Mark Robinson writes in The Investors Chronicle today:

The Chinese State Reserves Bureau is supposedly sitting on a $1.5bn paper profit after it bought heavily in physical copper reserves after the metal’s price slumped in the wake of the financial crisis. Last week’s copper price at $8,347 per [metric] tonne is within 7% of its all-time high (set in July 2008), so it represents a canny hedge by the Chinese if nothing else.

Given that China is now the biggest end-user of the metal, it is unlikely that the CSRB would want to cause undue disruption to the copper market, so any sell-off is likely to be both low-key and incremental.Other factors could destabilise prices. The standard industrial supply/demand dynamic only goes so far in explaining why demand for hard commodities such as steel, gold, and copper has ratcheted up of late. You also need to add in the increased inflows from speculative institutional investors, together with the growing appeal of hard commodities in terms of both portfolio diversification and as a hedge against currency devaluation arising from quantitative easing, and you have a recipe for further erratic fluctuations in prices.

The press has generally taken the view that the CSRB has believed all along in the commodities ‘super-cycle’, but it may just be that Chinese officials simply stuck to a fundamental view that demand for basic raw materials from the world’s emerging markets will invariably feed into increased market volatility.

On my bulletin board I have a photo I took of a black swan (in South Africa). Until Australia was settled, all swans were assumed to be white. Now even Swan Lake (in the Mariyinsky version) features a black swan king. What you think you know does not predict the future.

Having studied statistics in grad school, and hanging around with quants, your editor is also very wary of fat tails, normal curves which produce far more extreme “tail” events than are assumed likely. As Nassim Nicholas Taleb (“Fooled by Randomness”) has written convincingly, normal curves are misleading.

However, trying to anticipate all the possible weird outcomes, besides being hard to do, may not work. The latest research from Nice (France) by EDHEC, a biz school, concludes that trying to minimize the most extreme and improbable risks in a portfolio may be worse than not minimizing them at all.

Studying advanced modelling for alternative investments with support from Newedge Prime Brokerage, EDHEC’s Risk Institute tried to determine if portfolio selection techniques foucussed on extreme risks generated superior results than more traditional analysis of risk and return. And the results showed that guesswork may be better than too much sophisticated evaluation.

The results show that as asset managers increased the number of risk parameters they had to estimate, their foreecasts became less robust and less relevent than if they had stuck with a simple measure of portfolio volatility (like variance).

A problem with a focus on extreme risk in diversified portfolios is that you have to estimate a lot of numbers, not only for variance-covariance parameters, but also for higher-order moments and co-moments of the distribution of return, measures like the so-called co-skewness and co-kurtosis parameters describing how extreme fat tails are generated amd portfolios suffer asymmetric distribution. Skewness means the degree a normal distribution tilts to the left or the right; kurtosis measures the “peakedness” of the distribution; and a “fat tail” distribution tilts toward extremes.

Alas, optimising a portfolio holding 20 assets requires estimating 210 variance-covariance parameters, 1,540 skewness-co-skewness parameters, and 8,855 kurtosis-co-kurtosis parameters! All these estimates based on limited samples inevitably create substantially higher estimation errors.

Fingerspitzengefuehl is the new forecasting technique.

 

We report some happy Latin surprises in our blog today, which nobody predicted. But first a major beer breakthrough by Dominic Walsh in Bloomberg:

There are oil platforms, factory ships and cruise ships so large they are more like floating towns — and now one of the world’s biggest brewers is considering building large floating breweries.

SABMiller, which owns such brands as Pilsner Urquell, Grolsch and Peroni Nastro Azzurro, is looking into the concept of ship-borne breweries amid predictions that water and energy, both key to beer production, will become increasingly scarce commodities over the next 20 years.

A recent study, part-funded by SABMiller, found that there could be a potential shortfall of 40% in water resources available across the world by 2030.

The concept of a floating brewery has been put forward by Innovia Technology, a consultancy working with SABMiller, as part of a project to predict how a range of scenarios in terms of the cost and availability of water and energy will affect the technology required to carry on brewing in 2030.

What this may mean for paid subscribers is guessed at below: