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A rising US Dollar NOT what managed futures need right now.

December 14, 2009

 

The talk for much of the past few months by the talking heads on CNBC, Bloomberg, and elsewhere has been how weak the dollar is and how much weaker it could become if we keep running up huge deficits and scaring the Chinas of the world into thinking they should have less dollars on hand, and more Euros or Gold instead.

We talked in our October 5th, 2009 newsletter  how a down trending US Dollar was just what the doctor ordered for managed futures as a whole, which up to that point had been struggling through most of the year.  And as you can see from the chart below, that has mainly been the case since the US $ weakness started accelerating around the beginning of August.  The chart shows the inverse performance of the US $ (the line on the chart goes up when the US $ goes down), versus the daily performance of the Newedge CTA index (which tracks managed futures programs open to new investment with assets under management over $850 MM); and it is clear that the CTA index has been tracking the short US Dollar performance for most of the past 4 months (getting into trouble at the end of Oct. and so far in Dec. when the US Dollar strengthened).

We also showed in that October newsletter how the weakness in the US Dollar since the March stock market lows has fueled “fake” up trends in several commodities (Gold chief among them, which as of October was up in Dollar terms, but down in Euro terms since March 9, 2009) and CTAs have pounced on those fake up trends,  for the most part, showing nice gains in November as they have ridden the weak dollar, strong everything else trend up up and away.

Examples include Clarke Global Magnum with returns of +19.05% in November, Clarke Global Basic +13.46%, Integrated Managed Futures Global Concentrated +5.98%, Robinson Langley Capital +3.00%, Hoffman Asset +3.75%, Futures Truth SAM 101 +2.30%, and Attain Portfolio Advisors Strategic Diversification +2.02%.

But what happens when this party ends?

The performance of many multi-market systematic managed futures programs has become severely correlated with the fate of the US Dollar. A weak dollar and they are looking good. A strong dollar as we’ve seen to start December, and things could go from somewhat bad in 2009 to worse.

A look at the correlation between the Newedge CTA Index and the inverse of the US$ across various time frames is shown below. The upwards sloping line as we look at shorter and shorter time frames show that this weak US $/strong CTA performance link has become more pronounced as of late.

As we laid out in our October 5th, 2009 newsletter  mentioned above, this high correlation between managed futures performance and a weak US Dollar is due to the strong link between rising commodity prices and a weak US Dollar (with commodities priced in US Dollars, their value in terms of US Dollars must rise if the US Dollar falls in order to hold their ‘true’ value). With the trend in all of these commodities up since March, most multi market systematic programs (which tend to include some form of trend following) are left holding open trades which are long commodities like Gold, Crude, Soybeans, Sugar, and Cotton, while at the same time either short the US $ or long foreign currency futures against the US Dollar. US bonds, meanwhile, have always held a negative correlation with the US Dollar and have been rising as the US Dollar has been falling.

What hasn’t always been correlated to a falling US Dollar, is rising US equity markets, but that has been the case over the last few months as well, with the stock market rising or falling depending on whether the US Dollar is down or up that day.  Perhaps this is the downside of more globalization amongst the large companies comprising the US stock indices?

What this all works out to is most managed futures portfolios looking something like this: long energy, grains, softs, metals, stocks, foreign currencies, and bonds.  The only shorts of note are in the US Dollar, which is not a short at all, it is a long play on a weak US Dollar.

The following snapshot of three programs on our recommended list which contain classic trend following logic in one way or another, show just how pronounced this long effect is, with each having ~85% or more of their positions currently long.

Manager

Open Trades

Long Commodity

Long               Stock

Long               Bonds

Long FX (Short US $)

% Long

Hoffman Asset

13

5

0

3

3

84.62%

 

Integrated

22

8

2

9

2

95.45%

 

Robinson Langley

8

4

0

1

2

87.50%

#as of 11/30/09

With all of this long exposure, and that exposure reliant upon a weakening US Dollar – you can see how a strengthening US Dollar would not be a good thing for managed futures performance to close out the year.  And the last thing managed futures need to close out the year is another headwind, as they have underperformed all year in the face of a sharp drop in volatility.

Unfortunately, we’ve already seen some of this problem, with the US Dollar rallying just under 2% since the end of November. That rally has put pressure on all of the rising commodity markets we’ve been discussing. Since the end of November Gold has fallen -8.5% in just 7 trading sessions, Crude Oil is down -10.05%, Silver has fallen -9.72%, and 30 Year Bond futures are down -3.82% (there’s that odd weak Dollar/bonds correlation we’ve seen recently).   

What will managed futures performance look like if the US Dollar rebounds?

So what happens to managed futures performance if the US Dollar rebounds significantly and we head back down to the March lows in everything from stocks to Crude Oil to Soybeans? Was last week a warning shot, cautioning us that we sitting on the same precipice we were last July, ready to plunge down into the depths?

The stats do look eerily similar. In the 10 months from Oct. 07 to the highs in July 08, the CRB index (an index tracking commodity prices) was up 18.63%. The current bull run in commodities has been quite close,  with the CRB up 25.86% over the 10 months from March 2009 to the highs in November.

