The Speculative Run Of Hedge Funds. Ist Commodities Kaput?
I want to start out by pointing to an article a few months ago in the greatest magazine ever sold, The New Yorker, highlights the blow up of Victor Niederhoffer's hedge funds again. It is a very interesting read for those who are students of trading markets. Frankly, it's just plain interesting regardless. Niederhoffer is an incredibly brilliant man who just so happens to be one of the greatest and worst traders of our generation. A true walking paradox as are many of the world's greatest minds. After reading the article, I suspect the "worst trader" moniker has more to do with inner demons of self destruction than any inability. The paradoxical yin and yang or necessary opposites of humankind.
So, is Niederhoffer's blowup a sign of things to come for the hedge fund industry? We've already seen some major blow ups. Amaranth in natural gas. Goldman's main hedge fund looks to have ended last year down about sixty percent. Morgan Stanley's quantitative trading group lost almost four hundred million dollars in a single day. Then there was Bear Stearns' hedge fund debacle starting off the sub prime mess. The list is surely much larger than is being publicly acknowledged right now with rumors of massive losses running high and many funds likely hiding losses to continue to collect fees as long as possible. Of course, they can do that because of lack of regulation and oversight. Rumors even abound that some major financial institutions have hidden losses in hedge funds. We really don't know exactly what the state of the industry is because it has fought to remain opaque and to skirt investor and government oversight. Now we see creative attempts by attorneys to force transparency into the hedge fund community. Involuntary bankruptcy being one such method that would conceivably unlock transparency into the secret world of unregulated money. This brings up an important point. I read some remarks this weekend that lack of regulation or enforcement of regulation has not played a major role in this mess. That is about the most preposterous thing I have read this cycle. That's not really surprising as very few people really understand how the financial systems operate at their core. Most simply point to something like M3 money supply and say the Fed is printing money. This is such a crowded thought that is completely inaccurate.
The asset markets are setting up for a state that I would compare to an overburdened computer system. A term used to describe this state is aptly called thrashing. In layman's terms, this state can be reached when too many tasks are trying to access too few resources or the same resources. Ultimately the system implodes. Applied to global asset markets, we see fewer and fewer trades working and these trades are drawing larger and larger sums of money that ultimately leads to greater and greater distortions in these markets. Distortions that lead to an inability of resource markets to respond normally. Distortions that will ultimately lead to some level of implosion. Some commodities have seen ten year price runs in a month. Literally. Even though fundamentals are deteriorating or even cratering in some instances. Gasoline supplies, which I touched on a few months ago, are exploding. Gasoline supplies, long argued by Wall Stret personalities and traders as a reason why prices were so high, are now higher in the U.S. than when oil was at $10 a barrel. Oil supplies have been this high for quite some time as we have discussed. Of course, in bubbles we always see disconnects from fundamentals. That is, until the bubbles implode.
Platinum, as an example, has gone well beyond parabolic to something I have never seen; nearly straight up in the last month. Those who argue this is supported by fundamentals are living on Mars. I wrote late last year that platinum's primary driver, catalytic converters, was being reduced substantially by economic substitution in that market. Since then an American partner company of NASA has actually developed a catalytic converter that is thirty percent more efficient than any available today and apparently uses no platinum or other noble metals. It has already received some testing approval from California, the strictest emissions standards in the U.S. In other words, it's not in the idea phase. It's likely coming to market relatively soon. If there is anything positive about the industrial commodities bubble it is that we shall see tremendous innovation in the areas of economic substitution and efficiency. And, likely as the world ramps up massive new online supplies for these products.
Most of the investors in commodities likely have no idea of the economics or dynamics of these markets. These violent distortions in pricing are a very unhealthy sign we have reached a level of massive speculation. The only global assets that are now flying higher are these inflationary investments. And, they are very crowded on the long side of the trade. This enthusiasm is driven by massive inflationary bubbles in China, India, the Middle East, Russia and elsewhere where central bankers long ago lost control of their economies. In fact, there is a fair amount of evidence some of them never had control of their economies. American and European speculators are ramming the dollar to drive more and more inflation into dollar pegged economies to benefit from their trades in commodities. And, it appears the U.S. is more than happy to oblige a weaker dollar in an attempt to shake the international trade cheats and to help offset the domestic economy with export growth. But, that too is slowing because as we have written repeatedly since starting this blog, the global supply chain build out is reliant on the American consumer. Don't ever, ever, ever believe in this concept of the global economy disconnecting from the U.S. I read this perspective that the world has disconnected again just a week ago from a top commodities investor. This at a time when many of these commodity trades are likely the most overbought from a sentiment standpoint in modern history. The global economy is more reliant on the U.S. than at any time in my life in both economic and financial terms. As I have said before, these industrial commodity moves have nothing to do with inflationary concerns in the U.S. as we are told. It's about the quickening inflation in emerging markets that hot money is riding as the developed world starts to crumble. Inflation that I have repeatedly said will eventually lead to deflationary busts.
