Different Exposure, Different Price

Long Only Commodities as an asset class has been plummeting since around April last year, and the downtrend continues into 2015. The average move of commodity futures in January came out to be -5.02%, compared to ETFs -7.54%, with ETFs underperforming the futures markets they supposedly track by 2.52% {Past performance is not necessarily indicative of future results}.

Here’s our monthly look at:

1. How the numerous commodity ETFs which have sprung onto the scene the past few years are tracking a simple strategy of just buying the December futures market of that commodity, under the theory that the ETF will have to roll their positions periodically throughout the year, and in doing so take on costs the simple strategy does not have.

2. How the passive investment strategy of being long commodities (either via futures or ETFs) compare to an active strategy going both long and short commodity markets via a professional commodity trading advisor (as tracked by the BarclayHedge Ag Trader Index).

(Data as of January 30th, 2015)

Commodity ETF Over/Under Performance 2015

Crude Oil$CL_F
Brent Oil$NBZ_F
Natural Gas$NG_F
Live Cattle$LE_F
Lean Hogs$LH_F
Commodity Index $DBC-5.69%
Long/Short Ag Trader CTAs0.61%

(Disclaimer: Past performance is not necessarily indicative of future results)
(Disclaimer: Sugar uses the October contract, Soybeans the November contract.)
Long/Short Ag Trader CTA = Barclayhedge Ag Traders Index

7 Technical Indicators to tell when the Crude Sell Off is Done

Is Oil back at $100 and nobody told us? You would think with the Bloomberg headlines “Oil is on a Gigantic Tear,” and “Oil Enters Bull Market” that the down trend in Oil Prices may be over. Turns out, this is an example of why you sometimes need to read more than just the headlines, in one of those read between the lines / apply some context moments. Here’s Bloomberg’s context:

“After plunging for months, the price of oil has boomed over 20 percent in just the last three trading days. Last Friday it was just over $44 per barrel. Today it’s selling at nearly $54 per barrel.”

Now, Tuesday’s highs were in fact in the $54 range (even though it ended up the day in the $52 range) and the “bull market” math does work out if you buy into the sacred 20% level for signifying a bull market. But it sure doesn’t feel like a “Bull Market” in Crude Oil after the unbelievable veracity of the sell off, does it?  There should be some metric which adjusts the ‘bull market’ level for the just lived through ‘bear market’ levels.

Which leaves us with the question, how can you tell when these articles are just stirring the crude oil pot, and when is the market actually coming out of its months long downturn? How do professional trend followers tell when a trend is over? Or about to be over?

Is it as simple as watching until the market breaks through a carefully drawn trend line on your chart? It can be. But the professional traders who collectively run billions of dollars in managed futures programs with trend following models, actually use a few different methods for determining when a trend is over; looking at everything from moving averages to swing highs and lows, to directional indicators to relative prices.

Using some of these tools, we can look at just how far away (even after this three day “Bull Market”) Crude Oil WTI futures are from signaling an end to the down trend. PS – we assumed a closing price of $52.98 for the numbers below (that’s what was on our screen at the time we started writing).

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Move over Crude, There’s a new Oil in Town

Move over Crude oil, there’s another oily commodity market that’s doing it’s own swan dive of late. Who?  None other than good ‘ol Soybean Oil.

It has since rebounded a little from the 29 mark, but a -14% drop doesn’t quite live up to the -50% drop seen in Crude, but it’s certainly worth mentioning. And believe it or not, you might use Soybean Oil nearly as much as you use Crude Oil every day. We’re talking baked goods, salad dressings, and more which use vegetable oil, which usually has as its main ingredient – Soybean Oil (mind blown). Naturally, to get Soybean Oil, one must do something to the Soybean itself – do you ‘oil’ a Soybean the same way you ‘milk’ a cow?  No, you crush the Soybean – and end up with two parts, Soybean Meal and a byproduct – Soybean Oil.  Just think of another legume, peanuts, and what happens to a jar of natural peanut butter if it sits for a while…all that oil on the top… and you can imagine how a bunch of oil is locked up inside those beans.

And yes, of course, there are futures markets on Soybeans – and their products, Soybean Oil and Soybean Meal – and whole trading strategies built around trading the so called ‘Crush Spread’, buying the meal, selling the oil, and so forth. However, just because they all come from the Soybean – doesn’t mean all of the markets move together in lockstep. We looked back at the cash price of Soybeans, and Soybean Oil, and it turns out the correlation isn’t as high as you might expect, with some nasty moves into negatively correlated territory.

Soybean Oil(Disclaimer: Past performance is not necessarily indicative of future results)

The 10 year correlation comes out to be +0.25… which really isn’t that high for a market that’s completely dependent on the other futures market. How could that be…. Well, one of the reasons is you grow the Soybeans at a certain time, but they can be crushed at different times, and that the Oil can last longer than the bean itself – so there’s a bit of a mismatch in the deliverability of each.  The markets can also have different return drivers and other outside global policies that could affect the oil and not the crop itself. The most recent case, The EPA’s shift in import policy which could have caused the fall in soybean oil price via Reuters.

