Deflation hedges

[steph]

Hi, Is there a way to know how the CPI hedges are doing?

[giofranchi]

I think each quarter Watsa comments on them, and let us know at which percentage of cost they are reported on the books.

 

Gio

 

[petec]

I can't find it now but someone on here has previously commented that the swaps appear to be valued as Level 3 assets by FFH, meaning they have considerable flexibility in how they value them.  IIRC the poster felt they valued them using a very conservative internal model because they often seemed to get market down very shortly after they were purchased.

 

In other words, you might not be able to predict the carrying value even if you can get a price quote.

[steph]

ok. Thank you!

[captkerosene]

Could lower oil prices spur deflation?

[petec]

Could lower oil prices spur deflation?

 

I believe the swaps are on the main CPI index (i.e. including fuel and food) in which case low oil price will be a deflationary factor. 

[TwoCitiesCapital]

It's not just oil - many commodities are significantly off too. Unfortunately, unless if it affects housing/rents then I have a hard time seeing how it will significantly impact the index. Fuel is a low % of spending for most so it will be a low weight in the index.

 

I do believe that the weakness that were seeing across most industrial commodities/services is supportive of deflationary pressures - this isn't  limited to oil production shifts. Iron, copper, shipping, oil, lumber, natural gas, etc are all down significantly year over year.

 

 

[benhacker]

I can't find it now but someone on here has previously commented that the swaps appear to be valued as Level 3 assets by FFH, meaning they have considerable flexibility in how they value them.  IIRC the poster felt they valued them using a very conservative internal model because they often seemed to get market down very shortly after they were purchased.

 

That was me.

 

Just checked the latest filing I had, they made a $1B notional purchase for cost of $1.7m on 9/30/2014, and marked the value at $1.45m the same day.  So there model appears to be conservative (or perhaps the bid/ask on these contracts is massive)

[ERICOPOLY]

lower commodity prices means you can make stuff cheaper.

productivity gains mean you can make stuff cheaper.

 

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

 

higher productivity means we make products with fewer people.

 

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

[ni-co]

lower commodity prices means you can make stuff cheaper.

productivity gains mean you can make stuff cheaper.

 

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

 

higher productivity means we make products with fewer people.

 

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

 

What was first, deflation or lower oil prices?

[ERICOPOLY]

lower commodity prices means you can make stuff cheaper.

productivity gains mean you can make stuff cheaper.

 

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

 

higher productivity means we make products with fewer people.

 

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

 

What was first, deflation or lower oil prices?

 

Well in Japan they had deflation even with rising commodity prices.

 

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway  :-X

[ni-co]

lower commodity prices means you can make stuff cheaper.

productivity gains mean you can make stuff cheaper.

 

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

 

higher productivity means we make products with fewer people.

 

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

 

What was first, deflation or lower oil prices?

 

Well in Japan they had deflation even with rising commodity prices.

 

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway  :-X

 

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

 

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313

He is using oil as a leading indicator for the CPI.

[petec]

lower commodity prices means you can make stuff cheaper.

productivity gains mean you can make stuff cheaper.

 

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

 

higher productivity means we make products with fewer people.

 

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

 

What was first, deflation or lower oil prices?

 

Well in Japan they had deflation even with rising commodity prices.

 

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway  :-X

 

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

 

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313

He is using oil as a leading indicator for the CPI.

 

I recall going to a dinner arranged on this board before the 2009 annual dinner and someone asked Sam Mitchell: inflation or deflation?  He said: both, and what really matters is when one turns into the other.

 

I'm inclined to think he's right, and I think commodity prices coming down are deflationary at first, and that is so good for the economy that Eric's thesis plays out and we get wage growth and a little inflation.

 

But the third order effect is that, with those elements of the economy normalised, CBanks can and might have to raise rates, and it is quite possible that that will cause havoc.

 

Now, by the time you get to third order events your chance of making a correct prediction is so small as to make the exercise pointless!  But I can see how Prem's 2011 forecast of a possible decade of flattish nominal GDP with bouts of deflation might come true.

 

But then I suppose any forecast *might* come true ;)

 

 

[Luckyone77]

So, Europe officially slips into deflation with todays news. What does it mean and how exactly can you calculate what that means to FFH's deflation plays and the value of the company? I'm a marketing major not a Finance major, so, go easy guys.

 

A part of me is thinking it's time to buy more of their stock but FFH's "tech stocking picks" (Dell and Blackberry) seem to be SO off the mark that it gives me pause and concern about what they're thinking at times. I've spoken with 2 highly placed tech executives or tech board members (not a Blackberry employee) who thinks there's not a happy ending there. Frankly, they just laugh it off. Of course, they could all be wrong and Watsa could have the last laugh or FFH might simply be too stubborn to admit they've got a loser on their hands. Time will tell.

