Martin Kronicle

A judge ruled that Canadian trader Brian Hunter was found to have manipulated the Natural Gas market on the NYMEX. The exchanges now should move in and ban him permanently from trading.

Bloomberg News said on its website, “Hunter knew that New York Mercantile Exchange natural gas prices could be manipulated and set out to do it, the administrative law judge, Carmen Cintron, said in an 80-page ruling issued on a commission docket today. The ruling is subject to review by the full commission.”

“It is found that Hunter intentionally manipulated the settlement price of the at-issue natural gas futures contracts,” Cintron wrote. “His trading was specifically designed to lower the NYMEX price in order to benefit his swap positions on other exchanges.”

Hunter was the head energy trader at Amaranth Advisors LLC, an investment advisory firm, when it ceased operations.

At its peak, Amaranth managed $9 billion in hedge fund assets, but lost $6 billion in natural gas due to highly leveraged trades Hunter amassed for the firm. Hunter reportedly leveraged his trades for Amaranth 8:1. To put that into perspective, at their most aggressive posture, most other traders will not exceed 3:1 leverage over their entire portfolios, never mind one position in their portfolio. [These trades put Amaranth under, but were not part of the recent ruling for market manipulation.]

What Hunter did to warrant the manipulation ruling was what locals refer to as banging the close. By flooding the NYMEX with Sell orders in Nat Gas in the last 10-15 minutes of trading (the Close), Hunter found that he could manipulate the price downward as there were no likely buyers for the type of size he was representing for sale.

Hunter concurrently held similar Nat Gas positions at the ICE that were much larger. Those positions are called look alikes, because they a not physically settled like their counterparts at the NYMEX are. After First Notice, those long contracts can be delivered against. This is true for any commodity.

Conversely, ICE contracts are settled financially, like the S&P 500 for example, so a trader does not have to worry about getting delivered against. Hunter was short his contracts, so he did not have to worry about delivery in this case. His goal, however, was to artificially depress NYMEX Nat Gas contracts so as to lower his larger ICE look alike Nat Gas contract position and burgeon his account balance. Herein is the manipulation.

Hunter was manipulating the price downward, so if anything, it may have benefited consumers. However, manipulation in any market manner is unlawful. He likely affected other traders who might have had to contribute higher amounts of margin (collateral) for their commodity accounts in order to maintain their positions.

Hunter’s attorney Matthew Menchel said, “The FERC should never have presided over this matter, which is outside its competence and jurisdiction. Its decision means nothing in our view, and the FERC will have to accept the consequences when we get to the DC Circuit, which the FERC has been trying to avoid for the last few years.”

I disagree. And arguing some technicality does not vitiate the finding that he deliberately manipulated the Nat Gas market. He has personal responsibility for all his actions at all times.

You have the letter of the law and the spirit of the law. Hunter’s behavior seems to have violated both in this case.

It’s fun times these days to be a commodity trader / blogger. There is no mid-range to the comments. Most of the criticism or descending comments I get on anything I write about the role of commodity traders usually has the undertone of populist anger around TARP. I try to present a balanced argument to the anger that is misplaced on managers of commodity hedge funds and CTAs who get lumped in with the big banks who benefited from the bailout.

Wall St. is divided by partisan lines. But in the United States, Republican and Democrat politicians are Corporatists. The terms Democrat and Republican refer to how individuals are registered to vote, or who takes a certain side of an argument. The recent SCOTUS ruling means that China Investment Corporation can sway elections here in the US. Trends persist.

I do not have a political agenda, unless of course you think that being a proponent of preserving individual liberty and personal sovereignty is an agenda, then I have one. In my paradigm, I am responsible for everything that happens in my life…good and bad. I cannot blame anyone for my failures or the times when I’ve had bad luck. That is so foreign to me anymore, I don’t think blaming others for my failures would even feel good.

When Refco went under, I lost my one and only client at the time. And we were dealing with their Indian subsidiary…we were shot by friendly corporate fire. But, no one held a gun to my head and said “bank on one large client.” That was my doing. I admit to having visions of putting a 38-ounce Louisville Slugger to the forehead of Phillip Bennett, the now imprisoned Refco CEO, but that was just a mask for my fear of losing everything. There was no TARP money for me. There wasn’t an SBA loan either. There were friends and family, and my sense of persistence and determination.

I’m not a fan of any politician on either side of the aisle. For the life of me, I don’t know how anyone can idolize a politician. Nor do I idolize my mentors Ed Seykota, Victor Sperandeo, and Jim Rogers, for example. They continue to be kind and generous with me. I celebrate their mentoring and teaching and I pay it forward by sharing as much of it as I can with the readers on my blog for free.

My debate is not with those who criticize me or the commodity futures industry – I don’t think they fully understand how risk transfer markets work. It is with arrogant members of the academic community and especially those in the self-interest groups who believe in abolishing individual freedom and free markets to exert power or control over others.

Economically speaking, academics think in terms of pay-grades and tenure. I think because of that, it seems, they decree a sense of what is fair and what is not. They have no choice but to accept that there is only so much they can earn for all their teaching skills. Frankly, I believe that teachers, instructors, and professors are underpaid, but they do not stand on a higher moral ground because of the choices they’ve made professionally.

Special-interest groups are myopic at best. Whereas Wall St. benefited handsomely from the Greenspan and Bernanke Puts (Put Options), special interest groups want Legislative and regulatory Call options: they want all the upside, but don’t want to pay for the option.

