Materials Risk

Digesting the financial media’s latest headlines at the wrong time of day can be bad for your personal and financial health. Headlines can, when you can think about them rationally offer important clues into the state of financial markets, opening up opportunities for investors. According to Peter Atwater, President at Financial Insyghts:

“The morning headlines in the Wall Street Journal, the Financial Times the New York Times, the Washington Post… are huge mirrors. They are telling us how we feel and what we believe to be true.”

The front page of a newspaper or the opening items on the TV news broadcast are only ever things that confirm what we already believe to be true. After all, the media are trying to move us onto page 2 and so on, and to stick around for the next item on the TV news bulletin. According to Atwater trends are “over-believed” by investors, those that can be easily extrapolated long into the future are the most dangerous for investors:

“When everyone believes something is going higher, like interest rates last fall, the opposite is likely. As I write often, extrapolation kills.  And the bigger the trend-extrapolating headline and the more prominent the headline’s position, the more likely a reversal is. Typically, when something makes it to front page coverage, the end is near.”

With that in mind what do recent headlines say about the state of commodity markets?

“The migration problem is a coffee problem” – Washington Post

People don’t abandon their livelihoods, homes and ancestral homelands unless they can’t see the situation getting any better. For farmers in Guatemala that point appears to have been reached over the past year. The country is the largest single source of migrants to the US with numbers doubling over the past year to over 200,000. For coffee farmers there and elsewhere in South America the decline in coffee prices has been relentless and crushing; from a high of around 300 cents per lb in 2011 coffee futures fell to below 100 cents per lb in 2019. Coffee prices are under pressure due to an increase in mechanized production in Brazil (the largest producer), and higher output from Honduras, Vietnam and Colombia. The negative roll yield has been a boon for those short selling the futures contract.

Related article: Coffee prices: The top 10 most important drivers

‘The future is nickel’: Cobalt 27 sells off its namesake metal after tough year – Financial Post

Toronto based Cobalt 27 stockpiled cobalt and streamed mining rights in a bid to ride the wave of growth from the metals use in electric vehicle batteries. Over the past year the price of cobalt and the share price of Cobalt 27 has fallen by around two-thirds. Higher than expected output from the DRC and a slowdown in demand from China as auto sales ground to a halt were behind the fall. Yet like rhodium a decade ago, arguably sentiment towards cobalt was too high in the first place. Buying high and selling low doesn’t inspire confidence. Sentiment is so low that the company is selling off its cobalt holdings to focus on nickel instead.

Related article: What lessons does rhodium have for commodity investors?

‘It can’t get any worse’: Iowa farmers suffer as U.S. trade war with China escalates – Des Moines Register

Farmers have perhaps had it too good for too long. Strong growing conditions for several years and strong demand from China and emerging economies helped support US agriculture. Slumping agricultural commodity prices, trade wars and poor weather have battered US farmers. As with all the examples in this article sentiment could get worse before it gets better. But when the media start reporting that things can’t get any better, that there is no end in sight to the suffering that often sets the scene for a rebound in sentiment.

Fears of Chinese export cuts has sent the price of many rare earth metals up sharply in recent weeks and the share price of miners digging for the metals soaring. Its worth remembering that we have been here before. Back in 2010 China cut exports following a spat with Japan. What follows is an extract from my book, Crude Forecasts: Predictions, Pundits & Profits in the Commodity Casino

In 2010, Molycorp sensed an opportunity to capitalise on the high prices for REMs that had resulted from the cut in Chinese exports. The company’s Mountain Pass mine was expected to be America’s flagship source for REMs. The economics of Mountain Pass were built on extraordinarily rosy expectations of future prices. The Molycorp share prospectus included an assessment of current and future demand and supply for REMs and the implication for prices. Even accounting for the Mountain Pass facility starting production, prices for many of the metals were forecast to rise by 20–50% between 2010 and 2014, with prices forecast to double through to 2030. Nowhere in the prospectus was there any mention of the downside risks to prices, except this one line caveat in the footnote to the price forecast table, “that there will be no major changes to China’s rare earth strategy and no new application(s) that will have a material impact on demand.”

