Derivatives: Glowing Revelations
by Rob Kirby, Kirby Analytics. May 7, 2007
In case you haven't noticed the headlines about the Bank of Montreal [BMO] taking a "charge" against earnings relating to its [DERIVATIVES] trading – particularly in that of Nat Gas futures:
TORONTO, April 27 /CNW/ - BMO Financial Group (NYSE: BMO, TSX: BMO) said today that mark-to-market commodity trading losses estimated at between CDN$350 million and CDN$450 million, pre-tax, will be recorded in the second quarter of its 2007 fiscal year. The impact of this to BMO Financial Group's second quarter earnings, which will be announced on May 23, 2007, is estimated in the range of 45 cents to 55 cents per share.
I'm guessing there's a much bigger story here than the headline suggests. Bank of Montreal has taken a loss on DERIVATIVES TRADING of some 450 MILLION – and remember – total trading revenue for the whole of last year for BMO was reportedly in the neighborhood of 650 million.
Take special note of the wording in the release, namely, the losses are "mark-to-market."
This implies that the BMO still has these positions on the books. Today, or at the time of this press release, natural gas is/was trading at approximately 7.50 US.
By the BMO's own admission – to incur the magnitude of loss being reported - we know they are and have been "long" natural gas futures.
Natural Gas bottomed in price well below 5 bucks.
This means that the BMO's "long natural gas position" was almost certainly a MUCH BIGGER LOSS – at one point in time – than they are admitting to us now.
BMO's year end is Oct. 31. I'm left wondering why they did not report a bigger loss last quarter.
The bank further reported,
A number of factors contributed to these mark-to-market commodity trading losses. During the quarter, positions held by BMO Financial Group in the energy market, primarily for natural gas, were negatively impacted by changes in market conditions. In particular, the market became increasingly illiquid and volatility dropped to historically low levels. In conjunction with this, there was a refinement in BMO's approach to estimating the market value of this portfolio. [RK emphasis]
These adverse changes that gripped ole BMO in the latest quarter – well – it got me to thinking...
What do you suppose the same ole adverse changes would do if they ever infected ole J.P. Morgan and their 68+ TRILLION DERIVATIVES BOOK?
Does anyone – other than moi - ever wonder why J.P. Morgan has a derivatives book this big?
It certainly has nothing to do with "real" end-user demand, now does it?
Source: Office of the Comptroller of Currency, Quarterly Derivatives Fact Sheet
So, what ever the "real reason" is for J.P. Morgan to have a 68 TRILLION dollar in notional derivatives book – it must be a good one, eh?
And surely-to-heavens, it’s a good thing that the traders at ole J.P. Morgan would NEVER get "wrong footed" like the traders over at the ole BMO, eh?
As I stop to think about it, when J.P. Morgan grows their derivatives book – in 3 out of 4 of the most recent quarters by 5 Trillion increased notional per quarter – we can all sleep tight with good sense of well-being. After all, we do know that – or at least should be aware of, as Jim Willie recently revealed;
"The Bank of Baghdad was cited as a trading pit for JPMorgan last week, where oil funds are actually used to suppress the crude oil price. It is a clearing house for more, a convenient bank without the encumbrance of regulatory oversight, the perfect central bank for the cabal in power. The more sinister overt effect from the war is the invisible gun pointed at the heads of the Persian Gulf nations."
After all; what are the chances of anything going wrong in Iraq?
I guess IF ANYTHING EVER DID – you might want to have a fall-back position, eh?
Once again, let's consider the words of Mr. Jim Willie,
"The US Federal Reserve is JPMorgan. The Dept of Treasury is Goldman Sachs. The Iron Triangle supports the US Military. These entities do the government's bidding and execution of programs. Not one single Wall Street firm or bank has been marred by the rash of scandals since 2000. Only outsiders were damaged or ruined."
This all gives context to an article by Dawn Kopecki – who reported in BusinessWeek Online in a piece titled, Intelligence Czar Can Waive SEC Rules,
"President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye."
