2008-02-07

Wild Price Swings Could Implode Hedge Funds

I guess nobody has missed the wild swings during the first weeks of 2008 in the prices of just about everything that can be traded.
  • S&P 500 stock index from 1471 down to 1388 up again to 1429 down again to 1270 up again to 1396 down again to 1317. A span of about 16%.
  • Crude oil from 95 up to 100 down again to 86 up again to 92 down again to 87 $/barrel. A span of about 16%.
  • Gold from 840 up to 912 down again to 860 up again to 930 down again to 885 $/oz. A span of about 11%.
  • 10 year US treasury note yield from 4.05% down to 3.28% up again to 3.74% down again to 3.53% up again today to 3.74%.
  • And so on...
These wild swings in prices of equities and commodities have been very hard to predict. Now, hedge funds all around the world are making bets all the time on the direction that certain prices will take, and these bets are often highly leveraged (i.e. they borrowed a lot of money to bet). This means that a number of hedge funds have probably made bad bets over the last few weeks, some of them maybe bad enough to "implode" the fund, because prices have quickly and unexpectedly moved in the "wrong" direction. So I predict that we will soon see a number of hedge fund failures, and some of them might be rather spectacular.
We have already seen an example of what can happen when big trades go wrong in the case of the "rogue trader" at the French bank Société Générale. The losses in this case were about €4.9 billion, enough to topple most hedge funds.

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