Martin Kronicle

(click to enlarge spreadsheet)

If you haven’t heard, there was some news on the tape about Goldman Sachs on Friday regarding the SEC. Portfolio heat is high. Commodities and equities were down at the close because they’ve become highly correlated. Above is a spreadsheet with what was in the portfolios of many trend followers and commodity managers. The data are through Friday’s settlement.

When the correlation between commodities and equities runs high, you’ll get hammered and lose much more than you anticipated. More importantly, the client who owns the money will get hammered too. The above chart only includes the commodity portion. An endowment, pension, or macro hedge fund probably got hit on their equity exposure too.

It’s aggravating to get knocked out of a trade, but it’s much worse to lose your confidence – and that’s what big down days do to you. Once you start trading with scared money, you’re toast. If you find yourself saying, “WTF?” or “How can this happen?” you’re not in control of your risk, and maybe not of your emotions. Go to cash – I’ve seen lots of promising careers end in times when things become highly correlated.

If you’re not ready for this, go to cash until you figure it out. Last week, I wrote about what could be the cause of the next big financial crisis. I didn’t know the SEC was going to bring charges against GS any more than you did, but I have the tail risk hedged away.

With what looks like a conservative portfolio mix, and a low margin to equity ratio, a portfolio with $1 MM in corpus with such holdings would have been down almost 2% on the day. That is huge if you’re looking to run institutional money. For the record, a 2% “up day” would scare them away too.

Are all your holdings just one big trade?

A good teacher will help aggregate information and condense it for you in an organized manner. A great teacher will passionately help you discover the ability you have inside yourself and help you culture that pearl, so that your feelings and intellect become your allies.

Such is the approach Maria Bartiromo has taken in her new book, 10 Laws of Enduring Success, written with Catherine Whitney. The book details the events that Bartiromo had to overcome and the manner in which she had to persist from her days as a young girl in Brooklyn, to becoming the woman the world knows her as today.

The result is an inspiring and highly motivational book that is perfectly timed for today’s business environment. It doesn’t pander to her constituents on Wall St. either: it’s equally motivating to white and blue collars – and especially to women. While reading it, I kept thinking how this book reminded me of 2 other inspiring reads I recommend to my students: Napolean Hill’s Think and Grow Rich and Stephen Covey’s Seven Habits of Highly Effective People.

Read my full article How Maria Bartiromo May Become The Best Teacher You’ve Ever Had at the Huffington Post.

According to George Soros, Greece is basically meeting the conditions that the IMF would impose. He also said something much more ominous: we haven’t yet corrected the imbalances which have created the crash of 2008.

Protecting your capital at this stage should be your first priority. True it always should be your first priority, however, as I mentioned in my post about the potential #1 crisis, the current correlation between commodities and equities is nearly 1:1.

Whether your a trader or an asset allocator, I would suggest that you use protective stop orders – mental or GTC – or at a minimum have an uncle point to protect your capital. It can take a VERY LONG TIME for the markets to come back.

On a side not, is it me, or does it sound like there is a helicopter in the background?

It’s not portfolio heat, nor hedge funds and their alleged manipulation of natural gas, nor is it the current, nearly 1:1 correlation between commodities and equities.

It’s sovereign espionage and hackers as described in this great article called Researchers Trace Data Theft to Intruders in China from the NYT.

The Toronto spy hunters not only learned what kinds of material had been stolen, but were able to see some of the documents, including classified assessments about security in several Indian states, and confidential embassy documents about India’s relationships in West Africa, Russia and the Middle East. The intruders breached the systems of independent analysts, taking reports on several Indian missile systems. They also obtained a year’s worth of the Dalai Lama’s personal e-mail messages.

My guess is that if they can hack into email accounts, and take over PC’s (not Macs) and turn them into zombies, why couldn’t they zombie a Windows-based computer with:

1) a keylogger to capture your orders;

2) malware that will send all your orders to the spy thereby disclosing all your trades and account balances;

3) software that will enact wire-transfers (probably harder to do); or

4) intercept your orders and modify them so that your “new orders” tank the market, your equity, and possibly your firm.

As one blogger puts it, What say ye?

The Business Insider delineated 14 possible crises that could shake up the markets if they occurred. All 14 are “headline grabbers” and the talk of Twitter, but there is one that went unnoticed and I haven’t seen it mentioned on the WWW: correlation risk between equities and long-only commodities.

All you need is one unsuspected event in the US – forget the 14 in the article – and you’ll see your portfolio lose more than you might realize.

Stocks are leading the Bull markets, while commodities are following, as stocks are forecasting positive GDP growth. Moreover, there is more available capital to buy stocks than to buy
commodities, so this has also helped stocks outperform commodities recently. Thereby, commodities have been in a long trading range (in aggregate) from June 2009 to date, only creeping up.

However, amazingly the long-only commodity universe has had a tremendous positive correlation with stocks since January 2008; the S&P 500 has a 97.92% and 98.32% correlation to the DJUBS and the S&P GSCI (Long Only) Commodity Indexes, respectively.

Interestingly, the appreciation of these commodity indexes as represented by their ETNs (DJP and GSP was +25.5% and +37.1%, respectively, from March 2009 through the end of March
2010, while the S&P 500 has rallied 72.86% during such time period.

Due to the highest correlation I have ever seen between two different asset classes (even Long- Term U.S. Government Bonds have only a 93.9% historical correlation to Intermediate-Term Government Notes), if growth is lower than expected (3%-4%) both commodities and stocks should decline.

Source: EAM Partners, LP

That means you’re not going to see any diversification benefits in the short-term if the S&P goes south and you are a long-only investor. Worse, because the correlation to equities is so high, you’re going to lose on your long-only commodity investment(s) at the same time, making the % hit to your portfolio much greater than you may be expecting.