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A Flock of Ospraies
By Jon Nadler

Gold headed back to revisit Tuesday's low of $790 and then recovered once again before the close of futures trading, to climb back to just above $800 per ounce. The dollar gained further ground this morning, inching closer to 78.50 on the index, but gave up most of those gains after oil prices regained nearly $1 of their own earlier losses. News that the European economy contracted in the second quarter helped push the common currency to 1.44 against the greenback and only added fuel to the bonfire of commodities.

New York spot trading was off nearly $5 at $800.40 per ounce at last check, and doubts remain in place as to its ability not only to close above the round figure, but of avoiding a near-term decline to retest the $775 zone. Dollar strength is still sapping the confidence from among the remaining longs. Bullion is off nearly 11% over the past 30 days. Silver continued under selling pressure, opening at $12.90 per ounce, down 15 cents. Platinum fell $10 to $1373 and palladium declined $5, quoted at $283 per ounce.

Auto sales numbers released today showed carmakers skidding rapidly into what looks like a massive pile-up of unsold vehicles. Ford Motor led the sad sales list, with a near 27% drop in iron moved during the month of August. Its adopted child, Volvo suffered a 48.8% percent fall-off in sales. The Dow appears conflicted as it would like to celebrate the implosion in commodities but fears that it is a sign of another kind of contraction at work - one that cannot bode well for its component stocks. Oil speculators might be taking the slump in auto sales as a leading indicator of more demand destruction to come - as if the exodus of wounded commodity funds from the trading pits was not damaging enough.

Further price weakness continues to be the dominant feature of commodities trading. Speculators have been selling everything that even resembles a commodity, in the wake of the spectacular Tuesday announcement that a $3 billion commodities-oriented hedge fund had collapsed. Ospraie Management's flagship Ospraie Fund had lost nearly 40% during the August commodity meltdown and it has now been added to the pyre burning in that market since at least Independence Day.

It is believed that the fund in question has only 'illiquid' investments left as of now, but one has to wonder what was 'liquid' among the assets it held, most of which had to be dumped recently. Street talk is that the fund's lethal hits came from bad bets on copper and natural gas. One also has to extrapolate that this failure is not going to be a 'one-off' event - not when considering the tens of billions that have been thrown at the commodities sector over the past several years. The possibility of a negative-feedback price loop developing in this niche is growing exponentially. Manipulation, yeah, right. Try wrong guesses first. Then, quickly scan the books to learn who is exposed to what. Reuters' Laurence Fletcher delves into the matter and finds disconcerting symptoms:

"The closure of Ospraie Management LLC's flagship hedge fund is likely to be the first of several such failures, as a slump in commodities and a spike in financial stocks catch out funds with hard-to-sell positions. Five years of soaring commodity prices have encouraged a flood of investor assets and a raft of new hedge funds, which have sought investment opportunities in an increasingly crowded sector.

However, the recent setback in commodity and energy prices, driven by concerns demand for resources will suffer as economic growth slows, has seen many managers take substantial hits. Those in illiquid positions face the biggest headache as nervous investors look to withdraw their money at the first opportunity.

"I think there will be more problems," said one fund-of-hedge-funds manager who requested anonymity in order to speak candidly. "It will be an issue for hedge funds with quarterly redemptions who have gone into illiquid positions.

"It was not too dissimilar to the dot-com boom, where larger players bought a lot of smaller companies without too carefully considering them, (although) there is underlying value in the commodity and energy sector".

Ospraie said on Tuesday it could take up to three years to return the most illiquid 20 percent of its assets to investors. Performance issues have already been seen at RAB Capital's previously top-performing hedge fund RAB Special Situations, which invests in small-cap mining stocks. These tend to be harder to sell than shares of larger companies. Its listed feeder fund RSS.L has fallen 38.1 percent from the start of the year to Aug. 21.

And further problems could emerge if the current setback turns into a longer downturn in commodities.

"It was pretty much a one-way bet in the second half of last year," Randal Goldsmith, director of fund research at S&P Fund Services, told Reuters. "We're now seeing sharp corrections in commodities ... It can be very damaging. There are hedge funds that have taken significant positions in commodities and it if did prove to be a bear market, a lot of hedge funds would be in trouble."

Hedge funds which have been simultaneously betting on rising commodity prices and falling financials as the credit crisis unfolds have been hit particularly hard. The FTSE All Share Mining index .FTASX1770, which has rocketed in recent years, fell 21.7 percent from end-June to Sept. 2. Meanwhile the FTSE All Share Banks index .FTASX8350 rose 12.4 percent as investors snapped up cheap stocks.

The effect on hedge fund performance is seen in data group Hedge Fund Research's HFRX Global Hedge Fund Index, which fell 1.28 percent in August, taking year-to-date losses to 5.05 percent. Even managed futures funds, whose bet on trends in global futures markets has been one of the star hedge fund strategies so far this year, have been hit by the sharp reversal to which they are traditionally slower to react, and subsequent volatility in these sectors. Stop losses are widely used as risk controls (by managed futures)," said S&P's Goldsmith. "This works great if commodities or equities go in one direction, but if they go back up (it doesn't work so well). Volatility kills any trend-following strategy."

Despite the sharp losses, hedge fund managers remain divided about whether or not this is a blip or the start of a longer fall. "We haven't found unanimity amongst funds-of-hedge-funds as to whether this has come to an end is or just a correction," said S&P's Goldsmith. However, some believe markets have reached a turning point and out-of-favour sectors such as retailers could be due a rebound.

"The key relative call from here is clearly consumer versus commodity," said Cazenove hedge fund managers Chris Rice and Steve Cordell in a note to investors. "For the last five years it has been a one-way bet, but now the tide is turning ... In twelve months the chances of (British fashion retailer) Next ( outperforming (mining group) BHP Billiton are very high."

Looks like 'subprime' might be replaced by something new in the lexicon shortly. Someone is working on a clever word already. Danger also lurks in the presence of the 650-ton gold ETF (about half or more of which is likely hedge fund money) in the room, as it creates a potential supply overhang threat which India - even with its best 100 ton per month intentions - cannot possibly overcome. As one observer put it today, there is one escape clause in the price equation that is shaping up here. That clause: a repeat of October 1987. Faites Vos Jeux, S'il Vous Plait. Then, roll the dice, please.

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