A week after we were talking about the net long/short exposure of managed futures as an asset class through the lens of seven trend following models, the Wall Street Journal reported today that hedge funds are piling into long bonds. The piece is actually just a repackaging of sorts of the weekly Commitment of Traders report from the Commodity Futures Trading Commission, which showed that the net long position of so-called large speculators increased substantially (~500% according to Bank of America/Merril Lynch), with the the BofA/Merrill analysts saying that this much ownership of long contracts has pushed the 30-year bond futures market into “crowded long” territory for the first time since December 2007.
Now, we’re not quite sure how the authors jump straight to the conclusion that large speculators = hedge funds, especially when we’re talking about exchange-traded futures contracts here (they are likely making the same mistake they have been for years by lumping managed futures together with hedge funds). We’re also not sure if they are trying to imply that this crowded trade means bad news for risk on markets like stocks (that hedge funds are right) or that it means bad news for the hedge funds (with so many people in the trade that it won’t be right or doesn’t have much further to go).
But we still like the data and the observation that net longs haven’t been this long since December of 2007, despite the fact that we didn’t particularly like the chart from Bank of America/Merrill Lynch (speaking of crowded, could you make the title font a little bigger and try to leave as little space as possible between it and the chart you’re describing?). Anyway, the confusion over what this article was implying got us thinking – just how have the movements of large speculators’ net positions lined up with bond pricing over this period – what is the implication?
To find out, we overlaid the backadjusted US 30-year bond futures price chart onto the data for context. See below:
On the net short side in the graphic above, it is an easy story: large speculators have been largely wrong, with the large speculators having been net short bonds from about June 2008 through September 2010, and again throughout basically all of 2011 and the first four months of 2012. This is likely because of the largely accepted view that it is just a matter of when, not if, the mega bull run in bonds ends (when rates go higher). Every recent dip has filled us with anticipation, as managed futures would love a sustained downward trend in bond prices (yields higher; bond prices lower). But the difference between a hedge fund speculator and a managed futures speculator is that a hedge fund speculator is speculating where prices will be in the future regardless of where current prices are (and usually in contrast to where current prices are) – hoping to get into a new market dynamic early. In contrast, most systematic managed futures programs are speculating where prices will be in the future because of where current prices are – hoping to ride a current trend further. The fact that large speculators have been net short for most of the past 4 years tells us that those numbers are made up from more hedge funds than managed futures – as the position is in spite of prices, not in reaction to them.
On the net long side, it looks like the article had a hard time clarifying its implications… because the story is a bit muddled. The large speculators were correct last time we saw this a net long position this large (12/07), with bonds higher in the 12, 24 and 36 months following that reading; but wrong (in the short term) when net positions turned positive at the end of 2010 – just before a sell-off in bonds. Whether this move into positive territory presages continued strength in bond prices (despite the fact that they seemingly have nowhere higher to go – rates can’t go below zero, can they?) or is a contrarian indicator signaling a sell-off in bond prices (and likely rally everywhere else) is yet to be seen.
For now, we’ll just have to realize that it looks like the large speculator camp is notably long – which to us means it isn’t just managed futures this time around, but those predictive, in spite of current prices type hedge funds getting in on the action as well, switching their stripes from predictive to reactive in their speculation that prices will continue higher.