Performance Report: 2/29/2024
All performance data for our strategies is net of all fees and expenses. All performance data for indexes or other securities is from sources we believe to be reliable. All data is as of 2/29/2024.
Investment Strategy
MAP: Full ($500k+)
MAP: ETP (<150k)
S&P 500 Index2
Balanced (AOM)2
Global Balanced2
Jan. Return
(3.0%)
(3.8%)
5.2%
1.1%
2.0%
YTD
(5.3%)
(6.1%)
6.8%
2.2%
2.9%
Inception1
33.3%
18.1%
73.0%
19.2%
34.0%
VORR3
.659
.338
.735
.363
.415
Both the NASDAQ and the S&P 500 reached new historic highs in February. And while they continue their march higher, I continue to believe that equities do not represent a strong risk/reward investment opportunity. Here are the latest comments from Dr. John Hussman regarding the issues of cyclical equities:
Investors seem to be developing an excruciating and nearly frantic 'fear of missing out.' The intent of this note is to describe what we are doing – calmly and methodically, in our own discipline, to share the data surrounding those actions, and to remind investors how those actions will change as the data changes.
We can’t say with any certainty at all that stocks are at a market peak. We can also say with complete certainty that present conditions mirror what a market peak looks like.
In late 2021, I ditched cyclical equities and all interest rate-sensitive securities while shifting our exposure to hard assets. Avoiding interest rate risk proved wise and timely but we have missed out on continued gains in the broad stock markets. Over the past two years, our non-cyclical exposure has come in the form of equities and futures contracts. Some of our exposure has done well such as uranium, orange juice, and sugar. Some has done alright such as precious metals and oil. And there have been some real laggards such as the grains and natural gas. As a whole, my FULL-sized strategy has done well the past few years but my other strategies are lagging. Unfortunately, over the past few months, everything I’ve done has lagged by a decent margin.
In light of my poor performance this year, I believe it’s an appropriate time to take a deeper dive into why I’m doing what I’m doing.
To reiterate my thesis, I believe the FED and Wall Street are shorting commodities to help mitigate price inflation. Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.” Wall Street has become dependent, nay addicted, to the FED’s monetary inflation. But monetary inflation invariably leads to price inflation which the FED must control to uphold its mandate to Congress. Thus, if monetary inflation leads to price inflation, and one master requires the former while one master prohibits the latter, what is a central banker do to?
The FED is desperately trying to serve its two diametrically opposed masters which has become a dangerously perilous balancing act. But desperate times call for desperate measures. Thus, the FED has forced itself into a corner by selling hard asset contracts to suppress price inflation allowing them to continue to provide Wall Street with its much-needed liquidity fix.
I have provided proof of this entanglement in prior reports by explaining how commodities have shifted from backwardation (i.e. contracts trading at a discount thus favoring buyers) to contango (i.e. contracts trading at a premium thus favoring the sellers.) From 1956 until 2011, futures traded in backwardation but starting in the middle of 2011, commodities started trading in contango. Given that Wall Street never willingly loses money, the state of contango is simple yet positive proof that Wall Street is on the sale side of these transactions.
In this update, we'll examine more data points to categorically prove that Wall Street and the FED are shorting various commodities, in spite of the fact, they have absolutely no ability to deliver the real assets if physical delivery is required. (Historically, the only entities who sell commodity contracts were commodity producers who could deliver the commodity in the case of a short squeeze.)
I break commodities into three categories:
- Large and liquid
- Moderately traded
- Small and thin.
The following are commodities I follow in each of the above categories:
- Large and liquid: oil (CL), natural gas (NG), corn (ZC), soybeans (ZS), and wheat (ZW)
- Medium and moderate: Coffee (KC), sugar (SB), and live cattle (LC)
- Thin and small: Rice (ZR), orange juice (OJ), and Cocoa (CC)
My Full-sized accounts have owned all of these in the past year except cocoa, live cattle, and coffee. My MIN-sized accounts have only held the "Large and Liquid contracts" with some sporadic exposure to sugar. One of the aspects of the "Large and Liquid" category is they have mini and micro contracts which are a fraction of the size of the full contracts and thus I can buy the mini and micro contracts in smaller accounts. The thinly and moderately traded commodities do not have smaller or fractional contracts and the full-sized contracts for any commodity is going to be too large to buy in account below $500k.
Here is the performance of all these commodities since the beginning of 2022:
Large & Liquid
Corn
Soybeans
Wheat
Natural Gas
- 17.0%
- 1.2%
- 42.6%
- 72.4%
Moderately Traded
Coffee
Sugar
Live Cattle
- 14.4%
+ 49.0%
+ 21.0%
Thin and Small
Rough rice
Orange Juice
Cocoa
+ 25.5%
+ 226.6%
+ 122.2%
Clearly, the "Thin and Small" commodities are outperforming the others by a wide margin. Of the commodities I track, the average appreciation of the "Thin and Small" over the past 26 months has been 125% whereas the "Large & Liquid" have declined on average 33.3%. (BTW, I don't include crude oil in my study as the USD is backed by oil so for the FED to short oil would be to destroy their own currency.)
To give you an idea of how illiquid the “thin and small” markets are, I couldn’t even obtain historical price data for these commodities. By my rough cocktail napkin math, the crude oil futures market is more than 40,000 times larger than the market for OJ.
