Trend Following - Week in Review - October 4, 2024

Welcome to "This Week in Trend", where each week, we cover key movements and trends in the futures markets, offering insights on commodities and indices shaping the economy. From price surges to notable declines, we provide an overview of the factors driving these changes. Stay informed about the latest developments and navigate the market with confidence. Join us weekly to explore the dynamic world of futures trading and the trends that matter most.

“Trend Followers Stumble as October Brings a Rough Start”

This week has proven particularly challenging for trend followers, as geopolitical tensions and macroeconomic factors converged to unsettle the markets. The ongoing conflict in the Middle East has raised fears of energy supply disruptions, driving oil prices higher and increasing volatility across various asset classes. The VIX, widely known as the "fear gauge," surged in response, reflecting heightened nervousness among investors as uncertainty looms over global markets.

Further complicating the outlook is the ongoing ambiguity surrounding Federal Reserve policy. Recent comments from the Fed indicated that they are not following a "preset course" regarding interest rates, leaving traders wary about future monetary decisions. Additionally, stronger-than-expected U.S. jobs data added pressure, pushing bond yields higher and weighing on broader markets.

These forces have culminated in a difficult start to October. The SG Trend Index is down -2.53% month-to-date (MTD) as of October 3, 2024, with year-to-date (YTD) performance slipping into negative territory at -0.31%. In contrast to last week’s promising end-of-September performance, this downturn highlights the volatile and unpredictable nature of the markets as the new month begins.

The TTU Trend Barometer has plunged to 16, down from last week’s reading of 55. This significant drop signals an extremely poor trending environment, one of the worst readings possible. Such a sharp decline highlights the broader challenges trend followers are currently facing across multiple asset classes. As market conditions have cooled and volatility rises, traders are finding fewer clear trend signals to capitalize on, making it increasingly difficult to identify profitable opportunities.

The Top Traders Unplugged (TTU) Trend Barometer is a proprietary tool that measures the percentage of markets with medium to strong trends. Just as a thermometer reading of 0 degrees Celsius equates to freezing, when the TTU Trend Barometer reads a value that is less than 40%, market trendiness begins to get “colder” or weaken. Likewise, when the TTU Trend Barometer gets above 55%, the environment gets “hotter” (better).

Weekly Asset Class Snapshot

This week’s market landscape proved especially difficult for trend followers, as a surge in volatility and significant reversals across key asset classes made identifying clear trends challenging. VIX futures climbed by 5.95%, indicating heightened uncertainty in the markets. The sharp rise was driven by geopolitical tensions in the Middle East and ongoing ambiguity around U.S. interest rate policy. While volatility traders may have found opportunities, the sharp rise injected additional risk into other asset classes, making systematic trend-following strategies harder to navigate.

The energy sector experienced notable gains, with the sector rising 5.09%, largely due to a 9.23% jump in Brent crude and a 9.20% rise in WTI crude. The surge was fuelled by supply concerns linked to geopolitical risks in the Middle East. This sharp reversal in oil markets would have been particularly challenging for trend followers, many of whom had positioned short, anticipating further declines. Gasoline and heating oil also posted strong gains, further complicating energy market trends for those betting on continued weakness.

In contrast, the soft commodities sector saw steep declines, led by Cocoa, which plunged by -14.68% due to improved weather conditions and easing supply concerns in key production regions. Coffee and soybean meal also posted notable losses, further dampening the outlook for trend-followers in these markets. While some sectors, such as meats and grains, saw modest gains, up 2.30% and 0.67% respectively, the broader landscape posed significant challenges.

Bond markets also struggled, with rising yields driven by stronger-than-expected U.S. jobs data and fears of prolonged interest rate hikes. Bonds fell -1.46%, reflecting growing caution among investors, adding further strain on trend-following models positioned for more stable rates.

In the metals sector, movements were mixed. While the sector as a whole dipped -0.32%, palladium saw a sharp decline of -5.76% due to weakening demand from the automotive sector, while industrial metals like aluminium and copper held relatively steady on the back of sustained demand in the construction and manufacturing sectors.

Overall, this week posed significant challenges for trend followers. While volatility-based strategies may have found pockets of opportunity, the rapid reversals in energy markets and the broader mixed performance across asset classes made it increasingly difficult to capitalize on clear trends. With the TTU Trend Barometer plunging to 16, one of its lowest readings, the environment is proving as difficult as it gets for systematic traders.

