March 25 (Bloomberg) -- In June 2007, Michael Farmer, co-founder of hedge fund Red Kite Metals, hosted a lunch for fellow members of the London Metal Exchange. The topic wasn't the latest movements in the metals markets. Instead, he invited a theologian to speak on Christianity and gave a testimonial himself. Farmer, 63, a ``born-again'' Christian, has been mixing business and religion for years. It's done nothing to diminish his success. A metals trader since the age of 19, Farmer helped turn London-based MG Plc into the world's biggest copper trader during the 10 years he ran it. In 2000, Enron Corp. bought the company for half a billion dollars.
In 2005, Farmer founded RK Capital Management LLC, whose main fund is Red Kite Metals, and he quickly made Red Kite the world's biggest industrial-metals hedge fund. Red Kite Metals returned 188 percent in 2006, gaining from what Farmer calls the greatest bull market in commodities in modern times.
In 2007, Farmer's faith in the commodities boom took a blow. Red Kite Metals made big bets on continued price rises. When aluminum dropped 14 percent and copper barely gained, the value of the fund's holdings fell 50 percent in the first 11 months of the year, according to two investors.
Like the endangered bird of prey for which it's named, Red Kite was suddenly fighting for survival.
Now Farmer, a veteran of U.S. commodities trader Philipp Brothers, has come roaring back. The price of copper rocketed 26 percent in January and February and set a new record of $8,820 a metric ton on March 6. As of March 20, it was $7,840.
20 Percent Rise
Red Kite Metals gained more than 15 percent in January and more than 20 percent in February, according to people familiar with the fund's returns.
Farmer and his partner, David Lilley, who's also an evangelical Christian, are much more than fund managers. Most of their combined 60 years in the industry has been spent trading physical metals, as well as wagering on prices in the futures markets.
``They are known as the kings of copper,'' says Michael Nassif, president of Geneva-based Calibria Financial Services SA, which invests in hedge funds. ``They have the skills, experience and track record in these markets.''
Rising prices for industrial metals and other commodities have pulled thousands of new investors into what were once illiquid markets. Money invested in commodity hedge funds surged 83 percent to about $55 billion in 2007 from $14 billion in 2005, according to estimates by Chicago-based Cole Partners Asset Management. Mutual funds tracking commodity indexes held $125 billion at the end of 2007, compared with $25 billion in 2003, according to Barclays Capital.
LME Boom
With the boom in investing, the London Metal Exchange posted three consecutive years of record trading through 2007, when $9.5 trillion changed hands -- almost five times the amount in 2000. As of mid-March, RK Capital managed more than $1 billion in three funds: Red Kite Metals, Red Kite Compass and Red Kite Prospect I. All three trade in both industrial and precious metals. Red Kite Metals gained 145 percent from its inception in 2005 through the end of 2007.
Farmer has lately become a public figure in London. In 2006, he gave 640,000 pounds ($1.29 million) to Britain's Conservative Party, according to the U.K. Electoral Commission. He told the Daily Telegraph that he admired Tory leader David Cameron's commitment to family values. In 2007, he gave the Conservatives 410,000 pounds more.
Farmer and Lilley, 41, declined requests for face-to-face interviews, consenting only to discuss their business by e-mail via New York-based spokesman Todd Fogarty. They also declined Bloomberg's request for photographs.
Bullish on Commodities
Despite their 2007 setback, the pair of traders are as bullish on the metals markets as ever. ``The world is going through the biggest industrial revolution it has ever seen, and it's affecting the largest part of the human population ever,'' they wrote in an e-mail. ``This is bringing a combination of millions of new consumers and cheap manufacturing capacity. The implications for raw materials are dramatic, and the world has to learn to value them more highly.''
Not everyone agrees that commodity prices will keep rising, especially at a time when economists are predicting a U.S. recession and global slowdown.
``I think where we're really at in the commodity business - - and I've been at this since the 1970s -- is we're overvalued in a number of areas,'' says Don Roose, president of West Des Moines, Iowa-based brokerage U.S. Commodities Inc. ``We're nearing a commodity bubble that is very similar to the dot-com bubble.''
Donald Selkin, director of equity research at Joseph Stevens & Co. in New York, says the commodities boom has little to do with supply and demand.