One might ask, "Why can't the FED/Wall Street short small and thin markets?" The answer comes down to two variables. First, futures are a zero-sum game and thus for every seller there must be a buyer. The big banks can't sell more contracts than other parties are willing to buy. Second, shorting a smaller market is intrinsically more risky. Consider GameStop stock (GME) which increased over 2000% in one month when it got short-squeezed. GME was a small, thinly traded stock. The Reddit crowd who sought to go after Wall Street by squeezing the shorts had to pick a thinly traded stock to effectively create a short-squeeze. To squeeze TSLA or a larger name would have been impossible, but a small name like GME was obtainable.
Now let's dig further into the data. When we consider that agricultural commodities have historically experienced similar price performance, then how do we explain that the relationship between these securities just completely broke down over the past two years? And broke down along such an easily defined line.
Let’s examine specific correlations between these securities:
The following shows the correlation coefficient between coffee and sugar versus corn. Why corn? Corn is the largest agricultural commodity market in the world and is the most direct substitute for sugar. The two have historically carried a very high level of correlation.
Commodity
Sugar vs. Corn
Coffee vs. Corn
2004 - 2021
0.594
0.671
2022 - Current
(0.471)
0.117
I could only compare the performance between "Large and Liquid" and two of the "Moderately Traded" as I can't obtain accurate data for the "Small and Thin" commodities or live cattle. If I could obtain data on these securities going back to 2004, then the variance would be even more stark. But we'll work with what we have. I used 2021 as my cut-off as that is when price inflation first became “sticky” and the FED "doubled down” on their shorting scheme to combat price inflation.
Let’s consider sugar. Sugar and corn are substituted for each other in many ways and thus should be highly correlated. Corn syrup is used as a sweetener. Both are used to make ethanol. While the weather and other economic forces may not impact both equally as they are grown in different parts of the world, neither crop has benefited from external forces. So why has sugar outperformed corn over the past couple of years? Why haven’t ethanol and sweetener manufacturers shifted away from sugar into corn?
From 2004 through 2021, the correlation coefficient between corn and sugar was .594. Thus, if corn moved 1%, sugar on average moved somewhere between 0.59 and 1.39%. This level of correlation is meaningful. But in 2021, the relationship didn’t just cease to exist, it turned steeply negative. From the start of 2022 through February 2024, the correlation coefficient between the two clocked in at a negative .471. The relationship between the two virtually did a 180. There is absolutely no historical precedence for such an inverse relationship between two commodities that are substituted for each other. When examing the recent behavior of commodity prices, I am reminded of the famous line from the movie Ghostbusters, "It's like dogs and cats living together, MASS HYSTERIA!"
Before wrapping up, I would be remiss if I didn’t address the precious metals market. Gold closed at an all-time and more importantly, it just completed the confirmation of a bullish “Head and Shoulders Pattern”. Here is the chart.
Oddly, despite the impressive showing of the world's oldest form of money, gold mining stocks are deeply out of favor. Newmont (NEM), the only gold miner in the S&P 500, hit a 52-week low just two days before gold closed at an all-time high. GDX, the largest gold-miner ETF, was less than 2% off its 52-week low two days before gold closed at its all-time high. Historically, companies that produce commodities see gains that are several multiples of the commodity itself. Commodity producers have to cover their cost of production which is largely fixed so as prices go up, their margins increase at a much faster clip. Why gold mining companies are fairing so poorly in light of record-breaking prices for gold is “a real head-scratcher”.
From my perspective, it poses a really nice risk/reward opportunity. If gold continues to appreciate, then the mining stocks should play catchup enjoying sizeable gains. But if gold falls in value, our stops will be fairly close thus limiting our losses. Given that both gold and silver are embedded in very bullish patterns, the price of precious metals should be going higher but I have stops in place in case that premise is incorrect.
Conclusion
I had accepted the idea that as we wait for the inevitable short-covering rally in the commodity space, we might endure a period such as the last few months. But knowing it may be coming and living through it are two different things. It's been rough the past few months and I appreciate your patience. I’m confident there will be a massive short-covering rally in real assets and when that happens, we should see considerable profits. As I've reminded many of you in the past, my money and the money of my family are invested right along with yours. Unfortunately for all of us, I don't have a crystal ball telling me exactly when this short-covering rally may take place.
I concede that I am biased. It's like when you buy a new car, and all of a sudden, you see the same make and model everywhere. All I see in the markets is reasons why commodities will be short-squeezed. And that is certainly clouding my judgment in the short term. At the same time, the window to get into these trades may be short-lived. Much like surfing, I believe it's paramount that we get out in front of the wave or jeopardize missing the ride. Unlike surfing, there won't be many other waves like this one.
As always, please do not hesitate to call me at 512-553-5151 if I can be of assistance.
Best,
Matt McCracken
1) Inception date of 4/30/2019
2) All benchmark prices are obtained through the Yahoo!Finance website. S&P 500 Index is calculated using the index price. AOM is the iShares Core Moderate Allocation ETF. Global Balanced is calculated using a 40% allocation to the S&P 500, a 40% allocation to BND, and a 20% allocation to IEFA.
3) VORR is our "Value over Risk Ratio": Calculated by taking the total return divided by the sum total of all negative months. Ideally, the ratio represents how much loss an investor has to endure to get X gain. A negative RORR score implies there is more risk in the investment than return.
IMPORTANT NOTE: I had to remove the MAP - MIN strategy as there were only 2 accounts invested in it from inception and both accounts are now engaged in a different strategy. Thus I do not have a continuous account history to base since inception returns on.