Weekend Reads

This week wasn’t exactly boring in terms of stories to follow; with all eyes on Tampa for the Republican national convention, Hurricane Isaac making landfall in Louisiana, and Bernanke’s speech at Jackson Hole. However, in terms of market action, the low-volume, range-bound trading we’ve experienced through most of August continued. Fortunately, we’ve got just the thing to spice up your extra-long holiday weekend: our weekend reads.

  • A mutual fund that acts like venture capital? What could go wrong? (NYT)
  • Bernanke’s much-awaited speech at Jackson Hole (MarketWatch)
  • This August was the most boring month for markets in a long time (Business Insider)
  • After Isaac, New Orleans picks up yet again (Times-Picayune)
  • A fascinating look at Apple vs Microsoft (Felix Salmon’s Blog)

And just for fun:

Long-only Commodity ETFs vs. Futures- August 2012

It’s time for our monthly look at how the long-only commodity ETFs are performing versus simply holding the December futures contract and rolling annually.

Crude oil climbed higher in August, while natural gas took a tumble and corn stayed fairly flat. ETF underperformance against the December futures contract widened for crude oil and natural gas, but narrowed slightly for corn.

Futures trading is complicated, presents a risk of loss, and isn’t for everyone – especially since past market performance doesn’t necessarily indicate future results – but given the numbers, we’re left scratching our heads. Ultimately, we prefer a commodities investment strategy that can benefit from both rising and falling prices (like managed futures). But if you’re going to adopt a long-only strategy… we’ve yet to receive a good answer to the question: why invest in an ETF when you can just roll December futures contracts annually?

Read ‘em and weep:

Disclaimer: past performance is not necessarily indicative of future results.

PFGBest Update: NFA Making the Right Changes?

The news yesterday for PFGBest was good – the Trustee is finally going to move on making a distribution. While we wait to find out exactly how much that distribution will be, and at what point clients will start receiving the funds, the NFA revealed additional moves. As many of you know, we’ve been putting pressure on the NFA and its board of directors to conduct an extensive evaluation of its policies, practices and people, going so far as to call on Congress to launch an investigation of their own. After lengthy conversations with several board members, we seem to be making progress, with the NFA retaining expert consultants on the matter to conduct an independent review. The Wall Street Journal reveals:

Hiring Berkeley Research Group to examine the NFA’s auditing practices followed the July appointment of law firm Jenner & Block as counsel to the NFA as part of its internal review. Berkeley’s financial institutions practice includes market experts that helped examine the Securities and Exchange Commission’s failure to uncover the Bernard Madoff Ponzi scheme. A spokeswoman for Berkeley declined comment.

The review process is being overseen by a newly created subcommittee of the NFA’s board, made up of its public representatives and headed by Todd Petzel, chief investment officer of Offit Capital Advisors LLC.

Why does this matter? For starters, they’re not relying on a law firm to examine their practices; they’re turning to an organization with a history of working with regulatory bodies to improve their practices. Further, they board of directors is taking the situation seriously, designating a subcommittee to handle the situation instead of letting those who are potentially culpable guide the process. And it looks like this isn’t just an empty gesture, either. The findings of the committee, as it turns out, will have some significant consequences:

The fallout has extended to the agency’s most senior ranks. President and CEO Dan Roth last month raised with NFA’s board the issue of whether he should continue to serve, though didn’t formally offer to resign, according to people with knowledge of the discussion.

NFA directors determined at the time that it was premature to evaluate his future ahead of the external review. Decisions on bonuses for the 2012 fiscal year, which ended June 30, will also be deferred until that time, the people said. […]

While NFA board members have discussed general succession planning for senior management roles, directors haven’t pushed for any immediate changes, according to people close to the talks. With no evidence that anyone at the regulator was involved in the alleged fraud at Peregrine, the NFA’s board sees value in retaining its leadership—in particular Mr. Roth, who has worked for the agency since its inception in 1982-while navigating fallout from the broker’s collapse.

The NFA board decided to postpone decisions on bonus payments for senior management at a regularly scheduled meeting Aug. 16, according to a person close to the situation.

Now, we’re no fans of Mr. Roth and the direction of the NFA under his tenure, but we think this is the right move. We’ll give him props for putting his resignation on the table for consideration, and we’ll applaud the board of directors for deferring bonus payments until the final evaluation is completed; after all, those are supposed to be based on performance, right? But at least it appears as though there will be consequences if the evaluation yields poor results, as we believe it likely will – particularly if the review includes interviews with NFA members on the execution of NFA audit procedures.

Headed into the holiday weekend, we’re cautiously optimistic, but it looks like we may be FINALLY turning a corner in the PFGBest scandal.

Volume and Open Interest

When investors who are used to trading stocks first get into futures, most of what they see makes sense. Open, High, Low, Close, Volume – these are all fairly intuitive. But in the futures trade, there’s another number we sometimes use: open interest (OI). So what’s the lowdown on volume, open interest, and the role that these two stats play in the world of managed futures?

Simply put, volume refers to how many contracts changed hands on a given day. For example, suppose that George buys 20 contracts from John (who is now short 20 contracts to make the other half of the trade). Volume for the day would go up by 20. Now suppose John decides to close out part of his position by buying 10 contracts from our third friend Thomas (who is now short 10 contracts). Volume goes up again, to 30. Simple stuff.

