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Is the commodity bull run over?

August 4, 2008

 

Just one week before the opening of the Olympic games in China (an event that signified to many just how much demand for basic commodities there is in China, given the gargantuan scale of the build up to the Olympic games), we are starting to see cracks in what many believe is a decades long commodity bull run to be fueled by China.

Now, no one can claim with any certainty to know what will happen over the next week, much less decades – and a sell off now may just be a pause before runs up to new all time highs for many markets like Soybeans, Crude Oil, and Copper. But perhaps the trade for many was a variation on the old buy the rumor, sell the fact trade. Perhaps investors were buying commodities in ‘05,’06, ‘07, and early ‘08 – and are now using the Olympics as the exit point, as the pinnacle of China-mania.

Perhaps this recent sell off in commodity prices is the beginning of the end, so to speak; for what has become known as the great commodity bull run. Consider for a minute how far we had come since 2003:

(March 2003 – March 2008)

Copper

+413%

 


Crude Oil

191%

Wheat

+314%

 


Gold

183%

Heating Oil

+192%

 


Soybeans

143%

Those are some whopping numbers, representing gains of between 25% and 50% per year over the past 5 years. But now consider the moves we have made since many of these markets have peaked (only the Hog and Cattle markets remain near their highs).

% Down from recent All-Time Highs:

Wheat

-45%

 


Soybeans

-21%

Natural Gas

-40%

 


Heating Oil

-19%

Palladium

-36%

 


Silver

-19%

Cotton

-33%

 


Crude Oil

-18%

Corn

-29%

 


Copper

-18%

Platinum

-28%

 


Gasonline

-17%

Orange Juice

-26%

 


Sugar

-12%

Coffee

-23%

 


Gold

-11%

Some of these numbers sure don’t seem like a normal pause or breather before taking off to new highs. Some of these numbers look like full fledged sell offs, and you can be sure that if these were equity markets, we would be hearing the television pundits clamoring that we are in or near bear market territory for 14 out of the 16 markets listed above.

One thing which would confirm that the commodity bull run is over is if these sell offs start to feed on themselves much as the run to higher prices did, with further declines pulling more people in on the short side, which in turn leads to further declines. The traditional trend followers and speculators would then switch to the short side, and look to ride the trend down; while the new breed of commodity market interests (the long only index funds) would be selling like crazy to reduce exposure as fickle investors in those funds pull money out of suddenly underperforming commodity index trackers.

But, it is rare for a market to go from up trend straight to a down trend, with a nice A-frame shapes on the chart (^). It is more likely that we are in for an extended period of back and forth as the bears and bulls fight for control. What does this all mean for your CTA investments?

We wrote just a few weeks ago in our June 16th newsletter, How would Commodity Bubble Bursting affect CTA performance:, about the effects a possible bursting of the commodity bubble would have on the

What we didn’t touch on was the danger of correlations increasing during a sell off (or bubble bursting). There is an old trading axiom that the only thing which rises in a falling market is correlation – and that has been borne out over the past few weeks as we have seen sympathy selling in seemingly unrelated markets as Crude Oil went from $148 to $121 today.

Soybeans, Corn, Wheat, Cotton, Platinum and more have all seen declines equal to if not sharper those in the energy sector.

This causes problems for traditional CTA progams, (and even non-traditional ones) as their protection is in their diversification across markets and market sectors. A traditional trend follower will look to cushion losses in open trade profits from a sell off in one sector, wirh gains in another non correlated sector.

But when the sectors suddenly become correlated, then those programs who rely on market diversification for protection from losses become exposed. They suddenly lose their protection, and larger losses than they bargained for can result.

We saw this in real time this past month as several systematic programs with multiple market exposure struggled to losses. Among them were Clarke’s Worldwide and Millenium programs (-12% and -16%), Hoffman Asset -8.5%, Vision Capital -34.8%, and APA Modified -15.8%. But these programs were also among the best performers YTD as they rode those markets higher.

The trick, of course, is to make more on the way up, than you lose on the way down when the trends end; and any manager who can stay positive for the year despite the commodity bull run ending (if this is really the beginning of the end) will have done just that.