The problem, of course, if they are similar moving forward is that July 2008 marked an epic top in the commodity markets, where the CRB lost -42% of its value in just the next four months.  If history is about to repeat itself, what does that mean for managed futures?

We envisioned three scenarios below and theorized on what managed futures performance might look like should each come to pass.

One: A sharp sell off down to new lows .If there is a sharp sell off down to new lows, that will mean short term pain for managed futures (excepting option selling programs) as all of the long term positions outlined above give back significant open trade profits and are then stopped out of their positions.  However,  if the sell off continues down to new 12 month lows and beyond, managed futures programs will likely benefit as they get  in line with the short trend and ride it lower as was seen in September, October, and November of last year when the sell off in commodity and stock markets accelerated.  Option selling programs would have the toughest time in this scenario, as they did in 2008.

Two: A moderate sell off :  A moderate sell off, where we’re down 2 days, up 1, and so on; with no big spikes lower would be less painful for the long positions outlined above, because the managers would be able to move their exit points up little by little as time progressed. It would likely mean some down performance, but not the type of short term pain seen in case 1 above.  If the moderate sell off continued, managers would start to enter into short trades; but a moderate sell off would also likely mean the end of the high US Dollar correlation we’ve seen in 2009, as markets start to move based on their own fundamentals and price action in contrast to just being one big global recovery trade.  Option selling managers would likely do well in this scenario, as prices would be contained without many outliers. 

Three: A spike lower, followed by a sharp rally back up to current levels:  This scenario would not be good for anyone except really long term trend followers and buy and hold investors. The spike lower would cause losses on all of the long positions outlined above, and perhaps even take many programs short across commodities, stocks, etc.. If everything rallied back up in tandem, opposite a weakening US Dollar, that would then cause losses on the newly initiated short positions.  Option selling managers would likely struggle, seeing their far out of the money Puts increase in value on the spike lower, and then a few weeks or months later finding their sold Calls under pressure as the market rallied back up.

Which of these three scenarios comes to pass is anyone’s guess (and most likely it will be some convoluted combination of the three), but we do know for certain that in the short term, the last thing managed futures portfolios want to see right now is a rising US Dollar.  Some of the potential pain has already been realized during the past week, but there could be more to come if the Dollar rallies further. On the other hand,  rallies in Gold, stocks, grains, and metals today may mean that last week was just a little hiccup, and there is more upside for the short US Dollar/long everything else trade.

Who could do well if the US Dollar rallies? Managers who might escape a bit of appreciating US Dollar pain are discretionary managers such as Mesirow, Dighton (Dighton is actually long the US Dollar in a counter-trend play), and DMH – as well as short term and single market sector programs such as Paskewitz, Dominion, NDX, and Sequential.

Jeff Malec

 

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: Dollar rally sends Oil, Gold down

Overview

Market activity was mixed to weak overall as strength in the U.S. Dollar helped spur profit taking in the sectors that have recently benefitted from the steep fall in the greenback. The uneasy mood of a Dubai government backed company risking a possible default on a bond due Dec. 14th also kept pressure on some sectors. The news remained unsettling to most world markets, especially given the fact that just a year ago worries of debt defaults by some U.S. investment banks helped advance the worst recession since World War II. The Mideast news did little to dampen the stance by most central banks for leaving key lending rates unchanged  hinting that low rates would be the norm in the foreseeable future other than in a few countries where growth has exceeded expectations. European news was mixed as some countries had favorable growth figures which improved ideas of favorable earnings and a better recovery for some of the larger economies.  Asian headlines remained constructive as China indicated its recent export pace have turned the corner prompting ideas that the global recovery is taking hold. Other constructive developments were the higher U.S. retail sales figures and better than expected consumer confidence which helped enable a decent rally by the U.S. Dollar index +0.87%. The Japanese Yen +1.58% also had a strong rally aided by the U.S. news along with reports that the Japanese government will just watch for now and not intervene against the recent rally.  In other currency action the Swiss Franc -1.77% led the balance of the continentals down followed by the Euro -1.59% and the British Pound -1.20%.

Higher retail sales figures and better than expected consumer confidence figures were a strong pressuring factor for rate futures last week. The complex also took it on the chin from very poor note and bond auctions as the 30-year Bond futures ended -0.84% and 10-year note future shed -0.05% for the week.     

Stock Index futures posted mixed results during the last week as early pressure due to debt default worries gave way in some areas to better than expected news for the U.S. economy.  The Dubai turmoil was worrisome early in the week with a bond issue coming due on Dec14th sparking rumors that as the week drew to a close seemed to subside. The news from late week U.S. economic reports aided a recovery with both retail sales and consumer confidence improving more than expected. For the Week Dow futures +0.82% and Mid-Cap 400 futures +0.56% ended firm. Russell 2000 futures -0.45%, NASDAQ futures -0.04% and S&P 500 futures -0.01% all had small corrections.       

