I was chatting with my friend Brian over email this evening about the Amaranth Hedge Fund disaster. He keeps talking about something “lurking” out there; something like a LTCM perhaps. While I see his point, at this stage it doesn’t appear that there is the kind of “systemic risk” with Amaranth’s trades the way there was with the bond portfolio at LTCM. It’s still early so it’s tough to know any specifics about what went on but I think we know some things.
My initial thought was that Amaranth must have had naked long positions on the February ‘07 gas contract. It turns out, they were involved in spread trading, which means that they must have shorted a different month. Most traders consider spread trading a good risk management technique as diverging contract prices tend to correct. Evidently, natgas is a wild beast and has so much volatility that these spread trades are not hedges at all. Nonetheless, I would bet that when they entered this trade, they back tested it for 30+ years and concluded that they did have a hedge.
I’m not sure what the implications of this are… perhaps we will see an end to the positive correlation of nearly all asset classes over the past few years. Or maybe this is just a case of all this “fast money” creating extra volatility which is obfuscating the long-term trends:
- Commodity prices of all types will continue to rise as the BRIC countries continue to get richer and consume more
- The USD must fall dramatically from its current levels for many reasons, not least of which is the ghastly amount of consumer & government debt and the trade & current account deficits
- Because of all this debt, the
- We get plenty of inflation as a result of easy money policies all across the world – the government will do its best to adjust its definition of inflation so that it happens stealthily instead of overtly
- Since what we need the most is inflation, what we might get instead is deflation of asset prices. Now that would be bad!!
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