How Low Can it Go?

Since the peak in mid-2008, natural gas has been playing an impressive game of limbo. Just when you thought it couldn’t go any lower, down it goes. Last year we wondered whether the market was about to find the bottom, but we clearly spoke too soon. Today the price of natural gas in the futures market went below $2.00. In nominal terms, natural gas hasn’t been this cheap in more than 10 years. In inflation-adjusted dollars, we are looking at the lowest price since at least 1994.

Source: US Energy Information Administration. Disclaimer: past performance is not necessarily indicative of future results.

The list of factors driving this downward plunge is straightforward: production increases have been outstripping demand, leading to record high stocks. Production capacity reached a record high just as the US went into one of the warmest winters on record. Now, seasonal forces are coming into play: as we enter spring, heating demand is drying up, but it is too early for the summer heat to increase electricity demand.

There are also structural impediments to increased demand. Consumers and business that want to convert to natural gas to take advantage of lower prices must still dedicate time and expense to switching over. Converting or building new natural gas electrical plants requires even more investment. And, even though prices are low now, the past volatility of natural gas gives good reason to pause before making a long-term commitment. Barring an unexpected shift, some analysts are now seriously considering the possibility that the US may actually run out of capacity to store natural gas later this year.

Despite the long, seemingly inexorable decline in natural gas prices, not many of the CTAs we track are currently in short positions in this market. A brief surge in the price in late January of this year stopped out most of the programs who were short natural gas. Those who are short, like James River Capital and Futures Truth, entered the trade after that January spike, and are certainly enjoying the downward trend. While the short natural gas play has been a good one lately, it’s worth remembering that prices can only fall so far – they’re not going to start giving the stuff away. Like even the most limber of limbo masters, there will eventually come a point where it just can’t get any lower.

CTA Spotlight: Futures Truth

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

With another round of our Semi-Annual CTA Rankings in the books, it is time to dive in and highlight one of the programs listed in our Top 15. We recently profiled #1 ranked P/E Investments FX Strategy in February, while #2 ranked Emil Van Essen was the subject of the spotlight for  March. Therefore, tonight we are going to skip down to #3 in our rankings and discuss the Futures Truth Company MS4 program. The Futures Truth MS4 program is a short-term, multi-market, multi-strategy product that has been trading live for clients since October 2007.

If there were such a thing, the Futures Truth MS4 program could easily get the “Most Overlooked” award in the managed futures industry. While interest picks up slightly after the program lands in our Top 15, we would expect a much larger amount of assets under management (AUM) for Futures Truth given their ability to stay positive in 2009 (no small feat), drawdown under -10%, and over three year track record. [past performance is not necessarily indicative of future results]

If that name is sounding familiar, that’s because Futures Truth the CTA is the same as Futures Truth – the publisher of the magazine that tracks and publishes performance numbers on thousands of publicly available trading systems, sort of like a Consumer Reports of trading systems.

Click here to read on: http://bit.ly/oR3BuY


Managed Futures v. Bill Gross

Whether or not Bill Gross is actually short US treasuries in his flagship PIMCO program is up for debate. He said no on CNBC, but one of our favorite bloggers, ZeroHedge, essentially called him out- saying, No, you are short. But whatever side you take on that battle of semantics, Mr. Gross has made no secret of his worries about the massive US debt and deficits leading to lower prices in US Treasuries. By all accounts, it doesn’t look like Mr. Gross thinks the next leg in bonds will be UP.

But a funny thing has happened in the last few weeks while this debate has been playing out and silver and crude retreated from their highs. While everyone bemoaned their long-only ETF investments (don’t say we didn’t warn you), another trend began to emerge elsewhere…. In bonds.

Turns out, for all his grandstanding, Gross appears to be incorrect (for now). Bonds have not been going down under the burden of cumbersome U.S. debt. In fact, the current trend is decidedly UP.

How far up? The 30 year bonds have gained 5.33% since April lows, while 10 year notes are up 3.75%. Remember, bond prices move inversely of the rates, so rates moving lower means prices have moved higher.

