Is the Sure thing ever Sure?

Today we have been bombarded with the news that EOP has been taken out - LBO by Black Rock private equity fund. $39 billion the largest ever real estate transaction.

The fund was the biggest REIT in the US controlled by Sam Zell he we recently hosted in SA, and I had the pleasure of meeting.

Every single analyst report points to this being great for the REIT sector, even though private equity buyouts have been pretty common this year. The above deal was struck at a "modest" 8% premium to market.

My comments are what enables a private equity fund to pay more than market for a major asset. There is only 1 simple answer its ability to borrow large sums of money. There is no value add through management or technology, it is simply being given a license to go BIG on debt.

Now lets take a look at history; recent and not so recent history has proven that being too leveraged has resulted in blood bathes in times of interest rate volatility and or economic downturns.

Why shoudl this time be any different. I believe the numbers coming out of the US via weak GDP numbers and the yield curve inversion point to a coming recession, or perhaps can we postulate a little more gloomily a depression should the housing bubble burst.

The way things look technically from an Elliott Wave point of view is that I can finally see a clear 5 wave move over the last year which on its own without looking at where it features in the broader wave count, towards a healthy 15 - 20% correction.

As the market commentators shout from the bleechers that this is great for the REIT market, I am not so sure they will be right this time, but then again is the sure thing ever sure?????

Doubling Up - Just this Once!!

What do you do when you know you are in a hole, and the one way of possibly getting out is if you double up your position.

Is there a way to do it, knowing that in a sense you are braking some cardinal rules.

I am going to attempt to do it, but under the following conditions:

1. Knowing it is not sound trading practise.
2. Keep a very tight stop loss should the double go against me.
3. Be in the trade for a very short time.
4. Never get myself into a situation like this again.

Lets see what happens.

Professor Shiller is one the great students of irrational exuberance, (an excellent book worth reading) he has also been very bearish on the housing boom taking place throughout the world.

In this letter, I noticed something interesting that we mustn’t forget, and that is the fundamental long term shift in attitude towards housing. The housing correction will come, it may even be similar to the Japanese crash of the late 80’s and 90’s but over time things will more than recover. See the parts I have highlighted.

Take a look ……..

What Are Homebuyers Thinking?

Many places around the world have been in a housing boom since the late 1990’s. As I argued last year, in the second edition of my book Irrational Exuberance , the boom is rooted in speculative investment by ordinary homebuyers, fueled substantially by the worldwide perception that capitalism has triumphed, and that all people must look out for themselves by acquiring property. Convinced that private ownership has become essential to smart living, buyers bid up home prices.

Moreover, the fear that one must get in on the boom before it is too late often drives people to bid up home prices faster now. This certainly seems to be the market psychology in China and India, where rapidly rising incomes and newly successful people are widely expected to put pressure on markets for land, real estate, and construction materials. Real estate booms have been going on in these countries’ major cities for years. In China, despite some signs of weakness – the Shanghai market is down, for example – price growth is still robust in much of the country.

But the boom generated by such beliefs cannot go on forever, because prices can’t go up forever, and there are already signs of a hard landing. In the United States, newspapers and magazines are trumpeting reports in the last few months that the decade-long boom in home prices may be at an end, and that the bubble may be bursting. The psychology has suddenly changed, creating widespread fear of sharp drops in US home prices.

The new futures market for single-family homes at the Chicago Mercantile Exchange (which I helped establish last May with our firm MacroMarkets LLC) is predicting that by next August prices will fall between 6% and 8% in all ten US cities traded.

If home prices crash in the US, the bastion of capitalism, could it destroy confidence and end the boom in other countries? If so, could a worldwide recession follow?

This scenario is a distinct possibility, although there are reasons to be skeptical. Most importantly, the ultimate sources of the housing boom – the beliefs about capitalism and future economic growth – seem solidly entrenched.

The downward price trend in the US market, for example, does not seem to reflect underlying changes in long-run economic confidence. The survey that Karl Case and I conducted in May and June of this year, under the auspices of the Yale School of Management, shows sharp declines in short-term expectations for home prices in the US, but relatively little change in long-term expectations. Most people still believe that housing is a great long-term investment.

Maybe real estate prices are unlikely to fall to pre-boom levels because the fundamental change in perceptions concerning capitalism’s triumph will be longstanding. Changes in people’s fundamental ways of thinking are not easily reversed. Nor, therefore, is their interest in housing as a major speculative investment asset likely to change.

The transformation in investors’ beliefs is striking. Before the real estate boom of the late 1970’s, hardly anyone was worried about rising home prices. A search of old newspapers finds surprisingly few articles about the outlook for home prices. Those that did appear generally seem to be based on the assumption that minor fluctuations in construction costs, not massive market swings, drove the modest home price movements that they noted.

