The commodities ‘gladiator’

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Paul Touradji, co-founder of $1.5 billion New York-based commodities hedge fund Catequil Asset Management, learnt his trade in the ‘gladiator pit’ of Julian Robertson’s $24 billion Tiger Management. He was there for four years, and it was his first role trading commodities – before that he traded equity derivatives at O’Connor and Associates.

“You knew when you walked into Julian’s office with an idea that the first thing he was going to do was call the two or three most knowledgeable people in the world about that particular industry, idea or company, and essentially put you in a ‘gladiator pit’,” Touradji reminisces. “When you took an idea into that arena, you made damn sure it was well thought out.”

It was one of the crucial lessons he and the hedge fund’s other co-founder, Rob Ellis, took with them when they founded Catequil four years ago, soon after Robertson’s Tiger funds unravelled. Catequil’s strategy of investing long/short in commodities and commodity-related equities, based on fundamental research, has made it one of the most successful commodities hedge funds, but no performance data for the fund has ever been published, for “superstitious reasons”, says Touradji.

The other critical experience was running what he calls a “liquidity laboratory”. Some of Tiger’s trades in the 1990s were by far the largest the commodities markets had ever seen. Touradji learnt how to manoeuvre large sums of money within the constraints of highly illiquid markets. “We are very cognisant today at Catequil, in terms of measuring liquidity risk and not taking excessive liquidity risk,” he says. In this he uses a range of derivatives to create asymmetric risk profiles.

Touradji demonstrated its focus when Catequil – now a closed fund – was forced to turn away $1 billion in additional capital from existing investors when it restructured early this year. “One has to be disciplined,” says Touradji. “We’ve learned through our history that violating capacity constraints can actually be a material negative.” To emphasise the point, Touradji and Ellis say they both have 90% of their own capital tied up in the fund. “We serve our best interests by getting the best returns possible, as opposed to serving our egos by having the largest fund possible,” he says.

Despite large investor inflows into commodities during the past year, and commodity hedge funds and commodity trading advisers sprouting up seemingly on a daily basis, Touradji is critical about their strategies. Most commodity hedge funds do not research industry fundamentals, preferring to trade technically rather than attempt to pre-empt the notoriously unpredictable commodities markets, he says. And of those that do, few deal with commodity-related equities as well as commodities.

Touradji finds this surprising. “If an oil patch investor said to you, ‘I’m not sure where the oil/ gas price is going, I’m just an equity guy, but let me tell you about Exxon’, that has always been deemed as normal. If you spoke to a technology investor and he said, ‘I’m not sure where PC sales or microchip prices are going, but let me tell you about Intel’, you’d laugh him out of the room,” he says. “When it comes to the commodity-related industries, because the industry fundamentals are commodity prices, somehow the world says, ‘Oh well, we can’t figure that out anyway, so let’s just look at the stocks without the industry fundamentals.’ To us, that is odd.”

He also believes the commodities market suffers from a lack of talented and experienced traders. This means the current vogue towards commodity investments poses as many challenges as opportunities, Touradji argues. “One of the best things about being a commodities manager is the natural internal diversification,” he says. While even unrelated equities have a beta to the overall market, many commodities, such as sugar and aluminium, traditionally have no correlation at all. But the participation of “ignorant” thematic traders with the attitude that ‘commodities are good’ has suspended normal market trends, Touradji says. “It creates opportunities to trade directionally and fundamentally, but that comes with the risk that market dislocations are being driven wider than they have at any time in recent history.”

Such activity occurred in April and May, as fears that the Federal Reserve planned an imminent rise in interest rates resulted in participants fleeing from some metals and soft commodities. Zinc has dropped 10% since its high in April, while coffee has fallen 15%. Touradji says he sold on the way down for risk control, but is now going longer, believing the fundamentals are bullish. Momentum traders of coffee on the London International Financial Futures and Options Exhange have a short position of over a third of open interest, according to his estimates – a “quite alarming” fact, he says. “When the market turns, they will not only have to cover this position, but will likely go long.” He predicts the price of coffee will double in the next year, calling the situation the most exciting opportunity he has seen in five years. “The risk-reward is great, because everyone is short,” he adds.

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