Rumors were flying around the industry about the huge wheat rally that left Chicago Board of Trade locals battered and bloodied, à la stock traders after Oct. 19, 1987. The reason was largely an old-but-new trading method that takes advantage of what some huge long-only funds do in the commodities markets. The wave has been to catch some money on the rollover using bear spreads because typically the spread goes further in contango. Well, not this time. It is reminiscent of an options seller who is right 90% of the time, until the market spikes and he loses his nest egg. This apparently is what happened. Says one grain trader, “People were bear spreading a market that was making 12-year highs on the continuation chart, trying to squeeze 2¢ to 3¢ out in front of the roll. December 06/March 07 wheat spreads went from -20 to even money and those who sold March 07 to July 07 wheat spreads setting up for the roll in a few months got creamed. It went from -17 to +90 as we speak, a truly unheard of move, in about 10 days. It is estimated the locals in the pit who were situated for the roll lost
$80 million to $100 million.”
Who would think a benevolent contract such as wheat could do so much damage? Well, like flies on a horse who rolls over to scratch, traders who have set up bear spreads to take advantage of the long-only fund rolls sometimes get caught on the wrong side. Ironically, Managing Editor Daniel Collins had just completed his piece “Long opportunities,” (see below) in which he capsulized the methods to the locals’ madness. Long-only funds have increasingly become bigger players in the futures markets, basically purchasing commodity futures that follow various indexes, such as the Goldman Sachs Commodity Index (GSCI).
Reminiscent to the index funds in the 1980s, managers have seized, quite successfully, on using the similar idea in the futures markets. And no small names either: Henry Jarecki launched through his Gresham Investment Management group the Tangible Asset Portfolio in 1987, which since then has outperformed the GSCI and had a compounded return of more than 800%. Obviously, with Jarecki’s background in physicals and his analytic mind, creating a long-only fund made sense to him. Jim Rogers, who we’ve interviewed several times and who had forecasted a long-term bull market in commodities back in 1999, took a different step by creating his own commodity index, which has funds benchmarked to it. These are only two players in a largely growing area; in fact, the long-only funds have caused the Commodity Futures Trading Commission to review the Commitment of Traders report to see if a new category of commercial needs to be added. Further, with the markets being what they are, and the floor being the scalping machine it is, it makes sense traders would find a way to take advantage of these new market forces. Problem is, it doesn’t always work out the way it’s planned. The fall out from the recent move has yet to be determined, but based on anecdotal evidence it’s sure to be brutal.
Fact is, wheat is at near highs today; for a long-term view on the grain complex, check out contributing editor Carla Bauch’s “What will move grains in 2007?” (see below), in which she outlines where smart money says the grains markets are heading. With the “energy” factor, ie. the new popularity of ethanol for alternate energy methods using corn, and China’s new net importer status, grains are a go-to market, and not only for long-only funds.