`Massively Misguided'
``The near-record prices that we are seeing come from speculators -- it's massively misguided bullishness,'' he says. ``All economic data we have seen -- durable goods data, economic growth -- are quite negative. It will backfire one day, though I don't expect a market collapse in copper.''
Copper, like gold, will remain buoyant, Selkin says, because investors are using it as a hedge against the weakness of the U.S. dollar. Since copper and other metals trade in dollars, buyers outside the U.S. can purchase more dollar- denominated assets in their local currencies.
Though it also trades aluminum, nickel and tin, Red Kite Metal's main business is copper. It buys the metal from producers in North and South America and sells it to companies that turn the metal into wires and pipes for home and office builders and carmakers. The fund trades copper futures on the LME and buys the physical metal, holding it in warehouses around the world until Farmer and Lilley are ready to sell.
Nord Resources Deal
Tucson, Arizona-based Nord Resources Corp., an international copper miner, said in February that RK Capital agreed to buy all of the production through 2012 from its new Johnson Camp mine in Arizona. Nord Resources said it expects to produce up to 25 million pounds (11,000 metric tons) of copper cathodes, a finished form of the metal, at Johnson Camp every year.
Red Kite got its name on a day when Lilley and his family were driving in the Chiltern Hills, northwest of London. A red kite dropped out of the sky and scooped up a dead animal on the road. Lilley's son, then 9, couldn't stop talking about the sighting of the rare bird, which is related to the eagle, and a fund family name was born.
Farmer and Lilley work out of Red Kite's office on Broad Street Place in the City of London, 900 meters (2,950 feet) from the LME. Their office occupies the third floor of a seven-story building, above clothing retailers and a betting shop.
Precious Metals
While Farmer and Lilley buy and sell derivatives on the LME, two traders in Red Kite's New York office, Barry Feldman and Oskar Lewnowski III, buy copper and other metals from producers and sell them to the companies that fashion them into sheets, rods, pipes, tubes and wire. Lewnowski, a founding partner, also trades precious metals for the funds.
Fogarty says the firm employs about 30 people in London, New York and Bermuda. One of them is Farmer's daughter, Antonia, a staff researcher. Friends say Farmer bikes to work from his home in Mayfair. He's fit and trim and looks younger than his 63 years. Lilley, bespectacled and slim, would pass as a university professor; he enjoys reading history.
Red Kite moves markets via the huge trades it executes. According to a prospectus sent to potential investors in 2006, Red Kite Metals at that time was borrowing an average of six times its investment pool, which an investor estimated at about $1 billion.
Stockpiling Copper
At the March 20 price, that would buy about 750,000 metric tons of copper, or almost four times the combined total metal stockpiles currently held at warehouses registered with the Comex division of the New York Mercantile Exchange, the Shanghai Futures Exchange and the LME.
``If you buy a million tons of copper, that's guaranteed to get the market up,'' says David Threlkeld, president of metals trading firm Resolved Inc. in Scottsdale, Arizona. Threlkeld was the man who blew the whistle on Tokyo-based Sumitomo Corp.'s illegal effort to corner the copper market in the 1990s.
He says some big metal traders reduce world inventories -- and raise prices -- by buying up the stocks of producers in Latin America and then selling metal to the producers' customers from stocks held by traders at LME-registered warehouses. He declined to comment on whether Red Kite pursues that strategy.
``RK holds physical stocks of metal as part of its investment strategy,'' Farmer and Lilley said in a February e- mail. ``As a matter of policy, we don't comment on specific positions.''
A Spike in Price
In 2006, a year in which copper prices rose 44 percent, peaking in May, copper usage rose only 2.3 percent, according to the International Copper Study Group, a Lisbon-based organization funded by the governments of copper-producing nations.
``The gain that occurred in May 2006 was driven primarily by deep pockets of speculative players in the market, not demand and supply,'' says John Gross, publisher of ``Copper Journal,'' a trade publication based in Newport, Rhode Island. A few companies were involved in pushing up the price, Gross says. Asked whether Red Kite was one of them, he declined to comment.