OI is a little more complicated, because it refers to a count of how many contracts are “in play.”  In our above example, when George buys 20 contracts from John, OI would be the same as the volume: 20. But, after John buys 10 contracts from Thomas, OI would be unchanged, at 20. This is because the number of open contracts is still 20 – George is long 20, John is short 10, and Thomas is short 10.

To take the example one step further – if John closes out the rest of his position, buying 10 contracts back from George, volume would increase by another 10 – a total of 40 for the day. But OI would decrease from 20 to 10, to reflect the smaller number of active contracts in play (George is long 10, and Thomas is short 10).

So, what does all this mean for CTAs? Volume and OI are important factors in market selection. Volume speaks to liquidity, and OI speaks to how much a given trade will potentially move the markets. If a CTA gets too large for a market – that is, it’s trading so many contracts that it makes up a significant portion of that market’s OI – that can cause a problem. And it’s not just a troublesome for profits – due to the CFTC’s position limits, making huge trades in some markets may break the rules, and bring sanctions for the trader.

As a result, from market to market, you’ll see differences in how big programs can get before they really start to move the market with their trades and either stop accepting new capital or the program starts suffering. For traders in smaller markets, such as agriculture, that level may be as low as $50 or $60 million. Larger markets, like metals, can stomach more – up in the hundreds of millions. Global macro traders (managers trading 30+ world markets) can go even higher, handling a billion or two in AUM without a problem. Currency markets, because they’re so huge, allow FX traders to handle several billions of dollars before they start to be bogged down by size.

For managed futures, size does matter – volume and OI help CTAs determine whether a particular market is right for them. For investors and as a part of our due diligence process, asking the question of “what is the capacity” in any individual managers strategy is a serious question that the most forward-thinking managers are analyzing well in advance of volume or OI becoming an issue for their strategy.

PFGBest Update: It’s About Time

Today is August 30th. It has been a month and a half since PFGBest declared bankruptcy. After silence from the Trustee – FINALLY – news from his offices:

We will be waiting with bated breath. This process has been bungled – BADLY – but at a minimum, that means clients will be getting at least SOME of their money back. How much that is remains to be seen. As soon as we get more news, we’ll be with you.

Numb to the Rumors

Earlier in the month we wrote about the “August doldrums”- the sense that this month the markets have been, well, boring. Even taking into account the historically low activity in August, the lack of volume has been surprising. We aren’t the only ones to notice. But even the low volume doesn’t fully capture what we’re witnessing – the markets just aren’t going anywhere. The S&P 500 has been remarkably range bound, reflected by the lowest average daily true range of 2012:

S&P 500 E-mini Front-Month Futures Contract

*Through August 29. Disclaimer: past performance is not necessarily indicative of future results.

This August has been dull by historical standards, but it has seemed even starker in a year dominated by headline-driven ups and downs. The risk on/risk off trading environment of 2011 has followed us into 2012 – and when market correlations are high, the choice for investors increasingly boils down to “in or out?” And the answer for many this August, it seems, is “out.”

Neither the bulls nor the bears seem to have much conviction – and investors are content to sit on the sidelines for the most hated rally in recent memory. So what is everyone waiting for? Jackson Hole? The Troika report? The fiscal cliff? Rampant speculation about looming, potentially huge macro-economic bombs led to huge swings in the market earlier this year… but now all it musters is crickets.

In our view, the last year of the risk on/risk off see-saw has fostered a sense of weariness. Rumors and speculation can only swing the market so many times in a given period of time before those rumors start to lose their effect. Whether this is all to the good or not remains to be seen – we may still see extreme risk on/risk off swings once we get a concrete sense of what’s happening with QE3, the future of the Euro, or the fiscal cliff. But maybe, just maybe, the markets will stop swinging wildly on the rumors, and wait… to swing wildly on the facts.

A Golden Ruse

Oh, Gold. It’s been all over the headlines again, fueled partially by its dizzying ascent and partially by the call in the recently ratified GOP platform for a commission to investigate the ramification of a “metallic basis for U.S. currency” (read: gold standard). But before you go piling into all that glitters, Yahoo! Finance makes an excellent point-

According to the FTC, complaints in the area of investment frauds, including precious metals, have increased sharply over the past three years. In 2011, the FTC fielded 7,657 complaints related to investment fraud, compared to 6,490 complaints in 2009.

“Consumers are vulnerable, because other investments are not panning out for them. They’re looking for something different and precious metals are presented to them as a winning situation,” FTC attorney Dama Brown said.

After the financial crisis in 2008, as gold prices continued to rise, con artists began capitalizing on the economic climate and taking advantage of people’s fears, Brown said.

Sad facts, folks. Now, we’ve heard people encourage those looking for a gold investment to be careful – look for people who are licensed and reputable. However, as the article explains, not even that is really worth much faith.

Potential investors should know that people who sell “physical” precious metals, like gold or silver bullion, are not required to obtain licensing or training from the National Futures Association (NFA). Yet, some companies advertised their brokers as being licensed, Brown said.

“They are referring to a telemarketing license. If they were licensed in commodities, we’d call them brokers. But instead we consider them telemarketers,” Brown said.

The FTC has found that many fraudulent companies were operated by brokers who had lost their license to sell stocks or futures because of deceptive sales practices.

Pretty licenses, pretty words – all pretty much hollow. This doesn’t mean we have a whole lot of faith in the NFA, either, but it’s especially frustrating when the people peddling the fraud are hiding behind a piece of paper without any kind of real teeth in an effort to dodge their past indiscretions.

Just a friendly reminder – all that glitters…