Indeed, hardly anything interesting about home prices was ever reported at all, aside from an occasional comment in an article about something else. For example, an article in The Times of London in 1970 argued that rising home prices reflected the switch to a new British Standard Time (imposed as a three-year experiment in 1968 to facilitate commerce with Western Europe by putting Britain in the same time zone). The article claimed that the change raised costs by forcing British construction workers to perform more of their jobs in relative darkness. Speculative investment behavior was hardly an issue in those rare instances in which home prices were discussed.

To understand the nature of the subsequent shift, consider that it is hard to find anyone today who worries that automobile prices will soar because rising demand in China and India for steel and other materials will push automobile prices out of reach in the future. Though a small group of collectors invests speculatively in antique or specialty cars, the idea of speculating in automobiles just is not in the public consciousness. That is how it was with housing until the late 1970’s.

Now that we think differently about real estate, we will never be the same again. But, of course, housing prices can only rise so fast. High and rapidly rising home prices tend to stimulate new housing supply, which in turn tends to undermine prices. Over a period of years, as people see how much new supply there is, they may begin to revise their view that homes are such a terrific investment, causing a gradual, but eventually significant, drop in home prices.

Indeed, while changes in fundamental perceptions may not occur easily or fast, they should never be ruled out. Urban land prices in major Japanese cities have steadily dropped over much of the period since 1991, as the enormous faith in the miraculous powers of Japanese capitalism gradually faded.

The same kind of erosion in home prices could occur in many cities around the world. All that is required is that growth in housing supply eventually outstrips investors’ faith in capitalism to sustain faster growth in demand.

Overconfidence cuts both ways

I enclose a post from Dr Tharps blog on overconfidence this is a well documented behavioral finance phenomenon.

The point I wish to raise is that I saw a classic case of information over confidence yesterday. The guys in our office attended a presentation with a major money manager in our sector and the guys picked up some market intellegence that the money manager had a new R1 billion to spend which is a sizeable slug of our sector R65b.

Straight away the guys were filled with a sense of over confidence with the information they now had at their disposal. Now I know I am a contrarian, but can you imagine the shock when the market behaves to the contrary of what is expected from spending this new money.

How can it happen?

Firstly, there is a good chance that the information is not "new" or only been for their ears, secondly the market has been running up in the last week, which is perhaps the market anticipating the spending and therefore ala the efficient market it is adjusting accordingly.
Lastly, it is also possible that the new R1b is making up for withdrawls from other investors into the sector, which anecdotally is quite possible as the recent sell-off spooked quite a few retail investors.

So in essence one always needs to do their homework and then once it is done one needs to appreciate that there could always be another answer.

The Problem with Overconfidence

Most of us have a tendency to overestimate how right we are. This tendency does not depend upon intelligence. Nor does overconfidence in our positions depend upon our expertise in a given subject.

Experts may be more knowledgeable about their subject matter than others are, but they are still not very accurate in estimating how much they know. Expertise in technical analysis, for example, has little to do with making money in the markets.

The more information to which one is exposed, the more one tends to be overconfident about his or her positions. Thus, if you are exposed to a great deal of information in order to make a decision about the market, you will be more adamant about your position once you make up your mind.

Unfortunately, most information—especially financial information—has little correlation with price movements. Thus, exposure to a lot of data will probably make a trader much more confident in a position but have little bearing on whether he is correct about the direction of the market movement.

Posted by Van K Tharp on September 26, 2006 01:52 PM

FEAR - Like a deer in the headlights

It has been some time since I have experienced the kind of fear I am currently experiencing in the market.

Once again I am in a weak position as I trade away from my proven method of success and adopt what has proven to be my trading downfall, i.e. LARGE directional bets. These trades are to a large extent ego trades and are not good for me, my trading results and that is that.

I have no problem entering these types of trades on a small basis as they can bring the extra cream we all look for but they cannot be the primary source of my profits.

Lets briefly examine the positions.

The 1st one is an directional put option on the US real estate market. This index continues to make new highs and confuse the best known pundits, so I am in excellent company. The problem is I have had so many hassles with opening a new more efficient account that to a large extent I have traded this account poorly from a being on top of perspective. The details are boring so I won't go into it, once again I am too big relative to my mandate and have chosen to bury my head in the sand to a large extent.

The 2nd one is a call on the selloff of the SA Alsi 40, which like my 1st point has gone against my call and instead of trading it on a shorter basis I have allowed the greed of early success to grow my position into a size I am not comfortable with.

I have decided to trade both positions on a short term basis for now, as both trades seem pretty clear in the short term. My intention is to use hopefully success on the short term side to shrink my position size to a manageable level.

In the even of my short term trades working against me, I need to then look f0r the earliest opportunity to cut the trades.

I don't like being afraid, so let this serve as a warning for other times into the future. Being "nervous" is part of the job and is not the same as being afraid.

Time to be super vigilant, and on top of things.

Mike

The Hexagonal Bee Model

Have you ever wondered why the honey comb cells of a bee are hexagonal. The following idea I heard from a rabbi.

The strongest shape to use in such a structure is a circle, so why aren't bee hives cells made in a circle structure? The answer is that it involves too much wasted space. If the cells were circular then there would be alot of wasted space between each cell.