The key takeaway for trend followers is the importance of managing risk in these volatile conditions while staying agile to seize emerging opportunities as they arise across asset classes.

Top 10 Bear and Bull Price Moves

Here's a detailed analysis of the key market movers for the week.

What’s Moving Up

• Crude Oil Brent: +9.23%

Brent Crude oil surged by 9.23% this week, driven primarily by escalating geopolitical tensions in the Middle East. Fears of supply disruptions, particularly around key chokepoints like the Strait of Hormuz, have rattled global energy markets. With Iran playing a central role in these tensions, any potential disruption to oil exports from the region could significantly tighten the supply side, pushing prices higher. Additionally, Saudi Arabia’s extension of production cuts has added further upward pressure, with the market already leaning towards tighter supply.

From a macroeconomic perspective, these developments have exacerbated the already fragile supply-demand balance. Despite global demand forecasts remaining relatively stable, the uncertainty around Middle Eastern supply has caused prices to spike in anticipation of potential shortages. This upward move comes after months of a bearish sentiment, where demand concerns and higher inventories had kept prices suppressed​ (Barchart.com)​(Investopedia).

For medium- to long-term trend followers, this sudden price surge was likely unfavourable. Brent Crude has been in a bearish trend since April 2024, and many traders were likely positioned short, anticipating continued downward movement. This sharp reversal would have triggered unexpected losses for those holding short positions, as the bullish move broke through key resistance levels. The rapid change in sentiment highlights the challenges trend followers face when geopolitical events abruptly alter market dynamics.

At the moment, the market is poised for a potential shift, and systematic traders will likely be watching closely for confirmation of sustained upside movement. A clear breakout could signal the end of the congestion phase, providing new opportunities for medium- to long-term trend-followers.

• Crude Oil WTI: +9.20%

For Crude Oil WTI, which rose 9.20% this week, the reasons for the price surge were aligned with those for Brent Crude. Geopolitical tensions in the Middle East, particularly concerns about supply disruptions, and ongoing production cuts by Saudi Arabia were the primary drivers behind the bullish move​. As with Brent, the risk of supply chain interruptions in critical areas like the Strait of Hormuz further fuelled the upward momentum in WTI prices.

For trend followers, the dynamics mirrored those of Brent Crude. Many medium- to long-term trend followers were likely positioned short on WTI since its peak in June 2022, as the market exhibited a persistent bearish trend due to oversupply and demand concerns. However, since June 2023, WTI has been stuck in a congestion pattern, with prices fluctuating within a range without a clear breakout. This week’s upward move, while significant, is likely seen by trend followers as a reversion to the mean within this congestion phase rather than the start of a new trend. As a result, this movement may not have significantly altered the overall bearish positioning of systematic traders.

• Gasoline RBOB: +8.66%

For Gasoline RBOB, which increased 8.66% this week, the underlying reasons for the price move are largely tied to the same factors driving crude oil prices higher—namely, the geopolitical tensions in the Middle East and supply concerns in key global regions​. The ongoing risks surrounding supply disruptions and elevated seasonal demand for energy products have pushed gasoline prices up in tandem with crude.

For medium- to long-term trend followers, this move was likely unfavourable. Like crude oil, Gasoline RBOB has been in a bearish trend since its peak in June 2022, reflecting global demand concerns and an oversupply environment. Trend followers were probably short this asset, anticipating continued weakness in the energy markets. The sharp reversal this week, driven by external geopolitical shocks, likely resulted in losses for those traders still positioned short​. The unexpected nature of this spike underscores the challenges for trend followers when macro factors disrupt established trends.

• Heating Oil: +7.82%

For Heating Oil, which increased 7.82% this week, the price move can also be attributed to the same factors driving the broader energy complex higher. Geopolitical instability in the Middle East, coupled with seasonal demand as colder weather approaches, have both contributed to this upward pressure on prices​. These external shocks are adding to the tight supply situation, which has been a key driver for energy commodities like heating oil.

For trend followers, this price surge would have been unfavourable. Like the other assets in the energy complex, trend followers were likely positioned short in heating oil, particularly since its peak in September 2023, as the market had been reflecting a bearish trend due to softer demand expectations and higher inventories.

