Red Kite Evangelicals Reap 47% Sowing Bet on China’s Waning Copper Market

 Published: 1/11/2012 11:27:00 AM GMT
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On a dark, drizzly November morning, Michael Farmer steps to the pulpit to deliver a stern message to fellow parishioners at St. Helen’s Bishopsgate, an 800-year-old church in the shadow of the London Metal Exchange and in the heart of the City, London’s financial district.

“We live in a cursed world -- cursed by God,” Farmer tells the men and women who fill the church, most of them workers in the financial industry. “We live in a broken society; we have broken nations. Look at the euro zone. Life is a struggle and, in the end, is death.”

Yet those who believe in Jesus Christ need not fear, says Farmer, a thin man dressed in a charcoal suit and blue tie. Jesus will provide salvation from the daily hardships of disease and poverty -- and the firings that have left thousands of City workers unemployed, he preaches.

Farmer, 67, is a Conservative Evangelical who attends services every Tuesday at St. Helen’s, Bloomberg Markets magazine reports in its February issue. He also runs London- based RK Capital Management LLP, a metals-trading hedge-fund firm with $1.3 billion of assets under management. Its $400 million Red Kite Compass Fund tops Bloomberg Markets’ ranking of midsize hedge funds for the first 10 months of 2011, with a return of 47 percent, according to investors.

The $200 million Red Kite Metals Fund rose 34 percent, and the $100 million Red Kite Prospect Fund surged 50 percent, clients say.

China Copper Glut

RK Capital specializes in the buying and selling of copper and prospered by betting that the price of the red metal would fall in 2011 as the pace of construction in China slowed, investors say. The assessment proved correct, with copper retreating 26 percent as of yesterday from a record $10,190 per metric ton in February 2011.

Farmer says his faith makes him a better money manager by keeping him humble. The firm’s offices match his humility, featuring a simple orange sofa in the reception area, gray carpeting and walls free of art or photos. There is no receptionist; visitors press a button on the coffee table to let Farmer and Red Kite’s other co-founder, David Lilley, know they are there.

“Jesus warns us that there are many dangers to money,” Farmer says. “I know that in my heart there is greed, there is wanting just a little bit more. It helps that the Bible tells me to be wary of this and that one day I will fall off my perch.”

Farmer is active both in the church and in politics. He has given millions of pounds in donations to Britain’s ruling Conservative Party, saying it has done more than rivals to promote family values.

Farmer and Lilley, 45, aren’t just owners of futures and options contracts tied to copper; they also trade the physical metal, buying the commodity in North and South America, storing it in warehouses around the world and selling it when the price is right to companies that turn it into the wire and pipes used in the construction of homes, office buildings and vehicles.

Farmer previously ran MG Plc, which before its sale in 2000 was the world’s biggest copper trader. Lilley also worked at London-based MG. Farmer used that experience as a marketing point when he started RK Capital in 2005.

Physical trading also formed the backbone of what was once the firm’s biggest hedge fund, Red Kite Metals, which oversaw more than $1 billion at its peak, according to investors. The fund -- named after an endangered bird of prey native to Europe and North Africa -- proved as volatile as the prices of the metals it buys.

Red Kite Metals surged 188 percent in 2006 on the back of a global commodities boom, according to investors. It then plunged 50 percent in 2007, rebounded with a 19.8 percent rise in 2008, then fell 0.9 percent in 2009 and 25 percent more in 2010, when Red Kite’s bet that copper would decline proved premature.

Clients fled the metals fund, reducing assets to $200 million as of November, investors say.

Farmer says that from 2008 to 2010, the U.S. Federal Reserve buoyed markets, including those for commodities, by pouring billions of dollars into the economy. At the same time, he says, analysts mistook China’s aggressive buying of copper as a sign that its construction boom was continuing, when in fact the Chinese were stockpiling the metal.

The sluggish world economy makes Farmer a pessimist.

“We are not very positive about things,” he says. “The world is in a bad place. We are still fighting to recover from a very serious recession, and I think it is going to go on for another four or five years.”

One reason the assets of Compass surged ahead of Red Kite Metals is that Compass deals only in futures and options, not the physical metal.

“We avoid physical games because it includes other risks and is less liquid,” says hedge-fund investor Marcus Storr of Feri Trust GmbH, whose Bad Homburg, Germany-based firm manages 16 billion euros ($20.4 billion). “We’d rather stick to hedge funds trading mainly in equities of commodity companies and financial derivatives.”

Farmer and Lilley say clients often prefer funds that trade derivatives due to investor suspicion of money managers in the wake of the Bernard Madoff scandal. The contracts Compass buys can be more easily placed in individual accounts that clients control, they say.

The Compass fund grew 10-fold to $400 million in October from $40 million at the end of 2009.

Success in forecasting copper sales and prices depends on an understanding of the Chinese market, which consumes 39 percent of the world’s copper, according to Morgan Stanley (MS) estimates. RK Capital is now involved in transactions that account for as much as 15 percent of China’s supply of copper in a given month, Farmer says.

“At Red Kite, you are dealing with people who have many years in metals, with great expertise in China and the physical world,” says Robin Bhar, a metals analyst at Credit Agricole SA (ACA) in London. “What you can get from the physical market in terms of flows and views helps immensely to form a view in trading. They have very good market intelligence.”

Ren Gang, head of research at Shanghai-based Maike Futures Co., says Chinese copper demand could be weak in 2012 because local companies can’t borrow money for real-estate projects.

“Companies are short of money as credits are very tight,” Ren says. “There’s not much restocking of copper.”

Ren’s company is a unit of Maike Holding Group Ltd., which imported 600,000 tons of copper into China in 2010. In 2008, Maike partnered with RK Capital to set up an investment fund in Hong Kong.

