18/08/2010 Author: Zaki Abushal

Crop circles

Recent turbulence in wheat prices, coupled with a pullback in the rise of gold, have left many commodities funds caught on the short side with a YTD performance dent in July. But, despite short-term unpredictability, most CTAs will be looking to the long term

Talk to most money managers, particularly commodities managers, and they’ll remind you time and again that grain prices, in the long run, are headed in one direction – upwards. The maths are a little more complicated than population growth hiking up demand. But when you add to the mix the very real effect of natural disasters as well as the occasional political intervention, you’ve got an unpredictable price range in the short term.

Two weeks ago, Russian Prime Minister Vladimir Putin played havoc with crop prices when he chose to ban the export of wheat from Russia. The drastic move was driven by soaring temperatures and drought, and exacerbated by raging peat fires that decimated wheat harvests. Traders did have an eye on rising drought concerns in Europe as well as Russia but clearly markets didn’t price in Putin’s reaction. At the time, wheat futures were trending very slightly downwards, before spiking, yet, it’s these short-term, unpredictable moves that continue to make it very difficult to spot a trend, not only in wheat, but across all markets.

The decision made by Putin, and the prospect of a similar decision in flood-hit Pakistan should protect plummeting national wheat stocks but the broad effect felt by money markets were just as significant. Wheat futures surged 40% in July and kept rising in early August before pulling back. The positioning of CTAs was split; many traders were short the grain, which had dropped by 10% in March before rebounding by 8% in April and falling again, this time by 7%, in May. The dramatic July rise did serious damage to those on the short side. Managers are now looking for signals to take to the year’s end. Already the effects of July’s abrupt reversal have appeared in CTAs performance in July, notably the 12% hit taken by long-standing London-based manager Mulvaney, as well as the 8.7% fall suffered by the Hyman Beck and Company Global Portfolio. Despite the difficulty in July, the long-term story is fairly clear, as are fundamentals in the grain, which is why for many CTAs the swing in July will ultimately be fairly meaningless.

Gold was another long-term favourite that had surged in the first half of the year, touching highs in late May as well as in June. The pullback in July looked to be a reaction of many to a slew of positive corporate numbers and stronger than anticipated economic data, particularly from Europe. “Gold has been bouncing off a long-term trend line for a while,” says Sanjeev Lakhanpal, partner at CTA Beach Horizons. “The recent gold action is more a mean reversion – the fundamentals for gold are massively up, and pretty much everyone’s aware of the long-term trend in gold,” he says. More interestingly, it looks like gold may have reverted to its traditional dollar link, and will behave like a safe haven against the shaky looking currency, in the short term at least.

Stock indices offer a more complex story, but even they may be nearing a bottom. The indices have been rallying since the end of June, and a desperate two months for stocks, when a lot of corporate numbers beat expectations. Many managers and CTAs had historically low exposures, leverage and margin coming into July, a move which allowed some to build out positions through the month as stocks fell further and volatility picked up. Adding to the difficultly is the dislocation between indices globally, when there’s usually even greater correlation. This has left the likes of Beach Horizons short equities indices in Italy and Spain and long the Dax. As for the S&P500, “I can’t really see the S&P500 testing its February ’09 levels,” says Lakhanpal.

The story is clearly much more nuanced, particularly when you throw in short-term dollar uncertainty and the inflationary outlook, but the overall picture is becoming clearer, even if it is less positive than it was six months ago. Now, discounting some of the most unpredictable swings and political interjections, some semblance of rhythm may be returning to the markets.