This week’s sharp reversal, spurred by geopolitical risks, would have been a surprise, likely leading to losses for systematic traders maintaining short positions. The move underscores the unpredictability trend followers face when external events disrupt the expected market trajectory.

VIX: +5.95%

For VIX Futures, which rose 5.95% this week, the price movement reflects the heightened volatility in the markets due to geopolitical tensions and macroeconomic uncertainty. VIX Futures, which track expectations of future volatility, saw an increase driven by concerns over geopolitical risks in the Middle East and the ambiguity around U.S. monetary policy​. Unlike the spot VIX index, VIX Futures allow traders to speculate on or hedge against volatility in the future, amplifying moves when market conditions are uncertain.

The uncertainty around the Federal Reserve’s stance on interest rates, combined with geopolitical shocks, heightened caution among investors, leading to increased hedging activity and speculation in volatility markets​.

For trend followers, this surge in VIX Futures may have been favourable. Many volatility-based trend-following strategies are designed to capitalize on periods of rising uncertainty. The sharp increase in VIX Futures would have provided an opportunity for these strategies to profit as volatility climbed. However, for those following more traditional asset trends, this heightened volatility could introduce challenges, making other asset classes more unpredictable and harder to navigate. As always, managing risk in such an environment remains crucial for all types of systematic traders.

What’s Moving Down

• Cocoa: -14.68%

For Cocoa, which dropped -14.68% this week, the significant decline can be attributed to easing supply concerns. After months of tight supply driven by adverse weather conditions in key growing regions like West Africa, recent improvements in weather have bolstered crop prospects, alleviating fears of shortages​. This shift in the supply outlook led to a sharp reversal in cocoa prices, as markets began to price in the improved conditions.

Despite earlier optimism for a potential resurgence in the long-term bullish trend, this week’s steep drop was a significant move against trend followers who had positioned themselves for a continuation of the upward momentum. Many trend followers, likely long in cocoa, were expecting the price to rise further as global demand remained strong. However, the improved supply conditions have temporarily stalled the bullish trend, leading to losses for systematic traders who were caught off guard by the rapid decline​.

This reversal highlights the inherent risk for trend followers in commodity markets, where external factors like weather can drastically shift the supply-demand balance and reverse well-established trends. For now, trend followers will likely need to reassess their positions as cocoa enters a phase of price correction.

• Coffee: -5.26%

For Coffee, which declined -5.26% this week, the price drop can largely be attributed to improved weather conditions in key coffee-growing regions, such as Brazil and Vietnam. After months of adverse weather that had supported coffee’s significant rally, better-than-expected conditions have now eased concerns over supply, leading to a sharp price correction. This week's move reflects a reassessment of supply prospects, as the market begins to price in the potential for increased output from major producers.

For trend followers, this move was unfavourable. Coffee has been in a strong bullish trend since its low in October 2023, driven by tight supplies and strong global demand, particularly from Europe and North America. Many systematic traders who had been enjoying this bullish momentum were likely long in coffee, expecting the trend to continue. However, the improved supply outlook triggered this week’s reversal, catching trend followers off guard and resulting in potential losses.

This serves as a reminder of how quickly commodity markets can shift when external factors like weather change the fundamental dynamics. Trend followers may need to reassess their positions in the short term, but if demand remains strong, the longer-term trend could still present opportunities down the line.

• Japanese Yen (JPY): -4.48%

For the Japanese Yen, which fell -4.48% this week, the decline marked a significant move in favour of medium- to long-term trend followers who have maintained short positions since the yen’s peak in January 2021. After a prolonged period of weakness driven by Japan’s ultra-loose monetary policy and its divergence from global central banks, the yen had recently experienced a short-term bullish correction, linked to the unwinding of the carry trade and speculative buying.

This week’s sharp drop, however, likely provided a welcome reprieve for trend followers still positioned short. The yen’s continued weakness, compounded by rising U.S. interest rates and a strengthening dollar, reinforced the longer-term bearish outlook. Despite temporary corrections, the yen's decline aligns with the overall downward trend, boosting systematic strategies that have maintained short positions through the volatile swings of recent months.

For those trend followers still riding the yen’s long-term decline, this week’s movement would have reaffirmed their strategy, potentially adding to profits after a period of consolidation.