What concerns me looking at the prospectus, and should also have concerned any prospective investor at the time, is that there was no attempt to quantify the risks that the REMs market presented. No thought into whether substitute sources of REMs would be developed and no thought into whether the high prices would encourage manufacturers to substitute REMs with some other much cheaper product or at least reduce the amount they required.

Were investors emboldened by the stratospheric and parabolic price of REMs and the story that the demand for REMs would continue to grow sharply due to growth in demand from defence and the tech industry? Maybe. Did they think that China would continue to restrict supply indefinitely? Maybe. However, a cursory look at the history of other commodity markets should have given enough evidence to suggest that what goes up, inevitably goes down, eventually.

After REMs prices fell sharply post-2011, and due to the high level of investment required, Molycorp was eventually forced into bankruptcy. Investors in Molycorp were by no means the only suckers to fall for parabolic price increases as a trend. According to Chris Berry, many other REM mining companies were using three year trailing averages to justify their expectations of future prices. These price expectations then enabled what should have been a marginal project to get a valuation of over a billion dollars, and enabled many funds to be raised.

To an extent, it’s all about incentives, especially when it comes to early stage mining or exploration companies. In the early stages, running one of these companies is often more about salesmanship – convincing others to invest in your ideas – than geology. Executives spend all their time looking for financial resources, rather than those in the ground. And here there is the incentive to present the best possible story of how the future – prices, in particular – may pan out.

One final word from Chris Berry on the dangers to investors: “Beware narratives of limitless demand and limited supply which is nonsense junior mining companies excel in propagating. Any supply shocks will usually be met by some combination of recycling, thrifting, or technological advancement which displaces these unique materials.”

The ability to form accurate beliefs about what is happening in our world is key to our success as citizens, consumers, and of course as investors. Still, our ability to form and update beliefs sometimes goes badly wrong.

Misinformation and fake news has been getting plenty of attention following the election of President Trump. The impact stretches much wider. It affects political developments elsewhere in the world and matters a great deal in commodity and other financial markets.

Fake news is completely made up and designed to deceive readers to maximise traffic and profit. But the definition is often expanded to include websites that circulate distorted, decontextualised or dubious information that doesn’t reflect the facts of the story, or undeclared bias.

There is nothing new about fake news. Elaborate hoaxes designed to sell newspapers emerged in the US press in the 19th century. In 1874 The New York Herald gave an account of a bloody escape of wild animals from the Central Park Zoo. The article reassured readers by wrapping up with: “Of course the entire story given above is a pure fabrication.”

High quality media outlets compete to provide high quality journalism, fast. They also face a reputation cost and so invest resources to ensure they are perceived as high quality.

Producers of completely fabricated news are different. They have no need to make any investment in ensuring that their reporting is accurate. All they need is a vivid imagination. Unlike the story of wild animals escaping from Central Park Zoo modern fake news doesn’t tend to come with the same footnote warning of its fabrication!

Media consumers cannot always distinguish between high and low quality media providers. Articles are often tailored to pull on the readers psychological utility – whether that is political bias, fear or greed related to the markets or pure entertainment.

The motive behind most fake news is to cause a spike in web traffic and capture the resulting advertising clicks. The motive behind fake financial media could be to ‘pump-and-dump’. Build up a position, spread fake news that is likely to spike the price, and then sell into it.

The motives behind fake news may be much more nefarious than increasing traffic to a website and moving the price of assets. To sway the direction of elections, cement the power of those in position of power, and to destabilise those who others wish to weaken. The first casualty in war is usually the truth with the first skirmishes often used to justify use of greater force in retaliation.

That leads us to the events of 12th May. On that Sunday reports began to emerge of explosions from four crude oil tankers near the port of Fujairah in the UAE. Initially reported by websites with a reputation for spreading propaganda and then by other media networks in the region.