 

 

[giofranchi]

FFH's "tech stocking picks" (Dell and Blackberry) seem to be SO off the mark that it gives me pause and concern about what they're thinking at times. I've spoken with 2 highly placed tech executives or tech board members (not a Blackberry employee) who thinks there's not a happy ending there. Frankly, they just laugh it off. Of course, they could all be wrong and Watsa could have the last laugh or FFH might simply be too stubborn to admit they've got a loser on their hands. Time will tell.

 

The fact investment mistakes are often made is just a part of this life… And no one can do anything about that, but accept it as a matter of fact!

 

Probably FFH invested a bit too much in Blackberry… and now all they are doing is trying to defend their investment as best as they can… But I would be very surprised if they deploy new capital that way from now on!

 

Of course, in the end what truly matters are overall results. And until now FFH has proven to be able to achieve very satisfactory overall investment results! ;)

 

Gio

 

[meiroy]

The US will not go into real deflation.

 

The crash in commodities and oil is due to oversupply and NOT a drop in real demand.

 

These lower costs will boost demand and growth in the US.

 

That's it. Add Europe and China numbers to it and the outcome is the same.

 

If you live in the USA this year consider yourself a lucky bastard.

 

Carry on.

 

[One World Trader]

Sorry I cannot believe that an increase in supply means an increase in demand. Why would anything be more "in demand" if it can be obtained more easily?? Whether I think of an example in socks or stocks it doesn't seem to add up!! :)

[meiroy]

Sorry I cannot believe that an increase in supply means an increase in demand. Why would anything be more "in demand" if it can be obtained more easily?? Whether I think of an example in socks or stocks it doesn't seem to add up!! :)

 

I wrote:

"The crash in commodities and oil is due to oversupply and NOT a drop in real demand.

 

These lower costs will boost demand and growth in the US."

 

 

Now that oil is much cheaper, do you think people will use more, the same, or less?

 

If the economy grows due to lower oil and commodities costs (and other external factors), would aggregate demand increase or decrease?

 

 

 

 

 

[One World Trader]

My friend, I don't know anyone who goes to the pump to fill up for work and has another tank of gas they fill because the stuff is selling for half price. I think people use the same amount if not a tad more.

 

With returns on money in the bank at .1 percent with little wage increases and inflation at 2-3 percent per year the average person is seeing their effective purchasing power decrease over the past few years. Factor the last few years of this in and people are really hurting. So the little they are saving in gas like you suggest cannot be going back into growing the economy if they have to pay off the average americans credit card debt, which is 15,611. BTW that Iignores the white houses recent push to..yup you guessed it...raise the gas tax.

 

It's what they want you to believe though. :)

 

[Tim Eriksen]

My friend, I don't know anyone who goes to the pump to fill up for work and has another tank of gas they fill because the stuff is selling for half price. I think people use the same amount if not a tad more.

 

With returns on money in the bank at .1 percent with little wage increases and inflation at 2-3 percent per year the average person is seeing their effective purchasing power decrease over the past few years. Factor the last few years of this in and people are really hurting. So the little they are saving in gas like you suggest cannot be going back into growing the economy if they have to pay off the average americans credit card debt, which is 15,611. BTW that Iignores the white houses recent push to..yup you guessed it...raise the gas tax.

 

It's what they want you to believe though. :)

 

I think you are missing his point.  It is a basic principle in economics that a higher price leads to decreased usage, and conversely a lower price leads to increased usage.  Not for every individual but in aggregate.  Of course you could argue that demand is the relatively the same regardless of price for certain products, but it doesn't take much increase to bring supply and demand back in line.  For oil we are talking about a 1% change in usage.  Will lower prices increase travel.  Historically it does.

 

[One World Trader]

I understand, though hardly agree. Its exactly what they want you to think!!! As long as we're talking about spending while Americans are in debt, we are talking good short term gains for manufacturers and stores but bad long term games for the whole economy. Let me explain:

 

When individuals borrow and spend to finance productivity it is beneficial for the economy. In the past, individuals borrowed to build a factory which would produce goods that were sold at a profit that would pay off the loan. Today money is spent and borrowed for consumption whereas indebtedness grows while production capacity doesn't! For example buying a dress or football game tickets. The debt doesn't go away because there are no profits to pay off the debt from the spending.

 

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

[petec]

 

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

 

You can. but you might not want to.  The part you don't mention is that when people borrow to consume, someone somewhere borrows to build the plants to make the things that the consumers are consuming.  You might call this the "levering phase" and it works very well until the consumers, encumbered with debt, slow down their consumption.  Then neither group has the cash flows to pay off the loans.  Consumers consume less and start paying down loans.  Producers keep producing more and more to try to service their loans, but in the absence of demand they have to cut prices, and you get deflation.  You might call this the "delevering phase". 