For my two cents, I think it is a great time to get involved with one of these managers. These sectors won’t remain linked forever (remember, correlation is highest during the sell off), and there is the very real possibility that we could see trends just as strong on the way down (which will benefit the multi-market managers).

If you are already in one of these managers – the best course of action (as always) is to diversify yourself into programs which do something different. In this case, diversifying into CTAs which aren’t reliant on multiple commodity market trends to perform. These include the index option selling CTAs (Cervino, ACE, Crescent Bay, et al); Discretionary, single sector managers (Dighton, NDX, Rosetta, etc.); and CTAs with shorter term trading exposure (APA, Clarke Global, Pere, etc.)

What you don’t want to do, is be that client who gets out at the bottom and in at the top. Consider the past three years, which have seen several different environments which have suited different types of programs well.

2003-2005 – option sellers up, multi-market down

2006-2008 – multi market up, option sellers down

2009–2011- ???

Several investors have been the poster children for bad timing, getting out of the multi-market programs and into the option sellers at the beginning of 2007 just as volatility spiked, then compounding things and getting into the multi-market programs just as the commodity bull run ended.

Such an investor may be in successful programs, but never had success. We have long said in these writings, that you can’t chase returns – and that always going for the best performer, while ditching any program which struggles for a month or two (or a year) usually results in getting in at the top, and out at the bottom. It is far better to zig while everyone else zags.

In that light, if you have been looking to get some multi-market, commodity exposure – now is the time. You avoided getting in at the top, and can now get in (zig) when others are thiking of getting out (zag). If you are already in a program with exposure to multiple commodity markets, use the tough environment in July as a wake cup call and reminder to diversify into some other programs which can perform in such an environment.

- Barbara Mueller

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: Month in Review: Commodities (Crude) finally sell off, head lower

Overview

The Energy complex led all inflationary products down last month with losses stemming from worries of a deeper global economic slowdown than originally anticipated. The biggest loser in July was Natural Gas which shed -33.51% as supplies grew at a much greater pace than earlier estimated due to lighter consumption from a mild summer season in the U.S. to date. Heating oil followed losing -16.92%, with Crude oil down -15.85%, and RBOB Gas posting losses of -15.53%

The grains and foods followed along, seeing losses tied to better anticipated supplies and lighter than expected demand. In the case of the Grains and Oilseeds production was the main factor as crops in the U.S. fared better than originally anticipated after major flooding in June according to the USDA with crop conditions in both corn and soybeans better than those of a year ago. Corn led the way down -19.85%, with Soybeans -10.91%, and Wheat -9.39% keeping step. Other movers in the sector were OJ -13.56%, Cocoa -11.16%, Coffee -8.80%, and Cotton -5.29%. One bright spot of note was the Livestock sector as Lean Hogs gained +10.96% as prices due to fewer Canadian hogs entering the U.S.

The Metals also saw their share of pressure during July, especially in the industrial sector as signs of weaker growth in the emerging countries sparked heavy pressure in Palladium -17.59%, Platinum -14.17%, and Copper -5.70%. The precious metals were mixed with Gold -1.12% and Silver gaining +1.68%.

Despite heavy losses to start July, Stock Index markets fought back to mixed results for the month as better than expected earnings in some sectors and a few economic releases that were not as dire as earlier anticipated sparked some bargain hunting. The Russell +3.43% was the bright spot with the Dow and NASDAQ also eking out small gains. The Mid-Cap -2.21% and S&P -1.10% had trouble overcoming issues in the banking sector, but ended the month at much better than mid-month levels.

CTAs

We had been waiting for the other shoe to drop for some time, knowing commodity prices; and CTAs riding the prices higher, couldn’t keep positing gains month after month.

Well, systematic Multi-Market CTA strategies struggled in July as commodity prices finally began to reverse course after an eighteen month bullish run. Most of the losses among these CTAs were from open trades and reflect a give back of profits made over the last year and a half. However, it is never easy to see losses in an account, whether they be profits or not.

