Are Hedge Funds Struggling?

We've seen a lot of wild things in the stock market over the past few years. Homebuilders like Lennar (NYSE: LEN  ) have crashed and burned, financial companies from Citigroup (NYSE: C  ) to UBS (NYSE: UBS  ) are treading water at best, retail stocks have been punished, and the dollar has been in free fall. And all this while commodities like gold, wheat, and oil have been skyrocketing.

But it may get just a bit wilder now that that whole scenario has been flipped on its head. Financials have had fitful rallies, the dollar is showing some definite life, and oil has been sliding. While this could lead to a number of different outcomes, on The Motley Fool's CAPS service, blogger RVAspeculator thinks that this turn of events is delivering a sucker punch to some hedge funds and Wall Street trading desks.

As financials and much of the rest of the stock market crumbled, RVAspeculator believes, hedge funds started to rush to commodity and weak dollar plays like a mob of pre-teens raiding Barnes & Noble for the latest Harry Potter book. But, he notes, they were late to the game. The move in both the dollar and commodities has come over a number of years and now we're starting to see a reversal -- a reversal that this CAPS All-Star believes was at least partially precipitated by all of the hedge fund money that has come flooding in.

Although RVAspeculator doesn't think that the strength in commodities and weakness in the dollar are done quite yet, he doesn't think that it will make much of a difference for many hedge funds:

As the title of this post says, I believe you are going to see quite a few announcements coming out over the next few weeks detailing massive blowups in hedge funds. If a 30% loss is not enough being long some of these commodities during this period, imagine what happens when you start taking into account the leverage these folks put on in these trades!!  

Also think of the poor brokers like Lehman (NYSE: LEH  ) , Morgan Stanley (NYSE: MS  ) and JPMorgan (NYSE: JPM  ) who are already getting killed with their mortgage exposure now are going to have to face their trading desk blow ups.... Those losses could take away the only profitable business some of these house have left... trading. I expect to hear of "unexpected trading losses" from these guys as well.

Although these hedge funds got killed on the trade it does not mean they were wrong about future dollar weakness and commodity strength... Too many people on one side of a trade always causes temporary market dislocations such as this.

So what does this mean for the rest of us? If hedge funds are struggling, it could leave the rest of the market with even more of the gut-wrenching volatility that we've been experiencing over the past year. Hedge funds trying to get out of the "popular" positions to avoid more losses -- or worse, liquidating because of investor withdrawals -- would likely put an extra pop in financials as they close short positions and bring even more weakness to the commodity market.

But what do you think? Has RVAspeculator hit the nail on the head, or is he way off the mark? Visit his blog to share your thoughts, and while you're at it, why not check out the full CAPS service, where more than 115,000 investors have rated 5,500 stocks.

Keep right on Fooling:

JPMorgan Chase is a Motley Fool Income Investor recommendation.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants, because, well, it doesn't actually have legs.


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