Monday, February 2, 2009

Monoculture doesn’t work

This is obvious in agriculture and in markets, and the case for a diversification of both targets and strategies seems to be commonplace among commodity desks as well.  This point is highlighted in a study by Utilipoint; they very nicely summarized findings from a recent report titled “Changes in Commodity Markets—Impacts on Traders and Software”.  In the report, they address changes in the energy commodity markets, and in part of their survey, the authors focus on recent changes as described by participants in the physical side of the business.  Included in their findings (paraphrased):

“What Did We Learn? ….we've noted several general trends over the last couple of years that have significantly impacted the markets, including:

• Trading companies expanding their portfolios to encompass a broader range of commodities - With the possible exception of the companies that are in the markets only in support of an operational need, the majority of trading shops are now transacting in multiple commodities, with many trading energy alongside metals, softs, and other non-energy commodities.

• The raft of new entrants into energy and commodity markets, including hedge funds, investment banks, proprietary trading firms and more, and the impact they've had in bringing fundamental structural changes in commodity markets, including new markets and new instruments and almost effortless access for the ordinary investor who can now access and influence the market with the advent of Exchange traded instruments such as ETFs, ETCs an ETNs.

• The growing interdependency of commodities, both energy and non-energy, brought about by industrial shifts, new regulation, and continuing globalization.

• All major groups of respondents are trading a diverse set of commodities, though the physical traders tend to be more or less exclusively focused on energy and energy-related commodities; whereas the financial traders are trading a wider range of commodities overall and that exposure to commodities is only an aspect of a larger portfolio that includes significant exposure to other asset classes.

One area of particular focus for the study was to determine what the respondents felt were their most critical issues to be dealt with in the face of the turmoil in the markets…..the most critical business issues include risk management, market liquidity, tightening credit and collateral, understanding factors behind price formation, and volatility as well as a variety of technology-related issues such as reporting and data management. While there were some surprising regional differences in the rankings of many of the issues, Risk Management is clearly the critical business issue facing virtually all respondents given the current market conditions”

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