Analysis: Smaller commodity markets face big exposure to funds

By Lisa Shumaker

CHICAGO (BestGrowthStock) – While much attention is paid to the impact of speculators on the oil and gold markets, many smaller commodity markets are far more exposed to the whims of large funds, according to an analysis of regulatory data.

Measured in terms of both percentage of open interest and the ratio of longs to shorts, speculators have built huge long positions in cattle, hogs, cotton and silver futures, according to Commodity Futures Trading Commission data — much bigger than for mainstream markets such as oil or copper.

Live cattle, for instance, has 17 times more long than short positions. And large funds’ net long position in silver represents almost 20 percent of the open interest in that market — compared with about 5 percent in crude oil.

While risk liquidation tied to euro zone worries has already drained speculative interest in some of the biggest markets, the large, long positions in these smaller markets could lead to sharper corrections than the commodities might otherwise see if funds begin to unwind their positions.

“When you have a high percentage of small specs long a particular market, you’re vulnerable to these huge corrections when they happen,” said Michael Smith, president of T&K Futures and Options in Port St. Lucie, Florida. “Too many small specs are on one side of the market.”

For example, live cattle futures have already fallen 10 percent amid fund liquidation. Before the sell-off, funds had quadrupled their long holdings since the start of the year to a record long position in early May.

“It is quite normal for the market to top out this time of year but the sell-off has been accelerated because the funds continue to exit,” said Dennis Smith, livestock broker with Archer Financial in Chicago.

Much the same situation exists in feeder cattle, which is about one-tenth the size of the live cattle market.

Funds held a record long position in late April and have sold off 30 percent of their net long holdings since then.

Cattle attracted investors because the United States has the smallest cattle herd in 51 years and any improvement in the economy usually boosts beef sales.

Speculators also have an extremely long position in gold — about 55 long positions for every short, according to CFTC data. And 27 percent of the open interest is made up of large funds that are net long gold.

However, the precious metal is not likely to see a huge sell-off given that funds historically like to be long gold, which acts as a safe haven for investors in times of economic turmoil.

“Funds are not included to get short metals in any big way for the most part,” said Sterling Smith, analyst for Minnesota-based brokerage Country Hedging.

Fund liquidation has already hit some markets, sending prices tumbling, as investors worried that Europe’s banking problems could derail the economic recovery.

Large funds have sold off more than 50 percent of the net long positions in crude oil since the week ended May 4. Funds slashed their long holdings in RBOB gasoline futures by more than 80 percent.

“After the significant market volatility over the past few weeks, a lot of the risk has already been taken out of the market,” said JP Morgan analyst Lawrence Eagles. “Some of the selling pressure has been exhausted.”

SOME MARKETS RIPE FOR A RALLY

Fund holdings in some commodities also suggest those markets might be poised for prices to rise should investors regain confidence in the economic recovery.

After trading in a narrow range for most of April and May, natural gas futures have risen as much as 12 percent in the last two trading sessions.

“I think one that is ready to go up is natural gas,” said T&K Futures’ Smith. “The commercials are as long as they’ve been in years and the funds are as short as they’ve been in years. That’s one of the ones I’m buying.”

Copper also has the potential to rally, although it might see further fund liquidation first.

Large funds have cut their net long positions by 70 percent since early April. During that time, prices have fallen as much as 24 percent in the metal used in construction and power and a bellwether for the global economy.

“I think they (net longs) are keeping copper as a store of value because they see inflation coming,” said Zachary Oxman, managing director with TrendMax Futures in Encinitas, California.

“It’s kind of worrisome on the downside in the sense that if they really get a big push down or get another flash crash, and we start testing some triple-digit levels in the S&P 500 index (.SPX: ), you may see that come off in a meaningful way,” he said.

“It’s all euro driven. As long as this euro zone stuff hangs around, I don’t think anything is safe on the long side,” Oxman said.

Stock Today

(Additional reporting by Chris Kelly in New York; Editing by Alden Bentley)

Analysis: Smaller commodity markets face big exposure to funds