May 08/15 – Don’t be afraid to fade the hedgies

2015-05-08 12pm EDT  |  #AUD #Crispin Odey

When I was growing up, my old man was the research director for an independent Canadian stock brokerage firm. Although he is now retired (and has toned down the zip in his portfolio), his “investing” in junior Canadian mining stocks could be much more aptly described as “pure unadulterated speculation.” Over the years, I witnessed some pretty big swings in his trading account (both ways I am afraid, although if you could stomach the volatility, his trades were often spectacular, but they were usually go ups or blowups). And naturally, he gravitated towards other like minded individuals, so over the years I have met my fair share of river boat gambler investment types.

Yet even I had to do a double take when I read the latest Odey Asset Management results. From the FT:

Odey Asset Management founder Crispin Odey's flagship hedge fund slumped 19.3 per cent last month, after it was caught out when the Australian dollar strengthened against the US dollar.

The large one-month move, from one of London's best-known hedge fund managers, wiped out Odey European's small gain in the first three months of the year and took its 2015 performance to -18.2 per cent, according to investor documents.

The 2.33bn fund has built up a short position in the Australian dollar against a long position in the US dollar, which drove monthly gains of 4.6 per cent in March. However, since the end of March the Australian dollar has gained against the US dollar.

Holy smokes! How do you lose 19.3% in a month? It’s one thing for some Vancouver speculator to get tagged with that kind of monthly return, but this is one of the bigger institutional hedge funds. That sort of volatility is nuts!

I had a look at the Australian dollar and it barely moved during that period.

If a move from 0.75 to 0.80 is enough to cause Crispin to lose almost 20%, then the amount of leverage this guy must be using is bonkers. Granted if he was shorting Aussie, then he might also have been leaning on all the other deflation trades, but this sort of decline in his portfolio, from what is a pretty standard correction in the trend, puts Crispin in another league.

I actually kind of like the guy. It takes some real gumption to lose 20% in a month. Crispin is kicking it old school macro hedge fund style – like Soros and the boys used to do it. Nowadays most of these hedge funds are boring asset gatherers aiming to return 5% to 10% regardless of the market environment. But in the days of old, hedge funds used to try to shoot out the lights. They were often aiming for a 30% to 50%+ returns.

No one can describe Crispin and the rest of the gang at Odey Asset Management as boring. I just brought up their fund fact sheet. At the end of February, they were net short 124% of their portfolio in UK Gilts. I guess they are a little bearish on gilts. No wonder they are swinging around 20% in a month.

The more I read about these guys, the more I like them. But the real point of this piece is not to point out the freewheeling balls-to-the-wall style of Odey Asset Management. Instead I would like to remind you that these are the guys pushing around the markets these days. Although Crispin and the boys are a little more aggressive than most, these hedge funds travel in packs. Their trades are often amazingly similar. They like to think they are independent thinkers, but as a group, they really aren’t.

This spring the hedge funds became convinced that deflation was coming. Oil collapsed, the Chinese economy looked like it was in trouble, the ECB was panicking with QE – most pro-cyclical asset prices were headed lower in a deflationary mini-scare. Sensing the trend, the hedgies pushed this bet hard. They shorted the Australian dollar because of its sensitivity to the Chinese economy. The hedgies loaded up on German bunds and other fixed income – after all, in a deflationary environment, bonds are the best things to own. They leaned on anything commodity related. As these assets went down in price (or up in the case of fixed income), the hedgies became convinced their thesis was correct, and they did even more.

And that is how Crispin Odey became short enough Australian dollars that a 5 cent move higher wiped 20% off the value of his fund. Like all the other hedge funds, Crispin was convinced the global economy was collapsing into a deflationary quagmire. When this didn’t come to fruition, the squeeze higher (or the plunge lower in the case of German bunds) was painful.

When the hedge funds are pushing one of these themes, and the market is moving their way, it is tough to fight them. There are so many of them, their sheer weight moves many assets farther than seems probable. But they are wrong so much more than they are right.

A decade or two ago, there used to be a lot of retail participation in the market. That’s unfortunately disappeared. Now, we have minimal private investors, with mostly professionals trading amongst themselves. The hedge funds like to joke about selling their positions to the dentists, but the dentists haven’t been trading since 2001 and apart from the Central Banks, there is no more “dumb” money anymore. By the time the last hedge fund enters a trade, there is almost no one left for the rest of the hedgies to unwind the trade with.

This is why you have to watch the so-called “smart” money so carefully. When the hedgies have been riding high on a theme that has been working for quite a while, it is time to take the other side of their trade. Remember, they have precious few others to sell their position to, so they will still be bullish at the top. They will never get out in time because they are just trading with themselves.

Don’t be afraid to fade them. After all, you are trading against swashbuckling lunatics like Crispin. They might be big, but they are far from always right…

Thanks for reading and have a great week-end,

Kevin Muir

the MacroTourist