Trade Commodities instead of ‘Invest’ in them?

Ben Carlson has been nailing it lately over in Tumblr-ville on the new Yahoo Finance Contributor network. There was him pointing out the issues with using risk adjust returns, then some stats showing even Warren Buffet has had some very big Drawdowns… (consider that all of you who pull the plug at the first sign of trouble in the alternative investment world), and the one that most caught our attention – “Are Commodities for Trading or Investing?

The commodities piece was right up our alley, being in the business, so to speak. The piece echoes some of what we said in our newsletter last year: “3 Big Reasons Commodity ETFs aren’t Getting the Job Done,” which is basically that commodity ‘investing’ doesn’t look so great when it is a “long-only“ approach (only makes money when commodities go up) because:

  1. Commodities don’t always go up (e.g. iShares GSCI ETF (GSG) -37% since inception in ’06),
  2. Even when they do, they are very volatile,
  3. Even when they do, the access points are complex and won’t necessarily provide a return equal to what the commodity did.

Carlson goes a step further, however, quoting some academic research which shows commodities actually add volatility and reduce return… not reduce volatility and add return as is supposed to be the case with a non correlated investment.

So trade commodities instead of ‘invest’ in them?

Now, some might take that to mean that commodities should be avoided, and here’s where it gets a little confusing – because the lesson from this shouldn’t be that ‘commodities’ are to be avoided and that ‘commodities’ add volatility and reduce return.  The lesson should be that Long-Only Commodities do those bad things. The lesson should be that diversification into the commodities space isn’t as simple as buying and holding those volatile commodities. The lesson might be that they are better for ‘trading’, as Carlson points out, then ‘investing’.

Trading commodities can still give you exposure to moves that have nothing to do with the stock market (like Coffee being up 71% this year or grains selling off 30% the past few months). And that’s really what having exposure to commodities is all about. It’s about gaining exposure to outlier moves in commodity markets brought about by non-financial, non economic catalysts. Like droughts and snow storms.

But not everyone wants to sit around and ‘trade’ commodities. That’s not quite a retirement plan… “I put 40% in stocks, 30% in bonds, and trade 30% in commodities”… as it would cut into your golf time quite a bit.  For those who still want the commodity exposure, but not the trading screens – the target is professional commodities traders, or registered Commodity Trading Advisors.  Now, there are thousands of such registered professionals out there – but the grand majority of them don’t actually trade in commodities, despite their name. The grand majority do systematic trading on a portfolio of markets including bond, currency, and stock index futures.

The ones which trade commodities and commodities only – are what we call Ag Traders (short for Agriculture). So while Mr. Carlson’s question seemed to be of the rhetorical type – we can actually put some data to it and compare professional commodity trading with commodity investing via ETFs. Who wins?

Investing in the ‘trading’ of commodities versus just plain ‘investing’ in commodities has won out handily over the past 9 years. [Past performance is not necessarily indicative of future results].

Ag CTAs vs Long Only Commodity ETF(Disclaimer: Past performance is not necessarily indicative of future results)
(Data= BarclayHedge Ag Traders Index, GSG = iShares GSCI Commodity Index)

For more on how these professional commodities traders operate, download our whitepaper detailing Agriculture (or Ag) Traders.


Who needs the USDA when you can Live Tweet Crop Conditions

What gets Ag folks excited on a Monday morning on Twitter? Live Tweeting crop conditions. All day, the people of the “2014 Pro Farmer Midwest Crop Tour,” have been tweeting their hearts out with the hashtag #PFtour14 to show the conditions of corn and soybeans across the Midwestern states.

Crop Tour Logo

The goal of this four day tour is to provide accurate information of the condition of corn and soybeans as harvest season approaches. We can’t think of a better way to do such a thing then traveling state to state live tweeting the conditions in the field in real time.

Now you might be wondering, doesn’t the USDA already collect data from around the country to provide the conditions of various crops? Yes, but this crop tour is unique in that they don’t want to focus on  yield numbers specifically, but the big picture.

“Don’t focus on yield calculations from individual fields,” says Brian Grete, Pro Farmer senior market analyst and leader of the tour’s eastern leg. “That isn’t what we are trying to do, and we actually discourage scouts from tweeting individual yield results. Instead, we look at the entire area we cover as one big corn field. Twitter is most useful for getting a general idea of what scouts are finding. And the pictures are valuable.”

Essentially, give people the opportunity to tweet about the condition of their corn with pictures, and you got yourself one heck of a trend (pun intended). Take a look at some of the pictures from the first day of the tour, via the Ohio County Journal.

Corn 1 [Read more...]

ETF Commodity Exposure YTD

Here’s our monthly look at the various commodity ETFs and how they track a simple strategy of buying December futures and rolling them annually. Plus, a comparison to Ag Traders and an overall commodity index.  C’mon futures…

(Performance as of 7/31/2014)

Commodity ETF Over/Under Performance 2014

Crude Oil$CL_F
Brent Oil$NBZ_F
Natural Gas$NG_F
Live Cattle$LE_F
Lean Hogs$LH_F
Commodity Index $DBC-1.36%
Long/Short Ag Trader CTAs3.12%

(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

Even Bad Diversification Works

Last week, Business Insider unveiled the “Most Important Charts in the World.” If ever there was an outfit with a flair for the dramatic headline, that would be them…but there was one chart that caught our attention entitled, “Diversification Works.” It was from none other than Josh Brown at Ritholtz Wealth Management.

