.0120 to imply the number of USD to buy 1 JPY. It takes less than a little over a penny to buy a yen.

Students are then faced with quotes from financial websites where USD/JPY=83.4250 to imply that it takes more than 83 yen to buy one US dollar.

The trading logic is as follows
The currency listed first in the pair is referred to as the base currency. The second one is called quote or trade currency. This means the trader currently holds the base (USD) and he or she is using it to buy the quote currency (JPY). After looking at the quote the trader knows she will get 83.425 yens for every 1 dollar she trades.

The following chart explains it all.

Forward rate quotations

You are not alone if puzzled about how forward FX rates are quoted.  The mystery is very simple, they are expressed in points or pips

Given that exchange rates change by the second, It would be impractical to quote them in terms of currency prices. Forward prices are usually quoted as the difference in pips—forward points—from the current exchange rate. Since currency in the country with the higher interest rate will grow faster and because IRP (interest rate parity) must hold, it follows that the currency with a higher interest rate will trade at a discount in the FX forward market, and vice versa. So if the currency is at a discount in the forward market, then you subtract the quoted forward points in pips; otherwise the currency is trading at a premium in the forward market, so you add them.

How to solve triangular arbitrage problems

Once students learn that arbitrage in the wrong direction end in a riskless loss, they often ask how do we know which direction to take?
Assume the following information:

                             Quoted Prices from different banks
              Bank 1) Value of 1 CAD in USD= USD 0.90
              Bank 2) Value of 1 NZD in USD= USD 0.30
              Bank 3) Value of 1 CAD in NZD= NZD 3.02
              Given this information, is triangular arbitrage possible?  If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy if you had $1,000,000 to use.
The first step is to determine if there is an arbitrage opportunity. Start calculating the “implied” cross rate from Banks 1 and 2.
(USD/CAD) 0.9 / (USD/NZD) 0.3 = NZD/CAD 3
Given that Bank 3 offers more NZD per CAD, there is an imbalance, we can arbitrage the difference.
We would like to buy CADs for 3 NZDs sell CADs for 3.02 NZDs. Since we cannot directly buy CAD for @ NZD at the implied rate, we need to sell CADs to Bank 3)… In order to sell CADs we need to buy them from somewhere.  The problem tells us that we have USD and therefore we have to get the CADs from bank 1. Once we get them we can sell them to Bank 3 in exchange for NZD, which we then sell in Bank 2 for USD.
[$1,000,000/$.90 = C$1,111,111 × 3.02 = NZ$3,355,556 × $.30 = $1,006,667]

Friday, February 11, 2011

What makes a PIGS?

Much has been said about the PIGS (Portugal, Ireland, Greece and Spain).

One of the alleged characteristics is that these countries have high debt to GDP ratios. Indeed these countries sit high in ranking available in wikipedia. In fact Greece is N.5 with 144%, Ireland is ranked 11th with 98%, Portugal ranks 15th 83% and Spain ranks 27th in the world with a ratio of 63%. However, little is said about Japan, Belgium and Singapore which rank 2, 8 and 9 respectively. Brazil and India, shining stars of the BRIC are not too far ranking 31and 42

Another argument could be related to the 2008 financial crisis. If we look at the soundness of banks (as per the World Economic Forum in 2009) in different countries we can see that while is true that Irish banks rank at the bottom, Spanish banks are ranked 25th in the world with Greek and Portuguese banks coming in 45 and 62 respectively.

Another characteristic of PIGS is their high sovereign spreads or low ratings. An inspection of the sovereign ratings according to the Economist Intelligence Unit reveals that PIGS are no different from BRIC.

From these points of view, PIGS and BRIC are not so far apart...

There is however one difference between PIGS and BRICs...
Portugal 39.7                   Brazil 28.9
Ireland 35.4                     Russia 38.5
Greece 42.2                     India 25.9
Spain 41.5                       China 35.2

Which countries have more growth potential?