Hedge Funds and Index Funds In Commodity Markets

Index fund
Investment fund designed to match the returns on a stock market index. Mutual fund whose portfolio matches that of a broad-based index such as the S&P 500 and whose performance therefore mirrors the market as represented by that index.
Hedge fund
An investment vehicle that somewhat resembles a mutual fund, but with a number of important differences. If the fund is "off-shore", the fund does not have to adhere to any SEC regulations (and can only sell to non-U.S. investors or investment vehicles). These funds employ a number of different strategies that are not usually found in mutual funds. The term "hedge" can actually be misleading. The traditional hedge fund is actually hedged. For example, a fund employing a long-short strategy would try to select the best securities for purchase and the worst for short sale. The combination of longs and short provides a natural hedge to market-wide shocks. However, much more common are funds that are not hedged. There are funds that are long-biased and short-biased. There are funds that undertake high frequency futures strategies, sometimes called managed futures. There are funds that take long-term macroeconomic bets, sometimes called global macro. There are funds that try to capitalize on merger and acquisitions. Another distinguishing feature of hedge funds is the way that managers are rewarded. There are two fees: fixed and variable. The fixed fee is a percentage of asset under management. The variable or performance fee is a percentage of the profit of the fund. There are also funds of funds which invest in a portfolio of hedge funds. Another important difference with hedge funds is that the minimum required investment is usually quite large and, as a result, minimizes the participation of retail investors.

also from Arlan and Bryce at Farm Futures:

A look back at CFTC's latest weekly data on trader positions reveals some of the dynamics that have impacted prices in recent weeks. Corn prices rallied this spring as the trend-following hedge funds added 1.9 billion bushels to their net ownership of the feed grain between mid-February and early June. Index fund managers with long-term inflation concerns added 0.3 billion bushels of ownership during that same period, as the lead corn contract gained $1.00 per bushel.

The latest CFTC data is for the period ending July 14. As of July 14, the lead corn contract had lost $1.11, with another 35 cents since then. During that period, the trend-following hedge fund managers liquidated ownership of 0.6 billion bushels, while index fund managers actually added another 115 million bushels of ownership. Ironically, it's the index funds that CFTC seems focused on.

What does this data suggest that the money flow is telling us? Short-term dynamics are bearish for corn and the long-term dynamics are bullish. It does not however tell us if the short-term dynamics will last another week or for many months. That will heavily hinge on the global economy, the dollar and on the size of this year's crop. Those factors should determine whether the corn chart puts in a "U" shaped bottom or an "L" shaped bottom with low prices for an extended period of time.

Unfortunately, momentum is everything in the commodity markets and momentum is definitely on the side of market bears at this point. Hedge fund managers have little reason to change their strategy until chart signals turn upward. End users have every incentive to be patient as long as prices are coming down to them as well. Chatter of record yields simply add to the selling frenzy, with few traders having the courage to step in front of this train before it shows signs of turning around.