Commodity and Food products were mostly higher as weather issues and news of better exports seem to keep investor support filtering into most sectors of the complex. Weather concerns again led to higher prices in Corn +4.12%, although Wheat -3.69% and Soybeans -0.70 ended lower on news a possible larger Southern Hemisphere crop. The livestock sector was mixed as waning pork demand sparked pressure for Lean Hogs -1.99% with Live Cattle +0.08% supported by better exports expectation for beef. The Soft arena was strong on various reports indicating higher demand for the next few years due to population and income growth worldwide. For the week Sugar +6.57% led the way higher followed by OJ +2.95%, Coffee +.92% Cotton +.66% and Cocoa +0.53%.   

Trade in Metal futures was fairly active during the past week, although results were weaker due to default worries in Dubai, a strong greenback and better economic conditions in the U.S. prompting the pressure. For the week Silver -6.02% led the way down followed by Gold -4.24%, Palladium -3.68%, Copper -3.23% and Platinum -1.60%.   

The energy sector was mostly lower during the past week as supply and demand scenarios turned to a more negative state due to poor U.S. consumption figures which outweighed a report indicating higher international consumption for 2010. Crude Oil futures -7.42% led the way lower followed by RBOB Gasoline -7.22% and Heating Oil -4.84%. Natural Gas +12.58% were supported by U.S. weather reports showing a major cold wave arriving in the next week for most of the country along with spread unwinding versus other energies.            

Managed Futures

Option Trading managers are, once again, at the top of the performance list to start the month.  Leading the way all year long and, now down the stretch, has been the diversified trading of FCI OSS which is ahead an estimated +3.23% for December and was up +34.92% through November.  After stumbling in 2008 (-23.02%) they have since recovered to new equity highs for nearly all existing client accounts. 

Other option trading estimates for December are as follows: Ace Investment Strategist +1.05%, Cervino Diversified Options +0.51%, Cervino Diversified 2x +1.05%, Crescent Bay PSI +0.74%, Crescent Bay BVP +1.68%, FCI CPP +1.37%, HB Capital +1.83%, Oak Investment Group -1.33%, and Raithel Investments +0.88%.

Specialty manager performance has remained mixed most of the year and December is no exception.  The top performer throughout the year has been the Emil Van Essen Spread Trading program which is ahead an estimated +19.77%  through November and +0.73% so far in December.  Elsewhere, the Agriculture and Grain trading of NDX Abednego is flat, NDX Shadrach is ahead +0.16%, and Rosetta is down -0.82%.

After a nice month in November many Multi Market managers have had rough start in December.   Most managers started to give back profits after a better than expect unemployment report on Friday, December 4th.   The better than expected numbers caused the Dollar to rally and commodities to sell off (see main topic above).  Regardless a few managers have been able to navigate the rough waters and post positive results this month.  Leading the way is Dighton USA Aggressive at +3.95% est.  Dighton has had a rough year in 2009 and it is good to see Alex and his team get off to a good start this month.  Dighton is a discretionary trader and has been net long Dollar for the last couple months while systematic traders have been net short. December has also been kind to DMH +1.89% and GT Capital +0.92% who are discretionary traders as well. The only systematic multi market manager in the black this month is Dominion Capital Management Sapphire at +1.00% est.

Managers that have suffered losses to this point include Mesirow Financial Commodities Low Volatility -0.33% est., Quantum Leap Capital -0.54%, Sequential Capital Management -0.54% est., Mesirow Financial Commodities Absolute Return -0.88% est., APA Strategic Diversification -3.00% est., Futures Truth SAM 101 -3.23% est., 2100 Xenon Managed Futures 2X -3.85% est., Futures Truth MS4 -4.48% est., Hoffman Asset Management -3.75% est., Robinson Langley Capital Management -6.13% est., Integrated Managed Futures Global Concentrated -7.07% est., Clarke Capital Worldwide -7.80% est., Clarke Capital Global Basic -9.72% est., Clarke Capital Global Magnum and -11.70% est.

In short term index trading Paskewitz Asset Management Contrarian 3X St. Index is up +0.26% est. to start the month.

Trading Systems 

Systems had mixed performance last week with the majority of the day trading programs finishing the week on the wrong foot while the swing models had some strong performances. As we approach the holiday season, trading activity is likely to slow down significantly as major market players start taking time off for vacation.

Starting with the swing time frame, Bam 90 ES continues to impress adding another +$2,075 last week. Jaws US 400 jumped in line with the bearish trend in Bonds for +$1,538.35 on the closed out trade.   AG Mechwarrior ES and Waugh Swing ES managed small winning trades (one each) for +$182.50 and +$20 respectively.  On the losing side, Polaris ES lost -$305, Ultramini ES -$605, Strategic ES -$1,290 and Strategic SP -$7,700.

Shifting to the shorter time frame, Upper Hand ES and Waugh ERL were the only day trading programs able to finish above water +$20 and +$12.85 respectively. All other programs took a step backwards with results as follows: ATB TrendyBalance v2 Dax -€965, BetaCon 4/1 ESX -€180, Clipper -$260, Compass SP -$1,509.17, PSI! ERL -$502.50 and Rayo Plus Dax -€1,370.

 

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.