Amaranth’s Effect On The Markets
By Dr. Richard S. Appel
September 29, 2006 – The natural gas market has provided a roller coaster ride of profits and losses for those investing or speculating in it. It began 2005 below $6.00 an mcf (1,000 cubic feet). By December, the combination of an increasingly tight inventory, a rising oil market, and the devastation produced by hurricane Katrina made it soar and set a $15.75 all-time price record.
Natural gas conceived its Bull Market in September 2001, when it arose from its $1.76 base. It is an emotional market. This can be attested to by its February 2003 temporary spike above $10.00 an mcf with its following collapse to under $4.50 several months later. Similarly, in the weeks leading up to hurricane Katrina’s unleashing her fury, it was trading in the $8.00 range. This all changed when Katrina’s winds began to build and she approached the Gulf of Mexico’s prolific oil and gas fields, and the numerous onshore storage and processing facilities that she was destined to damage or destroy.
The spot price for natural gas approached $4.00 an mcf earlier this week. By so doing it broke below its $4.39 and $4.52 lows it posted in September 2003 and September 2004 respectively. How could gas trade at nearly $16.00 an mcf as recently as nine months ago, and then fall 75% in price? I believe that the surfacing of the Amaranth hedge fund collapse sheds some light on this issue.
Amaranth had earlier success in the natural gas market. They correctly anticipated its direction and accordingly positioned themselves in a bullish fashion. To their detriment, when the market reversed course they continued to maintain their existing posture and, I’ve read, they even increased their exposure. Finally, after suffering substantial losses, they attempted to sell their enormous hedged long positions in order to survive.
To their misfortune the apparent size of their position was known by various large traders who “smelled blood in the water”. They watched while Amaranth worked in vain to exit their positions, and they likely increased their shorts which drove the market still lower. Amaranth’s plight was further exacerbated due to their need to meet forced margin calls. These latter developments increased the downward pressure on the gas market and caused Amaranth’s losses to swell. I believe that the depth to which natural gas plunged was a direct result of the unfolding of these events.
Finally, the banks and financial institutions that financed Amaranth called their loans. This forced Amaranth to sell their energy book. Interestingly, it was reportedly purchased by J.P. Morgan Chase and the Citadel Investment Group. I suspect that they were two of if not the largest shorts in the market.
With the signing of the agreement and transfer of their positions to Morgan and Citadel, Amaranth took a reported loss approaching $6 billion. Simultaneously, J.P. Morgan and Citadel were gracefully allowed to offset their enormous short positions and bank untold profits. In effect, Morgan Chase and the Citadel Group were likely let off the hook of having to repurchase their huge short positions! Further, they likely did it at a steep discount to the market. If Amaranth had not been forced into liquidating their contracts, the buying by J.P. Morgan and Citadel to close out their futures contracts would otherwise have forced the market significantly higher.
In my opinion, Citadel and J.P. Morgan Chase played the game brilliantly. They garnered huge profits while Amaranth’s investors suffered incredible losses. What is interesting is that natural gas continued to substantially decline after the reported September 20 sale of Amaranth’s holdings.
The saga is not yet over. It remains to be seen if another distressed hedge fund or entity will surface and take the natural gas market further lower. In fact, that might be the impetus behind its continuing decline.
I believe that natural gas is in a major, secular Bull Market. As early as June 2003, when it was trading at $6.31, none other than the venerable Alan Greenspan stated, “Today's tight natural gas markets have been a long time in coming, and futures prices suggest that we are not apt to return to earlier periods of relative abundance and low prices anytime soon”.
I heartedly agree. Despite its temporary oversupply, if anything the U.S. supply vs. demand equation for the commodity has become more bullish since Greenspan uttered this quote. Further, I see no indication that significant additional supplies will be available in the next few years at a minimum.
In my opinion, when this price decline ends it will set the stage for what will likely be an incredible entry point. Additionally, I believe that natural gas and the companies that produce or explore for it are already enormously oversold and are preparing to resume their Bull Markets.
