Institutional Investor's Alpha Magazine - February 2009 - (Page 45)

Strategies Commodities Fools rushed in and prices soared in 2008. And then they tanked. Now some investors see vast new opportunities in an imminent recovery. TRUECOMMODITIES FILES STORIES FROM THE By M.Corey Goldman I n the spring of 2008, commodities trader Chris Nygaard and his colleagues at Vermillion Asset Management were perplexed. Overseas, food riots were raging; in the U.S. big-box chain stores were rationing rice; oil was heading well north of $100 a barrel; and countless charts were showing the prices of virtually every hard and soft commodity setting new records. Nygaard, the founding partner and co–portfolio manager of New York–based Vermillion, smelled a rat — and an opportunity. Futures prices for commodities were unfathomably higher than cash market prices, and old-fashioned supply-and-demand trading seemed to have vanished. Vermillion began putting on “calendar spreads,” wagers on where prices of commodities and commodities futures would be in relation to one another on a month-by-month basis. It also placed bets on commodity options — mostly that a vast majority of them were extremely undervalued. In time the ﬁrm was proved right, and though it came a bit too early to its assessment, the second half of 2008 made it look smart. According to investor documents, Vermillion’s ﬂagship Viridian fund rose nearly 26 percent for the year, and its Indigo fund was up a little more than 35 percent. Nygaard says that today a reversal is in progress. He thinks commodities are on the rebound but that they were overheated in March when the alarms were sounding on the models Vermillion uses to position and trade the more than $1.5 billion it manages in three commodities funds. Data from the Commodity Futures Trading Commission was showing speculator inﬂows in long futures contracts, signaling unsustainable extremes. So did a host of other indicators the ﬁrm monitors to ﬁgure out where price spreads and volatility are headed. No matter the commodity — corn, copper, cotton, oil, soybeans — the relationship between futures prices and real prices was bizarre. Measures of implied volatility on most options on futures contracts were off the charts, while fair-value pricing of extreme tail events — war, famine or some other cataclysm — was signiﬁcantly below where it should have been. It was clear at the time, Nygaard says, that most commodities investors were mimicking one another and few were generating alpha. “Commodities were all going up or all going down on any given day,” he notes. It took a little more than four months for commodities to peak and then abruptly change course. But it had taken serious conviction to ignore the springtime chatter that the new global economy and the industrialization of China and the third world would make $200-a-barrel oil FEBRUARY 2009 • INSTITUTIONAL INVESTOR’S ALPHA • 45

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2009

Institutional Investor's Alpha Magazine - February 2009 Contents Letter From the Editor Longs & Shorts Digging Out A Call to Mentor Dicey Detroit The Constant Skeptic Cover Story: The Undaunted What Were They Thinking? Dark Days in Greenwich True Stories from the Commodities Files Return of the Native The Quest for Cover Moving On from Madoff

Institutional Investor's Alpha Magazine - February 2009

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