With this logic one can argue that the best approach would be to build the cells in square shapes as this would be easiest to do and would involve no wasted space. Surely this would be a lot easier than building a complex hexagonal structure?

The answer given is that although a square structure would be most efficient it changes the "ideal" strucutre of a circle too much. The difference between a circle and a square is too great, therefore a hexagonal structure comes as the closest substitute.

From this we can learn a valuable lesson.

Often a theoretical model provides the best solution, but in practise it is often not practical to implement, the principle learnt from the bee cell within the hive, is do not vary the model too far from the original solution. If you need to make changes then do so but always try and keep as close to the orginal model as possible.

It is this principle which I wish to extrapolate into the basis of my theory on Macro-Economics.
Adam Smith's invisible hand has come the closest to describe the perfect market. Let us make changes where necessary but remember not to move too far from the original model.

Monetary vs Keynsian Economics

Thinking back to my university days I remember being touched by the monetarist argument more so than the Keynesian school.

In a nutshell I cannot see how a Central Body (government) intervention can ensure optimal allocation of capital. Therefore in the short term, yes, fiscal spending will produce jobs, and yes it will stimulate spending and kick start the economy but my question is at what cost?

In order for the government to spend it needs to finance this expenditure either by using money from taxes or alternatively by borrowing money. I have no problem with either on the assumption that the government concerned knows how to spend the money. My experience, and the experience of the ages is that any beaurecratic process usually leads to inefficient allocation of capital. To be blunt governments typically WASTE money.

A great example is what is currently taking place in China right now, and what happened in the Asian crisis in 1997. The government financed massive infrastructure development, the problem now is alot of the money spent was unnecessary.

So in the end you will pay in the long term for short term gains. The question Keynesians need to ask is whether it is worth it.

The monetarists take a somewhat more distant approach and only try to influence the economy via interest rates which in turn influence money supply which in turn influences supply and demand.

For now I am in the monetarist camp as I was in university.

Fooled by Randomness

This is just a great story of someone who has fooled the people around him with his random success. Let me be the first to say this guy seems to have amazing talents, and I am sure is greater than the average trader. However, the size of his bets and his success was nothing more than six or sticks.

Blue Flameout
How Giant Bets on Natural Gas
Sank Brash Hedge-Fund Trader

Up in August, Brian Hunter
Lost $5 Billion in a Week
As Market Turned on Him
A Low-Profile Life in Calgary
By ANN DAVIS
September 19, 2006

CALGARY, Alberta -- Of all the traders gambling big sums on energy, a
32-year-old Canadian named Brian Hunter made some of the brashest bets and the
fastest money.

Last week, he fell hard, proof of how quickly fortunes can reverse in gyrating
commodities markets.

Here in this bustling new energy frontier, Mr. Hunter headed the energy desk for
a Connecticut hedge fund called Amaranth Advisors. At the end of August,
trading natural gas, he was up roughly $2 billion for the year. Then he lost
approximately $5 billion -- in about a week.

His losses savaged returns for Amaranth, dragging its assets under management
down to some $4.5 billion from $9 billion at the start of September. In
disclosing the losses to investors in a letter yesterday, the fund said it was
aggressively reducing its natural-gas bets, effectively cutting out the majority
of Mr. Hunter's operation. He remains at the fund. (Even as Amaranth was
losing, some gas traders were winning; see article.1)

What hurt Mr. Hunter is what he had ridden to glory for the past year or so:
volatility.


Though unknown in public, he had created a buzz on Wall Street -- a wunderkind
to some, a ticking bomb to others. From a cramped trading desk, he thrived on
big price swings, reaping billions of dollars on price declines and surges
alike. Late last week, he watched with growing alarm as natural-gas prices took
a steep dive, particularly in futures contracts for delivery of gas for this
coming winter. His losses mounted in after-hours trading this weekend.

"The cycles that play out in the oil market can take several years, whereas in
natural gas, cycles take several months," Mr. Hunter said in an interview late
in July, when his returns were looking rosy. "Every time you think you know what
these markets can do, something else happens."

At that time, Mr. Hunter had more than $3 billion of bets outstanding, investors
familiar with the funds' holdings say. Shortly thereafter, a heat wave caused
natural-gas prices to go haywire, then soar. Many traders took hits. One
energy-trading firm, MotherRock L.P. in New York, imploded and decided to close
shop. The lanky Mr. Hunter, however, came out hundreds of million dollars ahead
in August, Amaranth investors says, and continued taking positions some other
traders had abandoned as too risky. He declined to be interviewed yesterday.

Big commodity players bypass the geopolitics of oil for the most-volatile major
commodity: natural gas. The blue-burning fuel heats 52% of U.S. homes and runs
many power plants in peak air-conditioning season. It also is a raw material in
a variety of industries, from fertilizers to chemicals.

