"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Saturday, September 13, 2014

Large Specs Continue Playing corn from the Long Side....and Losing

I have been commenting for some time now about the apparent disconnect between the hedge fund community and their slavish devotion to computerized trading systems, which are especially fond of trending markets, and their positioning on the wrong side of a major downtrending move in the corn market.

Not only are they long, they actually increased their net long standing this past week just ahead of the major USDA supply and demand report.

Apparently, not wishing to be alone in their misery, they must have recruited some other large reportables in their quest, because that category of traders likewise increased their already net long exposure to the corn market.

Here is the chart... you tell me which way this market is trending:

Here is a look at the Commitment of Traders report as of Tuesday this past week:

Back in early May the hedge fund guys began liquidating longs when the front month corn contract was unable to scale $5.15 or so after several attempts. You can see their exit from the commodity by comparing the price chart above with their net position line on the COT chart. Down, down, down corn went with them still remaining net long, ever after scaling back exposure. That came to a halt towards the end of July when they began rebuilding long side exposure. That re-entry on the long side helped push corn back up another $0.20/bushel towards $3.80 but that did not last long. Down it went some more all the way towards $3.40 with the same group still increasing longs.

What is going on here? How could a group of traders who live by the charts and whose entire discipline of trading consists of blindly following trending markets, whether up or down, miss a move of this extent to the downside? Also, since they are typically considered "smart money" and the small, undercapitalized trader is considered the "dumb money", how can one explain that the small traders, or general public, have been on the winning side of the corn market while the "smart money" has proven to have been the "dumb money" this time around?

A few, whom I respect, have suggested that this is the result of spreads being plied by these large specs who have been buying corn and shorting wheat as the fundamentals for wheat have been even more bearish than for corn. US wheat has been expensive compared other sources and with the US Dollar strength, even more pricey.

That seems to make sense but a closer examination of the spread chart ( corn vs wheat) would seem to conflict with the idea that it was a large number of these spreads with hedge funds on the long side of corn and on the short side of wheat explaining their apparent wrong positioning in corn.

Note on the COT chart that the big move out of corn as far as net long positioning goes by the hedge funds, began in May. Now look at the spread chart and what do you see? In early May the line shoots up sharply from near 225 under and runs all the way to 140 under. Clearly corn was gaining on wheat as it narrowed its discount. But, and this is noteworthy, the gain in the corn/wheat spreads came as hedge funds were bailing out of corn

In other words, hedge funds were not buying corn but rather were liquidating longs and scaling back their exposure to the long side of the corn market even as corn was gaining on wheat. The spread was moving in favor of corn as they were getting out, not as a result of them coming in to institute fresh spread positions.

If hedge funds were positioning on the long side of the corn market because they were spreading corn against wheat, the COT report would have shown them INCREASING THEIR NET LONG exposure to the corn market ( not decreasing it as they did ) all the while the line on the spread chart was moving higher ( favoring corn). The exact opposite happened however.

Referring again to the spread chart, it topped out in favor of corn in mid-June where the spread retraced a large portion of its gains and widened out ( in favor of wheat) by some 65 cents. I think some of this was clearly tied to the events in Ukraine during which wheat experienced some big rallies as traders feared a disruption of exports from key wheat exporter Ukraine. Black Sea origin wheat is a big competitor to US wheat and the latter rallied in price as traders were concerned about more business coming the way of the US and possible "force majeure" declarations.

Those fears were put to rest, flared up again, and put to rest once more as can be seen from the up and down action in the spread since early August. For the rest of that month, the spread moved in a 35 cent range.  Late in August, it began to turn again in favor of corn and has begun to climb once again.

Looking back at the COT chart and the build back in net long positioning for the hedge funds shows an increase that began in late July and has been for the most part continuing up to this past week.

You can also see that the corn/wheat spread has begun favoring corn at the same time these hedge funds have been adding to their net long position in corn. The theory that they are net long ( and on the wrong side of the corn market ) because they are working corn/wheat spreads thus NOW has credibility because the move in the spread in favor of corn is coinciding with the increase in their net long side exposure to corn.

How long they intend to work this spread however remains to be seen. Nor does this explain why they remained such large net longs in a market that clearly broke down in May of this year and has continued to move even lower in the face of one bearish USDA report after another.

The fact is that they have been stunningly wrong about corn and while they may now be playing a spread trade with wheat that is temporarily working in their favor, at some point they are going to be hit with the fact of a massive  ( a RECORD) corn crop alongside of a record soybean crop which is going to run into issues with both STORAGE AVAILABILITY and TRANSPORTATION AVAILABILITY.

My concern for corn is what happens once these hedge funds begin to close out losing longs or reverse spread trades ( which will also result in liquidating the long corn side of the spread)? We could very well see more downside than many are expecting, even at these greater reduced price levels compared to several years ago.