Seeking Alpha

Amaranth -- When Hedge Funds Forget to Hedge

by: Philip Davis
Speaking of hedge funds, on the weekend I said about oil: “...a 5% (so far) drop in September may have hedgies heading for the exits before they wipe out last year’s profits.” First hedge to cry uncle is already in, and it’s (drum roll please)... Amaranth!

On their web site Amaranth states: “Amaranth’s investment professionals deploy capital in a broad spectrum of alternative investment and trading strategies in a highly disciplined, risk-controlled manner. Our ability to effectively pursue a variety of investment strategies combined with the depth and strategic integration of our equity, credit and quantitative teams, supported by a world-class infrastructure, are some of the key strengths that distinguish and define Amaranth.”

This must be a form of highly disciplined risk control that I am unfamiliar with, as it allows a fund to lose 45% of its assets in 2 weeks. That’s 45% of $9.2B for those of you playing along at home!

This is one of the smartest funds on the planet and they got clobbered by oil’s move last week, the carnage may be indescribable as this thing continues to unwind. The CEO of Shell estimated that there is $100B of speculative plays on oil alone. When you add in gas (Amaranth’s downfall), gold and other metals, we could be looking at upwards of $500B on the wrong side of a trade!

It is easy to see the temptation; we’ve heard it ourselves from the oil bulls for 2 years now. Natural gas was $12.25 this time last year; it’s September, so gas should be $12, not $5! The problem is that this sort of logic does not take into account that, for 99 out of 100 other Septembers, natural gas was $4. The statistical aberration does not become the norm in one, two or ten years...

The premise oil and gas bulls are operating under is that for 100 years of being traded as a public company, through 2 World Wars, a Cold War and a depression, every investor, trader and analyst who ever lived undervalued Exxon by 150%. That’s right, the people buying oil stocks now think that, not only are they worth close to 2x more than at any point in history, but that here, at the high point, they remain undervalued.

Since April of 2005, Exxon has outpaced the S&P by over 100%, with half of that gain coming in the past 60 days. This is after tracking within 5% of the S&P for 100 years. How did Warren Buffet miss this one???

For the record, Mr. Buffett also seems to have missed out on the homebuilder craze as well...

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