We’ve highlighted a few times on this blog on how trend following can be helpful in portfolio construction with its ability to access a diverse set of markets as well as both sides of the return distribution (long and short) in those markets. Diversification is driven by both of those features. 2022 saw bond prices fall and commodity prices rise as inflation, war and interest rates rattled through the global economy and asset markets. The ability to get short exposure to bonds and the Japanese Yen as interest rates rose, coupled with long positions directly in the commodity markets that stoked inflationary fears, enabled trend following allocations to cushion traditional portfolios of stocks, bonds and credit. Direct exposure to the factors hurting traditional portfolios is a key benefit of trend following, as well as its adaptability in different environments. Indeed, in previous difficult periods for traditional markets the opposite exposures were the most helpful – long bonds and short commodities in the GFC were the right positions for trend to take.

On the commodity side in particular, we have long thought that owning commodities as a long only investment was a mistake, and that due to human ingenuity and product substitution prices would go down in real terms over time. The short side is too important to ignore. This can be true in financial crises like 2008/09 when crude oil dropped some 75%, but also in quieter times. The risk premium in Managed Futures comes from taking on risks producers and consumers want to shed, making participation on both the long side and short side necessary. Commodities are particularly useful as they are much less correlated to each other than something like bond markets. Crude oil, grains, softs and meats all have their own cycles driven by their own unique drivers and supply/demand curves. Current grain markets are a good example.

In 2022 grain markets spiked upwards as the Ukraine war directly impacted the wheat market. Prewar, Ukraine harvested some 33m tons of wheat as one of the larger global producers. Prices of US wheat had been trending higher through 2021 and were sitting around $8/bushel; by May they were 50% higher at $12/bushel. Wheat competes for acres with corn and soybeans, as farmers optimize a planting mix in part based on market prices. If wheat – which grows like a weed – is trading 50% higher than usual some acres shift to wheat and away from corn and soybeans, reducing expected crop sizes, pushing those prices higher. Long only caught that move. The best cure for high prices though is high prices, and possible crop shortages and fears of the same can be solved with a couple of good harvests. As those fears and shortages abate, prices fall again. This is what we have seen in 2024. Planting conditions were perfect, the growing season weather has been perfect. Seed technology and farming advances keep improving. Record yields for corn and soybeans this year. What happens when high prices meet record yields? Lower prices. It’s times like these you need your shorts.