Commodities Rally Is Fizzling Out as Merchant Fund Sees Oil Drop

(Bloomberg) -- The best is probably over for commodities this year as the Brexit vote adds risks to global growth and oil is set to retreat, according to the Merchant Commodity Fund, which returned 9 percent in the first half.

The fund, run by ex-Cargill Inc. employees Doug King and Michael Coleman, has changed its commodities outlook to neutral from bullish earlier this year. The U.K. vote to exit the European Union has led to uncertainty and growth remains lackluster in top user China, King said. Oil may drop to $40 to $45 a barrel within three weeks as stockpiles fall more slowly than expected, he said.

The Bloomberg Commodities Index has gained 11 percent this year, snapping a five-year drop, as El-Nino induced dry weather cut coffee and sugar supplies and floods in Argentina hurt soybean output. Oil has rallied on speculation less investment and steady OPEC output will lead to cutbacks from U.S. shale fields. Now, with markets taking a knock following the British referendum, the raw-material rebound is losing steam.

"Global growth, for sure, we think will be under some form of pressure, so you really have to look for supply problems to get any excitement going in the market place," King said by phone on Tuesday. The fund oversees $235 million in assets. "We think there's a correction coming in oil."

Brexit Concern

Central banks around the world have pledged more stimulus to prop up economies in the wake of the June 23 Brexit decision. Oil's fundamentals aren't strong enough for it to sustain this year's 29 percent rally, King said. Crude traded at $48.02 a barrel in New York on Thursday.

High gasoline inventories that will erode refining margins will eventually reduce crude demand, according to the fund. Abundant supply will push gasoline prices down to 130 cents to 140 cents a gallon, compared with about 143 cents a gallon now, King said.

The U.S. has made "so much gasoline that it's going to be an issue to get rid of before the end of the summer, so refining margins are probably under some pressure," he said. "The crude market hasn't tightened up anywhere near what one would have expected."

Robusta coffee is the fund's most bullish pick. The beans, hit by El Nino-related output problems in top growers Brazil and Vietnam, will climb 14 percent to $2,000 a metric ton in the next three months, King said. They've already gained in the past five months, the longest run since April 2014.

Coffee Outlook

"It's our favorite long if you like," he said. Robusta "seems to be too cheap versus the actual drawing of stocks and the tightness of that market."

Arabica coffee will also benefit from gains in robusta as consumers shift to lower grades of the variety to compensate for the robusta shortage, he said. While traders see a large Brazilian crop, inventories in the top producer are "very low" and restocking will be needed. At the same time, exchange stockpiles are falling.

Corn, which entered a bear market this week, probably won't fall much further and low prices offer a good buying opportunity, according to the fund. U.S. futures fell 3.8 percent so far this month after the U.S. Department of Agriculture said farmers planted more acres than previously forecast.

Merchant is bearish on coal and iron ore in the next three to six months and sees raw sugar falling to 17 cents to 18 cents a pound as speculators close out record bullish bets. Tightness in the market will probably only be felt in a year's time, King said.

"Most commodity markets will perform through supply issues rather than demand issues," he said. "It's a mixed bag, good for specialists that know what they are doing and not as easy for trend followers."

To contact the reporter on this story: Isis Almeida in London at ialmeida3@bloomberg.net. To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net, Nicholas Larkin, John Deane