Exclusive: Metals fund Red Kite flies high as copper crashes

NEW YORK Thu Sep 29, 2011 5:51pm EDT

NEW YORK (Reuters) - It was a long wait, but the world's most renowned metals traders Michael Farmer and David Lilley are finally profiting from a big, bearish bet on copper, trouncing rival hedge funds with a nearly 50 percent gain this year.

The $1 billion Red Kite Metals fund has returned close to 20 percent for each of the past two months as copper prices fall to their lowest in a year, industry sources familiar with the fund's positions told Reuters. That would comfortably rank it among the best-performing commodity funds this year.

While many other managers had bet on commodity markets extending last year's post-crisis rally as emerging economies power ahead and global supply lags, Red Kite took the opposite view on copper, betting that a spike to $10,000 a tonne early this year had severely damaged demand in China.

Now, after months of weak Chinese imports and as world economies teeter on the edge of another recession, Farmer and partner Lilley -- evangelical Christians with more than half a century's trading experience between them -- are reaping the rewards of that contrarian position.

"I know Red Kite has dug its heels into its shorts and that's paying off handsomely for them," said a source at a fund of funds in New York that receives performance numbers on Red Kite, among other funds.

Red Kite Metals -- whose gains follow a number of tumbles in recent years when its bets soured -- is the flagship of five funds run by London-based Red Kite Capital Management Ltd. A spokesman for Red Kite in New York declined comment.

According to Chicago-based Hedge Fund Research Inc, a database on the $2 trillion hedge fund industry, the average metals hedge fund was down 0.54 percent for the year through August. September figures are not yet available.

"Given the magnitude of the volatility we've just observed in metals, I'd certainly expect declines for many in that space this month," HFRI President Kenneth Heinz said.

The fund-of-funds source said Red Kite was up 17 percent this month up to September 23, taking year-to-date returns to 47 percent. In August, it rose nearly 19 percent.

Even with copper prices on the London Metal Exchange having slumped by a quarter this month alone, and down a third from their February peak, Red Kite believes the selloff isn't over, largely because of deteriorating Chinese demand, according to people familiar with its strategy.

While based in London with an office in New York, Red Kite has deep contacts in China, including a partnership with leading metals trader Maike, giving it insight into a country that consumes 40 percent of the world's copper.

DR COPPER AILS

LME copper is the second-worst-performing market this year on the Reuters-Jefferies CRB Index .CRB of 19 commodities, with prices struggling to stay above $7,000 a tonne after soaring to record highs over $10,000 in February.

While the price decline has been unnerving, daily swings in the market -- up to 7 percent between the highs and lows of a session -- have stunned even seasoned traders.

Data this week suggested that China's imports of refined copper were at their highest levels since January after surging 21.2 percent in July to 235,509 tonnes in August.

But a nagging perception that the world's No. 2 economy may no longer be as strong an engine of growth for global demand has been weighing on copper.

Also, the arbitrage for buying copper on the London Metal Exchange and selling it into China -- which may have helped spur last month's imports -- is no longer profitable, suggesting that demand weakness persists.

Aside from power generation, copper is mainly used in construction. That part of the demand equation for the metal is also suffering in China as Beijing moves to choke off funding for housing developers to cool a rampant property market.

Red Kite, named after a bird of prey, has not always done well.

In 2007, it lost nearly half its value when caught the wrong way on bullish bets on aluminum and copper. Last year, it tumbled 30 percent in one month -- January -- when London copper futures suddenly sank 9 percent.

Farmer ran Metal & Commodity Co, a unit of Germany's Metallgesellschaft AG, the largest copper trader, before starting the fund in London in 2005 with Lilley. Metallgesellschaft has since been bought by Sempra Commodities, which in turn has been acquired by JPMorgan (JPM.N).

(Editing by Dale Hudson)

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