However, for shorter-term models, the -4.48% decline would likely have been unfavourable. Many shorter-term trend followers may have started repositioning to the long side, anticipating a continuation of the short-term bullish correction that emerged following the carry trade unwind. This correction led some traders to see the yen as potentially oversold, prompting speculative positioning for a rebound.

The swift resumption of the yen’s long-term downtrend caught those repositioning to the long side off guard, resulting in losses. This abrupt reversal highlights the risks shorter-term models face when markets quickly reverse after a temporary correction, reinforcing the challenge of navigating through sudden shifts in sentiment.

• Soybean Meal: -4.01%

For Soybean Meal, which declined -4.01% this week, the move is likely to have been favourable for trend followers, given the ongoing bearish but volatile trend since its peak in February 2023.

The decline in prices was largely driven by improved weather conditions in key producing regions, such as Brazil and Argentina, where better-than-expected rainfall helped boost crop yields. This alleviated earlier supply concerns that had driven prices higher during periods of drought.

Additionally, weaker demand from key importers like China, amidst broader global economic uncertainty, added to the pressure on prices. These factors combined to reinforce the bearish momentum that has persisted throughout 2023.

This week’s decline aligns with the broader downward trend, reinforcing the momentum that systematic traders, who have likely positioned short during the price decline, could capitalize on. The move provides a confirmation of the prevailing market conditions, allowing trend followers to potentially profit from the continuation of the weakening trend, despite occasional volatility that has characterized the soybean meal market.

For those following the longer-term downtrend, this week’s price action further supports their strategies, providing a timely opportunity to benefit from the continued weakness in soybean meal prices.

• New Zealand Dollar (NZD): -3.03%

For the New Zealand Dollar (NZD), which declined -3.03% this week, the move was primarily driven by expectations of a significant rate cut from the Reserve Bank of New Zealand (RBNZ). Analysts are anticipating a 50-basis point rate cut, reflecting concerns over the country's weak economic growth and rising unemployment. These factors have contributed to bearish sentiment surrounding the NZD, pushing it lower against the stronger U.S. dollar, which is benefiting from solid U.S. economic data​.

For trend followers, this move likely wouldn’t have been of much interest, as the NZD has been stuck in a protracted congestion phase since early 2023. This latest decline is more of a reversion to the mean within that congestion period, lacking the clear directional momentum trend-followers typically seek. As a result, many traders have likely remained on the sidelines, avoiding this asset until stronger trends develop.

Conclusion

This week brought a diverse array of challenges and limited opportunities for trend followers. Energy markets surged, driven by geopolitical tensions in the Middle East, with both Crude Oil and Gasoline experiencing sharp gains. These unexpected price spikes due to supply concerns caught many medium- to long-term trend followers off guard, as many had positioned short, anticipating continued bearish trends in these assets. The sudden reversal highlights the difficulties of navigating markets heavily influenced by external macro events.

In contrast, VIX Futures provided some relief for volatility-focused strategies, allowing traders to capitalize on rising uncertainty. However, softer commodities like Cocoa and Coffee saw notable declines due to improved supply conditions, impacting trend followers who had bet on continued bullish momentum.

Currencies, particularly the Japanese Yen and New Zealand Dollar, saw sharp declines, with long-term trend followers benefiting from the yen’s continued weakness. However, shorter-term traders likely faced challenges as temporary bullish corrections reversed. Meanwhile, Soybean Meal continued its downward trajectory, benefiting trend followers as it reinforced the ongoing bearish trend since early 2023.

Overall, this week’s market dynamics demonstrate the significant risks and volatility that trend followers must contend with. Geopolitical shocks, coupled with shifting macroeconomic data, created an unpredictable environment where established trends were abruptly disrupted. The SG Trend Index's decline to -2.53% month-to-date and the TTU Trend Barometer's plunge to 16 reflect an especially challenging trading landscape, where clear trend signals are scarce, and the trending environment is near rock bottom.

Systematic traders will need to carefully manage risk, stay alert for potential trend breakouts, and be ready to adapt as conditions evolve. This week underscored the importance of maintaining flexibility in strategy while navigating the volatile and often unpredictable terrain of global markets.

List of Resources used in the Week in Review

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