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Opalesque Exclusive: Galena`s fund at ease with metals, as market is in contango

Posted on 17 December 2008

Benedicte Gravrand, Opalesque London: Duncan Letchford, lead-portfolio manager at the London commodity funds house Galena, talks about the metals market status quo and his metals fund.

Commodities funds win and lose

Trading remains high in the commodities – especially long/short trading - despite prices generally sliding down since this summer. But some investors have been pulling out of this sector because, as a hedge to stocks, it is no longer viable – commodities and stocks have become more correlated of late.

In the last month, a number funds such as Beach Horizon, Global Advisors, SVM, Merchant, Krom River, Mulvaney, Sextant, Tiberius and Sprott, gained on the back of falling commodity prices, especially CTAs/managed futures funds and some long/short funds. Some fund have been hurt too, especially those that bet on rising energy prices and agriculture: RAB Capital, Deephaven Global, Diapason L/S, for example.

Hedge funds are still dynamically invested in the commodities market: the FT reported last month that they were finding volatility trading too expensive and were turning to commodities trading instead, as derivatives based on commodity indices provided cheaper access to the “long volatility” trades, a successful strategy (coverage).

The Reuters-Jefferies CRB Index, a global commodities benchmark, today ended 0.5% down after last week’s record gain of nearly 9% that marked its biggest rebound since a slump in commodities that began August. (Source).

Letchford: near-term metals prices will remain under pressure
Falling prices for metals will most probably affect producers significantly as they will have to reduce output, endure losses, and some will go bankrupt. It is believed however that production cuts serve to bring the market back into equilibrium.

Duncan Letchford, lead portfolio manager of the Galena Metals Fund, believes that the metals markets has moved from structural supply deficits in a number of traded metals to concerns over surpluses, as the world becomes pre-occupied with a global recession and a period of lower demand. Some metals have seen significant production cutbacks already as producers respond quickly to significantly lower metal prices.

“The credit crisis has affected base metal prices more in terms of contangos than absolute price levels,” he added. Contago happens when the futures price is above the expected future spot price, leading the price to decline to the spot price before the delivery date.

According to Letchford, with money hard to obtain, the cost of carry has proved detrimental to all holders of metals, speculators, producers and consumers alike. Inventories on all major base metal contracts have risen as cash has become king and stock deliveries to the LME have accelerated. Precious metals with the honourable exception of gold have performed in exactly the same way, with only gold’s safe haven status keeping it relatively buoyant although still significantly off its highs.

Letchford expects near-term metals prices will remain under pressure as demand continues to weaken and the macro-economic situation worsens. In the longer term, historically low interest rates and producer cutbacks will fuel another rally as emerging market demand picks up and commodities are once again seen as a finite resource and an investable asset class.

Galena’s metals fund
The Galena Fund Ltd is a metals-focused hedge fund investing in base and precious metals, with a discretionary approach, and using a variety of trading strategies. It takes positions on non-ferrous metals (metals other than iron, and alloys that contain very little iron) and precious metal derivatives through a combination of futures, options and calendar spreads.

The fund takes on opportunistic positions based on information flow about the physical markets from the Trafigura Group (Galena is a subsidiary of Trafigura.) It was incepted in June 2004, has annualised +14.10% since, returned 5.25% in November and +16.17% YTD, managing $475m.

Selective re-opening
The Galena managers believe they can efficiently run the Metal flagship programme with $500m to $600m of AUM. For that very reason, the flagship programme has been soft-closed for quite some time.

Today, in the light of investors’ interest in alpha generating funds, they are proceeding with a selective re-opening for $100m to $150m.

“We are happy to carefully replace some of the capital leaving the Fund,” Letchford said. “Most of the few redemptions we experience - they represent less than 10% - are motivated by the need to keep multi-managers portfolios truly diversified. In a way, our YTD performance penalises us, since the allocation to our Metals Fund becomes proportionally (much) larger versus other funds that are flat or down.”

Trafigura and Galena
The Trafigura Group, the second largest independent non-ferrous trading company in the world and the third largest independent oil trader in the world, was established in 1993. It had a turnover of $51bln in 2007.

Galena Asset Management, a wholly owned subsidiary of the Trafigura Group, was established 10 years later. Galena has offices in London and Geneva, and manages around $655m in four funds: Galena Fund Ltd; Special Situations Fund Ltd; and the co-managed Malachite Fund LP and Azurite Fund Ltd.

Galena’s corporate website:
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