Casino Capitalism

Betting in the marketplace....

Bank of Canada Governor David Dodge also repeated a concern over a sharp reduction in the pricing of risk in financial markets, singling out the carry trade as a possible source of trouble.

The carry trade is a popular strategy that involves borrowing money in low interest rate currencies like the yen and then reinvesting in riskier emerging markets.

"One-way bets are always dangerous things," he said in response to a question about such trades.

....like betting on natural gas....

Bank of Montreal, Canada's fourth-biggest lender, said last week it will post a pretax loss of as much as C$450 million ($406 million) from trading in natural gas contracts. The bank plans to fire trader David Lee and Bob Moore, an executive managing director, over the losses, the National Post newspaper said today. The men are staying with the bank until the firm can unwind its trading positions, the paper said, citing unidentified people.

BMO said the losses are primarily from natural gas trading, while Desjardins Securities analyst Michael Goldberg expects more losses in the future.

“The commodity trading losses were the result of decisions that did not adequately recognize the vulnerability of the portfolio to changes in market volatility,” Bill Downe, President and Chief Executive Officer of BMO Financial Group, said in a statement.

Mr. Goldberg interpreted this statement as “faulty trading algorithms were based on garbage in, and they generated garbage out,” he told clients in a note.

This is the same bank that laid off staff knowing full well it was losing money based on a bad bet.

BMO More ATM's Less People

Banks Profit From Job Cuts

Fool me once....fool me twice.....ah heck fool me thrice

U.S. hedge fund faces billions in losses on natural gas bet

Monday, September 18, 2006 | 7:08 PM ET

Amaranth Advisors, a big U.S. hedge fund, has told its investors to brace for huge losses as a result of its costly bet that natural gas prices — now at a two-year low — would rise.

Some reports said the fund's losses could amount to $4 billion US.

"We anticipate our year-to-date losses might be in excess of 35 per cent as we near completion of the disposition of our natural gas exposure," the hedge fund said in a letter to investors obtained by several media organizations.

Amaranth traders apparently placed hugely leveraged bets that natural gas prices would rise.

A Hedge Fund’s Loss Rattles Nerves - New York Times

Enormous losses at one of the nation’s largest hedge funds resurrected worries yesterday that major bets by these secretive, unregulated investment partnerships could create widespread financial disruptions.

Alan Zale for The New York Times

Amaranth Advisors’ trading floor in Greenwich, Conn. The hedge fund said that it had lost more than $3 billion in the downturn in natural gas.

The hedge fund, Amaranth Advisors, based in Greenwich, Conn., made an estimated $1 billion on rising energy prices last year. Yesterday, the fund told its investors that it had lost more than $3 billion in the recent downturn in natural gas and that it was working with its lenders and selling its holdings “to protect our investors.”

Amaranth’s investors include pension funds, endowments and large financial firms like banks, insurance companies and brokerage firms. The Institutional Fund of Hedge Funds at Morgan Stanley was an investor in Amaranth; as of June 30, it had a stake valued at $124 million. The turnabout in the fortunes of the $9.25 billion fund reflects the decline in energy prices recently; natural gas prices fell 12 percent just last week.

The scale of Amaranth’s losses — and how quickly they appear to have mounted — was the talk of Wall Street yesterday, as was speculation on how much the bet was leveraged, or made on borrowed money. Still, there were no signs of ripples on the financial markets as a result.

Amaranth’s woes are largely the result of a decline in natural gas prices that began in December, well before the spring months of March or April, when they typically fall off. Amaranth’s biggest stake was a combination bet on the spread between natural gas futures prices for March 2007 and those for April 2007. Amaranth had often bet that the spread on that so-called shoulder month — when natural gas inventories stop being drawn down and begin to rise — would increase.

But instead the spread collapsed. In the last six weeks, for example, the spread between the two futures contracts ranged from $2.50 at the end of July to around 75 cents yesterday.

Traders briefed on Amaranth’s problems, including one person who examined the fund’s books yesterday, said that the losses might be considerably larger than the firm estimated. Over the weekend, according to one person briefed on the situation, Goldman Sachs examined the fund’s positions.

Amaranth is not the first hedge fund to experience problems in energy markets. MotherRock Energy Fund, a $400 million portfolio, shut down last month after losing money on its bets that natural gas prices would fall. Summer heat sent prices soaring and the fund lost 24.6 percent in June and 25.5 percent in July, according to one investor.

The natural gas market is exceptionally volatile, making it an ideal playground for hedge funds that thrive on wide price movements in securities. Natural gas prices are subject to more severe swings than oil, in part because gas cannot be stored easily.

Amaranth Advisors LLC was an American multistrategy hedge fund managing US$9 billion in assets. In September 2006, it collapsed after losing roughly US$6 billion in a single week on natural gas futures. The failure was the largest hedge fund collapse in history.

Amaranth’s energy desk was run by a Canadian trader named Brian Hunter who placed "spread trades" in the natural gas market. Hunter had made enormous profits for the company by placing bullish bets on natural gas prices in 2005, the year Hurricane Katrina had severely impacted natural gas refining and production. Hoping for a repeat performance, Amaranth wagered with an 8:1 leverage that the difference between the March and April futures price of natural gas for 2007 and 2008 would widen.

Natural Gas: Amaranth Advisors & Centaurus Energy

And although the loser in this, Brian Hunter is doing much better than the Amaranth investors. He’s still has the couple hundred million he made before he nuked Amaranth and being quite cheeky, he’s actually shopping around a new fund!

Econbrowser: Amaranth hedge fund losses

Of course, if anybody ever audited Amaranth's holdings, they would have seen what was going on immediately, and indeed NYMEX apparently inferred from the volumes that something was wrong and warned Amaranth to reduce its positions. But the way the hedge fund game is often played, foolishly credulous investors never get to see the books and base their decision simply on the fund's track record and slick sales pitch. I have to join Big Picture and Motley Fool in blaming the folks who supplied Amaranth with capital, rather than the managers themselves. Anyone who tells himself that 35% annual returns with no risk are there to be obtained by some unseen hedge-fund magic is soon to be parted from his wealth.

When you hold a significant portion of the outstanding contracts, you have the potential to move markets in a big way when you liquidate, making your swan song all the more dramatic when it comes. This is what happened to Long Term Capital Management, and it seems likely that a significant part of the September volatility in the graphs above is directly due to Amaranth.

I have often argued that as long as speculators make a profit, their actions tend to be stabilizing, as they have helped direct resources to where they are most needed. But by that metric, we got $6 billion worth of destabilization out of Amaranth last month. And when I hear a story like this, my first instinct is that there could well be a lot more of this going on. Amaranth's staggering losses leave me more open to the claim that a significant part of the general commodity price increases we have seen in recent years might be the result of actions by speculators who are destined to earn spectacular losses.

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