Amaranth Loss / Nat Gas Futures

[TRS]

How they gave one trader that amount of leverage, risky.

http://www.thefirstpost.co.uk/index.php?menuID=2&subID=931&WT.srch=1

[HenryTo]

Apparently, he has very "deep knowledge" of the natural gas industry. But to me, the spring prices for 2007 never made sense in the first place - given record high inventories and given the supply is projected to increase more than demand going forward. To me, it seemed like he was better on much colder-than-expected weather this winter or that a hurricane will come in and destroy the Gulf Coast's operation once again.

I would definitely like to speak to him to see how he came up with that conclusion.

[nodoodahs]

I don't generally like to be part of the echo chamber, so I'll try to say something new about the Amaranth losses in natural gas futures.

As I understand it, leverage isn't the problem. Leverage is just part of the game in futures.

My takeaways:

1. Never take a position big enough to wreck you.

2. If the market tells you that you're wrong, LISTEN. LOSERS average losers.

3. Never play markets that are illiquid when compared to your position sizing. Next spring's contracts? Puh-LEEEZE! How liquid could they be, especially compared to a position size that's capable of losing billions?

Interlude between takeaways:

"Dueling Idiots" on CNBC the other night. I'd have used "Dueling Fools," but that's taken. Both speakers seemed to be interested in finding reasons for more hedge fund blowups or for depressed returns. First idiot says there are thousands of hedge fund managers and too much capital in hedge funds for the caliber of talent available, therefore blowups like this will happen. The second idiot says that there are no good strategies left because all the ideas are picked over, therefore there will be no more days of exceptional returns. Hmm.

Apparently all the good ideas are being picked over by the thousands of talent-less hedge fund managers that are going to blow up soon? One of those opposing propositions is wrong, and judging by the continued futures blowups by "hedge fund professionals," I'm betting that outsized returns will still be around for some traders. Which brings me to another takeaway:

4. Trading contracts is a less-than-zero-sum game. Every contract has a buyer, seller, and broker. Somebody made a tidy profit on that move. Every dollar that Amaranth "lost" should be accounted for, because they didn't lose any money, they transferred that money to other hands when they bought contracts, and they got money when they sold contracts, although they sold low and bought high. Somebody won that trade, and it wasn't Amaranth.
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He was wearing my Harvard tie. Can you believe it? My Harvard tie. Like oh, sure, HE went to Harvard.

[HenryTo]

More details on the liquidation of its energy positions. Is there a long opportunity in energy here? Probably - but again, timing is of the essence.
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Hedge Fund Sheds Assets in Energy
By JENNY ANDERSON
Amaranth Advisors, the hedge fund that lost $5 billion betting on natural gas prices, sold its book of energy trades to J. P. Morgan and the Citadel Investment Group, according to two people briefed on the negotiations.

The sale leaves Amaranth, once a well-regarded $9.25 billion fund, with $3.4 billion, down 55 percent from the beginning of the year and down 65 percent for September, according to a letter sent to investors late last night.

The energy portfolio holds what remains of Amaranth’s disastrous trades on price differences in the natural gas market. Multibillion-dollar losses on those trades caused banks to recall large loans to Amaranth, in turn forcing the fund to sell significant holdings to pay the loans to avoid default.

According to the letter sent to investors last night, the energy sale, done at a loss, along with the sale of other fund assets, will prevent creditors from liquidating the fund.

“Amaranth is determined to earn back its investors’ trust, and one step toward that end is to share as much information as we reasonably can,” the letter said.

Both J. P. Morgan and Citadel, a Chicago-based $12 billion hedge fund, have large energy trading desks and can sell parts of the energy assets or hold them, hoping for prices in certain sectors, including natural gas, to recover. Representatives for Amaranth, J. P. Morgan Chase and Citadel all declined to comment.

With the energy holdings sold, Amaranth can turn its attention to dealing with its shellshocked investors. More than half of them are funds of hedge funds that saw Amaranth as a blue-chip name, stocked with star traders and an impressive track record. Amaranth’s future will depend, in large part, on how quickly investors decide to redeem their funds.

Investor anger is directed not only at the fund’s loss of more than 50 percent of its value in just a week, but the fact that Amaranth — after having a bad month in May, with funds falling 9.5 percent to 10.5 percent in value — apparently reassured investors that it would better manage its risk in the future.

Still, the May losses alarmed some investors, even as the fund continued to show returns of more than 29 percent for the year. Nervous investors who called or turned up at Amaranth’s expansive offices in Greenwich, Conn., trying to determine if the traders were taking too much risk, got a simple message: No.

“After May there was a lot of concern and they spent a lot of time explaining and demonstrating that if the month had ended three days later, losses would be a lot less,” said one investor who spoke on the condition that he not be identified because he is trying to get his money back. “They explained why it wouldn’t happen again.”

Yet investors also knew that the fund’s stellar results were coming from aggressive energy bets. Monthly letters detailed the status of strategies including being long or short on stocks, merger arbitrage and credit products as well as convertible arbitrage and energy.