As each day passes, there is more evidence supporting a position we are putting in an ultimate peak for many, if not all, commodities as I wrote earlier this year. I'm most comfortable with this statement as it pertains to industrial commodities. Investors are discounting ten, twenty or more years worth of fundamentals in these valuations. The commodity supercycle that Wall Street has been telling us is a foregone conclusion is going to be severely tested. Wall Street never stops the pump until they wake up and realize their thesis was totally disconnected from underlying fundamentals. Given the economy drives Wall Street and not the other way around, why would we ever really expect most people in this insulated 'group think' industry to ever be right on substantive macro issues?
Is a large commodities correction now starting? Well, when everyone is engaged in the same activity the outcomes are never constructive. When leverage is involved, the outcomes can be disasterous as we are finding out in other Wall Street messes. When traders exit large positions in the parabolic markets they are creating, it will be impossible to do so without inflicting damage to everyone engaging in these markets. And, in the futures markets where leverage is involved........... This has already happened in the wheat market where one trader lost $140 million a week or so ago. I expect many of these funds that are making significant paper gains in narrow markets right now to overstay their welcome. In parabolic markets, everyone is on the same side of the trade. Someone has to be left holding the bag. It therefore must be funds that were printing money on the way up.
So, here's a question. How upset would Americans be if they knew it was their own banks and unregulated financial firms that were driving up their cost of food and energy to levels that were causing significant pain and economic hardship while these firms were making billions at their expense? Is this really any different than the housing mess where bank schemes minted massive profits while driving prices higher while Americans are left in the aftermath holding assets that are imploding in value? I'm not saying global demand doesn't play a role in the rise of commodities but would that have been 50%? 100% rise? Even 200%? Instead of the 1,000% we are seeing across many of these assets? The Wall Street media machine encourages us to believe it's global growth driving prices. Of course. Otherwise, we'd regulate their involvement in commodity markets. The claim made by many that financial firms and hedge funds add liquidity to these markets and that fact is constructive. These markets were set up for buyers and sellers of commerce. Not for financial traders to overwhelm some of the smaller markets and add significant price distortions to the larger markets. In this environment the potential exists for pension funds and retirement funds, encouraged to invest in commodities by these same financial firms, to lose substantial monies. A significant number of retirement funds are already underfunded and losses in the commodities space could present greater burdens on the financial system. But, this is just another outcome of the same lack of oversight and regulation in financial markets we have written about repeatedly.
In closing, if anyone is interested, I uploaded a report by the Senate Subcommittee on Investigations titled The Role of Market Speculation on Rising Oil and Gas Prices: A Need to put the Cop Back on the Beat. This was written before the commodities trade widened out to other areas beyond metals and energy but it applies to all commodities. I would encourage you to read it. Of course, like everything other form of oversight and regulation, it was shelved or plowed by Wall Street lobbyists.
So, is Niederhoffer's blowup a sign of things to come for the hedge fund industry? We've already seen some major blow ups. Amaranth in natural gas. Goldman's main hedge fund looks to have ended last year down about sixty percent. Morgan Stanley's quantitative trading group lost almost four hundred million dollars in a single day. Then there was Bear Stearns' hedge fund debacle starting off the sub prime mess. The list is surely much larger than is being publicly acknowledged right now with rumors of massive losses running high and many funds likely hiding losses to continue to collect fees as long as possible. Of course, they can do that because of lack of regulation and oversight. Rumors even abound that some major financial institutions have hidden losses in hedge funds. We really don't know exactly what the state of the industry is because it has fought to remain opaque and to skirt investor and government oversight. Now we see creative attempts by attorneys to force transparency into the hedge fund community. Involuntary bankruptcy being one such method that would conceivably unlock transparency into the secret world of unregulated money. This brings up an important point. I read some remarks this weekend that lack of regulation or enforcement of regulation has not played a major role in this mess. That is about the most preposterous thing I have read this cycle. That's not really surprising as very few people really understand how the financial systems operate at their core. Most simply point to something like M3 money supply and say the Fed is printing money. This is such a crowded thought that is completely inaccurate.
The asset markets are setting up for a state that I would compare to an overburdened computer system. A term used to describe this state is aptly called thrashing. In layman's terms, this state can be reached when too many tasks are trying to access too few resources or the same resources. Ultimately the system implodes. Applied to global asset markets, we see fewer and fewer trades working and these trades are drawing larger and larger sums of money that ultimately leads to greater and greater distortions in these markets. Distortions that lead to an inability of resource markets to respond normally. Distortions that will ultimately lead to some level of implosion. Some commodities have seen ten year price runs in a month. Literally. Even though fundamentals are deteriorating or even cratering in some instances. Gasoline supplies, which I touched on a few months ago, are exploding. Gasoline supplies, long argued by Wall Stret personalities and traders as a reason why prices were so high, are now higher in the U.S. than when oil was at $10 a barrel. Oil supplies have been this high for quite some time as we have discussed. Of course, in bubbles we always see disconnects from fundamentals. That is, until the bubbles implode.
