Commodity Focus Q2 2017 Commentary
|Investment Style:||Systematic, Trends|
|Quarterly Return:||17.56% (net of service fee but gross of any applicable performance fee)|
|Q1 2017 daily return volatility:||1.83%|
|Average Trades per week:||10.2 (since inception)|
Contrary to bullish expectations which had driven the reflation trades early in 2017, in the second quarter of 2017 (Q2) the Bloomberg commodity index declined and actually broke out of its trading range incurred throughout the third quarter (Q3) 2016 – first quarter (Q1) 2017.
Regarding, Agriculture & Soft commodities, the oscillation from El Niño to la Niña has been the catalyst for significant reversals in weather patterns and agricultural crop forecasts globally. International grain stocks are currently contracting off record highs in 2016/17, and the abnormally warm weather outlook has triggered concerns that US crop yields will be adversely affected. Conversely, soft commodities have been subject to considerable selling on expectations of supply side improvements into 2017/18.
Within Energy, the significant increase in oil production by the (fracking) USA, encouraged the crude oil markets to ignore geopolitical risks and instead focused on the inability of the OPEC & Russia to rebalance the crude oil supply/demand market. The result was a fall by 20%, meeting the technical definition of a bear market. However the oil price seems to be a half-cycle ahead of the traders, consistently falling in the face of (ostensibly) bullish news and rising in the face of (ostensibly) bearish news. This pattern seems set to continue for the foreseeable future.
Industrial metals have bounced in the face of stabilisation in the Chinese economy, and are now technically bullish. Nonetheless an additional catalyst seems required to create the energy for the next move. Precious metals have been sold off as a result of waning inflation concerns, since inflation has been dragged lower by the aforementioned falling energy prices.
The portfolio came into the quarter with short positions in the agricultural & metals sectors. Additional shorts were added in the energy sector. Most of the short positions were moderately profitable and some were very profitable. Some of the short agricultural positions were closed when prices reversed sharply late in the quarter.
While the recent changes in the direction of commodity prices have been triggered by fundamentals, the response by the financial community has probably driven many of the prices – particularly grains - too far too soon.
For that reason, profits were partially realised on some positions, and remaining exposure is expected to progressively reduce early in Q3. Nonetheless the strategy manager does not believe that the current weather, politics & economics themes have run their course, and therefore expect to re-instate many of the positions at more favourable levels later in Q3 2017.
Short positions in metals will be increased if they fall further from the current levels – particularly platinum and silver, which appear technically the most vulnerable. Whatever happens, trailing stops are likely to be moved in the direction of the price trend, and exposure likely to be reduced in the event of counter-trend moves, not because the trend has changed but in order to reduce the volatility of portfolio returns.