 

If they're badly run the consuming countries will lower interest rates more and more and more to try to "stimulate demand", aka get levered consumers (or if that fails, governments) to lever more and spend more on more stuff that (mostly) doesn't produce an income.  If they're badly run the producing countries will borrow more and more to build more and more to keep headline GDP growing.  That's what China has spent the last few years doing.  Both policies just make the situation worse: more debt, more overcapacity, but no more demand.  It's extraordinary to think that global debt/GDP has gone from 175% in 2007 to 215% now.  The globe as a whole is not delevering, but the levering might be in its final phase.

 

I realise I'm drifting off topic here!

 

What is really interesting is whether Americans will spend their oil windfall, or use it to delever. 

[ni-co]

 

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

 

You can. but you might not want to.  The part you don't mention is that when people borrow to consume, someone somewhere borrows to build the plants to make the things that the consumers are consuming.  You might call this the "levering phase" and it works very well until the consumers, encumbered with debt, slow down their consumption.  Then neither group has the cash flows to pay off the loans.  Consumers consumer less and start paying down loans.  Producers keep producing more and more to try to service their loans, but in the absence of demand they have to cut prices, and you get deflation.  You might call this the "delevering phase". 

 

If they're badly run the consuming countries will lower interest rates more and more and more to try to "stimulate demand", aka get levered consumers (or if that fails, governments) to lever more and spend more on more stuff that (mostly) doesn't produce an income.  If they're badly run the producing countries will borrow more and more to build more and more to keep headline GDP growing.  That's what China has spent the last few years doing.  Both policies just make the situation worse: more debt, more overcapacity, but no more demand.  It's extraordinary to think that global GDP has gone from 175% in 2007 to 215% now.  The globe as a whole is not delevering, but the levering might be in its final phase.

 

I realise I'm drifting off topic here!

 

What is really interesting is whether Americans will spend their oil windfall, or use it to delever.

 

+1

This the right framework and exactly the right question.

[One World Trader]

 

I can think of an example country that is borrowing to build factories and their economy is growing rapidly... :)

 

You can. but you might not want to.

 

 

Actually, I do, however not in the short term!

 

At the end of the day, which country has the factories to produce more goods and which ones have the consumer debt? Which one has the ability to make more profit? :)

 

I agree with much of your response.  End of leveraging phase...absolutely. I agree that saying the economy grows in the long term with all this borrowing is unrealistic because sooner or later the buck has to stop because many less in America will have it to spend!

 

In addition, the US owes around 5 trillion to China. That would be easily deleveraged and the problems you speak of be fixed by selling off fixed assets in the USA to China. That shrinks the economy. This doesn't solve the problems within their governing system. It does however, mean that our economy would shrink accordingly to pay off the 5 trillion it owes while it deleverages.

 

Great final word, an important question!

 

[KinAlberta]

lower commodity prices means you can make stuff cheaper.

productivity gains mean you can make stuff cheaper.

 

lower commodity prices mean consumers can buy more stuff with same paycheck, leading to higher factory utilization and employment gains,

 

higher productivity means we make products with fewer people.

 

lately I believe productivity has disappointed during an environment of cheaper commodities.  Isn't this a bullish combination for capacity utilization and employment gains? Somehow I believe that is a headwind to deflation.

 

What was first, deflation or lower oil prices?

 

Well in Japan they had deflation even with rising commodity prices.

 

We're not seeing deflation here yet, but we are seeing lower commodities.  Real purchasing power is rising as is employment.  So far anyway  :-X

 

I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation.

 

Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313

He is using oil as a leading indicator for the CPI.

 

I recall going to a dinner arranged on this board before the 2009 annual dinner and someone asked Sam Mitchell: inflation or deflation?  He said: both, and what really matters is when one turns into the other.

 

I'm inclined to think he's right, and I think commodity prices coming down are deflationary at first, and that is so good for the economy that Eric's thesis plays out and we get wage growth and a little inflation.

 

But the third order effect is that, with those elements of the economy normalised, CBanks can and might have to raise rates, and it is quite possible that that will cause havoc.

 

Now, by the time you get to third order events your chance of making a correct prediction is so small as to make the exercise pointless!  But I can see how Prem's 2011 forecast of a possible decade of flattish nominal GDP with bouts of deflation might come true.

 

But then I suppose any forecast *might* come true ;)

 

I know back in 2010 or so, everyone was expecting a lot of inflation to appear by right about now.  So, since those expectations have changed quite dramatically or at a minimum those expectations have been pushed back by a few years, I would think that their hedges should be doing alright.  Am I way off base here?