John Arnold Closing Centaurus Energy Master Fund As Central Planning Slowly Kills Off Commodity Trading
More troubles for the nat gas world, as flashing red headlines confirm the inexorable trend which started years ago with the departure of more and more hedge fund titans who no longer have an advantage in a world where only liquidity matters.
- NATURAL GAS HEDGE FUND MANAGER JOHN ARNOLD TELLS INVESTORS HE IS CLOSING CENTAURUS ENERGY MASTER FUND - RTRS
Why is this not a surprise? Simple. As the FT reported earlier, take virtually everything you know about the nuances, the complexities, the intricacies of commodity trading... and shove it. But don't forget to thank the Chairman first, because the last bastion of "veteran advantage" in what used to be a rational trading arena, is now gone.
Once upon a time...
In the world of financial markets, few foreign exchange traders have had experience working in a bureau de change.
The same pattern applies for bond traders, who are unlikely to have experience of raising money directly on behalf of a company.
But this is not true in the world of financial commodities trading, where knowing the physical aspects of the business is regarded as an important, if not crucial asset.
Knowing how to analyse supply and demand and piecing together fragments of information gleaned from moving raw materials gives those with a physical trading background an edge, say analysts and hedge fund managers.
Indeed, most heads of commodities at the top investment banks started their careers trading physical commodities.
Then something funny happened:
Blythe Masters, the head of commodities at JPMorgan may be among a handful of those in top investment banking posts who have a pure derivatives background. However, some bankers and hedge fund managers suggest that she may be a vanguard, and that in 10 to 15 years many of the investment banks’ heads of commodities will not have experience in physical commodities trading – rather it will be in financial markets.
Why does this matter? Because it goes to the heart of the matter - no longer does supply and demand matter, no longer is anything like inventory, contango, backwardation, storage premium or all those concepts which mattered in a different physical-based world, even remotely relevant.
Because nobody cares any more about physical assets: everything is a rehypothecated copy of a rehypothecated copy of a rehypothecated copy...
“As commodities are increasingly driven by factors other than supply and demand, people from a financial background are becoming more important,” says one head of commodities at a leading bank.
Which means that those left trading commodities are simply those who best know how to leverage beta, while completely ignoring alpha, of which CDS creator (aka nearly infinite leverage on an uncollateralized product) Blythe Masters, running JPM's commodity desk, being the supreme example:
To many in the commodities industry, such a comment is akin to blasphemy, but the number of financial traders in banks and hedge funds who don’t have physical commodities trading experience is rising. “You have funds who really don’t give a monkey’s [sic] about physical trading,” says one hedge fund manager who used to be at Cargill.
The increased correlation of commodities to other financial assets and the larger influence of macro factors has made supply and demand analysis less critical. The rise in the amount of available information has also meant that the edge the physical traders have over pure financial players is much smaller than it used to be.
“We used enter into a physical transaction purely to get more information than everyone else,” says a former physical energy trader. “But the era when you lost money on the physical trade in order to make money on derivatives is probably over.”
And it is not just the nature of commodities trading that is driving the decline in financial traders without physical experience. The sheer number of pure physical traders trained by market leading companies are on the decline.
So to all those in the commodity space who think there are vast intricacies associated with being an industry veteran which leads one to being "better" at anticipating risk, predicting price movements, and everything else that makes a successful asset manager, sorry. You are now an extinct breed. The truth is with supply and demand irrelevant, something that has been the case for nearly a decade now, and the only thing that matters being how much liquidity "flow" comes from the central banks, it is time to unroot everything one has learned about pricing commodities, and strat from scratch. In fact, the TBAC said it best earlier.
"Anticipation of central bank behavior has become a significant driver of market sentiment."
Here we would replace "significant" with "only" and agree 100%.
As for those expecting a nat gas liquidation in the aftermath of Centaurus' fund closing: you are probably right... Unless of course some central bank eases overnight and floods the market with another trillion in new binary fiat which promptly has to be allocated to some hard asset.
Like nat gas, in the process setting off another massive short covering spree.
Some more from Reuters:
Legendary natural gas trader John Arnold is closing down his flagship Centaurus fund, a source said on Wednesday, as the former Enron wunderkind struggled to maintain outsized returns with prices near 10-year lows and regulations tightening.
The Centaurus Energy Master Fund is the biggest one that is open to outside investors, the source said. Arnold had a total of about $4 billion assets under management last year, although the source estimated that the Master Fund held around $2 billion.
After the fund suffered its first-ever annual loss in 2010, Arnold, who turned 37 last year, reduced its size because of diminishing market volatility and tough new limits on commodity speculators. He returned $1 billion of capital to investors last summer. The fund gained less than 10 percent in 2011.
Initially renowned as one of the youngest and best traders to emerge from Enron over a decade ago, Arnold went on to make his name as one of the most aggressive and successful hedge fund managers in the volatile natural gas markets, accumulating a $3 billion personal fortune, according to Forbes.
He is not the only commodity fund manager to opt out after one of the most industry's difficult years. Pierre Andurand and his partners said a month ago they would shut down BlueGold Capital, an oil-oriented fund, after a 35 percent slump in 2011.
Welcome to a world in which nothing matters except what a central bank does at any given instant.
Arnold's farewell letter below: