The purpose of this
paper is to illuminate the real purpose of the obscene size of derivatives
books amongst the world’s largest financial institutions. Derivatives in strategic markets are
controlled by governments through proxy banks and agencies using these
instruments. By sheer volume, the
trading in paper “tails” wag the
physical “dogs”.
When market volatility negatively impacts these large institutions
they are given a pass by regulators and accounting protocols in the interest
of national security and preservation of the status quo. Moreover, this ensures the
perpetuation of U.S. Dollar hegemonic power. The following accounts outline how
these instruments are used to project this power.
Amaranth
Advisors LLC went bankrupt in Oct. 2006.
By mid 2007 the Committee of
Homeland Security and Government Affairs released a document containing a
detailed investigation of the Amaranth scandal entitled “Excessive Speculation
in the Natural Gas Markets.”
Amaranth, hedge fund, was launched in 2000 as a multi-strategy hedge
fund, but had by 2005-2006 generated over 80% of their profits from energy
trading.
Market circumstances surrounding Amaranth indicated
that they were predominantly long natural gas. This is not surprising since
“very easy money policies” by the Federal Reserve, a hot housing
market along with rapidly industrializing Asian economies had created
steadily increasing demand – and a bullish environment - for
commodities in general and energy inputs in particular.
Juxtaposed against this inflationary backdrop, the
U.S. Federal Reserve, the Bureau of Labor Statistics, and the U.S. Treasury
ALL consistently fudged [lied about] economic data, always overstating
economic growth and employment data and perpetually understating the effects
of inflation. This has been well
documented by John Williams of www.shadowstats.com.
Amaranth became a high profile entity employing
leverage to push prices of a high profile strategic commodity like natural
gas higher. This put Amaranth at
odds with the 2 % inflation “kool-aide”
illusion that the Fed and U.S. regulators were [and still are] trying to
falsely sell the American people.
In 2008, Ludwig Chincarini CFA, Ph.D, penned a paper
chronicling Amaranth’s collapse titled, Lessons from the Collapse of
Amaranth Advisors L.L.C. linked here. The report gave details regarding
Amaranth’s management style and risk management practices as well as
chronologically detailing the last days of the hedge fund.
Through the research provided to us by Ludwig Chincarini
CFA,
Ph.D., we get an
accurate picture of Amaranth’s methodology for managing risk as
follows:
“The Chief Risk Officer of Amaranth had a goal
of building a robust risk management system. Amaranth was unusual in terms of
risk management in that it had a risk manager for each trading book that
would sit with the risk takers on the trading desk. This was believed to be
more effective at understanding and managing risk. Most of these risk
officers had advanced degrees. The risk group produced daily position and
profit and loss (P&L) information, greek sensitivites (i.e. delta, gamma, vega,
and rho), leverage reports, concentrations, premium at risk, and industry
exposures. The daily risk report also contained the following:
1. Daily value-at-risk (VaR)
and Stress reports. The VaR contained various
confidence levels, including one standard deviation (SD) at 68% and 4 SD at
99.99% over a 20 day period. The stress reports included scenarios of
increasing credit spreads by 50%, contracting volatility by 30% over one
month and 15% for three months, 7% for six months, and 3% for twelve months,
interest rate changes of 1.1 times the current yield curve. Each strategy was
stressed separately, although they intended to build a more general stress
test that would consolidate all positions.
2. All long and short positions were broken down. In
particular, the risk report listed the top 5 and top 10 long and short
positions.
3. A liquidity report that contained positions and
their respective volumes for each strategy was used to constrain the size of
each strategy. The risk managers also calculated expected losses for the
individual positions. The firm had no formal stop-losses or concentration
limits. Amaranth took several steps to ensure adequate liquidity for their
positions. These steps are listed on the more detailed version of this
section on the FMA website.”
In fact, the risk aversion procedures taken by
Amaranth don’t really seem much different than the mandated risk
management procedures practiced by J.P. Morgan, B of A, Citibank, Goldman
Sachs and Morgan Stanley – ALL with derivatives books measuring from
42.1 to 78.6 Trillion at Dec. 31/10.
