A Market Just Begging for Short Commodity Speculation

by: Mercenary Trader

by Jack Sparrow

U.S. stocks fell, giving the Standard & Poor’s 500 Index its biggest weekly drop in three months, as concern about Europe’s debt crisis intensified, speculation China will boost interest rates grew and Cisco Systems Inc.’s projection missed analysts’ estimates. - Bloomberg

The big news in the week that was? The huge whackage in commodities.

Stocks took their biggest lumps in three months, but the CRB index took its hardest punch in 18 months.

On Friday, gold, silver, oil, copper, grains, and sugar all got killed. (For a quick mental snapshot of the carnage, pull up CRB, DBA and SGG.)

One can imagine trend following commodity CTAs and “peaceful easy feeling” bulls looking like a Jackie Chan movie poster right about now.

So was Friday’s action a surprise? Yes and no.

Yes in the sense that you can’t really predict days like that — which is what makes the declines so steep in the first place.

No in the sense that anyone paying attention could have seen this coming – or at least seen the high odds that something like this would occur.

I mean come on. Flat-out surprise that China has to do something about its white-hot overheating economy? Really?

Case in point — last week’s Weekender, where we talked about gray swans. None of the risks taking front and center attention now are new! They have all been steadily building.

China has been an inflationary cautionary tale (with a Potemkin village overlay) for months. Europe has been a sovereign debt disaster in waiting — crisis delayed, not denied — for even longer. And the risk of U.S. corporations running disappointing numbers (after “sugar high” stimulus-driven earnings peaks) has also been well known. We have hammered on ALL the above points, repeatedly, these past few months.

Last week, a few big name investors and investment houses started talking about a “Super Goldilocks” environment for E.M. and “no risks any time soon.” Are you freakin’ kidding me?

This gets around to one of my pet peeves — overly confident prognosticators who act as if they have a special dispensation as to what the future holds.

I wish I could say to them: “Listen you knuckleheads. Nobody has true certainty as to what the future holds. And if they did, the market would have priced it in! That’s why trading is an odds game… and a risk management game.”

We got “beared up” on Friday not long after the open — having already been long the $USD — and now have a roster of short positions that includes the following:

  • short copper
  • short oil
  • short China

Why are these positions so attractive? In part because of the potential for so many complacent investors to be caught flat-footed. When everyone 95% agrees on something — home prices will never decline, China can’t be stopped, commodities can’t go down, etc. — there is real risk of “everyone” taking a frying pan to the face.

In addition, the logic for a short commodity speculation is more than just contrarianism for contrarianism’s sake. It is a recognition of a misunderstood and well underestimated scenario:

  • The possibility that QE will NOT prove inflationary, and that rising commodity input costs will further act as a DEflationary brake on the U.S. economy. (For more on this see my recent comment here.)

Boy, that would surprise the hell out of a lot of folks wouldn’t it? There’s a lot of profit potential when the crowd gets surprised…

Of course, this latest earthquake might be shaken off… determined investors might man up, buy the dips, and decide to go long sunshine again. But that’s what risk management is for…

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.