Trader’s Narrative

Last year saw an epic battle between two giant hedge funds over the natural gas market: Amaranth Advisors and Centaurus Energy LP. The two funds went head-to-head in a winner take all battle royale. The result was a massive flow of assets from one small group of people to another. Amaranth and the trader responsible for their bullish natural gas bet, Torontonian Brian Hunter, were demolished by the bear: Texan John Arnold of Centaurus Energy.

It was great fun for me to read about the story of natural gas because it reminded me of the way things worked on Wall St. in the time of Jesse Livermore with pools pitting their wits and capital against the public and other pools. The only thing that has changed is that outright manipulation is a bit harder these days thanks to stricter regulation. Everything else is pretty much the same.

The big score propelled Centaurus (fee structure of 3/30) and Arnold to the top of fund performance ratings. Arnold’s performance since starting in 2002 is simply breathtaking. He’s finished every year 200%+!!

And although the loser in this, Brian Hunter is doing much better than the Amaranth investors. He’s still has the couple hundred million he made before he nuked Amaranth and being quite cheeky, he’s actually shopping around a new fund!

Report Card Time:
The first time I mentioned natural gas was on June 1st 2006 (leftmost green arrow on chart). I was bullish and it sort of worked out. But at best I would give this call a C+. The second time I mentioned natural gas was on September 21st 2006 (rightmost green arrow on chart):

I suspect that Amaranth’s exit from the energy arena is a tell that natural gas will find support here and retrace some of its decline.

That second call is an A+ But why did I claim it was a tell? When you’ve got a player with a very large position going against them, sooner or later they will have to liquidate - either by their own choice or their prime broker’s. And as soon as they unwind their position, that will mean putting the breaks on the trend because they will be applying liquidity the other way.

Think of it as a string with a weight on one end that is twirling in one direction. It reaches a point where its acceleration slows, then stops and then reverses. This is exactly what happened. An inflection point was reached when Amaranth couldn’t sustain their long position anymore. They wanted to get out and Centaurus wanted to ring the cash register.

Amaranth Advisor’s spectacular implosion has been all over the major newspapers, business tv and countless blogs so I won’t rehash the story of how a supposedly ‘hedged’ fund made a tragic bet on natural gas and kept doubling down. We’ve all seen this classic pattern accompany each and every historic blow-up.

But for me the most interesting aspect of Amaranth’s story is that it could very well be a tell for the Natural Gas market. If your memory stretches that far, think back to the late 90’s when TMT was all the rage and everyone and their puppy wanted to get in on that ’space’. But over in the dank and dark corner of gold stocks and dedicated bear mutual funds managers were busy closing shop.

I’ve been bullish on natural gas for a while now but it hasn’t worked out really. And in case you’re wondering, I’m still bullish. I suspect that Amaranth’s exit from the energy arena is a tell that natural gas will find support here and retrace some of its decline.

Because it’s dangerous to go against the trend I would not play this with Natural Gas futures itself. It’s way too volatile. Instead I would go for an equity proxy like natural gas stocks or Canadian energy trusts that are heavily weighted towards NG.