Thursday, February 28, 2008

The Hedge Funds are Coming! The Hedge Funds are Coming!

I wrote a few weeks ago about the coming crush of hedge funds that are coming into commodity markets (I have zero proof but I know any hot market will draw in their computers like blood in shark infested waters) [Feb 12: Wheat is Being Ruined by ... what else... Hedge Funds and Speculators] I wrote:

... strength begets strength and strength means hedge fund computers scanning the globe for any pattern will start chasing each other into the commodity futures markets. While I do expect the trend to remain up, the volatility will increase (thanks hedgies!), and another interesting thing happened - the daily limits were increased so the intraday volatility will sharpen - cool! This allows wider ranges for daytrading for these futures, more fun for the hedge funds.

Again I am not a CBOT trader, never traded a future directly in my life but I know human psychology and the pure and utter greed and avarice on the Street - so I knew this would bring in the hedgies.... and the comments below by experts seem to confirm my guess from a few weeks ago.

Yesterday was apparently the most crazy day ever in wheat futures, a swing of 25% in 1 day! If it is "good" or "bad" I will leave that decision up to you, but you can see how these quant computers truly ruin any market (unless you are a daytrading dynamo). Wherever they go, it is like locusts - they will chew it up, spit it out, spin it, kick it, push it, punt it... and make sure volatility increases by a huge magnitude. And as Ben continues to cut and flood more liquidity into the world, as I stated many times, more and more is going to go into relatively small commodity markets because this is where "hot money" is going; so we will have a bubble - and I fear it will be epic. There is no shame investing in a bubble. It's just a matter of making sure you are not the last rat standing at the party when everyone piles out the door at once. I don't think we're even close but unfortunately the volatility of my once "stable" Powershares DB Agriculture Fund (DBA) is going to increase by a serious amount. Again, this was predicted but it's sort of like having a nice quiet society party, and the wedding crashers (hedge funds) show up with their tattoos, spiked hair, and brash attitude. Damn kids.... I do feel bad for the humans who have been in this market for decades, doing their things and then seeing "this" suddenly arrive.

Remember folks, all this macro thinking and fundamental analysis we try to do? It's is mostly useless in the short term as computers drive 70% of all trading. So when you sit there and ask "why the heck is this the outcome; it makes no sense in light of the news", try not to get too frustrated... it is not human decisions that makes most of the trades nowadays - simply computer programmed algrorithims churning out 100s of decisions by the second across the world. We're just along for the ride in most cases. And these markets are simply TOO small for all the fiat dollars now chasing into the system.

Welcome to the Jungle.

  • The largest price swing in the history of Chicago Board of Trade wheat futures on Wednesday baffled market analysts and sparked frustration among long-time traders who have used the market as a tool to hedge risk.
  • The CBOT March wheat contract traded in a range of nearly $2.70 in a single day, from a low of $10.65-1/4 up to $13.34-1/2, a record spot price for wheat on the 160-year-old market. The contract ended up nearly 7 percent, settling 80-1/2 cents higher at $12.80 per bushel.
  • Until two weeks ago, the normal daily trading limit for CBOT wheat was 30 cents a bushel, either up or down.
  • "This is why a lot traders won't trade this market anymore. This kind of volatility, and lack of connection to what's happening fundamentally in the market, have a lot of traders saying there are other things to trade that have less risk," said analyst Shawn McCambridge at Prudential Financial.
  • "You can't afford to participate in these markets if you're a small or medium-sized guy, as far as an elevator or producer. You could be doing everything 100 percent correctly, and the market trades like this, you could get annihilated," McCambridge said.
  • Yet CBOT floor traders said the market's latest violent gyrations reflect the increasing influence of hedge funds which have been pouring money into CBOT grains.
    The price action on Wednesday, they said, had more to do with fund maneuvers than with bullish fundamental factors.
  • "There is an enormous amount of bitterness down here," one CBOT wheat floor trader said.
  • "When I first started, we had 1/4-cent moves and an 8-cent range, and everybody was happy. Now we have $1 swings, and everyone is mad at each other," a longtime CBOT trader said.
  • He added of Wall Street investors: "Multi-trillion-dollar markets moving money into these type of markets ... exacerbates the problem."

Bloomberg adds....

  • Wheat futures rose more than 25 percent from today's low to their high, a gain that was bigger than all but seven annual price increases for the grain since 1973 on the Chicago Board of Trade. The volatility increased the potential profit and loss on every transaction, discouraging some traders.
  • ``A lot of players are just packing it in or drastically reducing positions because you just can't control the risk,'' said Jack Lablonde, president of Benchmark Trading Inc. in Cedarburg, Wisconsin.
  • ``It's a free-for-all,'' said Tomm Pfitzenmaier, a partner at Summit Commodity Brokerage in Des Moines, Iowa. ``I don't know if it's money management or fear. There's no fundamental justification for prices being limit up yesterday and down the limit today.''
  • ``All technical analysis and fundamental analysis is basically obsolete when the markets start to trade like this,'' said Marcus. ``Bulls and bears are both scared and are in a high-stakes game of hot potato right now.''

Again, I wrote last fall we will have a Bubble 3.0 - caused by Ben. Repeating same policy of Al. When people wrung hands that the Fed won't cut rates due to inflation I laughed. I remember literally saying so on the Halloween cut when "pundits" opined the Fed would be restrained. That's now how it works anymore - we cut, cut, cut - and the fact the financial problems were far bigger than anyone at the time cared to acknowledge would just cause them to continue to cut. Now at the time I said 3% by the spring (when we were around 4.75%) and I never envisioned 1.25% in 9 days. But the destination is the same. And why I think 2% is all but in the bag now as panic over takes the Fed. While they lie about how everything is just dandy.

I didn't know where the next bubble would be, but guessed either foreign markets or commodities. It could still be both. But commodities is such a smaller market, so this onrush of paper money is going to take this bubble to severe heights. Despite tremendous moves, I still think we're in the early innings. And the speculation in the agriculture commodities, is going to be felt the world over -- most likely with some famine. But hey, we bailed out the bankers in NYC, and we're creating some great profit opportunities for some of the richest men in the country (hedge fund managers in CT) and that's all that matters to this Fed. So smile away Ben... ignore Ron Paul and his sense... just smile away, and talk to us about how inflation will be gone when the US economy slows. And keep printing worthless pesos while you smile. In a year from now people will see the light. Until then, CNBC will clap at your actions. And people like me will be accused of Chicken Little tactics.... we'll revisit Spring 09.

Long Powershares DB Agriculture Fund in fund and personal account

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