“U.S. regulators have given the go-ahead for Argentina’s biofuel makers to qualify for U.S. biofuel credits, potentially making it  more attractive for South American exporters to sell into the U.S. market and potentially pressuring local prices.

The green light will effectively make it easier for the South American grains powerhouse to sell its big biofuel output into the United States, potentially jump-starting the local sector which has suffered from a drop in demand from its No. 1 customer, the European Union, due to a long-running trade spat.”

Argentina’s Biofuels Chamber, The EPA, The National Biodiesel Board, and the European Union!? Who knew Soybean Oil policies could be so exciting. Now the article doesn’t link this policy change to a fall in prices, and this policy change happened last week, so it’s unlikely that this is what caused such a drop. However, this policy change from the EPA will create more supply because Argentina happens to be the world’s largest exporter of Soybean Oil, and now it can export to the U.S., and it will be accepted the same as Soybean oil produced in the states. Will this increase in supply fuel an implosion from soybean oil? We don’t know that answer… but we do know it can’t go to zero.

So have fun eating that stir fry, French fries, or whatever you’re having off that griddle. You might just be enjoying some Vegetable Soybean Oil.

2014 – Best/Worst Performing Asset Classes

What “sport” has 1000’s of teams, no rules, gets played night and day across the world with a scoreboard updated minute by minute, day by day, year by year, and decade by decade? It’s none other than the “game” of investing, where a new year is a great time to see where different assets finished in relation to each other.

Now, we’ve said before that comparing different asset class performances is like comparing apples and oranges, so we won’t make too much of Managed Futures coming in “second place” But, hey, if you can’t trumpet managed futures good year on a managed futures blog, where can you do it? We’re just happy Managed Futures proved that they have unique return drivers, and can perform when stocks are moving up or down. (For more on how and why managed futures performed the way they did, see our 2014 Managed Futures Strategy Review).

Elsewhere, world stocks slid in December, to be the only other asset class finishing in the negative on the year other than commodities… talk about a tough year for diversified portfolios.

P.S – If you’re looking at commodities and wondering if we looked at the data incorrectly, the answer is no… commodities did end down -14.32% in December alone, down -32% on the year.

Asset Class Scoreboard Final(Disclaimer: Past performance is not necessarily indicative of future results)

Asset Class Scoreboard Chart

(Disclaimer: past performance is not necessarily indicative of future results.)
Source: All ETF performance data from Morningstar.com
Sources: Managed Futures = Newedge CTA Index, Cash = 13 week T-Bill rate,
Bonds = Vanguard Total Bond Market ETF (BND),
Hedge Funds= IQ Hedge Multi-Strategy (QAI)
Commodities = iShares GSCI ETF (GSG);
Real Estate = iShares DJ Real Estate ETF (IYR);
World Stocks = iShares MSCI ACWI ex US Index Fund ETF (ACWX);
US Stocks = SPDR S&P 500 ETF (SPY)

The 2014 Commy Awards

There’s the Emmy Awards, the Webby’s, the ESPY’s, (why do they all end in y’s), but no commodity awards as far as we know… Let’s see if we can’t do something about that, with the first (and perhaps last) edition of the Commy Awards:

(All Charts Courtesy: Finviz)

The ‘you probably didn’t benefit one bit from this’ market of the year = Coffee

In February, the coffee market shot up and never looked back, up around 48% on the year. However, unless you play with coffee ETF $JO, or are invested in a smaller niche managed futures manager – there’s no way you caught this move. It’s a shame too, because it was one heck of a move, and it all happened in first 2 months.

Coffee(Disclaimer: Past performance is not necessarily indicative of future results)

The Most likely to get your Houston Neighbor’s Grand Piano repossessed = Crude Oil

No one saw the crude implosion coming. Well maybe not nobody… but crude dropping almost  50% in 4 months was something trend followers sure enjoyed, even while the Russian government (and Ruble) did not. At 8.9 million barrels per day produced in US – that’s $411.7 million not there anymore… that’s a lot of pianos.

Crude(Disclaimer: Past performance is not necessarily indicative of future results)

The most popular, for no apparent reason = Gold

No matter how much the gold market moves, it’s the commodity market people love to write about, and people love to read about. Even though it finished the year basically unchanged, down -0.4% – there were reams and reams of digital ink written about its demise, its comeback, its luster, and its non-performance? And all for what? So that they can say they were wrong last time, and might be right this next time?  Honorable mention goes to the rest of the metals crowd, which actually fell quite a bit more than Gold.