Unlike oil, gas can't readily be moved about the globe to fill local shortages
or relieve local surpluses. Forecasts of freezing U.S. temperatures in winter or
heat and hurricanes in summer can send prices jumping, while forecasts of mild
weather can do the opposite. Last December, amid a cold snap, gas soared to a
record $15.378 per million British thermal units on the New York Mercantile
Exchange, or Nymex. This month, prices fell below $5 in the absence of major
hurricanes and with forecasters talking about another warm winter. Yesterday,
gas for October delivery settled at $4.942 a million BTUs on the Nymex, off four
cents.

Backed by borrowed money and a deep-pocketed fund, Mr. Hunter took on more
exposure to certain futures contracts than do some big investment banks
employing more than 100 energy traders, say several traders and ex-colleagues.
He sometimes held open positions to buy or sell tens of billions of dollars of
commodities.

His wins and losses were outsized: He was up for the year roughly $2 billion by
April, scoring a return of 11% to 13% that months alone, say investors. Then he
lost nearly $1 billion in late May when prices of gas for delivery far in the
future suddenly collapsed, according to investors in the Amaranth fund. He won
back the $1 billion over the summer, only to lose that and much more last week.

The whiplash trading in these markets could work to the detriment of energy
consumers. Some consumer advocates, utilities and federal officials say
speculation in the energy markets accentuates the volatility of this staple fuel
and that the increased volatility, in itself, hurts consumers. Volatility makes
it harder for utilities and municipalities to determine the best time to buy
gas for their operations. Many utilities posted losses on gas purchases over the
past year that proved to be poorly timed. They passed on those costs to
electricity and heating customers, even as futures prices were dropping.

But while energy consumers have seen their bills rise, many traders' paychecks
have soared. Mr. Hunter is estimated to have taken home $75 million to $100
million last year.

Mr. Hunter's swift reversal calls into question how well some hedge funds grasp
the risk they are taking in the now-popular energy markets. Vince Kaminski, a
risk-management expert who protested chancy trades while at Enron Corp. and
until recently was at Citigroup Inc.'s commodities desk, said yesterday that
it's dangerous to take giant positions in relatively shallow markets, which
certain months are in gas futures. "This is a typical mistake of inexperienced
and aggressive traders," he said. Mr. Hunter "appeared to have a position that
the entire market knew about. The markets are very cruel." Citing a well-known
epigram, Mr. Kaminski added, "'The market may stay irrational longer than you
can stay solvent.'"

Nick Maounis, Amaranth's founder and chief executive, said in August that more
than a dozen members of his risk-management team served as a check on his star
gas trader. "What Brian is really, really good at is taking controlled and
measured risk," Mr. Maounis said.

When Mr. Hunter began trading natural gas eight years ago, it was far less
volatile, hovering under $2 a million BTUs. Mr. Hunter had grown up in farm
country near Calgary, but his knowledge of gas was limited to summer work on a
rig in northern Canada. He knew markets, though: Unable to afford skiing while
in college, he poured himself into math at the University of Alberta. A
professor of his was a leader in the emerging field of financial modeling and
derivatives.

Mr. Hunter joined TransCanada, a Calgary pipeline company that was becoming a
player in the growing business of trading energy, rather than simply
transporting it. The company would help customers like gas producers lock in
prices for some of the fuel it shipped for them.

Mr. Hunter, then 24, came armed with fresh theories about options pricing, and
impressed his bosses with his ability to spot price anomalies. They gave him
increasing amounts of money to trade with after early successes. Among them: He
convinced them that options in Canadian gas were underpriced as a pipeline from
Canada to Chicago was set to go online and create a greater market for it.

"He helped us prove that mathematically...and it paid off hugely," says Shondell
Sabad, a former colleague there who now trades for a Calgary bank.

Traders like Mr. Hunter make complex wagers on gas at multiple points in the
future, betting, say, that it will be cheap in the summer if there is a lot of
supply, but expensive by a certain point in the winter. Mr. Hunter closely
watches how weather affects gas prices and whether conditions will lead to more,
or less, gas in a finite number of underground storage caverns. Roughly akin to
counting cards in bridge, a trader keeps track of how much gas is injected into
storage and how much might have been withdrawn for industrial and household
use.

Mr. Hunter moved to Wall Street to do the same work for more pay. He joined
Deutsche Bank's energy desk and gained a name trading U.S. natural-gas futures
-- where his wide profit and loss swings provoked a stormy face-off with
superiors that ended in litigation.

In his first two years at the bank, Mr. Hunter generated $17 million in profit
in 2001 and $52 million in 2002, according to a complaint he later brought in
state court in New York. By 2002, he pulled down $1.625 million in salary and
bonus and began supervising the gas desk.

In December 2003, just as his group was close to closing the year up $75
million, things went badly awry. In a single week, they had losses of $51.2
million, he said in his suit. He blamed "an unprecedented and unforeseeable
run-up in gas prices" along with "well-documented and widely known problems
with" Deutsche Bank's electronic-trade-monitoring and risk-management software,
which he said hurt traders' ability to extricate themselves from bad moves.
Deutsche Bank denied its systems were to blame.