Here’s how the U.S. Office of the Comptroller of the Currency
[OCC] states these behemoths manage their risk [pg. 8]:
“Banks
control market risk in trading operations primarily by establishing limits
against potential losses. Value at Risk (VaR) is a
statistical measure that banks use to quantify the maximum
expected loss, over a specified horizon and at a certain confidence level, in
normal markets. It is important to emphasize that VaR
is not the maximum potential loss;
it provides a loss estimate at a specified confidence level. A VaR of $50 million at 99% confidence measured over one
trading day, for example, indicates that a trading loss of greater than $50
million in the next day on that portfolio should occur only once in every 100
trading days under normal market conditions. Since VaR
does not measure the maximum
potential loss, banks stress test trading portfolios to assess the potential
for loss beyond the VaR measure. Banks and
supervisors have been working to expand the use of stress analyses to
complement the VaR risk measurement process that is
typically used when assessing a bank’s exposure to market
risk……..[more]”
And here is what OCC reports as VaR
for these selected banks
[pg. 9]:
The tables above show that J.P. Morgue had a 78.6
Trillion Dollar derivatives book [446
dollars in bets for every one dollar in equity] and estimates that the most
they could expect to lose in any given day is $ 71 million. [Note:
Amaranth, with an approximate 20 Billion Dollar Derivatives book – lost
an average of $ 420 million for 14 days straight for total losses of
approximately 6 billion at the beginning of Sept. 06].
As a housekeeping note: Years ago, circa 1998, J.P.
Morgue’s management deemed their proprietary measure of assessing risk
[VaR] so “brilliant” they “spun it off” in a separate company called RiskMetrics.
“JP Morgan [had] developed a methodology for
calculating VaR for simple portfolios (i.e.
portfolios that do not include any significant options components) called RiskMetrics. The success of RiskMetrics
has been so great that Morgan has spun off the RiskMetrics
group as a separate company.
RiskMetrics forecasts the volatility
of financial instruments and their various correlations. It is this
calculation that enables us to calculate the VaR in
a simple fashion. Volatility comes into play because if the underlying
markets are volatile, investments of a given size are more likely to lose
money than they would if markets were less volatile.”
RiskMetrics was
successfully marketed to some of the most astute, successful risk managers in
ALL THE LAND such as:
Bear Stearns
Bear Stearns Global Clearing Services and RiskMetrics Group to Offer Risk Management, Portfolio
Analysis and Investment Planning Solution to Independent Investment Advisors.
Publication
Date: 25-JAN-06
Article
Excerpt
NEW YORK -- Bear, Stearns Securities Corp. and RiskMetrics
Group announced today they have entered into an agreement to offer RiskMetrics Group's
WealthBench(TM) technology platform to independent
investment advisors and family offices via the Bear Stearns WealthSET(SM) wealth management solution. Investment
advisor clients of Global Clearing Services are now able to access WealthSET's
institutional quality risk analytics, investment planning, asset
allocation and proposal generation capabilities.
And
Lehman Bros.
Lehman's
prime brokerage to offer clients RiskMetrics tools
online
Published online only
Author: Gallagher Polyn
Source: Risk magazine | 13 Dec 2002
Lehman Brothers'
global prime brokerage unit will offer RiskMetrics'
RiskManager tool to hedge funds, fund of funds and investors
via its website, LehmanLive. The RiskManager service features value-at-risk, stress
testing and 'what-if'
scenario generation.
Observations
- most of the huge derivatives players take a
similar standardized approach to evaluating and assessing risk
- Despite relative uniformity in risk management
models among derivatives risk managers we see a disproportionate number
of smaller, relatively better capitalized players fail while larger
relatively under-capitalized bemoths continue
to make windfall gains and flourish.
- There appears to be a double standard being
practiced by the CFTC regarding position limits between the largest
derivatives players [like J.P. Morgue] and smaller ones [like
Amaranth]. Issues of
concentration [commodities laws] are enforced on smaller players and
ignored on the preferred players.
This preferential treatment extends to this day as the CFTC
continues to “look the other way” while J.P. Morgan and HSBC
increasingly dominate the short open interest in COMEX silver –
even as reported shortages of physical metal continue to crop up at
national mints around the world.
Perhaps some of you might be wondering how J.P. Morgue
et al really do it? How they can take such HUGE, LEVERAGED
risk and seemingly NEVER lose?