Professional investors earning huge sums of money each year, while the rest of the country is hurting is not an injustice. It’s progress. And trying to cap one’s income or legislate one’s behavior takes the United States backwards, not forwards. Education is the answer – especially in financial literacy. Education is what will close the gap, and IMHO it’s far better to encourage individuals to progress, than to truncate or retard their growth.

The whiners who blather about “what is fair” have already surrendered their power. They are in the camp that the government or a regulator should decide an individual or a group’s fate. I suggest that they learn to trade to better manage their risk or to enhance their compensation. It might also give them a new found sense of liberty. Fairness is a form of reality.

Americans are hurting now, and I genuinely feel for those who are out of work or have suffered through the real estate crash, have been laid off, or downsized. My father was in a labor union and spent months out of work in the late 70s. It was very painful financially and emotionally. I don’t blame President Carter: he made some very stupid decisions, but so did Presidents Nixon and Ford.

I teach anyone who wants to learn and I love when students argue because I know I’m challenging their set-in stone beliefs. My classes have a wide-array of students from various backgrounds and ability levels. Essentially, I teach Risk Management in the form of commodity trading to all types of traders, investors, and hedgers:

Investors

• CFA Charter holders who want to go beyond their professional studies of their charter
• Equity Mutual Fund managers who want to learn more about the cyclical markets of commodities
• MBAs, CMTs, Ph.D’s, and CFA’s who manage Equity or Fixed Income portfolios who want to manage basis risk
• Forex dealers
• Individuals who want to become CTAs or commodity investors
• Individuals who are looking for a change in career

Hedgers

My classes are very heavily represented by the hedging community.

• Energy companies
• Energy wholesalers
• Agriculture firms
• Electric Utilities
• Airlines
• Refineries
• Firms that use crude oil distillates to produce their products
• Individuals and firms who want to hedge an adverse move in a currency their dealing with

I am no apologist for a trader’s bad behavior on either side of the transaction. If a large trader can dominate the market, it hurts me, so naturally I’m against it.

If a commodity user or producer does not engage in hedging, and the commodity in question is an integral part of the business, then they are at the same time, foolish, gamblers, and irresponsible.

This post originally appeared in at The Ludwig von Mises Institute. You should read the comments there too – very insightful.

There is undoubtedly going to be a lot about Proprietary Trading firms in the news for a while and there’s a lot of questions about what and who they are and what they do exactly. It’s actually easy to understand: a trader is given a line of credit within his/her firm to trade for the purpose of generating trading profits. It is the firm’s own capital. The trader has one client: the firm – and in this case we’re talking about publicly traded firms that are under scrutiny. And they aren’t exclusively prop trading firms, they have what are called Prop trading desks.

I think a prop trading firm in the purest sense would be like the few I’ve mentioned in an earlier post, DE Shaw and Schonfeld. Another is Susquehanna Investment Group.

On the prop trading desk, the trader is typically given a monthly draw as salary, but that is not their main compensation, nor is it their motivation. I’d say all Proprietary traders are working for their bonus, which is a share in the profits they’ve generated for their firm. Those net profits go to the firm’s bottom line and are counted in EPS. If the trader fails to make money, they usually get fired. Most professional traders are excellent in playing superb defense – small or smaller losses are easier to overcome financially and emotionally speaking.

There have been some pretty stellar Prop trading desks over the years. Marc Rich’s first employer Philip Brothers (now Phibro) was a big trader in the day. So was their owner, Salomon Brothers. Another thing we can blame Sandy Weill for is killing Phibro and all the prop trading inside Solly. Trading profits can be volatile and neither Sandy nor Jamie wanted that type of risk on their balance sheet.

I’d have to look at the dates, but Commodities Corporation comes to mind as probably one of the first, if not THE first Proprietary trading outfit. I’ll have more on this in the next month. Goldman Sachs has always traded their own capital. They’ve also done merchant banking and investment banking and to my knowledge have never been too afraid to put their own capital on the line.

There has been some concern over the years about the concept of the Chinese Wall – the flow of information from the Agency desk to the prop desk and it’s not supposed to happen. Front running is putting your orders ahead of your clients. But what is it when you trade alongside that same client?

Here’s an example:

The Munderous Inter-net-of-my-fees Mutual Fund A (aka weapon of mass destruction) (Ticker:MFUXU) calls the floor of the NYSE and needs 1MM shares of MNO stock. You only trade 50M shares at a clip. Obviously, 1MM shares of buying pressure will put some wind in your sails if you’re long the 50M before the million share order gets filled. Doing so would be front running.

Buying the 50M shares (or another 1MM) alongside your client is called being a Specialist.

MartinKronicle has a Facebook fan page, if that’s what you call it.

The difference between commenting here on the blog and there on Facebook, it that you’ll be able to better interact with one another on my posts. I personally respond to each email and post as fast as possible, but I am entirely fortunate to have some very intelligent readers and fellow bloggers who interact with me and I want you to be involved.

I would encourage you to “become a fan,” as it’s called that for several reasons. There is a bit of a community that is formed around blogs and social media and you might meet some pretty smart people and make some friends too. My guess is some of you might have some friends in common. Wouldn’t that be cool…

Also, I believe in this enough, I’ll be posting some exclusive content on Facebook that won’t appear on the blog.