Diversification Works

(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: The Reformed Broker

Now if you asked a roomful of random investors what diversification in their portfolio meant to them, chances are all of them would have a slightly different answer. In this particular instance, Brown defines diversification as a portfolio including a 30% allocation to the S&P 500, 30% to foreign stocks, and 40% to bonds. We’ll give you the bonds, but pairing foreign stocks with US stocks doesn’t strike us as all that diversified.  Foreign stocks (MSCI ex US) have a correlation of 0.89 with US stocks over the past 10 years, for example.

And being managed futures folks, we couldn’t help but look at their chart and wonder… what if you had managed futures in the foreign stocks slot instead? Would diversification have “worked” then?

Here’s our chart swapping the 30% foreign stocks allocation with 30% managed futures, per the Newedge CTA Index.

Diversified with Managed Futures

(Disclaimer: Past performance is not necessarily indicative of future results)
(Diversified = 40% Barclays Bond Aggregate Index, 30%  Newedge CTA Index, and 30% SPY)

While Brown was bragging of the diversified portfolio regaining its peak 14 months before a stock-only portfolio, the portfolio containing managed futures regained its peak 35 months prior, or more than twice as fast!  How? Because 30% of the portfolio was positive during the 2008 crisis as managed futures became negatively correlated to stocks during the crisis.  Now that’s some diversification.

Some may concentrate on the far right hand side of both of these charts, where the stock-only portfolio has, after 7 years, eclipsed the total return of the diversified portfolio (whether diversified in other stocks or managed futures), and discount diversification as unimportant or even costly. You would have made more money not being diversified, but that’s not the point for those who want some protection.

The point, as Josh Brown points out, is to have shorter drawdowns. The point is to be able to regain a peak sooner. The point is to be able to not panic at the bottom.  And, of course, the point (for us) is that diversification can “work” even better when you aren’t diversifying with another form of stock market investment (foreign stocks), and instead gaining true diversification with different return drivers.

P.S. – Past Performance is Not Necessarily Indicative of Future Results. The chart should probably be titled – Diversification Worked (past tense), not works (present tense). We noticed a comment summing that up rather nicely, and ask the simple question: Will Simple Beat Complex in the Next 5 Years?

Facebook Comment


Can You Time the Market Without Crying?

We’ve all seen pictures like this one from Putnam showing how bad of an idea it is to miss the 10 best days in the stock market

Missing the Best DaysChart Courtesy: Putnam

But we read an interesting post on trying to time trading systems (that’s like timing market timing) that seemed to approach this in a bit more logical way. You see – it doesn’t make much sense to talk about missing the 10, or 20, or 40 best single days in the stock market. Most market timers aren’t trying to avoid a single bad day,  and get back in the next day. Most are looking at things like Price to Earnings ratios and the rest are trying to avoid bad periods… not just bad days. Plus, nobody is that unlucky trying to time the market that they miss just the 10 best days over a few decades. On the flip-side, nobody is that lucky that they would magically miss the worst market days over 10 to 20 years, only to get right back in the next day.

It makes much more sense to us to talk about what missing the best streaks of days looks like. The best 10 and 30 days periods, for instance. That would be a lot more interesting; to see how bad/good you would have been if you picked the exact wrong/right time.

Here’s what we found:

(Note: These figures do not represent actual trading, and were not taken from real experiences)

Missing the Best Trading Days

Missing the Worst Trading Days(Disclaimer: Past performance is not necessarily indicative of future results)
(Note: The figures and charts above are an example and do not represent actual trading)

In our opinion, the better argument for not trying to time would go something like this:

Trying to time the market?

  • If you’re incredibly smart, or lucky, or both – missing the worst 10 day streak would save you 549%
  • If you’re incredibly dumb, unlucky, or both – missing the best 10 day streak would cost you 212%
  • If you’re somewhere in between smart and dumb and have average luck – you’ll likely not miss anything… with missing the average 10 day streak resulting in 4%

We’re not sure if this supports timing or not – but it sure seems a better way to talk about it, rather than the more prevalent narrative about the big danger of missing the best 10 days in the stock market – like they come one right after the other or you’re the unluckiest person on the planet.  The whole thing is kind of silly anyway – as it is backwards looking, and would need to be completely thrown out the window if the next 30 years were the negative image of the past 30 years, with stocks returning –70% over the span. If that happens, then timing would do no good, again – it would be better to not be involved at all…



Performance of 40 Futures Markets Mid-Year

We’ve officially made it half way through the year, meaning those who did well will likely be mentally doubling their first half success in imagining where their year will end, while those who struggled will act like a weekend golfer making the turn – saying ‘ok, let’s turn it around now… let’s get it done on the back nine’.

