Tuesday, January 30, 2007

Amaranth's death throws

The following description of Amaranth's dire situation will be no surprise to readers of the Recapitulator:

The final agonies of Amaranth, described by dozens of people close to
the roller-coaster negotiations about its fate, began on Friday, Sept.
15. Bleeding cash and facing a Monday demand for money it didn't have,
Amaranth scrambled through an intense weekend to find someone who
would take over losing energy investments for a price.

See a timeline of key events in the history of hedge funds.It did
negotiate a rescue plan, requiring it to pay nearly $2 billion to
Goldman Sachs Group to take toxic trades off its hands. Strapped for
cash, Amaranth aimed to get the money to do the deal by using cash
collateral on deposit with its middleman for natural-gas trades, J.P.
Morgan Chase & Co.

But on Monday morning, just after Amaranth had told its investors a
rescue was close, J.P. Morgan said it wouldn't release the collateral.
The firm was effectively responsible for making sure parties to
Amaranth's trades got paid, and it said the rescue plan didn't free it
of this risk, according to people familiar with its stance. J.P.
Morgan's refusal killed the plan. Amaranth's situation went from dire
to desperate.

Two days later, J.P. Morgan itself agreed to take over most Amaranth
energy positions. With a partner, it cut a deal that turned out to be
lucrative for J.P. Morgan -- earning it an estimated $725 million --
but more painful for its longtime client, Amaranth.

Ruthlessly squeezing a client, and taking the positions over at the most opportune time. The Recapitulator respects the negotiation and business skill involved here, but also marvels at how far away the clients of Amaranth were from this whole process. Where did those wonderful profits come from??

Sunday, January 28, 2007

Funds of Funds

The online version of the Wall Street Journal has written about Fund of Funds and their business model (being more of an asset gatherer as opposed to competent risk managers.)

The Recapitulator, not working in that industry, does not know the relative merits of this argument, but he can opine on the, to quote Mr. Gross of PIMCO, "Alpha Beta anemia problem".

A friend of mine outlined a good list for determining whether or not to invest something. I somewhat disagree with using the Sharpe ratio, with all of its weaknesses (for instance, one still has the problem of determining the appropriate "benchmark", and hopefully now my readers will indentify my disdain for "Beta" used as a proxy for "Risk")

In any case, here are the points he made:

"1. Did the study actually make money on an absolute basis? Why invest
in something which lost money but did relatively better than the market?

2. Did the study outperform the market on a risk adjusted basis? This is
equivalent to asking whether the Sharpe ratio of the study was better
than the market. If it did not this means that someone could have bought
the market portfolio with appropriate leverage or deleverage and either:
a) Outperformed your study with equal risk (despite the leverage)
b) Matched the return of the study but with less risk

3. If the study involves selecting either good days or good stocks out
of a given sample did the study outperform the overall average of the
sample? In other words if the sample has a built in bias did the study
outperform that bias?

4. The study should be statistically significant by all of the foregoing

This is an excellent way to begin wether or not one should invest in Fund of Funds products. If diversity is a goal, one should be very careful how one describes the "market" to compute ex-ante or ex-post risk adjusted returns. Fund of Funds allows access to many different types of assets, and taking advantage of (historical) negative correlation has beneficial effects on a portfolio.

In other words, it is as it has always been. Caveat emptor. One must know what one is buying, and therefore an investor with Fund of Funds should have independent personell assess the relative expertise of the Fund of Funds shop.

Thursday, January 18, 2007


The recent decline in oil appears to be a change of regime for the Saudis. Previously, they have pegged the price and let quantity float.

Now, geopolitical events (and their desire to gain market share amongst increasing supply at higher price levels) have given them an opportunity to be the primary provider to the west.

The Recapitulator thinks it is no coincidence that major policy changes are afoot in Iraq given the precipitous decline in oil.

Peak oil theory was always silly. $150.00 oil? $200.00 oil? Given the amounts of oil (and oil equivalent from coal and other resources) that come on line with each point of increase in the price, this theory was always a marketing ploy driven by those who were long oil. Where are those people now? For those who followed the marketing ploy, it is yet another example of the psychological bias of investors to over-weight confirming theories that are congruent with their investment positions.

Thursday, January 11, 2007

All is quiet on the Western Front...

The novel by Erich Maria Remarque serves as a good title for today's column...this is a fairly mystical post today.

Risk spreads continue to compress. The dollar demonstrates its wonderful reslience in the face of a surprise interest rate rise by the Bank of England (which heretofore has been extremely transparent...inflation targeting means no surprises, right?). The Recapitulator is bullish on the dollar...and the recent announcement that China will purchase U.S. financial assets comes as no surprise on this view.

The Recapitulator is not a permabull, permabear or any subspecies therein. There is a time for all seasons (there, I have now exhausted my quota of silly analogies to describe an economic system).

We have already stated volatility will spike...we have seen some of that happen already, but the probabilities are clustering around February.

Venezuela, Russia, Somalia, Iraq, etc. All problems, and the relative calm on the political front, a situation that will not continue.

Monday, January 01, 2007

Silly article of the month


"The foremost reason is that when nations choose to eliminate their smaller coinage or degrade the metal content in their coins, it is commonly a tell-tale sign of the currency’s devaluation. To discontinue production or shift metal content would be a blatant admission of the loss of purchasing power of the dollar, and it is beneficial to hide this so as not to damage the dollar’s reputation, even if it means losing millions in minting costs.

Currently, the dollar’s position as the world’s reserve currency is very precarious. Several central banks around the world, including Russia’s, Sweden’s and Qatar’s, have announced they are reducing dollar holdings. Most recently, even China has indicated that it will reduce its dollar holdings.

The fact that pennies and nickels are now worth more for their metal content than their 1-cent and 5-cent face value is undisputable proof of how much value the dollar has lost since its founding. This is not good news for the U.S. dollar, whose reserve currency status is largely built upon confidence that it will remain a stable store of wealth."

These statements completely misunderstand the modern fiat currency system our government employs. The ReCapitulator despises laws made for these purposes, but the conclusions regarding the stated weakness of the dollar resulting from a (historically ephemeral) rise in commodity prices are not valid. Specie money backed by commodity is degreaded when the commodity in question (gold, silver, whatever) is degraded...but the dollar is not pegged to any commodity or metal. Stating that the difference between the commodity price levels (which are priced in dollars) and the face value of coinage is certainly not "undisputable proof" of the dollars weakness "since its founding". This is more of a commodity arbitrage type of argument as opposed to an argument supporting prospective dollar weakness, and the ReCapitulator reminds his readers to be extremely skeptical of commentary predicting dollar weakness based on same.