Gross may be missing out on this bond action, but many of the managed futures programs we track have identified and are participating in the trend. Programs we track which are holding long bond positions include 2100 Xenon Fixed Income, Accela Capital Global Short Term, Auctos Capital Global, Blue Fin, Clarke Global Magnum, Clarke Worldwide, Covenant Aggressive, Futures Truth Sam 1010, Integrated Global Concentrated, James River Capital Navigator, and Robinson Langley.

Are we surprised? Not really- managed futures programs tend to love trending bond markets. And this is how systematic managed futures programs are supposed to work. They don’t care how much debt the US has or if the largest bond investor in the world is betting against the up trend. They ignore all of that noise, and merely identify and react. Identify, react, repeat. Identify, react, repeat.

So, while the rest of the world was looking the other way, many managed futures identified a new up trend in bonds and reacted to it – putting on long positions. These programs are all in a position to have added to their P/L this month, but will it be enough? The same price correction that distracted us from Gross’ prosthelytizing also decimated returns for many programs caught off guard by the departure from the trend. While the bond market may help even things out some, it may not be enough to bring some programs into the black for the month of May.

Moving forward, we’ve got an epic battle on our hands. On one hand is managed futures, riding a technical trend higher and ignoring the doomsday financial prophets. On the other hand, bond king Bill Gross is betting that fundamentals will eventually crash US bond prices and interests rates inevitably climb, and is biding his time on the matter. Managed futures is winning this round, but who will win out in the end?

We certainly wouldn’t mind seeing Mr. Gross on the same side as managed futures next time (that’s a lot of fire power), but that will likely have to wait until this trend runs its course and bond prices start heading lower.

Can trading gains offset pain at the pump?

With Crude Oil up $2 more dollars today, it seems like just a matter of time until we see $5 per gallon gas in the US. (here in Chicago we’re already seeing $4.50 at some stations).

Those of us in the managed futures industry usually have an odd take on price increases such as this, sometimes actually ‘cheering’ prices higher despite the pain it will do to our budgets and credit card bills.

This is because our clients are usually benefitting from such trends higher, thanks to most managed futures programs being designed to try and capture trends in one manner or another. Indeed, one of the main reasons for getting involved with managed futures for many is the desire to participate in trends such as the one we’ve seen in crude (see our past post on Crude’s breakout signaling a new trend up).

Crude Over 5 Years

But it seems a little bit different this time. For one, most managed futures program which are long Crude just got long recently (around $100), so while profitable – it’s not that profitable that you can ignore what’s happening at the pump.  Secondly, do we really want $5 gasoline throughout the summer? Will managed futures participants really offset the extra real costs they will incur via their long exposure in a managed futures program (whose gains could be offset by losses elsewhere).

And finally, participation in managed futures doesn’t guarantee you will participate in trends such as the move higher in Crude Oil. Of the CTAs we track, there are only a handful of programs with long energy exposure.

Short term systematic programs Futures Truth SAM 101 and systematic multimarket programs APA Strategic Diversification, Auctos Capital Global, Covenant Capital Aggressive, James River Navigator, Futures Truth MS4, and Robinson Langley Capital are all long crude, while short term systematic Accela Global Short Term is long JPE Gas and Bouchard Capital is long heating oil.

While these programs will likely be cheering Crude higher yet, the higher costs for gas, plane tickets, food, and everything else is likely to dampen the enthusiasm somewhat.  The bottom line – sometimes you have to be careful what you wish for…

Anatomy of a Trend Following Breakout… Crude Oil

At the risk of being one of those people who throws a bunch of lines, arrows, and squares on a chart and says… look at this…we have re-created a chart of Crude Oil over the past 20 months to highlight how a classic trend following trade looks.

While there are hundreds of different ways to do trend following, the general idea is to bracket the market with volatility adjusted bands, and when the market ‘breaks out’ above those bands, go long – when breaking out below the lower band – go short.

We have used rather standard 80 day averages and standard deviation lookbacks to create the bands in the chart below, showing that Crude Oil broke out to the upside on 2/23.  The classic trend following trade is to go long on the open following that breakout, which was last Thursday’s open of 98.97, and risk down to the 60-100 day moving average.  In our example, we’re using the 80 day moving average (the lighter orange line), which sat $6.57 away from the entry at 92.41 on 2/24, representing $6,570 of risk on the entry day.