Mr. Hunter argued that even though the desk as a whole lost money, he personally
made trades that netted the bank $40 million that year. He and his natural-gas
colleagues got no bonus. By February 2004, relations had soured to the point
that supervisors locked him out of the trading system and made him an analyst,
moving him off the desk. Mr. Hunter left in April and subsequently sued over the
withheld bonus and claimed Deutsche Bank defamed him. It denied the
allegations. The suit is pending.

Mr. Maounis, the head of Amaranth, took a chance on Mr. Hunter. Amaranth was one
of the first hedge funds to build an energy desk soon after the demise of
Enron, under the leadership of former Enron energy trader Harry Arora. Messrs.
Arora and Maounis hired Mr. Hunter and initially kept him on a tight leash. Mr.
Maounis says the firm knew of Mr. Hunter's history at Deutsche Bank but did
extensive checks and found "nothing that made us uncomfortable."

Mr. Arora was relatively conservative and sought to make diversified commodities
investments. He brought Mr. Hunter along and the energy group posted steady
returns of 30% to 40%, say people familiar with its operations.

Mr. Hunter wanted to make bigger bets in his main market, gas. He had an ability
to keep calm with huge bets on the line and markets were going berserk. In July
2005, for instance, he was in Calgary at Stampede, a rodeo festival, when the
gas market began moving erratically. Mr. Sabad, his former TransCanada
colleague, says Mr. Hunter got on the phone a few times but didn't panic or
trade from his hotel room. "He asks himself, 'Do I still like my position?' If
he does, he adds more," Mr. Sabad says.

Around that time, Amaranth agreed Messrs. Hunter and Arora could separate their
trading "books" and each control his own trades. Then late last year, the
double-whammy of Hurricanes Katrina and Rita made Mr. Hunter a hero at Amaranth
and a minor legend on Wall Street, as he made $1 billion for Amaranth.

Mr. Hunter trolls for what he calls "mispriced" options -- that is, the chance
to buy or sell something at a price that appears farfetched to the market but
that Mr. Hunter sees as a distinct possibility. Leading up to the hurricanes,
Mr. Hunter had built a complex portfolio of options, among other bets, based on
the idea that gas could get extremely expensive in the early fall. An option to
buy gas at, say, $12 cost very little in summer 2005 because gas was then
trading at only $7 to $9. When gas soared to $13 after hurricanes ravaged Gulf
of Mexico production, such options such as these, which he had been buying,
soared in value.

His success was a rebuke to his ex-colleagues at Deutsche Bank, where lawyers
were wrangling with him over his request to take depositions from former
superiors, even as he was banking big trading profits. It also was hard for Mr.
Arora, still his boss but not the rainmaker. Mr. Arora eventually left to start
his own hedge fund.

It was vindication for Mr. Hunter. In its annual Christmas card, Amaranth
referred to its energy-market winnings by quoting Benjamin Franklin: "Energy and
persistence alter all things." It sent out toy antique gasoline pumps.

Amaranth agreed to let Mr. Hunter trade from his hometown of Calgary, where he
began with the fund's blessings to build an even bigger portfolio. A world away
from New York gridlock, he zoomed to work in his new gray Ferrari, or
occasionally a Bentley, which he tells friends is better in snowy Calgary
winters. Besides the cars and a new house he is building in a wooded area, he
keeps a low profile. Some of his pick-up-basketball buddies don't even know what
he does. Though he consented to several interviews for this article, he
wouldn't allow a photo.

From his desk on a trading floor, Mr. Hunter monitored dozens of "instant
messaging" tabs from brokers and pored over weather screens. Six traders traded
were there on a recent day this summer, in a space crammed with boxes of KitKats
and Hershey bars, microwave popcorn and bags of running clothes. The only fancy
touch was a basketball signed by Michael Jordan encased in Lucite.

Bruno Stanziale, a former Deutsche Bank colleague now at Societe Generale, works
with energy companies that need to hedge, or sell forward, their production. In
an interview in July, he contended Mr. Hunter was helping the market function
better and gas producers to finance new exploration, such as by agreeing to buy
the rights to gas for delivery in 2012. "He's opened a market up and provided a
new level of liquidity to all players," Mr. Stanziale said.

Mr. Hunter saw that a surplus of gas this summer could lead to low prices, but
he also made bets that would pay off if, say, a hurricane or cold winter sharply
reduced supplies by the end of winter. And he was willing to buy gas in even
farther-away years, as part of complex strategies.

Buying what is known as "winter" gas years into the future is a risky
proposition because that market has many fewer traders than the contracts for
months close at hand. Deals for those far-away months are done in
over-the-counter transactions that can be hard to exit. In May, his team's
position fell nearly $1 billion when the prices of far-forward gas contracts
took a steep dive -- much as they did last week. In this case, a number of gas
producers suddenly sold more gas than Mr. Hunter expected.

By summer, Mr. Hunter appeared to be proving doubters wrong. Amaranth's overall
fund gained around 6% in June, was roughly flat in July, and gained 6% in
August, according to investors.