Without further ado, the front nine scores across 40 different futures markets courtesy of Finviz:

Futures Performance 2014 Q2(Disclaimer: past performance is not necessarily indicative of future results)
Chart Courtesy:

Some of our thoughts:

• 65% of the markets are positive of the year, down from 75% last quarter.

• Corn and Wheat went from number 4 & 8 on the leader board last quarter, to a negative performance on the year thanks to an ongoing multi-month down trend.

• Coffee and Hogs continue to hold their position as the top commodity performers. However, coffee is down considerably (-19%) from its 2014 highs, while hogs have been hitting new highs.

• Nikkei is the only stock futures index that remains negative of the year

• CHF, CAD, USD, and EUR are almost unchanged on the year

• The S&P 500 & the 30 Year Bond’s YTD performance are almost identical.


Natural Gas ETFs – Heads You Lose, Tails You Lose More:

We did our monthly look at how various commodity ETFs track the futures markets they’re designed to follow recently, and found a rather interesting data point in Natural Gas.

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

Nautural Gas VAMI(Disclaimer: Past performance is not necessarily indicative of future results)
Natural Gas Futures = Selling the December Futures contract the last week of November (including exit costs), then using the following December contract numbers)

We’ve talked before about “3 Big Reasons Commodity ETF’s Aren’t Getting the Job Done,” and the usual picture is of the ETF underperforming the asset they track because of prices being in contango and a little thing called roll yield, which the ETFs have to pay if further out prices are more expensive than nearby prices, and if you look back at UNG since inception, it’s clear that the ETF underperforms a simple strategy of rolling the December futures annually:

Natural Gas Compare(Disclaimer: Past performance is not necessarily indicative of future results)

So why is UNG suddenly outperforming the December futures strategy?  You guessed it… Natural Gas has moved ever so slightly into Backwardation – the condition opposite ‘Contango’, where the near prices are more expensive than the further out prices. In that scenario, the ETF earns the roll yield instead of paying it. Here’s a nice graphic and stats from Hard Assets Investor: showing the 5yr annualized roll cost has been 10.37% (a cost of 10%), while the current roll cost is -2.5% (a benefit of 2.5%).

Natural Gas Backwardation detailsNatural Gas Chart Real Hard Investor
Charts Courtesy: Hard Assets Investor

But whether or not the futures are down -67% since 2009 or the worst ETF ever is down -78%, does it really matter. It’s kind of like being the cleanest dirty shirt or skinniest fat kid. You’ve still lost a boat load of money betting on the “energy of the future”.  And I guess that’s what the folks at Direxion and VelocityShares and ProShares were thinking when they launched Inverse Natural Gas products… and not just inverse, but 2x and 3x inverse. Why just go short, when you can double and triple your leverage? Direxion even got the great ticker – GASX – seemingly unconcerned with the link to the world’s number 1 brand for flatulence and bloating relief.

If you had to guess when these guys launched their inverse Natural Gas ETFs, what would you choose:

A. In mid-2008 when Natural Gas had risen ~100% over the last 12 months

B. In 2011 and 2012 when Natural Gas had fallen between 60% and 80% from its highs

Pat yourself on the back if you chose B. These funds were launched in a hurry to capitalize on the big move down in Natural Gas prices, just in time for prices to rally about 130% from their 2012 lows, just like the long Natural Gas ETF (UNG) launched just in time for Natural Gas to fall 80%.  A look at the all time charts for these ETFs is like watching a race to see who the first one to hit -100%.

Inverse Natural Gas(Disclaimer: Past performance is not necessarily indicative of future results)

We’re not sure if this is a commentary on the volatility of Natural Gas, on the dangers of turning futures markets into ‘safe looking’ ETFs, or on the age old problem of investors getting in exactly at the wrong point… but it sure is a weird set of circumstances when investors buying the long ETF are down about the same amount since inception as those buying the short ETF. They can’t win for losing. Here’s the sad performance since inception of the various Natural Gas ETFs:

ETFs that "Make" Money when Nat. Gas goes UP

Total Return
GAZiPath DJ-UBS Natural Gas TR Sub-Idx ETN-94.21%
UNGU.S. Natural Gas Fund-93.83%
BOILProShares Ultra DJ UBS Natural (2X)-76.01%
UNLU.S. 12 Month Natural Gas Fund-64.60%
UGAZVelocityShares 3X Long Natural Gas-49.17%
NAGSTeucrium Natural Gas Fund (25% weighted)-45.58%
DCNGiPath Seasonal Natural Gas-39.32%
GASLDirexion Daily Nat Gas Rltd Bull 2X Shrs24.61%

ETFs that "Make" Money when Nat. Gas goes Down

Total Return
DGAZVelocityShares 3x Inverse Natural Gas -94.16%
GASXDirexion Daily Nat Gas Rltd Bear 2X Shrs -90.95%
KOLDUltraShort DJ-UBS Natural Gas-26.98%
GASZETRACS Natural Gas Futures Contago 6.38%Jun'11

(Disclaimer: Past performance is not necessarily indicative of future results)
Source: Google & Yahoo Finance