Hedge Funds Position for Showdown Against Index Funds in Grains

(Agrimoney) – Hedge funds sold down heavily in ags in the run up to Christmas – leaving themselves vulnerable to a clash with index funds, which many observers believe fueled buying pressure in grains evident in Tuesday’s rally.

Managed money, a proxy for speculators, cut its net long position in futures and options in the top 13 US-traded agricultural commodities, from corn to sugar, by 51,632 contracts in the week to last Tuesday, analysis of data from the Commodity Futures Trading Commission regulator shows.

The selling was led by grains (including the soy complex) in which the net long – the extent to which long bets, which profit when values rise, exceed short holdings, which benefit when prices fall – was cut by 44,259 lots to less than 29,000 contracts.

That sell down in grains was more significant than many observers expected, according to Terry Reilly at Chicago broker Futures International.

“The CFTC report showed funds less long than estimated for soybeans, and more short than expected for Chicago wheat,” and less bullish than expected on corn too, he said.

Fund showdown

However, this selling potentially leaves hedge funds on track for a showdown in index funds, for which the early-year period brings a crucial portfolio rejig which is expected, this time, to bring buying in grains.

During the so-called “re balancing” process, index funds rejig their portfolios to the weightings of the index they follow.

This often meaning selling top performing commodities of the previous year and buying laggards, while adjusting to changes indexes such as Bcom or the S&P GSCI make to headline commodity weightings too.

For Chicago soft red winter wheat, this re balancing process will bring buying equivalent to 8.9% of daily trading volumes during the reweighting window, from January 9-13, according to Societe Generale calculations, and for Kansas City hard red winter wheat buying equivalent to 14.1% of daily volumes.

Corn, soybeans and soymeal will see smaller rates of buying, and soyoil marginal selling, the bank said.

‘Selling may be limited’

And many other investors have already begun positioning ahead of this process – a factor seen by many commentators as behind a rally on Tuesday in grains which saw corn and soybean futures gain nearly 3% in Chicago, and wheat futures soar a little over 4%.

“The [hedge] fund position is still running a sizable short that many feel is being covered due to year end and the index rebalance,” said Joe Lardy at CHS Hedging.

Broker Benson Quinn Commodities, said that it “wouldn’t rule out additional short covering” by hedge funds, noting that “selling may be limited in anticipation of index funds having to buy wheat”.

With futures in Chicago corn, soybeans and wheat trading above 10-day moving averages, many recent short bets now stand at a paper loss, with Kansas City wheat trading temporarily above its 40-day moving average too on Wednesday.

Sellers in softs

However, hedge funds looked on surer footing in selling on New York-traded soft commodities, in which they cut their net long by a further 23,784 lots in the latest week.

That took above 160,000 contracts the cut in the net long in a run of eight consecutive weeks of selling, the longest such spree in three years.

Index funds look more likely sellers in soft commodities, particularly in raw sugar, the SocGen analysis shows.

In the latest week, index funds cut their net long in sugar below 150,000 contracts for the first time in eight months, encouraged by ideas that recent higher prices will boost output in 2017 from producers such as the European Union.

In coffee, hedge funds, encouraged by improved hopes for Brazilian output next year, cut their net long for a sixth successive week, the longest selling streak since early 2015.

Bullish on cattle

In livestock too, in which hedge funds raised their net long for a sixth successive week to a two-year high of 145,649 lots, their positioning looked in line with the trend of index fund moves.

Live cattle and lean hog futures will be the biggest beneficiaries of index fund buying during the reweighting process, according to the SocGen analysis.

That said, prices in both contracts have already gained notably since the bank made its calculations, early this month, with live cattle futures for December closing on Tuesday at 114.95 cents a pound – a four-month high for a spot lot, and up 22% from a mid-October low.