Although Mr. Hunter had fared well in that period, many traders say Mr. Hunter
was acquiring positions that were too large to get out of if the market turned
-- including a bullish bet on winter gas. Amaranth won't detail its positions or
his trading strategy, so it is unclear exactly what caught Mr. Hunter unaware
last week. However, in recent weeks, people familiar with the transactions say
Amaranth bought MotherRock's gas positions in an attempt to cancel out some of
its trades and reduce its market exposure.

Expectations of a warmer-than-average winter are rising. Last week, the National
Oceanic and Atmospheric Administration said the El Nino weather phenomenon has
formed in the Pacific Ocean. That typically means warmer winters in the U.S. and
lessens the threat from hurricanes in the Gulf of Mexico. All this, and the
recent fall in crude oil, helped to devastate gas prices.

Amaranth has scrapped plans relayed only a month ago to investors to offer them
a separate energy-only portfolio to invest in. Congress, meanwhile, is jumping
in to debate whether hedge funds are to blame for all the volatility.

The Commodity Futures Trading Commission argued in a 2005 report that hedge fund
trading didn't increase volatility and even improved the functioning of the
markets by giving energy companies more trading partners. But a recent report by
the Senate Investigations Committee warned that the energy markets were badly
underpoliced. It cited an explosion of trading on electronic trading systems and
over-the-counter platforms over which the CFTC has no authority -- and in which
Mr. Hunter and other big traders are extremely active.

APEXHI - MY LITTLE NEMESIS

I was a founding director of ApexHi which we reversed listed in 2001, taking a company with R275m in property assets to its current +- R7billion.

This company was launched with classic financial engineering that has way surpassed all concerns wildest dreams. A structure of subordinated debentures was put in place offering investors with a more conservative profile a much safer investment and others with apetite for risk a higher risk reward instrument.

Fortunately for the company and its shareholders the bull market was just getting ready to take off and ApexHi maanged to be in the perfect spot at the right time. The quality of assets was really poor, but this higher yield proved to be immensly attractive to investors seeking yield, and being part of a bull market, risk premiums we about to shrink (quite frankly I think some investors forgot such a valuation criteria existed).

So what happened? In classic terms 1 + 1 = 3 not to shabby for a company with poor assets and a "thin" management team. Once again management were fortunate to hold an inflated asset which enabled them to continue buying better quality properties with overvalued paper. Hence the appetite for this companies higher yield has driven its price to a level that it can purchase assets far better than its original portfolio, and still at the same time increase the growth in distributions.

What a story.!!

Management now are about to embark on phase 2 of the amazing financial engineering story they pulled off in 2001, with the launch of the C debenture. Will it work or will 1 + 1 + 1 = 3.

As a natural contrarian, I believe ApexHi has come one debeture too far. I look at the forward projections maangement see's in its distributions going forward. Yes certainly in the next few years things look good. No actually more than good - great.

The problem is the next few years is not going to last for ever. Just like every cycle in life or business comes to an end, so will this incredible journey. The question I ask is will the downturn in the cycle finally play catchup to the incredible 1 + 1 = 3. My view is I think so.

I recently took a look at the premiums the A & B debentures were trading at relative to NAV; 60% , 130%. This is just unsustainable.

So my view is that this next chapter is likely to mark the companies history with the inevitable reversion to the mean of whatever a reasonable premium/discount to NAV is appropriate for this stock.

One thing I know for sure is that management is likely to pay for the day of being the dumping ground for "dog" properties, and although it is now a much smaller part of the portfolio, I suspect the downturn whenever it might come will occupy way too much of managements time.

Your ever faithfull contrarian.

Mickson

CHINA - THE MARKET JUST STEAMS AHEAD

Most people are sucked into the hype associated with 10% + GDP growth and think this is unbelievable and the way to go. So many countries have made the mistake in the past and it is just amazing to watch so many people fall for the same mistake again.

The old saying, "history repeats itself" is once again in play.

The Chinese economy is growing in the 10-12% range and perhaps more, as much activity probably goes unreported. There is nothing wrong with strong growth, but there is legitimate concern about growth that is not actually market-based. The Chinese government is concerned about too much capacity in too many industries, as well as real estate speculation.

Every local government has had access to cheap money. So, they build more factories with little view to markets and profits. As Simon Hunt notes from a recent rip to China:

"In our travels around Shandong Province we came across a prime example. A local government company decided in 2000 to construct a power station and a copper tube plant. We cannot comment on the feasibility of the power plant, but it was quite clear from our visit that the ACR tube plant with a capacity of 60kt/a will never make a decent return on capital, let alone will lenders ever get to see their money back.

"Not content with one white elephant, the company is building a sheet/strip plant with a capacity of 100kt/a and a capex of US$250 million, using all imported equipment, just to add to the circa 1.5MT/a of new capacity being built in China. Our discussions also showed that they had not undertaken a rigorous market study prior to starting to construct. Power stations, tube and sheet/strip mills have all been fashionable projects, and China is a land of fashion followers."

