Top China Macro Fund Shorts Commodities, Debt on Inflation

(Bloomberg) -- Accelerating Chinese inflation will derail a global rally in commodities and deepen a rout in the nation’s bonds, according to a top-performing macro fund manager.

Lu Jun, who manages about $1.6 billion at Shanghai Congrong Investment Management Co., is shorting raw materials such as ferrous and chemical products in a bet that mounting price pressures will cut short government efforts to reduce capacity in mills. He’s also bearish on Chinese sovereign debt, he said in an interview in his Shanghai office.

Prices of commodities from steel to aluminum have surged as China closed plants and boosted environmental controls, curbing output. While the nation’s consumer price index has remained subdued, core inflation -- which strips out food and energy prices - is the highest in six years at 2.3 percent. Concern about higher prices and rising borrowing costs have hammered bonds this month, with the 10-year yield surging to the highest level since 2014.

"We haven’t felt much inflationary pressure at the moment so that’s why China’s able to continue with the supply-side reforms," Lu said. "If inflation picks up, it won’t be able to carry forward the reforms, and then commodity prices will start to drop."

Lu’s 700 million yuan ($105 million) Congrong Allweather Fund has returned 37 percent this year, beating 96 percent of its peers, according to Shenzhen PaiPaiWang Investment & Management Co. His bearish stance toward raw materials is a shift from last year, when he had a large chunk of his fund’s assets in commodities, while equity exposure was kept low and fully hedged, enabling him to return 37 percent.

Inflation Risk

“China’s economic recovery rekindled enthusiasm among global commodity bulls as they bet the economy would drive prices higher,” said Lu, formerly chief investment officer of JPMorgan Chase & Co.’s local asset-management venture. “I’m afraid they’ll be disappointed this time.”

Lu said he was shorting bonds because he expects interest rates to rise in the short term, while robust demand for consumer products will boost inflationary pressures.

The 10-year yield climbed 3 basis points to to 3.83 percent, the highest since December 2014, at 4:07 p.m. in Shanghai. Some analysts are now predicting yields will climb to 4 percent and beyond.

"The government is working on debt reduction so liquidity conditions and broad supply of base money wouldn’t be too loose," Lu said. "Consumption has been strong along with the economic recovery on the other hand, so people are expecting a pick up in inflation."

Lu is now selectively long on stocks and has bought shares along the supply chain of the consumer industry. A notable increase in China’s consumer loans led him to bet on more domestic spending, which would boost corporate profits and wage growth, thereby fueling more spending.

“We are long-term bullish on consumption,” said Lu. “Though consumption loans may slow down in the near term as authorities will want to keep overall leverage in check.”

Lu, who started Shanghai Congrong Investment Management in 2007, said he aims to replicate the success of Bridgewater Associates LP in China, where he sees huge potential in hedge funds.

“We want to copy them,” he said. Congrong has more than 30 employees and is planning to recruit more analysts to grow its business. “Talent hunting could be difficult though, as there aren’t many experienced practitioners in this relatively new industry.”

--With assistance from Winnie Zhu Charlie Zhu and Zhang Dingmin

To contact Bloomberg News staff for this story: Amanda Wang in Shanghai at twang234@bloomberg.net.

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Sarah McDonald

©2017 Bloomberg L.P.

With assistance from Amanda Wang