According to a letter sent to investors, 56 percent of the firm’s capital was invested in energy-related bets as of June 30, generating 78 percent of the fund’s 2006 returns. The firm had roughly 6,670 energy trading positions that were leveraged — or increased with borrowed money — about 4.5 times.

Amaranth started the year with $7.5 billion. At its peak at the end of the summer, the fund had assets of $9.2 billion. Returns through the end of August were 24 percent, despite a volatile run with its energy positions over the year. Then on Monday, investors received a brief, but disturbing, letter: the fund would be down at least 35 percent for the year, or $2.6 billion, as a result of bad bets in natural gas.

Some investors had bristled at the increasing volatility in the fund. Lehman Brothers Alternative Investment Management invested in Amaranth Partners starting in January 2002, according to a letter it sent to some of its fund of fund investors. But by fall of 2005, based on concerns about volatility, it placed redemptions for most of its money not subject to withdrawal penalties. By the beginning of this month, it had reduced its exposure to Amaranth by more than 50 percent.

The impact on Lehman Brothers Diversified Arbitrage Fund for the year “is expected to be approximately flat,” the letter said. A Lehman spokesman declined to comment.

Investors continue to worry about how much money is left in the fund and how it will be distributed. Amaranth has restrictive gates, allowing it to refuse to honor redemptions if more than 7.5 percent of the fund’s assets are redeemed. This all may be irrelevant because the general partnership or board of a fund has the right to freeze all redemptions if allowing investors access to the funds would put the entity in jeopardy.

“It’s quite possible that a general partner or board of directors could decide that adverse events had occurred, such as those that may have occurred at Amaranth, and that a fair and appropriate response would be to suspend redemption rights and effect the orderly liquidation of the portfolio,” said Stephen Culhane, a partner at the law firm of King & Spalding.

A conference call with investors is planned for later this week, said one person who had spoken with the fund.

According to the letter, Monday was the deadline for Oct. 31 quarterly redemption requests. “We are evaluating all redemption requests received to date and will report back to you when we have completed our analysis,” the letter read.

The sale of the energy holdings does take pressure off Amaranth. The energy positions, some of them severely underwater, left Amaranth in a precarious position, having to meet margin calls — loans from banks — extended to help magnify those bets.

Amaranth was forced to liquidate positions last week to meet those calls, selling everything from its positions in leveraged loans and convertible bonds to the stocks it held.

Negotiations on a sale of the energy trades lasted through Tuesday night, culminating early yesterday. Wall Street firms including Goldman Sachs and Citigroup also looked at the assets.

One relationship that might have helped negotiations is that among Amaranth’s 400 employees, its chief operating officer, Charles Winkler, was the former chief operating officer for Citadel, one of the eventual buyers. Mr. Winkler, a lawyer by training, declined to comment.

[rffrydr]

Thanks for the tip.

Everyone sees the disparity between Nat Gas and Crude and on a simple BTU comparison and historic 6 or so multiple between the two jump in. That is everyone and his dog buys Nat Gas because we're talking about energy and the "crisis" after all. It's a no-brainer. That's Amaranth's advice.

But what if the disparity was the other way round?

I continue my XLE short postition. Used the Opec bounce to buy 60-50 put spreads and look to cover at crude $48.

Last summer before Katrina etc. I recall pointing out that one of the brief sell-offs was triggered by, yes, by purely inventory concerns: there was no more place for the stuff!

This relationship to storage is much more direct in Nat Gas and is always a crucial factor in setting up for the big winter. This summer we got suprise heat and still the underground caves are full. --NG, don't forget is also a byproduct of oil wells. So much so that rigs stopped new drilling for the the stuff months ago.

Crude's not so direct, fungible, distributed storage, storage at sea, etc. etc. But with oil in the stratosphere is there any surprise that there may be a logistical snag?

Back to Peak Oil: as long as it's going to disappear inventories don't matter. And the long-term is magic in markets: it makes everyone a believer and is Wal Street's religion.

I remember clearly when it happened: peak oil had been around, broke early in Nat Geograpahic--and then the Shell inventory "surprise." In the context of a depleting North Sea, Chinese expansion and a culture of SUVs that was it. Sprinkle in Russion shenanigans, we've been living with Peak Oil ever since.

The Chevron and Co. find deep in the Gulf changed all that. We won't see this oil for a decade maybe--but in terms of Peak Oil, we're on the other side of the mountain.

Nat Gas is our energy barometer.

ps With Hedge Funds as the rest, nothing is obvious. They will continue to fail at precipitous rates if only out of self-interest. Drop 10% in your fund and you're a long, long way back to those fat fees. Close and reconstitute you're back to %20 of the first 1%. From the article above, "we'll do a better job of it in the future." Money Magic.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Of course crude's up 2bucks since I wrote this. A lot of volitility around OPeC cuts:
``They are probably having a conversation about whether to make an announcement intra-meeting, which smacks a bit of panic, or to have an informal decision to cut production and announce it at the meeting in December,'' said Craig Pennington, global leader of energy research at Schroder Investment Management Ltd. in London.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aIWMw7YMC5Eg&refer=home

Notwithstanding, read it all--there's that 50 number in there.

