Metals stuck in rut; coffee, cocoa best bet in commodities: Jefferies

Metal prices will be stuck in a rut into next year due to festering uncertainty over the timing and scale of tapering in the United States, with soft commodities such as coffee offering a better chance of returns, said Jefferies Bache's president.

Commodity markets had been underpinned by the Federal Reserve's massive financial stimulus, but now face at least six months of a cloudy U.S. economic picture and questions over how and when the central bank will curb its bond-buying, Marc Bailey said.

Bailey, who has run the London commodity brokerage since 2006, before it was bought out by U.S. investment bank Jefferies Group, said the partial U.S. government shutdown, the looming year-end and the fact that the Fed is due for a new chairman had further muddied the waters. He added that big investment decisions were unlikely until the outlook clears, curbing market activity.

"People are going to be closer to the sidelines than they would normally be for this last quarter," London-based Bailey told Reuters in a telephone interview.

"We've seen very difficult returns for those in the commodity industry, for both discretionary CTA and trend followers, and I don't see that changing substantially for the next six months."

Confusion over the future of U.S. stimulus has whipsawed a host of so-called Commodity Trading Advisors (CTAs), with many heading for a third straight year of losses.

Added to that, the allure of commodities as a hedge against inflation has soured, partly due to the Fed and Bank of England's successfully driving stimulus without causing prices to skyrocket, said Bailey.

Jefferies burst on to the LME last year, snapping up a host of traders from its competitors to debut in the top tier of the exchange's floor dealers, a year after buying veteran commodity futures brokerage Prudential Bache for $430 million.

But revenue generated from trading bonds, currencies and commodities (FICC) slumped 85 percent to $33 million in the three months to September.

Jefferies was not alone, with the uncertainty over U.S. monetary policy sapping activity at investment banks and funds on both sides of the Atlantic over the summer just as regulatory pressure squeezed their risk-taking activities.

London-based commodity hedge fund Clive Capital, which ran about $5 billion at its peak, closed last month, blaming a lack of investment opportunities and investor outflows.

TIME FOR COFFEE?

It has become more challenging to make money with investors turning away from the asset class and many commodity markets mired in surplus, continued Bailey, who also sits as a non-executive director for three commodity funds including Krom River Commodity Fund.

"You're left with: 'What is the best of a bad bunch?'," he said.

"The best you can do is look for value. Where is the event risk to the upside? Where is supply disruption possible? And where is a situation where you find that the cost of production is meeting the current price?"

Agricultural and soft commodities such as coffee and cocoa offered the best chance of returns as they are prone to the risk of unexpected weather.

Coffee traded in New York could represent an opportunity for the patient, Bailey said, potentially recovering to around $1.35-$1.40 a pound. Arabica coffee futures dipped to a more than four year low of $1.1395 per lb in September, pressured by expectations of abundant global supplies.

He said that sugar could extend a technical rally, although that could stop short around 20-20.50 cents per pound.

New York sugar futures have climbed around 8 percent in the past month, with the front month peaking at 18.76 cents on Thursday, the highest since mid-March. Their rise has been supported as wet weather disrupted harvests in top grower Brazil.

Swamped by oversupply, industrial metals are a tougher bet, although tin could offer some potential due to Indonesia's crackdown on trade, Bailey said.

"Tin could offer a good opportunity here, with government rhetoric helping to support prices, but there is some evidence to suggest that demand will still be met with adequate supply."

LME tin prices have rallied 10 percent since late August after Indonesia's government slapped down new rules forcing all physical trade through an exchange, which slashed September exports by 90 percent.

(Additional reporting by Sarah Mcfarlane in London; Editing by Joseph Radford)