From the July/August 2013 issue of Futures Magazine • Subscribe!

Kathleen Kelley: Learning from the “old” boys how to seize opportunity

We look to identify these inflection points in individual cycles in each market as well. The commodity markets especially are inefficient and so they overshoot. And when we see that overshooting we are looking to enter into a position. So we try to identify crowded trades. We’re somewhat contrarian when we start off with an idea. And then we have a three- to six-month time horizon. We then become trend positive, but we’ll usually start off being contrarian. We use a combination of options and futures to [put] ourselves into these contrarian positions. 

We’re very research intensive and somewhat value investors in commodities, if you will. We’re looking for low-priced commodities to buy and high-priced [ones] to sell. We have smaller allocations to interest rates and FX, but usually more than 50% of risk will be in a commodities base. We’re really using commodities to express a macro view. We use a risk management process that Paul still uses at Tudor. A lot of the principles that guide how we operate here were those that I learned at Tudor. 

We are largely contrarian and a lot of times we will be taking the opposite view of CTAs  [commodity trading advisors] that are all one way. As long as we’ve done a deep dive on research and have a differentiated view than the consensus in the market, that’s when we’re going to start to enter into a position. So we’re going to be negatively correlated with CTAs because we are somewhat contrarian to their position at the beginning. [Also], we are normally negatively correlated with the commodity indices because [of our] contrarian [philosophy]. We are not long-only. So in general we have low or negative correlation with most of the indices. 

FM: Walk us through a typical trade, if there is such a thing, from inception to pulling the trigger.

KK: In the beginning of this year people got very bullish on the platinum market and started to think [that] prices were going to go much higher. And the market was very long so the first thing that we look at is why everybody is long this market and what are the underlying assumptions they believe. 

And then we go back to our supply-demand analysis or economic analysis, depending on the market. We ask the questions: ‘What do we think? Do we agree with these underlying markets’ assumptions or do we disagree?’ In the case of platinum, we disagreed with the market consensus. We thought from a supply and demand basis that the market was too optimistic and was expecting this big move higher in prices. And everyone was positioned that way. For us that is an investable thesis because everybody is all one way and we have a differentiated view backed up by our supply-demand analysis. So we’ll start to go short there. 

We’ll usually enter into it through options and add to it in futures. At the beginning, because we are trying to catch this inflection point, we are just going to have our premium at risk in these low-delta options. Then as the market starts to behave the way we think it is, we’re adding to it with futures. And so, our differentiated view was from the fact that we thought that Europe, which on the macro view was still very weak, and that automotive demand from there would still be weak, and that’s the biggest source of demand for the platinum market. 

On the supply side, we thought that South African producers were actually getting a fairly good price on the basket of commodities that they mine. We thought that they would continue to produce because they had started to get a better basket in local currency terms. And as this has played out over the last couple of months, the move in the [U.S.] dollar has helped that basket go even higher, so that their local currency has weakened. The basket that the miners are getting is the highest it’s been in five years, so we think that they [will] continue to produce, [which] means [more] supply that the market is looking for. And we think that demand continues to be bad, which [means even] less demand. We need it to be a surplus market not a deficit [one], which is what the rest of the market is looking for. So we expect platinum prices will continue to go lower from here. 

That is something that we’ve had on since February. We were a little bit early. The market started to turn in March and we’ve had that on since then. 

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