So let's just say, if J.P. Morgan were to have a "BMO-like-OOPS" – so long as it was in-the-national-interest – REST ASSURED – they would likely be "excused" from proper or adequate disclosure to shareholders – wouldn't they?
Moving On To Gold
Over the past couple of weeks, we've learned that two major gold producers [Barrick and Lihir] have dramatically reduced their hedge books [short gold positions].
In the case of Lihir, announced buy backs amount to approximately 1 million ounces.
The funds raised will close out Lihir's hedge contracts of 934,500 ounces of gold at a contract price of $343 an ounce and repay a 480,000-ounce gold loan at $449 an ounce, it said.
In Barrick's case – the buy backs amount to 2 million ounces.
Chief Executive Officer Gregory C. Wilkins, betting prices will keep rising, exited contracts to sell 2 million ounces of gold at fixed prices that were 41 percent below bullion on spot markets.
Folks need to understand that when these "hedges" were established – sovereign gold [physical bullion held in the vaults of Central Banks] was mobilized [loaned or leased] – REMOVED FROM THE VAULT – and sold into the market. These loans were facilitated by "Bullion Banks" like J.P. Morgan and Goldman Sachs.
The methods by which Central Banks account for gold – they continue to report their inventory of gold as if loaned or leased bullion NEVER LEFT THE VAULT.
The reason this is all so noteworthy is this:
While gold producers have been busy immunizing their balance sheets from further increases in the price of gold – they've been doing so with FUTURES – NOT PHYSICAL BULLION.
We know this because the announced buy-backs of Lihir and Barrick alone amount to + 3 million ounces in the last quarter alone. For this amount of physical bullion to be taken out of the market – and returned to Central Bank vaults - inventories on COMEX would logically and necessarily have been decimated - and this CATEGORICALLY did not happen.
When the investment world wakes up and realizes that Central Banks do not have gold bullion in their vaults in the amounts they claim to have – it stands to reason that the gold price will rise rapidly.
You see folks, in the murky world of derivatives things are not always as simple as they seem or as clear as they're stated.
And If All This Wasn't Enough...
It was announced last week that NYMEX plans to soon begin trade in Uranium futures;
Uranium's set to make waves in futures
New York Mercantile Exchange, Ux Consulting to launch uranium futures
By Myra P. Saefong, MarketWatch
Last Update: 7:27 AM ET Apr 27, 2007
SAN FRANCISCO (MarketWatch) — It's hard to ignore any commodity that's seen a more than 1,000% price climb over the course of five years, especially one that's about to be traded on a futures exchange for its first time ever.
Weekly spot prices for uranium stood at $113 a pound on April 23 — that's an 11-fold increase from the $5 price it cost in 2002, according to data from Ux Consulting Co., LLC
Just think of the possibilities – it surely won't be long now before BMO's and J.P. Morgan's earnings "really start to glow" and their derivatives books have some REAL [as opposed to synthetic] radio-active waste in it!
We should all sleep much better now!
Overseas equity markets began the week with a bullish tone as Japan's Nikkei Index climbed 274 points to close at 17,669. North American markets began the week somewhat muted with the DOW ahead by 48.30 to 13,313.00, the NASDAQ slipping 1.20 to 2,570.95 and the S & P gaining 3.90 to 1,509.50. NYMEX crude oil futures lost .33 to close at 61.60.
Interest rates were a basis point lower on the day with the benchmark 5-year bond ending the day at 4.54% while the 10-year bond finished at 4.63%.
On foreign exchange markets, the US Dollar Index shed .08 to close at 81.54.
The precious metals complex did better with COMEX gold futures gaining .60 to 689.00 while COMEX silver futures added .07 to close at 13.59. The XAU gained 1.41 to close at 143.26 and HUI rose by .33 to 346.24.
On tap for tomorrow, at 10:00 a.m. March Wholesale Inventories – expected + .4% vs. prior +.5 %.
Wishing you all a pleasant evening and a prosperous tomorrow!
© 2007 Rob Kirby