[rffrydr]

The Merc got its first whiff of cold air today--not to mention the prospects of Nuclear Winter: oil did squat and natgas actually down. Still oversold but if anything can get more oversold....

[diesel]

Lots of positive divergences in MACD, RSI and the stochastics indicators in the NATGAS producers now and positive price action. Looks like a good entry point for a short term trade to me. Thoughts?

[rffrydr]

Yeah, that's what it looked like at 62 crude. We're now leaving 60 behind us. XLE's sticky, in part because the magic world of Exxon accounting and other stock specific stuff... Maybe's it's real. XAU/GOLD is at a long term support two days ago bounced... and then today.

I'm taking a longer view and staying short, making in crude what I'm not in the stocks. The investments houses are going back to commodity recs.

But, as we saw last May, big moves will push the oscillators, and divergences. If there's no rally in the next few weeks there's gonna be alot year-end bonus lock-ins. If you like the idea that these stocks will still be raking it in no matter what the price I'd rather buy Alcoa. I wouldn't buy any oil co with Russian exposure that's for sure.

But I'm crazy, I'm not a Peak Oil BELIEVER.

[HenryTo]

diesel,

I had thought about that but I am still sitting tight. Spot and November futures prices close to a $2/MMBtu differential so producers are injecting as much gas as they can. Spring 2007 prices at over $7.70 which is totally ridiculous given a mid-cycle slowdown scenario with current inventories at over 400 Bcf higher than last year's at this time:

http://tonto.eia.doe.gov/oog/info/ngs/ngs.html

If we don't have a colder-than-expected winter, then Spring 2007 futures prices will continue to come down.

Henry

[rffrydr]

Here's your divergence, check out Amaranth on

www.hedgebay.com

It's "units" are still worth something: the bid is around 20cents on the dollar.

[rffrydr]

Anybody looking to short a bounce in the equity arena this is what should be hit hardest at $50 oil:

http://biz.yahoo.com/ifunds/061006/20061006_oilsands_new_etf_jb.html?.v=1
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

Thanks for the tidbit, rffrydr. Amazing that a sector that is more leveraged to oil prices and more cyclical could have a significantly higher P/E and P/B than the XLE.

By the way, I just got off a conference call with the CIO at Tremont this morning. Says that the Amaranth debacle was not new. Nothing that hasn't been totally discussed before, such as:

1) The fund got too big for the markets they had the expertise on initially. Had to branch out to other markets which they did not have good knowledge of.

2) From inception to the end of 2004, Amaranth was known for its risk management expertise - and their standard deviations numbers were the one of the lowest in the industry. In 2005, returns doubled but S.D. doubled as well.

3) Head of energy trading book left in March 2006.

4) Fund posted a 13% return in April of this year. Amaranth would definitely have gotten out of their positions if they could - but they couldn't so the returns were not real returns.

5) Fund of funds were taken by surprise since not many risk managers had expertise in the natural gas markets.

[rffrydr]

One man's trash... is a fertilizer maker's treasure--ironically on the squeeze put on global grain production for ethanol and biodiesel:

http://finance.google.com/finance?q=POT

The quote is of the exception, potash producer. Check out the comps for nat gas based producers for heady times in ag.
_________________
Today is the Tomorrow you worried about Yesterday!

[HenryTo]

I was having dinner last week with a friend from SUEZ Energy North America - and he told me an interesting story. By the time August arrived, the fact that Amaranth was holding so much concentrated, leveraged, and illiquid positions in nat gas was longer a secret. Amaranth was vulnerable, but not many folks really stuck it to them. The guy that really stuck it to them, however, was John Arnold - former "star trader" at Enron who now runs $2 to $3 billion in his own hedge fund. This is a guy who can do multi differential equations in his head and the execution was perfect. But he is also known for his lack of risk management skills (at Enron, he was up over $200 million in one year but then had a bad streak and ended down over $200 million for the year) so many traders are now betting that he will also blow up at some point - sooner rather than later.

Looks like John Arnold had a pretty good 2006 at the expense of the San Diego County, etc.

I then subsequently had lunch with another friend last Thursday whose boss is a friend of Greg Whalley, former president at Enron who now works with John Arnold. Says that the fund has employees' money, and two other investors - with the major one being George Soros. Also says that Mr. Arnold can pick up the phone anytime and Soros can wire to them $50 million within 48 hours. Must be a cool luxury to have in troubled times.

http://www.nytimes.com/2006/01/15/business/yourmoney/15traders.html?pagewanted=1&ei=5035&en=6b0d2c03cd871b41&ex=1223701200&partner=MARKETWATCH