For a clue as to how difficult a month it was, the top systematic CTA in July at Attain was Clarke Capital - whose Global Magnum program made +0.61% and Global Basic Program lost only -1.19%. Most of Clarke’s success came from doing nothing (what a novel idea) as the manager was very quiet in both these programs throughout the month. Next in line was Optimus Capital at -1.19% and Northside Trading at -1.50%, while the Attain Portfolio Advisors Strategic Diversification Program weathered the storm at -2.37%. The next level of CTA’s in the red includes Hoffman Asset at -8.50% and Robinson-Langley with returns of -8.69%. Finally bringing up the rear are Longterm Trading -15.32% and Attain Portfolio Advisors Modified Program at -15.75%.

In comparison, discretionary multi-market managers performed much better than systematic traders in July. This is almost to be expected anytime a quick and volatile market reversal occurs in the commodity sector. The one advantage a discretionary trader has over a systematic trader is that he or she can quickly exit a position on a whim, and not wait for a signal, to protect open trade profits during volatile market conditions.

Both multi-market discretionary traders tracked at Attain were profitable in July with DMH Capital making +3.80% and Dighton USA making +0.25%.

Finally, Pere Trading Group, who specializes in trading the e-mini SP via a short term swing trading model, had a very nice month in July as the model feeded off of several large moves in the S&P futures - with returns of +29.15%.

Another bright spot in July were the option selling CTAs, who reminded investors of the power of portfolio diversification. July's top performing option manger was LJM Partners LTD with a solid gain of +4.46%. This month gain puts the program ahead approximately 30% for the year and up over 78% over the past 12 months - Congratulations to Scott Sykora and his team! LJM began his trading back in 1999 and has since produced an annualized rate of return of 32.15% with a maximum drawdown of 46.54% - needless to say the program is not for the faint hearted, but has certainly been rewarding (+1,346% All time...yes over 1000%).

Other option seller, estimated returns for the month included: Ace Investment Strategist -0.50%, Ascendant S1 +4%, Cervino Diversified Options +1.01%, Cervino Diversified Options 2x +2.38%, Cervino Commodity Options +3.96%, Crescent Bay PSI +1.0%, Crescent Bay BVP +0.50%, FCI +2.30%, Raithel Investments -0.15%, Zenith Index +0.92%, Zenith Diversified +1.54%, Zephyr Aggressive +1.84%, and Zephyr Moderate +0.56%.

For the Agriculture mangers July was a bit of mixed bag with performance ranging from +2% to down -7.8%. Chicago Capital was the top performing manger in this sector for the month earning +2.02% in July. This months returns represent 3 consecutive profitable months in a row and has helped investors in the program to work their way back toward positive returns for the year (not quite there after a -5.58% in January). Other returns for July were as follows: NDX Abednego -5.38% (+6.05% YTD), NDX Shadrach -7.81% (+33% YTD), and Rosetta Capital +1.29% (+15% YTD).

Trading Systems

Trading system results were mixed for the month of July, with a select group of seasoned programs accounting for the majority of positive returns.

Beginning with the day trading systems, Compass SP had a standout month, finishing ahead +$9,958.62 on fifteen trades. The strong month pushed the system into triple digit returns for the year to date, and has it on pace for its best year since inception. Waugh eRL finished the month +$2,276 on eighteen trades for the month. BounceMOC eRL was quiet with just two trades but made the best of those trades +$1,651.76, and its cousing BounceMOC eMD followed a similar pattern with just one trade for +$705.

On the losing side, BetaCon 4/1 ESX lost -$492.22 on five trades for the month and Rayo Plus Dax traded eight times for a loss of -$3,417.57.

Moving on the swing trading systems, Bounce eRL and eMD had similar results to their day trading equivalents +$1,690 and +$700 respectively. SeasonalST ES had four trades for a loss of -$957.50 and Ultramini ES lost -$3,515 on eight trades.

In long-term system trading, we saw a continued slide in commodity markets forcing most systems out of their long energy, grain and metals positions. However, with the huge run-up of the past year it will take some continued downside movement before we start to see trend-following programs entering short in these markets.

IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.

Please read carefully the CFTC required disclaimer regarding hypothetical results below.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.