Amaranth Debacle - Commodity Market Implication

By Neil Behrmann

November, 2006:- Unlike the Long Term Capital Management saga, the Amaranth debacle has had limited impact on global markets.  The inevitable result, however, is likely to be tighter regulator and central bank surveillance on hedge and managed futures funds.

So far Amaranth's contagion has been limited to commodity markets.  As Amaranth liquidated its positions in September, natural gas futures tumbled by 35 per cent. The announcement of the Amaranth loss was inevitably followed by hedge, managed futures fund and trader sales of other commodities. Crude oil tumbled by 18% in September and gold by 10%.  When Amaranth's losses were made public their declines and those of commodities such as copper accelerated.

Since then there has been a limited revival. The main concern of participants about the natural gas debacle is that commodity markets are relatively illiquid compared with foreign exchange and bond markets. It is fairly easy to enter when prices are going up, but when they start declining it is difficult to get out.

The head of a specialist mining finance company contends that some $200 billion so called "investment" money floats in and out of metals and this shouldn't concern the market.  Others fear---, especially in regard to copper, which has fallen to 313 cents a pound from its May peak of 399 cents--- that a small number of hedge funds are holding huge quantities of the metal.  Current prices are still more than five times the 62 cent a pound levels seen in 2001 and are way ahead of the cost of production. 
If there is a slowdown in the US economy producers will find it difficult to place copper and the large speculators will struggle to sell.  

Fund of funds and pension funds are thus likely to be wary of volatile hedge and managed futures funds that specialise in commodities.  Such caution could reduce the flow of investment funds into these markets, leading to a further downturn. Pension funds may also reject the present fashion and become wary of investing directly in commodities.

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