I feel that the natural gas price grossly overshot its downside target when it entered this correction. This was to a large degree the result of Amaranth’s misjudgement of the direction of the market, and the “sharks” that astutely recognized Amaranth’s plight and capitalized on it. Remember, J.P. Morgan and Citadel were sufficiently happy to book their profits when it was trading in the $5.00 range
Of great importance to myself and other investors is my belief that the gas complex shares should perform far better in their next upleg. When natural gas soared on three earlier occasions in its Bull Market, the gas shares did not perform as one would expect. True, many of them multiplied in price. However, to my thinking, gas stock investors were unwilling to use in their decision making, any price near the $10 or $16 peak prices that the hydrocarbon posted. I doubt if more than a few people valued these companies using more than about a $6 mcf price.
This is understandable because investors and other interested parties did not believe that those prices had staying power. They had been through too many wide swings in its price, and didn’t want to overpay and expose themselves to serious losses as they had done in the past.
If I am correct, this mind-set will be softened when natural gas resumes its Bull Market. If it can surpass and remain above the $10 or so level for a number of months, I believe that more and more investors will begin to realize that it is truly in a secular Bull Market. In this event, they will begin to attribute substantially higher gas prices when they evaluate a company’s worth.
I sense that many natural gas stocks have posted or are approaching their lows, and that their risk vs. reward levels are now exceptional. It may require a time before gas stabilizes and resumes its Bull Market. Few markets can sustain this sharp a free-fall and immediately reverse course and move sharply higher. Yet, given the fact that the likes of J.P. Morgan Chase was satisfied to cover when it was at higher levels, natural gas is likely either at its nadir or within shooting distance of it. In any event, given the beating that the gas exploration and producing companies have suffered, and the likelihood that gas prices will be far higher in the foreseeable future, I view staged entry into their shares an excellent opportunity.
I publish Financial Insights. It is a monthly newsletter in which I discuss gold, the financial markets, as well as various junior resource stocks that I believe offer great price appreciation potential.
Please visit my website www.financialinsights.org where you will be able to view previous issues of Financial Insights, as well as the companies that I am presently following. You will also be able to learn about me and about a special subscription offer.
By Dr. Richard S. Appel
I expect to have positions in many of the stocks that I discuss in these letters, and I will always disclose them to you. In essence, I will be putting my money where my mouth is! However, if this troubles you please avoid those that I own! I will attempt wherever possible, to offer stocks that I believe will allow my subscribers to participate without unduly affecting the stock price. It is my desire for my subscribers to purchase their stock as cheaply as possible. I would also suggest to beginning purchasers of these stocks, the following: always place limit orders when making purchases. If you don't, you run the risk of paying too much because you may inadvertently and unnecessarily raise the price. It may take a little patience, but in the long run you will save yourself a significant sum of money. In order to have a chance for success in this market, you must spread your risk among several companies. To that end, you should divide your available risk money into equal increments. These are all speculations! Never invest any money in these stocks that you could not afford to lose all of.
Please call the companies regularly. They are controlling your investments.
FINANCIAL INSIGHTS is written and published by Dr. Richard Appel and is made available for informational purposes only. Dr. Appel pledges to disclose if he directly or indirectly has a position in any of the securities mentioned. He will make every effort to obtain information from sources believed to be reliable and to present correct ideas and beliefs to the reader, but the accuracy and completeness of his work cannot be guaranteed. Dr. Appel encourages your letters and emails, but cannot respond personally. Be assured that all letters will be read and considered for response in future letters. It is in your best interest to contact any company in which you consider investing, regarding their financial statements and corporate information. Further, you should thoroughly research and consult with a professional investment advisor before making any equity investments. Use of any information contained herein is at the risk of the reader without responsibility on our part. Past performance does not guarantee future results. Dr. Appel does not purport to offer personalized investment advice and is not a registered investment advisor. The information herein may contain forward-looking information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, the statements contained herein that look forward in time, which include everything other than historical information, involve risks and uncertainties that may affect the company’s actual results of operations. © 2006 by Dr. Richard S. Appel. All rights are reserved. Parts of the above may be reproduced in context for inclusion in other publications if the publisher's name and address are also included for credit.
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