Conflicting reports began to emerge of what happened. While the port authorities in Fujairah denied the reports, UAE authorities disagreed, suggesting that there had indeed been sabotage. Reports from Saudi Arabia meanwhile indicated that two of the vessels were Saudi.

‘Officials’ from the US and neighbouring countries were quick to blame the attacks on Iran. Headlines around the world proclaimed that Iran was behind the attack. Eyewitnesses reported seeing huge explosions. Brent crude prices jumped over a dollar to over $72 per barrel when markets opened on the Monday morning.

Despite the uproar there was little or no evidence to support any of the claims. The most telling of all was satellite footage of the area which showed zero sign of any explosion. Samir Madani from Tanker Trackers picked up the story, outlining the evidence – or lack thereof. Check out Samir’s summary from 12:30 below.

Propaganda has always been a tool for political powers to bend the consent of the people to their will. That will never change. Yet the events of 12th May offer an important lesson in how participants (whether active or passive) should react to events which could have wide ranging political consequences. One that we should all be very careful to guard against.

An increase in the supply of fake news has a detrimental impact on the supply of legitimate news. The economist George Akerlof illustrated how a dodgy used car market can infect the market for well functioning cars. The same can happen in the market for news. In a market where buyers have imperfect information (your typical trader or investor), while sellers possess a profit motive the markets tend to be thin, insubstantial and poor quality. Investors could then become more sceptical of every piece of news.

This is exactly what a recent study by Yale University found. Researchers examined the financial markets reaction to fake news published on crowd sourced financial media platforms Seeking Alpha and the Motley Fool. The revelation of the existence of fake news resulted in an immediate decrease in the markets reaction to all news published on social media platforms, even if it was a legitimate report. Encouragingly they found that trading activity didn’t decline in response to news published by authoritative sources.

So what are some of the ways that you can increase your chances of spotting misinformation and fake news on “FinTwit”, other social media and in the mainstream financial market media?

• Find out about the source: Look at the website where the story comes from. Is the story well-presented? Are the images clear? Is it well written without any spelling errors or exaggerated language (e.g. capitalised text)? If you’re not sure, try clicking on the “about us” section, and check that there’s a clear outline explaining the work of the organisation and its history.

• Look at the author: To check if they are real, reliable and “trustworthy”, look for other pieces they have written and what outlets they have written for. If they haven’t written anything else, or if they write for websites that look unreliable, think twice about believing what they say.

• Check for linguistic traits associated with honesty: Truth-tellers tend to use more self-reference words and use longer sentences compared to liars. When people lie, they tend to distance themselves from the story by using fewer “I” or “me” words. Liars use fewer insight words such as realise, understand, and think, and include less specific information about time and space. Liars also tend to use more discrepancy verbs, like could, that assert that an event might have occurred.

• Check for references: Authoritative articles should link to other news stories, articles and authors. Click on the links and check if they seem reliable and trustworthy. Reports of an official or an anonymous source could, and probably are made up.

• Check the dates: Have the articles been edited or changed in some way? The emphasis of a story may change significantly from how it was originally published. This doesn’t necessarily mean that it is false, but it could mean that you should be cautious about the motives of the media outlet.

• Do a Google Reverse Image Search: Check to see all the other web pages that have similar images. This then tells you the other sites where the images have been used – and if they’ve been used out of context. Beware that some websites may use old photos as evidence.

• Social media check: Look up the source on Facebook or Twitter. Do they use misleading, sensational or provocative language? If yes it may mean they have exaggerated the ‘truth’ in the story.

• Trust, but verify: You will find plenty of honest, hardworking experts on Twitter trying to uncover the truth and share it with the wider world. Unfortunately, you also find people that look to spread misinformation and propaganda too. So be careful who you trust.

• Check if the story is being shared on any other mainstream news outlets: If it is, then you can feel more secure that the story is not fake news. Organisations such as the BBC take special care to check their sources and very rarely publish a story without having a second source to back it up. Although everyone makes mistakes sometimes.

• If you have any doubts about the credibility of a story there is something you can do about it. Don’t share it: By sharing it you automatically give it a wider audience, but you also lend it a little extra credibility.