RIP Randy Pausch

This phrase from an interview with Nassim Nicholas Taleb, author of the very good although sometimes rambling Black Swan struck a nerve:

Stress should also be irregular and ferocious – early men did not have bad bosses, but they did occasionally run into lions.

Doesn’t seem all that compatible with modern office life, does it?.

It’s really disappointing to find both the Economist and the New Yorker dead wrong about the reasons that oil prices are so high. I know that commodity futures markets are somewhat arcane and hard to understand, but I expect better out of the Economist.

Futures markets deal in contacts for the future delivery of a good, such as corn, pork bellies or crude oil. They specify an amount, a location to be delivered and a price. Traditionally buyers and sellers of commodities use them to hedge their risk — a farmer or a manufacturer can lock in a price now and they will know exactly what they need to pay. Centralized futures markets are also used for price discovery – they are a central source of information for how much people are willing to pay for a good or service and provide information buyers and sellers would not be able to acquire on their own.

There are three different kinds of investors in commodity markets: hedgers, speculators, and arbitrageurs. Hedgers deal with the commodity in their day-to-day business, and have a need to manage risks due to prices going up or down significantly. Arbitrage traders take advantage of the difference between futures prices and spot prices — if the futures price is higher than the spot price, they will buy a commodity on the spot market and sell a futures contract and make a profit. Speculators are in the market to make a profit because they have a different idea about the best price for a commodity than the buyer or the seller. To prevent market-cornering activities futures market regulators usually limit the positions for investors who do not deal with a commodity as a buyer or seller. Speculators, in moderation, are vital to the proper functioning of a market because they provide liquidity to both producers and consumers.

Recently, however, large investment banks like Goldman Sachs and T. Rowe Price have taken advantage of some 2000 legistation defining large banks holding commodity ‘index’ funds, which constantly purchase a market basket of commodity futures and sell them right before expiry as ‘hedgers’ and not ‘speculators’ even though they have no interest in an underlying commodity. These investment banks have recently promoted these commodity funds as a new asset class to large pension and endowment funds, who have channeled scads of money into these markets.

As a side note it’s important to note that commodity markets are much smaller than capital markets — they comprise about 1.2 trillion in total value worldwide, rather than over 12 trillion for equities markets (like stock exchanges), so when hundreds of billions of dollars are suddenly thrown into the commodity futures market, it has a huge impact.

So, to summarize: large pension funds with the assistance of Goldman Sachs and its ilk, are buying huge amounts of futures contracts, driving up the price of those futures contracts in the futures markets. These index funds are price-insensitive, long only and have unlimited firepower.

So how does this affect the spot prices? Enter the Arbitrage trader, who sees that futures contracts are too high. She will buy a barrel of oil on the spot market and use it to fulfill a futures contract. Theoretically each arbitrage trade will bring up the spot price and bring down the futures price until they are in line with each other.
With oil, there is little excess delivery or storage capacity, so very little arbitrage is possible, and with relatively few trades, suddenly the spot price and the futures price meet.

For commodities that do not require dedicated infrastructure to deliver and store, arbitrage trading keeps the futures contract price down in line with the spot price, which is why other commodities have not seen the huge price increases that oil has. (Why the Economist fails to recognize this simple fact is beyond my understanding.) If there is little ability for arbitrage, the spot price rises to meet the futures price very quickly.

Therefore investment banks and pension funds play a large, if not the defining, role in the rise in the cost of oil, and the regulatory body, the CFTC, is asleep at the switch.

I chuckled inside when I read the following headline:

Barack Obama accused of distorting the Bible by evangelical leader James Dobson

Ah yes, we’d better leave the bible-distortion to the professionals. I especially loved the quote:

“I think he’s deliberately distorting the traditional understanding of the Bible to fit his own world view, his own confused theology,” Mr Dobson said.

I guess if anyone would recognize that, it would be Mr. Dobson. He’s built quite an empire that way. While I admire Obama’s spunk, is it a good idea to go after Dobson? It’s at least a different tactic than the Democrats have tried in the past.

What is there to do in Antarctica in the wintertime? Six months of darkness and you’re stuck in a remote outpost all winter long as part of a skeleton crew. How to pass the time? Reuters reports that the final shipment arrived, and as part of it, there were 16,000 condoms. The mind boggles.

I’m not one of those super-smart foreign policy strategists, but there are some interesting forces at play in the middle east right now:

• Oil is at record prices, so
• Saudi Arabia (and other oil producers) are raking in the money as never before, so
• They want to keep the gravy train coming in, so
• They have a heretofore unprecedented interest in keeping the middle east stable, so
• Among other things, they have stepped up their anti Al-Qaeda efforts, and
• Have invited other leaders to discuss an Israeli-Palestinian peace, and
• Are inviting other leaders for summits on getting along

So, wouldn’t now be the perfect time to ditch Iraq, when the Saudis and their brethren have the money, motivation and cultural influence to turn down the temperature in the region?

I’d been meaning to post again about how the DNC compromise on MI and FL changed the landscape (not much), and opine some more about statistics and politics, but FiveThirtyEight.com does so much better than I ever would.

You want monte carlo simulations of election outcomes based on pollsters and their historical track record? Check.

Spot on analysis? Check.

Some of the best writing on health care on the Web today comes from Jay Parkinson. He cites an article by Benjamin Atkinson about the problems facing health care in this country that is SO spot on it makes me want to cry. It’s unfortunate that neither Obama or McCain even come close to addressing the issues he points out.