Interesting comments from Steve Saville on hedge funds:
The Hedge Fund Economy
Some of the strange linkages we've seen in the markets over the past 15 months and the absurd extremes recently hit by some popular technical indicators can, we think, be at least partially attributed to the proliferation of hedge funds. In theory the thousands of hedge funds that now exist should be a balancing force in the markets -- they should act to make the markets more efficient -- because in many cases they are looking to exploit situations where the markets have temporarily moved 'out of whack'. In reality, though, there appears to be an enormous amount of trend-following going on, with the hedge-fund community piling into, and then out of, trades in the same way that a herd of wildebeest might stampede in one direction and then suddenly change course upon the sighting of a lion.
One of the biggest influences on the markets over the past year was the putting-on and subsequent unwinding of carry trades (borrowing at a low rate and then 'investing' the proceeds in something that is expected to earn a higher rate). Specifically, speculators borrowed large sums of US dollars with interest rates at generational lows and exchanged the dollars for higher-yielding currencies. They also used the borrowed dollars to purchase investments that would likely benefit from the inflation that was clearly raging behind the scenes. And as long as the Fed was talking-up the prospect of DEFLATION, or, at least, refusing to acknowledge any INFLATION, this seemed to be a riskless trade. However, as soon as it became clear that the days of a 1% Fed Funds Rate were numbered there was a rush for the exits that caused sharp reversals of the preceding trends.
The carry trades probably haven't been fully unwound, which is why we get US$ strength combined with weakness in everything that benefits from rising inflation (gold, for example) every time something happens to CONFIRM the inflation. The reason is that the more visible the inflation becomes the more likely it is that the Fed will be forced to hike short-term rates aggressively and the less attractive the US$ carry trades will appear to be. It might not make sense, but this is the thinking that seems to be permeating the markets right now.
The popularity of the carry trade with hedge funds has caused a counter-intuitive response to inflation news over the past two years (talk of a DEflation threat has caused gold to rally and the US$ to fall whereas talk of an INflation threat has caused the US$ to rally and gold to fall), but this is not the only area in which we are seeing the footprints of the hedge fund community. |
