Ray Simpson worked in a cattle feedlot when he was a teenager, and after graduating from Texas Tech University in 1979 he would return to the livestock business, working for Cargill at one of its packing plants.
"I bought cattle for that company for 17 years. I learned a lot; it was where I really got my business foundation," Simpson says.
Although he didn’t hedge for Cargill, he learned the dynamics of the business. With a lifetime in the cattle business, he began trading for his own account, and after he left Cargill, he purchased his first feedlot.
"Cattle and feedlots: I know that business inside-out, upside-down," Simpson say. And he understands hedging. "I never would have survived 9/11 or the BSE (Mad Cow disease) scare in 2003; I never would have survived 2008 without hedging. Those kinds of markets put a lot of people out of business," he says.
Most importantly, Simpson has a clear understanding of the difference between speculating and hedging. He may be from Texas, but he is no Texas hedger. "They are two totally separate entities," Simpson says. "My hedge account is my hedge account, and that is my cattle business. When I put a hedge on, I don’t touch it until the cattle [are] sold. The way I look at my spec account, I know that in the springtime the cattle market gets pretty good. In the wintertime when it gets wet and slow, the cattle will slow down in their gait. Around the 4th of July, the cash market typically bottoms out and looks forward to a fall rally."
This expertise allowed Simpson to trade profitably, to manage the risk in his feedlot business and to maintain profitability. "It is a very risky business. I offset my risk, I short-hedge my cattle and long-hedge my corn. I try not to buy anything that doesn’t look like it can have a profit," he says.
Simpson’s brokers at Lakefront Futures & Options, LLC noticed this and approached him about managing money; Ceres Funds Management LLC was registered in 2005 and began managing customer funds in 2008.
Nick Leblebijian, co-founder of Lakefront, says Simpson initially was hesitant because of the headaches involved in managing money, but Leblebijian and Jon Marcus, co-principals with Simpson in Ceres, manage the business in Chicago, allowing Simpson to focus on trading and running his feedlots in Texas.
It has worked. Ceres has produced a compound annual return of 28.18% including a 104.56% return in 2010.
The CTA program mainly trades spreads from a discretionary outlook with a focus on the cattle crush, which trades feeder cattle and corn vs. live cattle. Simpson’s experience in the cattle business helps him understand the dynamics of the cattle crush.
"You can’t underestimate what the cattle feeding industry will do to the margins to keep their pens full. It is not a secret, but Cargill, JBS, Tyson, these huge corporations and packing houses will [take huge losses] buying feeder cattle to keep their feedlots and packing houses running efficiently," Simpson says.
The need for commercial enterprises to operate at peak efficiency at the cost of bidding up feeder cattle is an exploitable edge for Simpson. "The money they lose feeding these cattle is more than offset [by] their packing house profits."
In late spring, Ceres was long April feeders and December corn, and short April live cattle. It has been a profitable long-term trade, but Simpson will take a quick profit if a position turns. "It is better to take the money and regret it than to not take the money and regret it."
Simpson also will trade basic calendar spreads based on seasonality and attempts to exploit the movement of index funds.
He will exploit the Goldman roll, but says it has grown more difficult. "When I first started, the open interest was 75,000, now it is 175,000 but there are so many other funds."
He says the vast majority of the roll is no longer concentrated on the five-day period of the Goldman roll. Ceres experienced its worst drawdown as a result of what appeared to be an influx of assets into the long-only commodity space in January. The program dropped 40% on a series of bull spreads (such as long April/short June) in cattle and hogs in a bull market because of a huge influx of capital over fear of food inflation. April cattle was a record low $1.50 premium to June instead of the typical $3 to $4, but actually went negative. "That is what blew those spreads apart. The front end just sat there, but they bought the back end," Simpson says.
He learned a valuable lesson from that drawdown, which the program nearly has made up already. He sees a lot of opportunity in winter cattle spreads, and expects long April 2012 cattle and short December 2011 to be a long-term play.
We wouldn’t doubt him, as he knows his business. "I have been there and done it. I have been at the packing house, I have been at the feedlot, I have been on the backend of a working chute, if you know what end that is. I just know this business."