October 19, 2021

Commodity Insight: They ain’t gonna go away

A complaint I hear daily is about the influence computer trading has on all markets. When a market — in particular, a commodity market — rises or falls sharply, the movement is blamed on the “funds,” “computer trading,” the “algo boys” or high-speed trading.

I am asked daily, “What are funds doing?” Those complaining and asking such Freudian questions are hoping that old saw taken from cowboy wisdom, “The water ain’t gonna clear up ‘til you get the pigs outta the creek,” will spill over to the marketplace regarding computer trading.

Most all I talk with want the “funds” to stop trading. They want “algo boys” to cease and desist.

My retort to each complainant is clear and to the point: “It ain’t gonna happen.” I say, “They ain’t gonna go away.” The marketplace will not clear up and get easier because the funds suddenly halt their market activity.

The most recent example of the funds having an outsized impact on a market is with cattle. The funds embarked on a buying spree with cattle futures in mid-May with futures and cash prices around the $122 to $124 level at best.

Demand for beef began to ratchet higher, China was a noted buyer and the technical signals were flashing a “buy” and the funds simply loaded up on the long side.

By late August, cattle futures hit a five-year high of $138 or so, but the cash cattle remained stuck at the $122 to $124 level. Futures were far over cash, a bearish sign.

When boxed beef prices began to leak, the funds quickly turned to sellers. From the Aug. 24 high of $138 basis December to the low posted Sept. 13 of about $125, futures dropped nearly $13.

Yes, indeed.

On Aug. 24, cattle hit a five-year high, but on Sept. 13, the market hit a four and a half-month low. It took the funds about 135 days to push cattle prices sharply higher, but only 13 days to wipe out all the gains.

It has been years since cattle futures took such a drubbing in short period of time. And the collapse with prices was blamed squarely on fund liquidation of long positions.

Over the years I touched on computer trading by the funds and so forth several times. From my book, “Back To The Futures,” in a chapter entitled “Number Crunchers,” I wrote in 1982: “Computers, computers! That is all I hear about anymore. Computer trading programs and buying and selling stock futures, bond futures and now livestock features. Most markets have fallen sharply over the past few weeks and the blame is placed on these electronic marvels and their operators. Today, computer trading programs and their impact on markets is the single most discussed topic in the world of investments.”

In my other book, “Haunted By Markets,” in a chapter entitled “Algo Trading,” from June 2013, I wrote: “FC Stone used the slang expression, ‘algo’ for algorithm trading, which is nothing more than high-speed computers buying or selling stocks or commodities in fractions of a second. Here is the Wikipedia definition of algorithms, ‘In mathematics and computer science an algorithm is a step-by-step procedure for calculations. Algorithms are used for calculations, data processing and automated reasoning.’ What Wikipedia failed to mention is that algorithms are now used for high-speed trading, as well.”

Based on the history of computer trading since the early 1980s, I can say with confidence the funds are generally the ones that push markets and prices to highs that are not sustainable by fundamentals. The funds are also the ones that push markets and prices to lows that are not sustainable by fundamentals.

The funds are not biased in the least. Understand it is the funds that put the highs and lows in based on their buying and selling sprees.

My work in forecasting markets and prices is based on supply and demand, not mathematics. Still, I do indeed have several computer programs that help me with forecasting.

This week, my trend following systems flashed a forecast that cattle prices in 2022 will embark on a robust bullish market. Another market my system now favors is the long side of KC wheat where the stocks to ratio is at a record low, a bullish sign. The new year is looking good.

I understand the frustration many have with the algo boys, high-speed trading and so on. Still, just because the water clears up once the pigs get out of the creek, it is not the same in the marketplace.

In my view, investing and trading in stocks, bonds, currencies or commodities is an art, as well as a science. I blend fundamentals with a reliable computer trend following system.

I suggest you do the same because computer trading is here to stay. They ain’t gonna go away.