In February Armored Wolf benefitted from the acceleration in commodity prices, which combined with new client additions grew the hedge fund’s assets under management “briskly,” according to a letter to investors reviewed by ValueWalk.

Ukraine

Commodity gains helped fund

The letter, written by Chief Investment Officer John Brynjolfsson, noted February’s Commodity markets reversed January’s weakness and then some. The US dollar was supportive, with a tiny decline, and bond yields declined slightly, thus reducing financing costs. And equity market bounce generally kept risk-on hopes alive for commodities, while the subsequent weak follow-through from stocks further benefited precious metals.

Commodity gains were particularly impressive given ongoing weakness in economic releases,” the letter noted, then highlighted what normally would depress commodity prices. “With only a few exceptions, economic news out of the US, Europe, China and the rest of the emerging markets was disappointing. Inflation still remains at low levels and the only real sign of economic acceleration is seen in Germany and peripheral Europe – though at barely positive growth rates. If current economic forecasts are to be believed, there should be a much more commodity supportive macro environment later in 2014.”

Looking at Ukraine with wary eye, Armored Wolf has EU Periphery Bond Spreads at work

Hitting the key issue that is relatively under-reported in the Ukraine dispute, the letter said “the threat of Ukrainian debt default and extended loss of inexpensive energy supplies, would strain the already weak and over levered Eurozone Banks, sovereigns and economies more broadly.”  The threat of debt default was the initial cause of the Ukraine crisis, as the International Monetary Fund drove a hard bargain with the over-leveraged Kiev government, who then turned to Moscow for assistance.

How does the fund position itself amidst trouble in the Caucasus, money printing and Bitcoin implosions?  Right now they are short European Periphery Bond Spreads, which will profit to the extent there is a flight to quality in the core, or inflation in the periphery. “Other views held are that 10 Year Treasury Note yields are headed to 2%, Bond Market volatility is underpriced, and this cheapness can be harvested by buying note options on the CBOT… instruments linked to Merrill Lynch’s MOVE INDEX. It is at 58, near all-time lows. We also continue to like Gold, it’s a great hedge against regional instability in the Caucasus, bitcoins Mount Gox collapse, and money printing more generally. We don’t like the Euro, though obviously as it makes interim highs, tactical trading can reduce the pain of action counter to our view.”

Positive on housing, technology, manufacturers

When considering how to position the fund going forward, the letter notes a positive outlook on housing and technology yet is cautious on China.  “Looking ahead, we are positive on the U.S. housing market (specifically transaction volumes, new home starts, and remodeling, and to a much lesser extent, prices), various areas of the travel/leisure industry, industrial manufacturers, technological innovation (at a fair price), and the U.S. consumer,” the letter said. “We are cautious on Chinese investment-related exposure (mining, real estate), energy producers, and stocks whose primary thesis for investment is “momentum” and “hitting new 52-week highs”

Economic news to consider

Three pieces of economic news caught the fund’s attention. At the top of this list was the level of January new home sales, which were reported at 468K versus expectations of 400K.  A second news item to watch was that in the fourth quarter of 2013, U.S. household debt (mortgages, auto loans, credit cards, and student debt) increased $241B from the previous quarter, the largest increase since the third quarter of 2007, and increased $180B from the prior year’s quarter. “With low interest rates and slowly recovering employment data, consumers are gradually satisfying pent-up demand for durable and non-durable goods alike,” the letter said.

The third point to consider was that Wells Fargo & Co (NYSE:WFC) lowered its FICO minimum for FHA loans from 640 to 600, evidence of the earliest stages of easing credit conditions that “has a number of mixed implications across the U.S. economy, and we will be attempting to profit from those and other macroeconomic trends in the months ahead,” the letter noted.

Emerging markets

Investors are still reluctant to add exposure to emerging local markets despite the softer tone in US data and lower US Treasury rates which are typically good for emerging markets, the letter noted. “Once evidence on both fronts emerges in coming quarters, emerging markets may start attracting inflows once again, particularly if by then real interest rates help to anchor EM currencies better and this improves the risk-reward of investing in the asset class,” the letter predicted.