The rally in copper, aluminum and other industrial metals began in 2002, as China, the world's fastest-growing major economy, accelerated its purchases of metals to build power grids, autos, homes and skyscrapers. That year, the world's most populous nation overtook the U.S. as the top consumer of copper. Executives at companies including London-based Rio Tinto Group, the world's third-largest mining company, say China's demand for metals will continue to drive up prices.
The China Factor
``Chinese growth is not expected to be significantly affected by any further slowing of U.S. economic activity,'' Vivek Tulpule, Rio Tinto's chief economist, said in a Feb. 13 statement accompanying the company's second-half earnings report.
Frank Holmes, chief executive officer of U.S. Global Investors Inc., a San Antonio-based family of mutual funds that invests in natural resources, says the rapid industrialization of the developing world is what's driving prices.
``We see the growth story in emerging markets as the key long-term driver for copper, nickel and other commodities,'' he says. ``China and India are leading a massive global infrastructure buildout. Creating this infrastructure requires huge quantities of energy, steel and other natural resources.''
The flood of buying and selling, and the constant trading by hedge funds such as Red Kite, has greatly increased metals' price volatility. Copper's price movements, as measured by the market price of traded options, peaked at 61.53 percent on May 16, 2006, compared with a reading of 22 percent at the beginning of that year. It was 37.29 percent as of March 20.
Price Swings
Price swings are also forcing metal brokers who trade on the LME to set aside more cash to guard against losses, as the exchange's rules require. The amount climbed to $1,000 a ton in mid-2006; it was $500 as of mid-March of this year.
Involvement in the copper market by hedge funds such as Red Kite creates much-needed liquidity, says a copper buyer who declined to be named. It can also increase costs. Manufacturers of copper power cables, for instance, have to borrow more to keep their inventories up when prices rise, the buyer says. And sellers of copper rods and wire must hike prices for their customers when the cost of their raw material spikes.
The world of copper wasn't flooded with money and investment back in 1963, when then 19-year-old Farmer started at A. Strauss, a now defunct LME brokerage that mostly dealt in tin. In 1968, Farmer took a job as a trader at London-based Anglo Chemical & Ore. His mentor there was Manfred Kopelman, a copper trader.
An Exec at 30
Kopelman bought and sold big stockpiles of the metal, in the process influencing the price, says Trevor Tarring, former chairman of U.K.-based industry magazine Metal Bulletin. Tarring is author of the 1996 book Corner! A Century of Metal Market Manipulation (Metal Bulletin).
In 1974, at the age of 30, Farmer was named a managing director at London-based Cerro Metals Ltd. ``He was someone who produced consistently strong results, working for large-scale trading companies with high-volume business,'' says David Waite, who worked for a competing company and has known Farmer since 1972. Waite was an original Red Kite partner; he left in 2005 and now runs Far Hills, New Jersey-based CRM Associates, which advises metal buyers and producers on hedging.
In 1983, Farmer rejoined Anglo Chemical, which by then was part of Philipp Brothers -- now Phibro, the commodities trading unit of Citigroup Inc. Farmer traveled extensively in Africa and the Americas studying the copper markets, a former colleague recalls.
Enron Deal
Farmer hired the younger Lilley in 1988 from agricultural giant Cargill Inc. and brought him along in 1989 when Metallgesellschaft AG, a German metal trader, hired Farmer to head its physical trading operation. Initially called Metal & Commodity Co., the company went public 10 years later in London as MG Plc with Farmer and Michael Hutchinson as co-CEOs.
In 2000, trading company Enron bought MG for $448 million and renamed it Enron Metals. Farmer won't say how much he earned from the deal. Enron sold the firm in 2002, and it's now called Sempra Metals, based in London.
Red Kite Metals has been as volatile as the markets it's part of. Kimberly Tara, CEO of Boston-based commodity investment fund FourWinds Capital Management, wasn't surprised when Farmer's funds took a tumble in 2007. FourWinds was an investor in Red Kite Metals until 2006, when Tara redeemed her investment, concluding the fund's huge investment in the metals market was too risky.
``We thought it was too much capital for the strategy being deployed -- and a risk to us,'' Tara says.
Farmer and his crew at Red Kite still have faith in the metals boom. The kings of copper continue to believe that as long as China and India keep building, an investment in the red metal can't lose.