How many such projects are there? The central government has laid down rules designed to make it more difficult to build projects which are not economically rational. But the local bureaucrats have ignored the rules. Beijing is starting to crack down. Some 100,000 projects, initiated since the beginning of the year, are under investigation. Forty percent of these violate at least one rule, and 14% are actually illegal.

Conveniently for the central government, a large number of local bureaucrats are due to be replaced (through retirement or elections). Look for their replacements to be more loyal to the central government.

Beijing is not trying to stop real infrastructure growth. The concern is excess capacity, which leads to deflationary pressure. Directing all this from a central government is a mind-boggling task, and one about which I must admit I harbor doubts as to how it will actually work. But so far...?

The government has stated that its objective is to bring down the growth of Foreign Direct Investment (FDI) from the plus 30% in the first half of the year to 20% by year-end. Both monetary and administrative measures will continue to be taken until this goal is in reach. That is a big drop and is already being seen in construction activity, according to a report just issued by Jonathan Anderson of UBS.

How? Among other things, the government has taken back the ability of local bureaucrats to approve land sales. If you can't buy the land, you can't build the factory. Adherence to the rules is being aggressively pushed, with strong messages coming from the very top leadership. Plus, in the past few weeks we have seen some very difficult new positions. Foreign businesses cannot sell land and repatriate their capital. And limits have been placed on how much (or even if) foreign firms can invest in businesses in certain sectors, some of which seem to clearly violate WTO rules, at least from this side of the Pacific.

That being said, the Chinese government has affirmed they will meet their WTO obligations to open up their banking sector to foreign firms, although the rules they are adopting will make it expensive to do so.

All this gives rise to even more protectionist rhetoric from both the left of the Democratic and the right wing of the Republican parties. They demand that China revalue the Renminbi by 30% or so immediately. Such verbal political garbage may play well to the home crowd, but it makes no economic sense. Exactly why do these politicians want Americans to pay 30% more for their Chinese imports? Such a move would cause a deep and severe recession in the US, not to mention China. Let's see if we can really destabilize the world. Idiocy.

The Chinese will continue to do what they have done for years, and that is to act in their own best interests, just as every other nation does. And it is in everyone's interest that they slowly move to a free-floating currency, which it evidently seems they are doing. As strong as the Chinese economy is, it is more fragile than it appears. A shock of a quick 30% adjustment in currency valuations would precipitate a deep recession in China. That is something the world does not need.

It will truly be a miracle if the Chinese can avoid a recession over the next few years, as all economies eventually succumb to the normal business cycle. But unless the government makes a large blunder, it will be just like the next recession in the US. It will pass and then the growth will resume. The Chinese government is managing a very difficult transition, from a centralized socialist economy to a market-driven economy. For all the problems, from this seat I think they are doing better than any of us could imagine 10 years ago. Yes, they have a long way to go, but they have come a long way. If they can continue down the path they are on, it will accrue not only to their benefit, but to the world's advantage.

How Does one Remunerate a Hedge Fund Team?

My colleague and I today spent a long time analyzing the best way to incentivize a new member of our team.

Do we all share equally in the bonus pool (me included = CEO), or do we maintain a hierarchy, and furthermore do we introduce a meritocracy system?

The problem with meritocricy is the element of discretion as a research analyst is not always able to quantify the $ value they have brought to the company.

The system that I have in mind is as follows: an agreed % of the bonus pool is decided. It then remains for senior management to decide whether the party concerned in fact qualifies for the bonus. The actual amount then falls subject to a formulae. The only negotiation revolves around the predetermined % of the bonus pool, and the discretion of the manager to determine whether the merit is in fact in place.

To protect staff from bonus pool abuse, if management are not happy with the staff member they need to follow a set of rules to document a trail of measures to ensure the staff member stays on track for bonus recognition.

In the event that the staff member continues to underperform a system of demerits is to be put in place that will 1st see the staff member reduced to 50% of their original bonus participation. A further demerit will result in no bonus and the discussion of either cutting ties or agreeing for the employment contract to be reinstated.

What is Economics ?

Economics is not a science, no matter how many algebraic formulae's you design, it remains an art!

My insight into economics is that its flavour depends on the mood of the day. In other words it is an art but expressed as a science, and represents the collective mood of the people at a particular time.

It is for this reason that demand and supply have always stayed constant, it is just these mainstays of the science, develop a cloak of emotion that is drawn from the collective mood of the day.

At the end of a period of growth certain characteristics are common place within the society of the day, it is these emotions that popularize the theory of the day.

What I am therefore in essence saying, that the theories that have been developed through the centuries are nothing more than a reflection of the "demand" & "supply" of the people at that time.

I therefore think that in order to be a successful economist, one has to first understand the history of the art, and then try and apply the benefits learnt through the ages to fit in with the mood and expectations of the collective society of the day.

Economics, politics, sociology, maths & history are inextricably linked one has to understand them all in order to be a successful economist.

A Contrarian point of view is it Nautre or Nurture?

I speak from experience on this subject, after all I am an unabashed Contrarian.