Gold(Disclaimer: Past performance is not necessarily indicative of future results)

The S&P..who?  Award = Cattle

The S&P 500 wasn’t the the only market hitting new all time highs throughout 2014, so was Cattle. The problem? Not too many noticed or wrote about it, and it doesn’t count if it was an article about higher beef prices at the grocery store.

Live Cattle(Disclaimer: Past performance is not necessarily indicative of future results)

The Market most likely to make you look like an Idiot (Again) = US Bonds

Earning its 5th straight award in this category is the Bond market. 2014 was supposed to be the year for higher Interest Rates and Lower Bond prices, except it wasn’t. The US Bond Aggregate Index ETF ($AGG)  ended the year up 5.50% for the yr and rates dropped from  3.9 to 2.7, while everyone and their sister thought higher rates in store in ‘14 Bonds. You think yields will continue to drop or has it finally reached its lowest point? Are you willing to say it will go the other way? How about asking the people that made the same decision last year.

30 Yr Bond(Disclaimer: Past performance is not necessarily indicative of future results)

The Most (un)Likely to Succeed / Best Closer = US Dollar

It had its best quarter in 4 years, while other currencies fell flat. But it wasn’t just what it did, it was how it did it – closing fast. For the first six months, the USD didn’t move, while the last 6 months resulted with an up move of 13%.

USD(Disclaimer: Past performance is not necessarily indicative of future results)

The Most Likely Cause of your Acid Reflux = Corn

It’s hard to trade a market that has three consistent trend reversals in one year. From January to May it was up about 20%, then fell around 36% over the next 5 months, and rebounded 24% to close out the year. You must have a strong stomach to dabble in this market (honorable mention = Nat Gas)

Corn(Disclaimer: Past performance is not necessarily indicative of future results)

The Jennifer Aniston = U.S. Stock Indices

This year saw US stocks pile onto the already outstanding run the stock market has been on over the past 5 years, so while the stock market run may be getting a bit older… it’s still looking good, just like Jennifer Aniston.

US STocks(Disclaimer: Past performance is not necessarily indicative of future results)

6 Takeaways from the Performance of 8 Asset Classes YTD

Our takeaways:

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The Commodity Super Cycle Ain’t Over – Yet

Great long-form piece by Erik Swarts over at Market Anthropology (we borrowed the title) talking the commodity super-cycle, and how it might not be dead… We’ve talked about it being on the way to the morgue here and here.

Mr. Swarts bases his logic on multiple comparisons to different past market regimes – be it the 1930s – 1940s interest rate regime, the 1970s commodity cycle, or the 1980s stock market breakout; and gets a bit technical both with his charts and the writing:

…when we extrapolate a normalized comparative study – balanced by momentum (RSI and stochastics) signatures across the complete run of the 1971-1980 boom, we find an estimated comparative leg higher up to the early part of the next decade. Fittingly, this would roughly match the duration of the previous commodity boom that extended for ~20 years along the mirrored trough of the long-term yield cycle in the early 1930’s and 1950’s.”

CRB Commodity Super Cycle(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Market Anthropology

Now, it’s easy to gather from all of the charts and talk about rates continuing to be lower that this is all a way of saying that low rates will spur inflation and re-fuel the commodity super-cycle Jim Rogers style. But in fact this is a much more nuanced conversation than that. Mr. Swarts’ main point, from what we can gather, hinges on this one line:

“For gold to reach $700/ounce or oil $50/barrel, real yields would be pushed significantly higher.”

We have to admit that took us a second to understand, and in fact we went looking for some explanation. Why would real yields be pushed higher for Gold and Oil to go down… Doesn’t it seem higher yields = inflation = higher commodity prices??  Enter Pimco, with a great description of the link between Gold prices and real yields.

….when real yields on other assets are high, investors would likely want a bigger discount to the long-run estimated real value of [a store of value, constant long term purchasing power] asset. Conversely, when real yields are low, the opportunity cost of owning the [store of value, constant long term purchasing power] asset drops and investors would likely be willing to pay a higher price relative to the asset’s long-run estimated real value… As gold increasingly becomes a financial asset, when real yields rise, gold prices should fall if they are to maintain a given level of financial demand relative to investors’ other opportunities. Similarly, when real yields fall, we expect the price of gold to rise. “

A little technical, but the basic idea is that the more people view Gold… and its cousin Black Gold (Oil), as a long term asset which will hold its purchasing power in real terms, the more that assets nominal price will move in relation to the level of real yields. And that relationship will be an inverse one, with prices down as yields go up, and vice versa. Indeed, this is why – in part – Gold and Oil have sold off so violently over the past 12 months (especially the past month), as investors are assuming a rise in real yields.

We’re by no means Gold bugs trying to make a call on where Gold will go from here. And this analysis misses the fact that there is more to ‘commodities’ than just Gold and Oil. There’s things like Coffee, Corn, and more which aren’t really considered to hold their purchasing power (although we’re sure people would much rather have Coffee in an apocalypse than Gold); but this is definitely something to noodle over…