Strategies for 2008

Lets see how wrong I can be in a year's time:

US:

Distressed will do poorly relative to expectations. Too much money chasing too few defaults.

Risk arb to do well. Dispersion of valuations and financial strength, cross border opportunities for emerging market acquirers. Currency effects, cheapening USD makes US companies interesting targets.

Equity long short. Hard to generalize but dispersion likely to increase, so positive for the strategy.

Direct lending. Good place to be. Bank credit contraction is very positive for the strategy. PIPEs will struggle in the exit thoughl.



Europe:

Distressed to do well. Fewer players, less capital, more economic leverage even if less financial leverage.

Risk arb to do well. Mid caps heating up. Cross border heating up.

Equity long short. Dangerous place to be given how export dependent Europe has become. German economy very levered to China and Asia. Infrastructure growth in Asia to support demand for capital goods and intellectual property in countries like Germany.

Risk arb, interesting currency angle across the pond.


Generally:

Convertible arbitrage. CBs are cheap by any measure. Asian CBs, India, Japan, India, cheap. European CBs are less interesting.

Vol arb should profit as volatility remains high. Implieds have cheapened while real vol remains high.

Cap structure arbitrage. A very interesting strategy for the times. Ample opportunities to get it horribly wrong. Temptation is very high to double up and pray for convergence. Stability of capital will reward this strategy. Arbitrage profits exist and remain quite rich but mark to market risk is high.

Strategies to do poorly:

US distressed debt. As above, too much money, legacy of cov lites. Strategy likely to do well but not in 2008. In 2009 should be a roaring strategy.

Commodities. Too many directional traders taking a long view on energy and ags, chasing returns, riding momentum. Demand picture is strong but not robust.

Direct lenders. The ones who give up yield for equity upside are going to find their kickers more volatile than valuable. IPO markets moribund. No exits.

Not many strategies will do poorly. As the world works its way out of recession most strategies will find tailwinds.

Oil and Gold

Forecasting is a losing game. Forecasting commodity prices is a particularly risk losing game. So here goes.

The price of oil in gold has traded in a range 0.04 – 0.06 from 1989 to 1999. In 1999 it rises to a new range. 0.08 – 0.12 breaking to 0.15 in 2005. Currently the ratio trades at 0.12, near the top of its range.

A research study by Purvin and Gertz, an energy consultant has the oil price at 60 – 70 USD per barrel if you exclude non economic demand, that is speculative demand and accumulation of strategic reserves.

A plausible explanation for elevated oil prices is that the Middle East peace process (a misnomer clearly) was derailed in 1999 and the new Intifada began in 2000. Accumulation of strategic reserves provides a base line of support for oil prices.

The Intifada isn’t ending any time soon. If anything the region has become less stable and there has been an escalation in posturing in recent weeks and months. On the other side, India and China are operating disinflationary policy, the US and Europe are in recession. Economic demand for oil is likely to fall.

Short oil spot. Long out of the money call on oil to hedge. Long gold futures spot, hedge with short call on gold. Alternatively long put spread on oil, long call spread on gold. More expensive but less exciting. All strikes and notionals to reflect the view that oil quanto gold will fall from 0.12 to 0.08.