El Nino Trades Boosting Merchant Commodity Fund Returns by 10%

  • Fund managed by Coleman and King gained 10% in first quarter
  • King sees further gains in sugar, coffee and palm-oil prices

El Nino-related trades from sugar to palm oil boosted the Merchant Commodity Fund’s performance by 10 percent in the first quarter, according to managers Doug King and Michael Coleman.

The fund’s returns come after a 3 percent decline last year and a record increase of 59 percent in 2014, King and Coleman said in an interview Tuesday at the Financial Times Commodities Global Summit in Lausanne, Switzerland. Supply disruptions caused by the El Nino weather pattern mean that for the first time in three years, most of the fund’s bets are on rising prices.

“So many opportunities we see are El Nino-driven opportunities and not really through demand growth but more through supply curtailments," King said. “We sort of traded those themes rather well in the first quarter."

The El Nino weather pattern boosted palm-oil prices by more than 20 percent in the past 12 months as dry weather hurt production in Malaysia and Indonesia. Raw sugar rallied 10 percent in the period as dryness slashed output in India and Thailand, widening forecasts for global shortages for this season and the next. Robusta coffee has gained in the past two months as a lack of rain threatens the crop in Vietnam, the largest producer of the variety.

Further Rally

Palm oil could rally another 15 percent to 20 percent in the next three months before peaking as Indonesian production has been lower than expected, data that isn’t readily available to market participants, King said. Reduced output in the world’s biggest grower will be noticed through Malaysian export data.

Robusta coffee could rise to $2,000 a metric ton from $1,510 now as dryness limits output in Vietnam and Indonesia. Arabica beans, favored for specialty drinks such as those made by Starbucks Corp., may climb to $1.60 a pound to $1.80 a pound in the next three to six months as exchange-certified stockpiles decline. That compares with $1.236 a pound in New York now.

“The certified stocks of arabica are declining pretty quickly,” King said. “They are down from close to 3 million bags to 1.4 million bags. The last time we got down to 1.3 million, 1.2 million, we had quite a sharp spike.”

Sugar prices could rally to 18 cents a pound in six to 12 months as dry weather cuts output in India, the world’s second-largest producer, this season and the next, according to the Merchant Commodity Fund. They were 14.29 cents a pound Wednesday. A lack of rain has also cut Thai production, helping send premiums in the physical market higher. F.O. Licht earlier this month tripled its sugar-shortage forecast for 2016-17 season that starts in October to 4.9 million tons.

It will take longer for sugar prices to gain as speculators have boosted bets on higher prices and futures fall with movements in their position, Coleman and King said. Large and small speculators excluding index funds reduced their net-long position by 7.3 percent in the latest week from a record 224,258 contracts a week earlier, U.S. government data showed.

“In the medium term, if you look at supply and demand, there should be a repricing of sugar,” King said. “There may well be a drop down to 13.50 cents beforehand” as speculators assess their bets, he said.

Oil Position

The Merchant Commodity Fund, which profited from tumbling crude prices in 2014, is neutral on oil, and more positive about natural-gas futures and summer-specification gasoline, King said. Natural-gas production is starting to show “meaningful” declines and demand for gasoline remains strong, he said.

“We feel summer spec is a different animal so it’s out there to prove if they can produce against what’s a pretty solid global-demand growth picture,” King said, referring to gasoline. “Demand will stay very strong at this low, flat price.”

While investor interest in commodities has started to pick up in the past six weeks, it still has to translate into inflows, said Coleman. The Merchant Commodity Fund currently has $240 million of assets under management, he said.

“It’s fair to say it’s been a very difficult proposition to market a commodity fund over the last few years,” Coleman said. “Even with that very good performance, the negativity towards the asset class has made it difficult to raise any significant assets.”