RCMA’s King sees Brent falling below $50 on over-supply

This article is by Will Wainewright and it originally appeared on the Bloomberg Professional service.

7 Jul 2015

Doug King, co-founder and chief investment officer at RCMA Asset Management’s $240 million Merchant Commodity Fund, speaks to Bloomberg Brief’s Will Wainewright about his view on oil and Chinese demand for commodities. The fund returned 9.6 percent in the first quarter, making it the top-performing CTA/managed futures fund among those that report to Bloomberg Data. The interview has been edited and condensed.

Q: You had a great 2014. What drove that performance?

King: We posted a 59.3 percent gain last year, a record year since inception with the best month being December when the fund rose 19.5 percent. The OPEC meeting on Nov. 27 was central to our gain at the end of the year. We were already shorting oil, but the meeting caused us to strengthen our bearish view.

This was vindicated as the price plunged during December. We also had a structural bearish bias on the coal and iron ore markets that also fell heavily in December.

Q: What conclusions did you drawfrom that OPEC meeting?

King: This turned out to be an amazing meeting. After huge pre-meeting hype, the meeting was over within a few hours — these can often run for days. There was defiance in the statement regarding maintaining OPEC production with other producers restricting production if necessary and a casualness about it with the next meeting not scheduled for another seven months. For me, it flashed market share fight and subsequent price war. The market had been complacent for several years and this meant a huge readjustment as OPEC seemed no longer willing to be the “swing producer.”

Q: How has the fund done this year?

King: Less well. The fund is around zero for the first five months of the year. We expected the oil price to remain lower than it has done. Oil demand has been stronger than we anticipated, but I don’t know how much of that is real demand, as opposed to “filling up the pantry” now because it was cheap. We are very skeptical about whether the demand numbers we are seeing will be maintained through the second half of this year. We see the oil price going lower from here, Brent crude could head well below $50 a barrel again in our view. We don’t believe the world is growing as much as it needs to grow to mop up the over-supply.

Q: What else is the fund betting on?

King: China’s demand for commodities remains in an upward trajectory in general. The reason we have declining prices in most commodities is due to the incredible response in supply that has occurred globally to meet this demand. For example, the world has added over 200 million acres of land producing corn, wheat and soybeans in the last 10 years. One area where Chinese demand growth is declining is coal. Imported demand for coal into China will decline in 2015 as domestic coal mines are supported and a diversification into cleaner gas powered capacity continues. The world will therefore continue to be structurally oversupplied, with coal and prices continuing to trend lower until one of the major producers bites the bullet and cuts back.

Q: Are there plans to grow the fund?

King: The Merchant Commodity Fund is capable of managing more than $1 billion comfortably. The fund’s assets peaked at $2.3 billion in 2008 and we ran over $1 billion in the markets for five years between 2007 and 2011, so that sort of size is perfectly feasible. Our performance last year led to a significant uptick in enquiries and due diligence requests, but that has yet to translate to an increase in the size of the fund. Commodities in a multi-year bear market remain a cold sector to a lot of investors, with equity markets seen as offering greater opportunities by contrast. However, as seen last year, even bear markets which were the norm when I started my career, offer huge investment opportunities.

Q: Do you manage any other hedge funds?

King: No, but the fund manager, RCMA Asset Management, is linked to the RCMA Group, a physical commodity trading group which Mike Coleman and I acquired separately in 2010. We have expanded this business over the last five years from 60 to 180 employees in 11 offices worldwide. The core of this business is supply-chain management and we physically distribute annually over a billion dollars of commodities such as rubber, cotton, white sugar, fertilizers and coffee around the world. Mike and I worked in that sort of business when we were at Cargill prior to starting the fund.

Q: How does your ownership of RCMA Group benefit your hedge fund?

King: The main opaque area in commodity trading and investing is demand. The supply side of the equation is overly analyzed by all, with abundant statistics readily available. Our link to a substantial physical business allows us to extract real time data on global demand in commodities such as rubber. Rubber is a hugely predictive indicator to global GDP as it is extensively used in the industrial sector via the manufacture of tires for trucks and heavy industrial machinery. We started to get bearish on oil and other industrial commodities such as iron ore in the spring of 2014 based on our view that global GDP was significantly below perceived estimates. This view was formed as our sales of rubber worldwide were proving to be disappointing despite a price fall of 30 percent from 2013 price levels.