Not everyone is bearish. Goldman Sachs Group Inc. (GS) analysts Max Layton and Allison Nathan say market jitters in Europe have led traders to take their focus off the fact that copper supplies are under pressure. Strikes by workers in Latin America have created a copper deficit, which will trigger a “strong rally” in the second quarter of 2012, the analysts wrote in a Nov. 20 report.

Copper rose to a one-month high of $7,820 a metric ton in London trading today after analysts, including Royal Bank of Scotland Plc’s Nikos Kavalis, predicted China will ease monetary policy in an effort to spur growth.

Some Red Kite funds have been volatile. Hedge funds with big performance swings risk pushing away institutional investors such as pension funds and insurance companies, says Neil Campbell, London-based head of alternative investments at brokerage Tullett Prebon Plc.

“It’s very hard for an institutional investor to be convinced that a fund that is up 100 percent in any year is able to manage the downside risk,” Campbell says. “Very few investors will have the stomach to deal with that volatility.”

Farmer says his firm accommodates investors eager to limit risk.

“We have had the roller coaster ride,” he says. “We learned from that and try to reflect our investors’ wishes. If they want less risk, we can build a managed account that is less risky.”

Some of the volatility stems from the rapid growth in metals trading. Copper and other industrial metals bought and sold on the London Metal Exchange rose to $11.6 trillion of contracts in 2010 from $2.5 trillion in 1999.

The assets of hedge funds that trade metals rose to $86.8 billion in the third quarter of 2011 from $13.4 billion for the same period in 1999, according to BarclayHedge Ltd., a Fairfield, Iowa-based data provider.

RK Capital earned a net 116.2 million pounds ($179.6 million) from 2006 to 2010, with the profits distributed to its four partners -- Farmer, Lilley, Oskar Lewnowski III and a firm the three men control called RKX Services Ltd., according to government filings with the U.K.’s Companies House.

New York-based Lewnowski, 46, a former Credit Suisse AG (CSGN) investment banker, oversees a $400 million fund started by RK Capital in 2008 that provides financing for mining projects in return for the right to purchase metals pulled from the ground.

Called Red Kite Explorer, the fund has business deals with Calgary-based Rio Alto Mining Ltd., which is excavating gold and copper in Peru, and Nord Resources Corp., a firm that’s digging for copper in Arizona, according to press releases and filings with the U.S. Securities and Exchange Commission.

Farmer’s other life, as a Christian, didn’t start until he was 35. He says he had a “revelation” after his wife, Jenny, gave birth to the first of their three children.

“It wasn’t so much me making a decision. It was more me seeing something that had been in front of me all my life, but I was blind to.”

At his November sermon at St. Helen’s, Farmer related a story about a job promotion offered to him in the 1980s when he worked at commodities trading firm Philipp Brothers. He accepted the position, with a caveat.

“I’m a Christian, and there are more important things to me than the company and making money,” Farmer says he told his boss at the time. “There is God. There is my family.”

Farmer says he once asked his church rector if he should give up finance and go to theological school. The rector told him the finance industry also benefits from the presence of Christians.

Lilley, for his part, sees little conflict between work and the faith he shares with Farmer.

“God wants you to use your talents in the appropriate way,” he says. “If by the grace of God we can do something in business, then great, but try to make sure your faith also guides how you trade and the use of any proceeds.”

Farmer donated 150,000 pounds to St. Helen’s in 2010 and helps manage 2.48 million pounds held by a trust affiliated with the church, according to a government filing. The assets are invested in stock funds overseen by Zurich-based GAM Holding AG (GAM), the filing says.

Farmer and Lilley also fund a charity called the Cross Trust, which is focused on advancing the Christian faith and providing support for the poor, sick and elderly, according to filings with the U.K.’s Charity Commission.

The Cross Trust, of which Farmer and Lilley are directors, had assets of 1.5 million pounds in April 2010 after making 595,152 pounds of contributions in the preceding 12 months. The biggest donations were made to a Christian college and the Relationships Foundation, a U.K. group that encourages the government to promote family-friendly policies.

Since 2008, Farmer has given 205,296 pounds to the Conservative Christian Fellowship, which urges Christians to support Britain’s Conservative Party, according to the U.K. Electoral Commission. Farmer has donated an additional 3.28 million pounds directly to the Conservative Party since 2001.

He says he was first inspired to donate a decade ago, in reaction to the then-ruling Labour Party government’s policy of giving public assistance to unwed mothers, which he saw as encouraging them to have more children out of wedlock.

Farmer and Lilley say they are sympathetic to the demonstrators who set up encampments in the vicinity of financial centers around the world to protest disparities in wealth between the barons of the financial system and ordinary citizens.

“There is a problem, and I am not sure that problem is going away,” Lilley says. “Those with resources can either use them to create jobs and employ people, or they can blow them on overpriced champagne and conspicuous consumption.”

The October Occupy London protests, centered in a tent encampment around St. Paul’s Cathedral in the City, forced the church to temporarily close.

The demonstrators heaped opprobrium on the bankers in the buildings around them. In his St. Helen’s sermon, Farmer said he wasn’t there to assign responsibility for the global financial crisis. He urged his audience to stay true to their Christian beliefs even in a year when almost 10 percent of London’s finance employees had lost their jobs.

“They can fire you, and that’s really bad,” Farmer said. “They probably won’t, because if you are a Christian, you are probably hardworking and honest. But if they do, you are still with the Lord.”

To contact the reporters on this story: Jesse Westbrook in London at [email protected]; Chanyaporn Chanjaroen in Singapore at [email protected]

To contact the editor responsible for this story: Michael Serrill at [email protected].

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