From an IOI Investing Alumnus

When I first started with IOI’s coursework one of the things I could not get my head around was the “Structural Effects” that Erik kept on about. Thanks to Erik’s time, patience and conversation I’ve found that it is really, really important to understand the “plumbing” that makes the capital markets work. Things like participant incentives, liquidity measures and incentives (rebates), overnight lending requirements, what securities are used to construct an ETF (especially the levered sort), the effects of investment funds on the supply and demand of financial instruments and so on. These things can and do affect the prices of assets I invest in – sometimes only over short time periods – creating real mis-pricing opportunities.

One of the clearest places to see these structural effects at work is in the commodities markets. These market structures have been around forever and they are largely untouched by financial engineering. We still talk carefully about supply and demand effects on oil prices – just like a century before. Commodity markets can get cornered…still. There are rules in place to be sure, but the efficiency of these markets to operate pretty well unfettered makes them a great study for engaged investors.

So, on your educational reading list this week should be this piece in the Economist, Of Mice and Markets – Investing in commodities. The author lays bare the push and pull between supply/demand drivers and the powerful effects of speculation. The example given is that while supply/demand does indeed show long run oil prices falling, short term oil prices have risen thanks to a combination of supplier manipulation and the contemporaneous unwinding of short positions by hedge und participants.


What’s crucial for an intelligent investor here is that sometimes you can be directionally right about the fundamentals but the trade doesn’t work for “structural” reasons. The hedge funds had taken a short position, but because suppliers keep coming together and hinting at managing supplies better, the market responds to that short term hint and the hedge fund’s position gets WHACKED. Now, they are right about the long run oil price, but their trade structure did not adequately account for this kind of supplier “manipulation”.

It would have paid for them to better study and understand the structural possibilities before taking such short term positions (but hey, those are the cheapest!). The Economist’s piece does a wonderful job in a short number of words to explain the current structural considerations in the commodities markets. There’s a “how to think in advance about the possible structural and market outcomes of an investment position” lesson here for all of us.

In the meantime, Invest Intelligently…