Originally published by Managed Account Research, Inc. on June 6, 2008.
CTA ConfidentialSM
"An ongoing series of qualitative investigations
into managed futures trading programs"
CASE NO. 0002978
Strategic Investments, LLC
Dick Stoken, Principal Trader
Commodity Program
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. INVESTING IN FUTURES AND OPTIONS INVOLVES RISK AND MAY NOT BE SUITABLE FOR ALL INVESTORS. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. THEREFORE, INVESTORS SHOULD CAREFULLY CONSIDER THESE RISKS AND DETERMINE WHETHER THEY ARE SUITABLE FOR INVESTING IN LIGHT OF THEIR FINANCIAL CONDITION AND INVESTMENT OBJECTIVES.
Strategic Investments is a commodity trading advisor (CTA) established in 1990 by Dick Stoken, principal trader for the company. Mr. Stoken graduated from the University of Chicago Business School with a MBA. In 1959 he bought a membership on the Chicago Mercantile Exchange which he still holds today, and subsequently registered as a CTA in 1983, a decision that eventually led to the formation of Strategic Investments. In March 2007, Joseph B. Chesney joined Strategic Investments as principal in charge of all non-trading aspects of the firm including investor relations. The combination is formidable as Mr. Stoken has nearly 50 years of experience trading the futures markets, which includes his writing and publishing several books on the subject; meanwhile, Mr. Chesney, who has a degree in management from Aurora University, has over eleven years working professionally in the trading, infrastructure and sales aspects of the futures and equity markets. Add to that an actual track record going back to 1992 and Strategic Investments presents itself as a unique investment opportunity in the managed futures space.
Given the current conditions in the commodity markets, Managed Account Research jumped at the chance to gain some historical perspective by interviewing Mr. Stoken, a true veteran futures trader whose trading experience goes back before the heydays of the 1970s. The following article is based on that interview.
Stoken got his start in futures back in 1959 when he bought a membership on the Chicago Mercantile Exchange. That was before the introduction of the frozen pork belly contract (used to make bacon), a major innovation at the time since it was the first futures contract related to frozen, stored meats.
In 1965, Stoken partnered up with Barry Lind of Lind-Waldock fame, and after gaining a fair share of success, left to write a book about the markets. "Cycles," which was published in 1978 by McGraw-Hill, was named best investment book of the year by Stock Traders Almanac, as was his second book, "Strategic Investment Timing," published by McMillan in 1984, which also received accolades.
It was in 1984 that Stoken started up Neims-Stoken Partnership, the predecessor to Strategic Investments which has been registered as a commodity trading advisor since 1990. To provide some perspective, at that time there was only $10.5 billion invested in managed futures versus $67 billion invested in hedge funds. As of the end of 2007 there is an estimated $205.3 billion in managed futures.
Strategic Investments track record starts in July of 1992 and reflects an annualized return of 14.05% through April 2008. There aren't that many CTA performance records of over 15 years of length, since many "hot traders" come and go. Moreover, there are even fewer who can claim consistent positive returns with a -0.08 correlation to the S&P 500, and negative returns in only three of those fifteen years (1994, 1997 and 2001).
Asked the question about present-day volatility in the commodity markets, Stoken said "it has a lot of similarities with 1972, 1973 and 1974. That was the last time that you had these kind of moves in commodities, but we didn't have as many contracts such as energies then either."
No doubt, this is a historical time in the commodity markets. In fact, we have not seen since markets like this since the 1970s when President Nixon unilaterally cancelled the Bretton Woods Agreement of 1944, which stopped direct convertibility of the US dollar to gold. Similarly, the recent decline in the US dollar since 2002-2003 is also cited as a contributing factor to current across-the-board volatility in commodities.
Stoken explains that one "could go into cause and effect, but [Nixon] had to get the U.S. dollar off of the gold standard because of inflationary pressures that were boiling."
At the beginning of the 1970s, the U.S. economy was in financial trouble as the Vietnam War drained U.S. Government finances, at the same time as Lyndon Johnson (and to a lesser extent, Richard Nixon) sought to expand the Government welfare state. Most significant were the vast shipments of grain sent from the West to the Soviet Union each year, which helped make up for the failure of kolkhoz, Soviet collectivized agriculture. Trade relations between the two blocs increased substantially during the era of détente.
The aspect that is analogous to now with respect to emerging markets was détente -- Russia was brought into the free market, and that became a big factor. Interestingly, wheat was the first commodity to take off, and from there everything followed. "You had a sense that almost every commodity just took off, surpassed their old time highs by quite a bit, and just surprised everybody. It caught the industry off guard."
Stoken states that there was a stronger case for inflation then, then now. "Inflationary expectations were embedded in the environment of the 1970s. That meant both prices and wages were escalating. In the current environment, so far, the wage element is missing. While in the present environment there are a variety of factors which are feeding into higher prices for commodities, beginning with low interest rates spurring monetary growth and a couple of decades of benign prices decreasing incentives to develop commodity production," says Stoken. "For example, increase in agricultural productivity has not kept pace with demand from China and India. We've come as close to a perfect storm as we can."
As to the theory of commodity index funds and ETFs playing into the cycle of higher commodity prices which was recently brought up in hearings on Capital Hill, Stoken thinks "most definitely... it's almost all on the bull side, but at the same time the situation couldn't develop without underlying fundamentals."
Generally, Strategic Investments' trading approach is multi-faceted and has an ongoing development process dating back to the inception of its track record in 1992. Their stated competitive advantage comes from a long-term trend following approach, emphasis on risk management, and a proprietary blend of relative strength and volatility adjustments which directly influences how positions are constructed.
