This weeks episode of the Systematic Investor Podcast already hit the virtual shelves on Saturday, basically front-running our weekly summary. The guys engaged in an worthwhile discussion on the combination of mean-reversion strategies and trend following.
This reminded me of this paper from 2010 applying mean-reversion and momentum on the fx market. The paper shows that while some classical cross-sectional momentum approaches can not easily be combined with mean-reversion, a joint modeling perspective following Balvers, Wu and Gilliland (2002) creates significant abnormal mean returns (slightly underperforming those of the stock market) and Sharpe ratios higher than in the stock market. If anyone (like me) feels the need to extend the data set and check the results for themselves, please let me know via firstname.lastname@example.org as I’m happy to help in exchange for a cold beer.
In this article, Mark Rzepczynski fittingly used Palladium’s case to highlight the inelasticity of supply and demand in commodities. The article definitely shifted our attention back to the markets last week. And the good news for people hoarding the stuff with an eye on fiscal armageddon? It’s less shiny than Gold and with a 4.8 rating on the Mohs hardness scale vs 2.5 for gold it’s at least a bit harder. Yes, it’s not hard enough for a post apocalyptic battle axe or a knife – you need at least a hardness of about 5.5 – but then again sometimes even old bottle caps turn out to be quite useful if you find the right recipient. So maybe you should go out, buy some of the stuff and diversify your holdings.
Demand for many commodities can be very inelastic because there are limited substitutes. Palladium is a necessary metal in catalytic converters especially for gasoline engines and the next closest substitute, platinum, is less efficient. 85 percent of palladium usage is tied to the automotive industry, so high auto production with more stringent pollution standards will keep demand high.
Supply is also inelastic given the costs of developing new mines and the fact that there are often decreasing returns to scale with mining. In the case of palladium, it is a by-product metal from nickel and gold mining. New mining is a function of the average or combined cost of the metals to be found. Palladium has been in net deficit for a number of years and the inventory buffer stock has been eroded.
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