Well, here’s a clue:
back in early 2006, Business Week reported,
President George W. Bush
has bestowed on his intelligence czar, John Negroponte, broad authority, in
the name of national security, to excuse publicly traded companies from their
usual accounting and securities-disclosure obligations. Notice of the
development came in a brief entry in the Federal Register, dated May 5, 2006,
What that means folks,
is: “if J.P. Morgan is deemed
to be acting in the name of National Security or the National Interest
– THEY [and presumably others] CAN “LEGALLY” BE EXCUSED
FROM ACCOUNTING.
The reality is that derivatives
trading is risky. Major
players in the derivatives trade ALL, more or less, use the same risk
management practices. The key
difference[s] between J.P. Morgan et al and interlopers - hedge funds - who
come-and-go is that the banks who act for the Federal Reserve have the
backing of the Great Guttenberg and they are not subject to regulatory
oversight or accounting.
These key banks have created ridiculously larger and
disproportionate derivatives edifices in key strategic areas of interest
rates [bonds], energy and precious metals where the sheer volume of paper
trade overwhelms and assigns false pricing to the underlying physical trade
– ie. the tail wags
the dog. Control of the pricing
in these strategic instruments works hand-in-hand with global U.S. hegemonic
strategy of dollar price settlements in key strategic commodities and the
perpetuation of supremacy of the Dollar as the world’s reserve
currency.
It’s in this context that we begin our
examination of the Amaranth kill shot.
Review of the
Amaranth Kill Shot Sequence
The black text
below in “quotes” was excerpted from Ludwig Chincarini
CFA,
Ph.D, Lessons from the
Collapse of Amaranth Advisors L.L.C. linked here [pg. 17].
The chart below chronicles
the milestones – beginning with the entrance of J.P. Morgue into the
Nat. Gas futures trading arena at the turn of 1995/96. It should be noted that the Nat. Gas
price movement that led to Amaranth’s demise has been described by some
very qualified professionals as being a 5 or possibly even as high as a 9
standard deviation event where the fund lost an average
of $420 million per day for the first 14 trading days of September, totaling
a final loss of around $6 billion.
According to Dr. Jim
Willie PhD. [Statistics] a 5 standard deviation event has a one in 1.74
million chances of happening.
Willie told me 9 standard deviation events do not happen in nature.
This appended passage is a
play-by-play of Amaranth’s final days where virtually all of their
equity was vaporized in a matter of 14 days. Chincarini
documents how the CFTC took issues of concentration on the NYMEX seriously,
when it suited them to do so, as it pertained to Nat. Gas and Amaranth. Rob Kirby comments in blue:
Excerpt begins:
“Of particular note was an August 8, 2006
complaint by NYMEX officials that Amaranth’s position in the September
2006 contract (near-month contract) was too high at 44% of the open interest
on NYMEX. … Amaranth reduced this short position by the day’s
close by 5,379 contracts (see the change in NYMEX contracts from the close of
August 7 to the close of August 8), but they also increased their similar
exposure short position on ICE by 7,778 contracts.
Thus, ironically, the request by NYMEX to reduce
Amaranth’s positions led Amaranth to actually increase their overall
September 2006 position. At the same time, they also increased their exposure
to the October 2006 contract; a contract that is a close substitute to the
September 2006 contract. In particular, they had increased their October 2006
position in NYMEX natural gas futures by 7,655 contracts and their equivalent
position on ICE October 2006 contracts by 4,984.”
[Rob Kirby
note: to say that the October 2006 contract was a Close substitute for
the September 2006 contract is VERY misleading BECAUSE September was still
the lead “spot” month – and Amaranth was being FORCED to roll out of their spot position
– exposing a “weak hand” [like an open wound / blood in
water attracts sharks]. If,
instead, the “short” – undoubtedly J.P. Morgue - had been
told to cover – the price would have EXPLODED UPWARD. Additionally,
and more telling, the fact that Amaranth was using ICE Nat. Gas contracts as
substitutes for NYMEX contracts illustrates that there *used-to-be* a high degree of correlation between Nat. Gas traded
in Europe and Nat. Gas traded in North America – more on this later].
