Perspective: Morning Commentary, 12/18/2015

Friday, December 18, 2015

December 18 – Today marks the end of the final full trading week of 2015. Trade is expected to thin dramatically over the next couple of weeks, which can lead to either very quiet markets in a slow news period or considerable volatility if market-moving news emerges. It’s also a time of position squaring ahead of the holidays, end of the fiscal quarter and fiscal year.

The dollar is modestly weaker this morning after surging more than 2,100 points off Tuesday’s low, propelled higher by the Federal Reserve’s rate hike on Wednesday; wrapped in a dovish statement that also suggested on-going tightening. The rally completed a 62% retracement of the early-month collapse triggered by the European Central Bank’s failure to meet market expectations that it helped to create.

Commodity traders are now focused on whether the dollar can successfully test the 12-year highs set on December 2nd. A push to new highs would be expected to be bearish for the broader commodity sector, making U.S. commodities less competitive on the global market. Crude oil dropped to a new low for the move earlier today, with West Texas Intermediate dropping to a nearly seven-year low of $34.39 per barrel. Even so, the funds appear reluctant to push the major commodity indices to new multi-year lows this morning. Thus far, we’re seeing consolidation ahead of the weekend and holiday period.

The speculative hedge funds are having a rough year. These trend-following funds are quick in and quick out of the markets, depending on the news, chart signal or latest trend, taking greater risks with the hope of reaping larger rewards. Yet, Hedge Fund Research Inc. reports this morning that 257 funds were liquidated in the third quarter of this year as the commodity rout gathered steam. The fund casualties were up from 200 funds liquidated the previous quarter. Closures totaled 674 for the first three quarters of the year, up from 661 closed in the same period the previous year.

The HFRI Fund Weighted Composite Index fell more than 4% in the third quarter; its biggest drop in four years. China’s yuan devaluation caused accelerated losses in the commodity and equity markets, catching many fund managers off-guard. The volatility seen during the quarter differentiated many of the funds. Total assets managed by the funds dropped to $2.87 trillion, down $95 billion from the previous quarter and the biggest drop since the big crash in the fourth quarter of 2008. Yet, new start-ups continue to exceed those that fail. New funds numbered 269 in the third quarter, up from 252 the previous quarter.

The next several weeks should prove interesting for these funds. The dollar and crude oil are both at pivotal points at opposite ends of the spectrum. Rainfall deficits are building in the northern half of Brazil, bringing crops in the area to the cusp of a crisis, although just-in-time showers have sustained them to this point. Forecasters are casting doubts about next week’s event, which could be the triggering point, which is why soybeans saw a short-covering reversal Thursday after approaching contract lows. Meanwhile, India’s wheat crop finds itself in a similar situation, although wheat stocks are more abundant yet at this point.

The turn of the calendar should also increase the focus on the potential implications of a waning El Nino weather pattern for the approaching 2016 growing season here in the United States. Global corn stocks minus China are just at a 47-day supply, up 11 days from the modern-day low of 36 days set three years ago. Those supplies are destined to increase to burdensome levels if weather patterns cooperate, but could create renewed volatility if the Brazilian situation threatens the safrinha crop, while a waning El Nino raises risks for the U.S. Midwest. That’s the kind of uncertainty that makes fund managers wary of building larger short positions.

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