Crude Oil bollinger bands

Moving forward, the classic trend following model hopes prices will remain above the moving average long enough to pull that average above the entry price, thereby locking in a gain. If prices fall and the moving average doesn’t advance, the trade will lose the difference between the entry and wherever the moving average is at the time prices close back below it.

To see why and how trend following, and managed futures in general, are long volatility strategies where profits can be many times the amount risked on a trade – one only need imagine Crude Oil going to $150 on the back of an uprising in Saudi Arabia or something.  In such a case, the trade could make $50+ ($50,000) on the same initial risk of just $6,500, for a risk/reward payoff of nearly 8 to 1.   Conversely, if peace spreads across the Middle East over the next few weeks by some chance and Crude Oil sells of $50 down to $40 something, you still only lose the $6,500 (ignoring slippage and the possibility you could be locked limit down and unable to get out).

This ability to make a great deal more than you risk when volatility explodes is the classic trend following model’s calling card. The downsides, 1. only a small percentage of such breakouts may succeed and 2. Crude may go up to $140, and then all the way back down to $110, making for an overall gain, but causing pain in that your account will have given back $30 of open trade profits.

We’ll see how this breakout fares for those with exposure to the energy markets via trend following. Managers who have seen breakouts in their own models in Crude and currently hold long positions include:

Corn, Wheat, Soybeans at fresh 1 to 2.5 year highs benefiting Managed Futures

We mentioned in our 2011 Managed Futures Outlook how it may be tough for managed futures to see gains this year from further upside moves, but the entire grain complex is proving us wrong over the past several weeks, and again today – with the grain complex making fresh 1 to 2.5 year highs today after a bullish US crop report painted a picture of tightening supplies (stock to use ratio at 5% lowest since

Managed futures have, for the most part, participated – with those programs without profit targets and longer long term models maintaining the most exposure, and those with profit targets (they already booked gains on many grain positions) or looking at shorter term data with some positions, but not as many as one would like gievn the recent highs.

Looking at the charts to the right and their nice upward sloping trends over the past two and  half months, we would expect systematic, multi market managers (aka trend followers) to be involved, and wouldn’t you know it, the list of managers we track with long grain exposure reads like a trend following anonymous roster:

Expanding Commodity Volatility = Good or Bad?

It has been an interesting past two days in commodity markets, with some sharp moves up/then down, before settling in a little today…. with Silver moving nearly 10% in a session and a half, Cotton falling from its highs, and grain markets moving: (Sugar has dropped about -7% in the hour or so since we started writing this)

11/09 High 11/10 Low % Move
Silver 2934 2648.5 -9.7%
Wheat 7606 6950 -8.6%
Cotton 157.23 145.81 -7.3%
Corn 605 565.25 -6.6%
Soybeans 1330.75 1269.5 -4.6%

This movement comes on the back of several markets hitting new all time (nominal) and or multi-year highs, while other markets remain well below their all time highs despite recent moves to the upside:

Aussie all time high Corn -37% below ’08 high
Canadian nearing all time high Crude -52% off ’08 high
coffee 13 yr highs S&P -23% off ’07 high
Cotton 9 yr high Soybeans -11% off ’08 high
Gold all time high Wheat -56% off ’08 high
Silver all time high
Sugar 29 year high

What does it all mean? Such volatility has been associated with tops and bottoms in the past, and it could be the commodity bulls are running out of steam a little. But seeing how far Wheat and Crude (for example) have to go to match the highs in other markets…. maybe the recent volatility is just signaling a breather and market consolidation before pushing higher.

We’ll have to wait and see where we go from here,  but the commodity volatility has caused short term losses for some managed futures managers.  Short option seller ACE Diversified has felt the brunt of the moves and is down significantly for the month. Meanwhile, shorter-term multi-market traders likeDominion Capital andFutures Truth SAM 101 have been whipsawed a few times of late, buying false breakouts lower. Finally, spread traderEmil van Essen is down about -2% in the past few days, as volatility usually shows up in the front month contracts more so than in back month contracts (the theory being that whatever today’s crisis is, can be worked out by the further out delivery date).

We had one client start Emil Van Essen on the pullback today, and applaud that contrarian view – as expanding volatility should be good for managed futures as a whole moving forward.