“On August 9, 2006 the NYMEX called Amaranth
with continued concern about the September 2006 contract and warned that
October 2006 was large as well and they should not simply reduce the
September exposure by shifting contracts to the October contract. In fact, by
the close of business that day, Amaranth increased their October 2006
position by 17,560 contacts and their ICE positions by 105.75. For September
2006, Amaranth did follow NYMEX instructions by reducing NYMEX natural gas
positions by a further 24,310, but increased September ICE positions by
4,155.”
[Rob Kirby
note: winning or losing when
institutional trading often comes down to “who blinks
first”. The CFTC decided
that Amaranth would blink first.
At this point, Amaranth’s fate was sealed – and J.P.
Morgue undoubtedly knew it. A
noble assist in the Amaranth Kill Shot sequence has to go another Fed /
Treasury lackey institution – Goldman Sachs – who re weighted
their vaunted Goldman Sachs Commodity Index (GSCI) which, at the time, had
roughly 100 billion in institutional money following it.]
“On August 10, 2006 another call from NYMEX
urged Amaranth to reduce the October 2006 position since it represented
63.47% of the NYMEX open interest. In response to this call, Amaranth reduced
the October 2006 position by 9,216 contracts, but increased their similar
October 2006 ICE position by 18,804 contracts.
By the end of this three-day session of calls from
the NYMEX warning Amaranth of its position size in September and October
contracts, Amaranth had actually increased their overall positions from
August 7, 2007 to August 11, 2006 in those two contracts by 16,484 (a
decrease in September 2006 positions by 23,143 and an increase in October
positions by 39,627).”
[Rob Kirby
note: commentators made much
of Amaranth’s elevated risk [VaR] measures
and leverage employed – 5.23 times. One should remember that the
“other side” of Amaranth’s trades was principally J.P. Morgue.
Morgue is the biggest hedge fund on the planet – with market cap of
roughly 176 billion and a derivatives book of [at Sept. 30/06] 63.477
Trillion for leverage of 361 times.
Incredibly, extreme, dizzying leverage NEVER seems to cause P & L
problems for ole J.P. Morgue’s derivatives book which at one time
topped 90 Trillion - EVER. In
fact, at Dec. 31/10, Morgue’s derivatives book was 78.656 Trillion with
market cap of 176 billion for leverage today of 446 times]. In fact, Chincarini himself conjectured [on pg. 19],
“The reconstruction of the VaR
of Amaranth’s positions on August 31, 2006 was high, but cannot
entirely explain Amaranth’s losses in September 2006 unless one
designates the Amaranth collapse as a 5 standard deviation event.”
Others, like Hilary Till of Premia
Capital Management characterized the price move that buried Amaranth as a 9 standard
deviation move:
“Hilary Till of Premia Capital Management released a damage control piece
assessing aspects of the Amaranth case. She
assured us that the market move associated with Amaranth’s loss was a
nine standard deviation event. If you don’t know what that
means, it is statisticians’ speak for “it won’t happen
again.”
[end] -
Interesting, in Dr. Jim Willie’s words,
“a 9 standard deviation never did happen, at least not
naturally.”
Ladies and gentlemen, Amaranth Advisors LLC was surgically
removed from the financial landscape by the Fed / J. P. Morgue in a
“joint kinetic movement”.
Amaranth Versus Long Term Capital
Management [LTCM]
For those who forget, LTCM was a hedge fund founded
by bond guru John Meriwether which suffered a spectacular collapse in 1998
and was subsequently bailed out by consortium of banks at the behest of the
U.S. Treasury and Federal Reserve.
Fed and Treasury officials argued at the time that the bailout was
necessary because the collapse of LTCM posed systemic implications for the
global financial system.