Platinum, as an example, has gone well beyond parabolic to something I have never seen; nearly straight up in the last month. Those who argue this is supported by fundamentals are living on Mars. I wrote late last year that platinum's primary driver, catalytic converters, was being reduced substantially by economic substitution in that market. Since then an American partner company of NASA has actually developed a catalytic converter that is thirty percent more efficient than any available today and apparently uses no platinum or other noble metals. It has already received some testing approval from California, the strictest emissions standards in the U.S. In other words, it's not in the idea phase. It's likely coming to market relatively soon. If there is anything positive about the industrial commodities bubble it is that we shall see tremendous innovation in the areas of economic substitution and efficiency. And, likely as the world ramps up massive new online supplies for these products.
Most of the investors in commodities likely have no idea of the economics or dynamics of these markets. These violent distortions in pricing are a very unhealthy sign we have reached a level of massive speculation. The only global assets that are now flying higher are these inflationary investments. And, they are very crowded on the long side of the trade. This enthusiasm is driven by massive inflationary bubbles in China, India, the Middle East, Russia and elsewhere where central bankers long ago lost control of their economies. In fact, there is a fair amount of evidence some of them never had control of their economies. American and European speculators are ramming the dollar to drive more and more inflation into dollar pegged economies to benefit from their trades in commodities. And, it appears the U.S. is more than happy to oblige a weaker dollar in an attempt to shake the international trade cheats and to help offset the domestic economy with export growth. But, that too is slowing because as we have written repeatedly since starting this blog, the global supply chain build out is reliant on the American consumer. Don't ever, ever, ever believe in this concept of the global economy disconnecting from the U.S. I read this perspective that the world has disconnected again just a week ago from a top commodities investor. This at a time when many of these commodity trades are likely the most overbought from a sentiment standpoint in modern history. The global economy is more reliant on the U.S. than at any time in my life in both economic and financial terms. As I have said before, these industrial commodity moves have nothing to do with inflationary concerns in the U.S. as we are told. It's about the quickening inflation in emerging markets that hot money is riding as the developed world starts to crumble. Inflation that I have repeatedly said will eventually lead to deflationary busts.
As each day passes, there is more evidence supporting a position we are putting in an ultimate peak for many, if not all, commodities as I wrote earlier this year. I'm most comfortable with this statement as it pertains to industrial commodities. Investors are discounting ten, twenty or more years worth of fundamentals in these valuations. The commodity supercycle that Wall Street has been telling us is a foregone conclusion is going to be severely tested. Wall Street never stops the pump until they wake up and realize their thesis was totally disconnected from underlying fundamentals. Given the economy drives Wall Street and not the other way around, why would we ever really expect most people in this insulated 'group think' industry to ever be right on substantive macro issues?
Is a large commodities correction now starting? Well, when everyone is engaged in the same activity the outcomes are never constructive. When leverage is involved, the outcomes can be disasterous as we are finding out in other Wall Street messes. When traders exit large positions in the parabolic markets they are creating, it will be impossible to do so without inflicting damage to everyone engaging in these markets. And, in the futures markets where leverage is involved........... This has already happened in the wheat market where one trader lost $140 million a week or so ago. I expect many of these funds that are making significant paper gains in narrow markets right now to overstay their welcome. In parabolic markets, everyone is on the same side of the trade. Someone has to be left holding the bag. It therefore must be funds that were printing money on the way up.
So, here's a question. How upset would Americans be if they knew it was their own banks and unregulated financial firms that were driving up their cost of food and energy to levels that were causing significant pain and economic hardship while these firms were making billions at their expense? Is this really any different than the housing mess where bank schemes minted massive profits while driving prices higher while Americans are left in the aftermath holding assets that are imploding in value? I'm not saying global demand doesn't play a role in the rise of commodities but would that have been 50%? 100% rise? Even 200%? Instead of the 1,000% we are seeing across many of these assets? The Wall Street media machine encourages us to believe it's global growth driving prices. Of course. Otherwise, we'd regulate their involvement in commodity markets. The claim made by many that financial firms and hedge funds add liquidity to these markets and that fact is constructive. These markets were set up for buyers and sellers of commerce. Not for financial traders to overwhelm some of the smaller markets and add significant price distortions to the larger markets. In this environment the potential exists for pension funds and retirement funds, encouraged to invest in commodities by these same financial firms, to lose substantial monies. A significant number of retirement funds are already underfunded and losses in the commodities space could present greater burdens on the financial system. But, this is just another outcome of the same lack of oversight and regulation in financial markets we have written about repeatedly.
In closing, if anyone is interested, I uploaded a report by the Senate Subcommittee on Investigations titled The Role of Market Speculation on Rising Oil and Gas Prices: A Need to put the Cop Back on the Beat. This was written before the commodities trade widened out to other areas beyond metals and energy but it applies to all commodities. I would encourage you to read it. Of course, like everything other form of oversight and regulation, it was shelved or plowed by Wall Street lobbyists.
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