Commodity Boom Beats Up Skeptic; Will He Be Right? [WSJ]
By HENNY SENDER
May 19, 2006; Page C1
Few outside the rarefied world of high finance have heard of Dwight Anderson. But as commodity prices take a dive, he and his New York investment firm, Ospraie Management LLC, are at the center of the upheaval.
Mr. Anderson -- along with the rest of Wall Street -- must decide whether falling prices for everything from platinum to oil are a temporary hiccup or a lasting response to rising global interest rates. Gold fell yesterday to $679.60 a troy ounce and is now down $40.20 from the latest 26-year high it hit about a week ago.
Other commodities are also hovering near record or multidecade highs.
The booming economies of China and India have contributed to the rise of commodities prices over the past two years. But the biggest impetus for the gains had come from speculators pouring into the market, hoping for lucrative returns in the face of low interest rates in more-traditional investments.
Mr. Anderson, a longtime investor in and student of commodities markets, has been caught in the crossfire. For years he has ranked among the most successful traders in commodities and the companies that traffic in them. But amid the speculative fever of the past few months, he had his worst quarter ever, with Ospraie down 13%.
The reason: He concluded that the boom couldn't last.
Commodities trading can be a brutal way to try to make money. Gains can soar by double-digit figures one month, only to fall the next. It is especially brutal for traders, like Mr. Anderson, who grew up in a world where prices were determined more by fundamental supply and demand than by speculative fever chasing the market's upward momentum.
Until a few years ago, many on Wall Street had little interest in commodities. The reason: The companies that produced and distributed the stuff -- say, Exxon Mobil Corp. in oil or Cargill Inc. in grains -- would always have an edge in understanding supply, demand and prices because they controlled the flow.
Commodity prices tend to be cyclical, rising and falling in tandem with the overall cycle of global economic growth. However, sometime in the past two years, the charts show these prices making an abrupt leap above their historical trading range.
Price spikes like these have consequences in the real world, since they amount to a redistribution of wealth -- stoking the prosperity of resource-rich countries and the anger of consumers frustrated at the expense of, for instance, filling their gas tanks.
The volatility of the past few years also transformed stodgy commodities into one of the most profitable trading sectors. Wall Street firms usually don't break out numbers, but analysts say that commodities have added as much as $1 billion each to the profits of Morgan Stanley and Goldman Sachs Group Inc. in recent years.
Ospraie now has about $4 billion under management, a figure that includes Mr. Anderson's flagship fund as well as the money of a number of managers that trade under his flagship brand in related areas. Last year, Lehman Brothers Holdings Inc. took a 20% stake.
"He decoded the basic-materials world when nobody else was in it," says Michael Novogratz, a founding partner of Fortress Investments and a longtime basketball partner of Mr. Anderson.
Mr. Anderson's path to trading had some twists and turns. As a kid growing up in upper New York state, he says, he wanted to be a veterinarian.
After graduating from Princeton, he ended up working at Amsterdam Printing, an upstate New York paper and printing company, after first working as a consultant for a company that developed software to help automate manufacturing operations.
In 1993, he went to graduate school at the University of North Carolina on a university scholarship funded by Julian Robertson's legendary hedge fund and eventually ended up working for Mr. Robertson. Mr. Anderson then moved on to the hedge fund of the equally legendary John Paul Tudor, Tudor Investment Corp., where he formed Ospraie -- named for the raptor -- as part of Tudor, then took the fund out of Tudor (with a lot of Tudor money) in 2004.
Like all traders, Mr. Anderson has made some bad bets. For instance, he underestimated how high scrap-steel prices would go in 2004, hurting some companies whose stock he held. He also took a bath on oil-services company McDermott International Inc. when the company was hit by a sudden surge in asbestos claims from the days when it built ships a quarter of a century earlier. In recent months, he suffered as the markets, driven by speculative funds riding trends, reached highs that seemed irrational by the standard of veteran traders and investors.
To figure out his strategy, he studies not only price charts, but also the balance sheets and cost structures of the individual industries. The goal: to figure out what price levels might force the industry to take major steps that change the supply-and-demand dynamics, such as adding extra production capacity if prices soar or shutting down some of the current capacity if prices fall.
It is a complex mix of old-fashioned number crunching, probability theory and a measure of luck. To see how it works, consider copper, demand for which is tied closely to the world economic cycle. On average, copper costs about 80 cents a pound to produce; if prices fall below that, production isn't profitable. However, mines won't cease production if the price falls only to, say, 77 cents a pound, because shutdowns entail costs too. It takes a drop to about 72 cents before it makes economic sense to start cutting back.
In late 2001, copper plunged to 60 cents a pound after the Sept. 11 attacks. That gave producers every incentive to cut production. But would they?
"At those price levels, the industry was bleeding. You could expect to see massive closures," Mr. Anderson says. But "nobody wants to be the first to shut down and let others benefit from the reduced supply,"
At that point, Mr. Anderson took a bet and began accumulating a big position in copper on the London Metals Exchange, betting that the prices and the profit margins of major copper producers would bounce back -- and held his breath.
Mr. Anderson kept his eye on the high-cost producers, such as Phelps Dodge Corp., of the U.S. Phelps Dodge was the first to crack, announcing a temporary cutback in production. Then BHP Billiton did the same.
By January 2002, copper bounced to more than 75 cents. Mr. Anderson maintained his position, because he knew the price hadn't yet risen high enough to give producers an incentive to reopen capacity.
Now, though, he is less certain what his next move should be. Mr. Anderson takes out a chart mapping copper prices from 1988, the year he began to be interested in commodities trading. "I have never seen these levels of copper prices in my career," he says. "Everyone is making money at these levels. Everyone wants to reopen old mines and finance new mines. At some point, there will be a surplus and the price will inevitably drop 40% or 50%."
To back up that statement, he compares this decade with the 1950s, the most comparable period he could find, as Japan and Europe rebuilt after World War II. He assumes a rate of growth in the price of copper of 5.1% a year, far more generous than the 2.8% average of the 1990s, to reflect the emergence of India and China on the world economic stage. And he concludes that copper will still shift to surplus sometime in the next two years.
"I can see (a) where we are now, and I can see (c) where we are going," he says. "I just can't be sure of (b) when we get there -- and with how much volatility."
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