Here’s why:
Much
has been written on the Bank of Italy, LTCM and gold – like this
excerpt from Embry / Hepburn back in 2004 at pg. 29:
….in September 1999, TheStreet.com quoted Nesbitt Burns gold analyst Jeff Stanley as
saying on a conference call: "We've
learned Long Term Capital
Management is short 400
tons."74
In addition, Frank Veneroso
stated:
“I have received many testimonies that LTCM
had extensively used gold borrowings to fund its leveraged positions, and
believe it likely that the Fed removed these shorts from LTCM's
books in the course of the bailout of LTCM.”75
Reg Howe also spoke of the apparent LTCM gold short
position:
“Recent confidential information from a highly
reliable source confirms rumors that at the time of its collapse, LTCM was
short a substantial amount of gold (300 to 400 tonnes
is the range most often mentioned), and that this position was covered in
some type of arranged off-market transaction.”76
Crucial to the allegations of gold price
manipulation is a statement Veneroso made in 2002:
We conclude from our argument based on the
development of an inadvertent corner in the gold markets, from a
“prison of the shorts”, that, since the Long Term Capital
Management crisis in late 1998, the official sector has been managing the
price of gold.77
The “prison of the shorts” cited by the
renowned gold analyst is the situation that developed due to the large
speculative gold short positions.
When
sovereign gold is lent / leased – it is generally sold into the market
to raise cash balances.
The
Italians were lending / leasing their sovereign gold and investing the
proceeds with LTCM. Italy was no doubt attempting to reverse their sagging
fortunes with their substantial sovereign gold holdings due to the reality that their gold holdings were ONLY
losing value over that time frame:
The declining gold price
was effectively “screwing Italy’s chances” of QUALIFYING
FOR THE EURO – by negatively impacting the value of their reserves.
This would have made the
Italians HIGHLY CAPTIVE and AGREEABLE – given their predicament - to
any proposal to help reverse or alleviate that REALITY.
Thinking that LTCM was infallible
– owing to them having a couple of Nobel laureates on staff and also
being predisposed to playing fast-and-easy with their gold accounts –
Italy still wasn’t done. Next up was a gold loan / lease –
arranged by your friendly neighborhood bullion banker [like Goldman
Sachs]. The proceeds were
invested in LTCM in the belief they would earn the ‘magical
gains’ that LTCM had been delivering to their investors.
Embry / Hepburn tell us that Long Term Capital
Management denied they ever traded gold. In a letter sent to attorneys for
the Gold Anti-Trust Action Committee, LTCM’s attorney James G. Rickards maintained [pg. 29]:
“None
of LTCM, LTCP, nor their affiliates, has ever entered into any transaction
involving the purchase or sale of gold, including without limitation, spot,
forwards, options, futures, loans, borrowings, repurchases, coin or bullion,
long or short, physical or derivative or in any other form whatsoever.”73
While Jim Rickards may be “technically correct” that
LTCM was not directly involved in trading gold or in gold price rigging
– they would UNQUESTIONABLY have had direct knowledge of the genesis of
the sovereign Italian funds that were invested with LTCM – because Rickards’ own bio states that he principally
organized the bailout.
When LTCM failed, they had to be bailed out because
a public bankruptcy would have:
A]
exposed the Italian manipulation of their sovereign gold [which did aid and
abet in a wider – globally coordinated - gold price suppression]
and
B] that Italy was playing “financial accounting
tricks” to qualify for the Euro, i.e. the Euro
might have been still-borne.
When the “gang” of investors met at the
Fed’s offices in NY to discuss the bailout of LTCM – it’s
been well reported that Greenspan and then Tres.
Secretary Rubin laid it on the table that all LTCM investors were going to
have to help bail LTCM out.
Bear Stearns realized that unsustainable
“short” monkey business was involved where Gold was concerned and
basically said – NOT A CHANCE WE PAY A
NICKEL!!! Further details
of the LTCM / Bk. of Italy / Gold connection are laid out in a subscriber
only paper titled, Fine Italian Dining, archived at kribyanalytics.com.
Amaranth had no golden skeleton buried in any of its
closets – therefore a public bankruptcy / dismemberment – mostly
for the benefit of J.P. Morgue, who effectively got to close out their short
nat. gas positions for pennies on the dollar by ‘absorbing’ Amaranth’s
longs – was not only desirable, but preferred because it sent a clear
message to any and all other hedge funds who might have harbored thoughts of
becoming large players in such a strategic space.
You see folks, when you are printing money like a
banshee and telling the world that inflation is running at 2 % - you
don’t want interlopers with deep pockets – like Amaranth –
bidding the price of strategic commodities like natural gas – UP.
Rob Kirby
KirbyAnalytics.com
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