Like a sea captain surveying wrecked ships washed up on the rocks, I’m more than a bit nervous holding livestock funds like iPath Livestock ETN (COW) after seeing the stunning drop in sugar, which has plunged 43% in seven weeks on news of better-than-anticipated crops from Brazil and India.
It’s a dramatic reversal for what had been for a few months one of the strongest markets on earth. Sugar more than doubled from spring 2009 to February 2010, when it reached a 30-year high. Already a popular arbitrage between oil, ethanol and corn, sugar became an outright speculative favorite as well.
Taking advantage of higher prices, growers responded by increasing output, among the factors that have contributed to the commodity’s sharp decline. iPath Sugar ETN (SGG) has dropped 44% from its peak.
iPath Sugar ETN (SGG) - Price vs. Shares OutstandingSource: Rosewood Research
It’s a sobering reminder that, no matter how solid our research is or strong our convictions are, the market itself is the final arbiter. I remember dumping U.S. Natural Gas Fund (UNG) at $42 in 2008 and feeling certain I was selling the bottom. On Friday it traded at $7 – an all-time low.
Sugar’s drop is also a disquieting scene for anybody holding commodities, many of which have rallied sharply on expectation for economic growth.
As regular readers know, one commodity in which I currently have a position is livestock, which despite a correction last week, is still up solidly for 2010. I’m from the school that says the best way to handle a winner is to hang onto it. Aiming for the big trends in livestock means believing that cattle will eclipse the all-time highs seen in late 2008 and that hog prices could easily add another 10% to match their historical peaks.
Yet there is evidence that livestock’s recent rise has attracted speculative interest. Last week, the open interest (or number of contracts outstanding) on the Chicago Mercantile Exchange (CME) cattle futures hit a new record as did the long (bullish) holdings of speculative investment funds.
While often attributed for goosing markets higher, the speculative herd is often the sign of a market rolling over rather than taking off. As we wrote last summer, investment in the U.S Natural Gas Fund (UNG), for example, boomed even as the value of the commodity plummeted.
Like the wrecked ships washed against the rocks, the dramatic drop in sugar prices reminds us how quickly a profitable trade can reverse especially in smaller commodity markets.
Yet when it comes to my trade in livestock, I’m still compelled to hang on for the journey. The position is still a win, and while speculative interest has climbed, it’s still far from bubble standards. Beyond a few wise market watchers, nobody’s talked about making money in cattle since Hillary Clinton.
And because the position accounts for less than 5% of my portfolio, a 40% drop like sugar’s decline wouldn’t sink my entire ship. Ideally, a stop loss order below my purchase price would provide a life raft long before the drop gets that severe. Of course it all seems so rational in theory. The trick is maintaining that reason and rationality even amid the chaos of volatile markets -- which is exactly why there are so many ships wrecked against the rocks.
“Those who argue that housing prices are now at the point of a bubble seem to me to be missing a very important point,” said Barney Frank, the senior Democrat on the House Finance Services Committee on the floor of Congress in June 2005. “Homes that are occupied may see an ebb and flow in the price at a certain percentage level, you’re not going to see the collapse that you see when people talk about a bubble and so those of us in our committee in particular will continue to push for homeownership.”
At the time of writing, Hoenig’s fund was long shares of iPath Livestock ETN (COW).
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.
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RT @JonathanHoenig: Survive the Slide When Markets Reverse http://bit.ly/9zCDJi $COW $UNG $SGG
RT @JonathanHoenig: Survive the Slide When Markets Reverse http://bit.ly/9zCDJi $COW $UNG $SGG
RT @JonathanHoenig: Survive the Slide When Markets Reverse http://bit.ly/9zCDJi $COW $UNG $SGG
Survive the Slide When Markets Reverse http://bit.ly/9zCDJi $COW $UNG $SGG
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