In the spring of 2008, commodities trader Chris Nygaard and his colleagues at Vermillion Asset Management were perplexed. Overseas, food riots were raging; in the U.S. big-box chain stores were rationing rice; oil was heading well north of $100 a barrel; and countless charts were showing the prices of virtually every hard and soft commodity setting new records.
Nygaard, the founding partner and co–portfolio manager of New York–based Vermillion, smelled a rat — and an opportunity. Futures prices for commodities were unfathomably higher than cash market prices, and old-fashioned supply-and-demand trading seemed to have vanished. Vermillion began putting on "calendar spreads," wagers on where prices of commodities and commodities futures would be in relation to one another on a month-by-month basis. It also placed bets on commodity options — mostly that a vast majority of them were extremely undervalued.
In time the firm was proved right, and though it...