My definition of the ubiquitous term “funds” is large investment firms using algorithms to diversify holdings and alleviate some risk.
The evolution of this industry has changed the nature of the commodity complex from short-term speculation to long-term investment.
Fund activity can be tracked by simply studying price direction over time.
A question that floated to the top of the social media cesspool called X, like a Baby Ruth bar in a swimming pool, caught my attention this past weekend. The poster asked, “Who are the funds?” It’s a great question given the term is used so nonchalantly these days.
As with most things, this question reminds me of a story. Back in the mid 2000s, following the passing of the Energy Policy Act of 2005 that included the Renewable Fuels Standards program and the subsequent increase by the CME in the number of contracts that could be held by noncommercial traders, those not actually involved in the trade of the underlying cash commodity, investment money started to flow out of the more tradition long-term investment sectors of equities and Treasuries and into commodities. King Corn ($CNCI) rose to power as investors wanted to take part in the long-term demand market created by the booming US ethanol industry. On the other side of the ledger, a well-known stock analyst for a major financial media network bemoaned the “commoditization of equities”. The investment world was being turned upside down and inside out as we watched.
Shortly after that the industry saw the rise of computer-driven trade. That’s an oversimplification, as algorithms have been used by long-term investment companies for decades, but the evolution of the system hit another gear as the 2000s progressed. We watched as Watson, my name for the algorithm-driven investment industry in general, changed from being easily manipulated by the wording of headlines, often with the key words having nothing to do with the story itself, to a more technical system based on momentum, moving averages, volatility, and yes some form of fundamental analysis.
With that little history lesson completed, the question remains, “Who are the funds?” My definition is the investment industry that has become more involved in the commodity complex as a way of diversifying from more traditional holdings. Looking at the proverbial hurricane about to make landfall in the markets, remember the next US Inauguration Day is Monday, January 20, the floodlight will be on what the next move by this group might be.
Back on November 1, 2024, I wrote a piece talking about how the S&P 500 Index ($INX) had completed a bearish key reversal on its long-term monthly chart. Then came the US Presidential Election with the subsequent euphoria/hysteria taking all three major US stock indexes to new all-time highs, raising the question of if US equity markets were still bearish. By the end of December, it was interesting to note both the S&P 500 and Dow Jones Industrial Average ($DOWI) had again completed bearish technical reversal patterns. This raised a different set of questions, including if these patterns mean anything if Watson doesn’t pay attention to classic technical analysis.
I had this discussion with one of the top Elliott Wave analysts in the business recently at a conference in Florida. He was still adamant the patterns he has spent his long career tracking are still relevant, though I left the state bordering the newly named “Gulf of America” still certain in my mind the evolution of fund activity has made tradition technical analysis obsolete and familiar fundamental analysis (think government reports in any market sector) more useless than ever.
How then do we track the activity of the investment side of commodity markets? I know the original question came in during a discussion of CFTC Commitments of Traders reports, a subject as misleading as any other set of government numbers given the large majority of those who talk about these reports quote an incorrect set of data.
Putting that aside, tracking fund activity is relatively simple. If we reduce market noise, first by turning off most commentary about the subject and second by staying off social media, through the use of close-only charts (choose your timeframe) we have an idea about the flow of large investment money. We do this by applying Newton’s First Law of Motion to market analysis: A trending market will stay in that trend until acted upon by an outside force. Usually, that outside force is fund activity. This is why Newsom’s Market Rule #1 reminds us to not get crossways with the trend. If we do, then we are going against what the big money in markets are doing. Most of us can’t afford to make this mistake.
Are funds trend followers or trend setters? I’ve long argued for the latter, but talking to the those in the investment industry who write the algorithms that make up the bulk of electronic trading tell me they are trend followers. I’ve come up with a new idea (that may not be new to others): What if they are both? That’s a subject worthy of a book, though by the time one is written the industry will likely have continued to evolve.
Who are the funds? Large investment firms using algorithms to both set and follow trends across the various market sectors to diversify holdings and alleviate some risk. Our job isn’t to understand why they do what they do but rather watch what moves they make. Or in other words Newsom’s Rule #5: It’s the what, not the why.
On the date of publication, Darin Newsom did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.