The question I wish to pose is as follows:

Is the fact that I am a contrarian something I learnt growing up, or is it something I was born with.

The first thing I need to identify is whether I am a contrarian in every aspect of my life, or does it refer only to trading. My answer on this is that I believe I really am only a contrarian when people speak of a sure thing. In other words when there is such conviction by a group of people I find that I have an automatic response to go for the other side.

It possibly stems from the fact that I absolutely hate it when people are so full of themselves or their analysis that they are not prepared to consider an alternative possibility.

Coming back to the isse of nature vs nuture.

I don't believe my upbringing was one to confront the establishment and to intellectualise all analysis. I don't believe my sister is a contrarian. Having possibly refuted both the nature and nuture argument.

I am leaning to the belief that my contrarian disposition is part of my psychological makeup which is part nature part nurture. To be a contrarian you need to have broad shoulders so you need to be prepared to take on the establishment. Surprisingly you don't need to enjoy conflict which I don't on one hand and do on another.

Can a contrarian be trained, and what gives me the right to call myself a contrarian?

The above questions need to be analyzed and for now I wanted to capture the essence of the question, ignoring whether I may or may not have made any sense.

I will conclude with a last observation. Being a contrarian requires a pretty sizeable ego. Being a good trading contrarian requires an insight and control of ones ego.

The Time is Nigh

You may be saying what is this bloke smoking, but every now and again a trader gets that gut feeling that things are about to work out the way you "feel".

Tonight is one such moment. I am sitting in the same study I was in on the 10th January feeling "confused" but bearish. Tonight I sit less confused but bearish.

Let me try and place things in perspective I made the following post on the 10/1/2006:

have just come back from vacation, it is the start of a new year, I have a brand new fund that needs to be invested, I am sitting in my study watching the markets and I haven't a clue as what to do.

The greatest minds in the world tell us that the US is sick, and by sick I don't mean the flu. The US is infected with a terminal disease that can only be cured with painfull surgery, and strict observance of a health programme, anything else will lead to death.

Let us not blame this on the Americans alone, a culture of spending all of tomorrows earnings today has pervaded most of the western world, and this increases the chance of major "illness" spreading across the globe in an epidemic the like the world has never seen before.

It is against this backdrop that I ponder the weightings and directional balance of the virgin fund I have been blessed to consumate.

I will end tonights session by saying that I have maintained a bearish view on the markets for over 3 years in the face of a bear market rally, the "pain" has been severe and the error humbling. However, I stand tall and steadfast in my view that we are indeed in a bear market rally, and the time is nigh for a monumental correction in the markets that although painfull and devestating for the world should provide bountiful profits for our new fund.

"Stay the Course"

So why am I so confident this time.

Firstly, I believe nothing has changed from my observations back then, secondly the market having gone up probably makes my argument back then stronger. Finally, I am a strong believer in the Elloitt Wave Principle and the setups across so many markets are perfect. Something that hasn't "really" been the case. I say this because all the previous setups were never classic and were chased out of fear of missing "all the move".

I am a lot wiser than I was at the beginning of the year, although I must say I have a long way still to go.

Just to conclude with a personal note.

To be a trader / hedge fund manager requires nothing less than committment, passion, resolve, insight and all the above again.

Socionomic Ideas

ABN Amro completes first office sector swap
An article in Property Week of 13 January 2006 reports that
ABN Amro completed the first office sector swap with Lehman
Brothers, swapping the IPD office return against the IPD allproperty
index for a one-year period. The size or price of the
trade was not disclosed. Rawle Parris, Executive Director of
property derivatives for ABN Amro was quoted as saying:
“This is the first time the office sector has been traded and the
first time someone has done a property-for-property swap.”

Maybe this might signal something interesting.

The Lonely Thoughts of a Hedge Fund Manager.

I have just come back from vacation, it is the start of a new year, I have a brand new fund that needs to be invested, I am sitting in my study watching the markets and I haven't a clue as what to do.

The greatest minds in the world tell us that the US is sick, and by sick I don't mean the flu. The US is infected with a terminal disease that can only be cured with painfull surgery, and strict observance of a health programme, anything else will lead to death.

Let us not blame this on the Americans alone, a culture of spending all of tomorrows earnings today has pervaded most of the western world, and this increases the chance of major "illness" spreading across the globe in an epidemic the like the world has never seen before.

It is against this backdrop that I ponder the weightings and directional balance of the virgin fund I have been blessed to consumate.

I will end tonights session by saying that I have maintained a bearish view on the markets for over 3 years in the face of a bear market rally, the "pain" has been severe and the error humbling. However, I stand tall and steadfast in my view that we are indeed in a bear market rally, and the time is nigh for a monumental correction in the markets that although painfull and devestating for the world should provide bountiful profits for our new fund.

"Stay the Course"

US REIT COMMENTS

GRT has a clean 5 waves down, a great short, however, 1 little blip up to come.
HOV is really bearish
EOP is possibly a 1-2, 1-2, alternatively we have a bullish wave 5 to come