The Commodity Program trades precious metals, energies, grains, meats and softs, and utilizes different fundamental models for each sector. The objective is to "try to use the technicals and marry them with the fundamentals." With certain fundamental models, such as with the grains, technicals are mapped more stringently to the fundamentals, but with other markets like crude oil, fundamentals are loosely mapped.
"We've reduced our trading to three sectors. Metals in which gold is our core market, energies where oil is our core market, and agriculturals which include grains, meat and soft markets such as cotton, sugar and cocoa, but the core market is corn," explains Stoken. "We will stick with core markets until another market within a sector is showing more promise. Relative strength is used to make that determination."
As a variety of these markets have become increasingly frothy, Stoken is "starting with the assumption that we're basically in 'nose-bleed' territory. But also with the idea that we don't know if we're in the sixth inning of a twelve inning game, or the eleventh inning. So we're trading much more carefully."
This aversion to risk plays into an important aspect of Strategic Investment's approach. Risk control is facilitated with the use of volatility models to determine when a specific market's volatility has increased to the point where risk is unacceptable. Stoken also uses technical tools to indicate entry and exit points, as well as requiring confirmation that both technicals and fundamentals are working in the same direction.
Stoken explains further, "Having a technical part of our system, which is a large part, means that we are trend followers and can't anticipate or say that it's a top or not. And even if our fundamental models say that the market is turning bearish, it becomes an indicator to get out, not to go short."
In effect, Stoken does not initiate or maintain positions which conflict with the long term trend as identified by Strategic Investments' proprietary algorithms. "Our trend identification and risk management are our strengths. In addition to constant risk monitoring, we've built into our system volatility gauges which when triggered immediately decrease the leverage of the particular trade and tightens our stops. This is in addition to our low margin-to-equity usage, which averages between 6% and 10%."
Strategic Investments has also developed a proprietary model which indicates whether or not there is an overall bull market or bear market in commodities. This model provides a lot of stability to stay with the trend, but after it turns, there will likely be some give-back. "Right now we're in a fairly strong bull market. However, if the market turns bearish, the technicals will always be late -- that's the nature of these indicators."
Asked if production capacity and demand factors from emerging markets would sustain a commodity bull market for many years, Stoken replied, "As far as capacity is concerned, that is a hard one to say. I've been around these markets for a long time and I've heard a lot of arguments. With respect to grains, at least in the U.S., there is land that we can bring on, as well as with countries like Brazil and Argentina, they're adding to the production of food. With globalization, we're part of a world market."
Stoken suggested that livestock is an example where feed costs haven't yet fully permeated into the cost of meat. According to his experience, the price of meat is really important in the overall inflationary outlook because it goes straight to the pocketbook of the consumer when they eat dinner or go out to a restaurant.
Stoken continued, "If we're talking about a long-term bull market such as what Jimmy Rogers is talking about, something like 15-20 years or so, I wouldn't rule out that possibility. On the other hand, if we do see that, the bull market is not going to be as contiguous as we've seen from 2001 until now. I think that we could go into some two to three year bouts when we see some big bear markets in commodities."
Charts going back to the 1950s show that commodities generally have a tendency to stay range-bound, punctuated by occasional super-spikes which reset the equilibrium range. Stoken, however, thinks that the commodity markets still have new highs to make. "Commodity spikes anticipate general inflationary rise, then they settle back. And then they test their highs and lows before playing within that range."
When asked about Strategic Investments' source of return, Stoken's replied that, "in these current markets it is probably from the consumer, the general public, in the form of inflation." Stoken further states, "Our edge is having a flexibility of thought to realize that, if prices have broken out into the stratosphere, it doesn't mean that we know, or anybody else knows that we're smart enough to know where the top is going to be. But as volatile market conditions develop, we will increase our level of caution."
As is true with most traders who have proven to have successfully traded the commodity markets for a long time, the key is risk management, a disciplinary requirement for professional traders.
With such an extensive background and established track record, we asked why assets under management were under $10 million. The answer is that Strategic Investments did have sizable assets under management through an exclusive agreement with an offshore fund. In the spring of 2007, a decision was made for the firm to divest itself of those assets out of a desire to market in the U.S., and raise capital on their own with a self-sustaining infrastructure onshore. That's why there is a window of opportunity to invest.
As it stands now, Strategic Investments is working on building relationships with established participants in the managed futures industry. This is where Chesney's focus comes into play, leveraging his background in alternative and traditional investments that he gained while with Merrill Lynch and Morgan Stanley.
In addition, Strategic Investments is now joined by Stoken's son, Kingsley, who at age 38 is a successful businessman in his own right, having been a partner in a boutique private equity firm which was geared towards acquiring and developing small businesses and commercial real estate. Kingsley also has fifteen years of futures market experience including research and trading for his own proprietary account, and is positioned to provide continuity to his father's trading methodology in addition to his business acumen.
The wisdom gained from trading the commodity markets nearly fifty years is a unique quality that Managed Account Research does not see every day. Given current market conditions, Stoken's experience should be the type of characteristic that investors seek. Combine that with a robust performance track record and operational depth, and it is likely that Strategic Investments will quickly attract additional assets.
To gain a better understanding of Dick Stoken's thought process about the markets, we recommend reading any one of his three published books, CYCLES (McGraw-Hill, 1978), STRATEGIC INVESTMENT TIMING (McMillan, 1984), and THE GREAT CYCLE (Probus, 1993).
