Understanding Those Big, Bad Commodity Funds
By Jim Wyckoff

How many times do you read the news wires and hear about the commodity funds (or just the "funds") doing this or doing that in the market? And it seems like these big bullies are always on the opposite side of the market than the smaller speculator. To the less-experienced traders the "funds" may seem like the CIA or the Mafia: a powerful and secretive force that has a reach far and wide. In this feature, I'll try to present a clearer picture of the funds, and maybe dispel some myths regarding them.

Just what are the "funds?" They can come in several forms, but usually it's a large pool of investor money (funds) that is managed by a single entity, such as a Commodity Pool Operator (CPO) or Commodity Trading Advisor (CTA). The CPO or CTA then trades futures contracts with the goal of gaining the best annual return on that money possible--better than any other funds or "managed accounts."

Most wealthy investors do not put a big portion of their investment portfolio into futures trading. But some may put 10% or less of their portfolios into managed futures trading accounts. Still, given that it's usually the wealthier investors (and not the smaller investors) that put a small percentage of their portfolio in the futures market, even that small percentage coming from many wealthy investors into commodity pools can add up to a lot of speculative cash pouring into the futures markets. Thus, the "funds" can and do have the weight to move markets.

Generally speaking, the commodity fund operators are trend-following traders who use a shorter-term timeframe to trade futures. Many tend to use moving averages as a major trading tool, or some type of mechanical trading system. Either way, these traders rely on technical analysis for the vast majority of their trading decisions. The funds like to see a market start to "lean" one way, and then pile on positions in favor of the way the market is leaning. This is why markets tend to become overbought and oversold, on a technical basis. The fund buying or selling causes markets to over-react, or become over-extended.

Probably the one commodity group where the funds have the most notoriety is the grains complex. The grains provide an excellent medium for the funds because of the liquidity (high volume and open interest). Given that the funds usually take big trading positions, it would be more difficult for them to dabble in futures markets where the liquidity is thin, such as lumber or platinum. Also, the higher-liquidity markets allow the funds to get into and out of positions more discreetly.

Even with the big pools of cash that the commodity funds possess, they can't stand up to the "big brother" of futures markets: the commercials (the hedgers). The major food processors such as Cargill or Pillsbury have the huge clout and very deep pockets to keep the funds honest and keep futures markets fairly priced at most times. But still, the funds have enough power to more than jiggle markets once in a while. Here's an analogy: The funds are like a fly and the commercials like a horse: A biting fly can still make a horse wince. 

Jim Wyckoff became a financial journalist with Futures World News for many years, cutting his teeth as a reporter on the futures trading floors in Chicago and New York, where he covered every futures market traded in the United States at one time or another including commodity futures trading in Softs and Metals.  Click here for full bio >>