Best of the Week
Most Popular
1.Stock Market Crash and Recession Indicator Warning: Extreme Danger Ahead - Harry_Dent
2. Is This How World War III Begins, In Almost Complete Silence? - Jeff_Berwick
3.Trump Wins 2nd Presidential Debate, Betfair Betting Markets Odds Bounce - Nadeem_Walayat
4.Why Krugman, Roubini, Rogoff And Buffett Dislike Gold - GoldCore
5.End of SPX Stock Market Correction Nears - Tony_Caldaro
6.Get Ready for the Future - Exponential Machine Intelligence Mega-trend towards Singularity - Nadeem_Walayat
7.US Housing Market Bubble II – It’s Happening Again! - Andy_Sutton
8.FTSE BrExit Stock Market Panic Crash Resolves towards New All Time Highs - Nadeem_Walayat
9.Can Trump Still Win Despite Opinion Polls, Bookmakers and Pundits all Saying Hillary has Won? - Nadeem_Walayat
10.Gold’s, Miners’ Stops Run - Zeal_LLC
Last 7 days
4 Incredible Market Forecasts You Have to See to Believe - 26th Oct 16
Silver Prices in an Exponential Financial System - 26th Oct 16
Rigged Election: Hillary and Trump Caught Partying Like BFF’s With Kissinger at Jesuit Gala - 26th Oct 16
The Current Message of Yield Curves: Inflation or Deflation? - 25th Oct 16
Broken Central Banks: 4 Quick Pix - 25th Oct 16
Government Stimulus is an Oxymoron, Debt to GDP - 25th Oct 16
Where Will Crude Oil Price Head Next? - 25th Oct 16
Diamonds in the Gold and Silver Mining Stocks - 25th Oct 16
Trump’s Gettysburg Address against the New World - 25th Oct 16
This Past Week in Gold - 24th Oct 16
Can Gold Continue To Rise, Since The Usd Is Moving Higher Too? - 24th Oct 16
Why are Americans Avoiding the Stock Markets; Fear or Lack of Money? - 24th Oct 16
The US Is NOT a Low-Tax Jurisdiction - 24th Oct 16
Stocks, Crude Oil and EURUSD Trend Forecasts - 24th Oct 16
Stock Market Another Month to Go? - 24th Oct 16
Large Sell-off in Stock Market Looming - 24th Oct 16
Ungovernability - 24th Oct 16
Stock Market Boredom Before The Storm - 24th Oct 16
Establishment Mainstream Media Elite Buys US Election for Hillary Clinton, Time Running Out for Trump - 23rd Oct 16
Inflation About To Explode Higher - 22nd Oct 16
Still waiting for SPX uptrend to kick off - 22nd Oct 16
Will a Rising US Dollar Crush Gold’s Fledgling Bull? - 22nd Oct 16
Why The Global Economy Will Disintegrate Rapidly Back to Olduvai Gorge - 22nd Oct 16
GLD Bleeds Out; Weekly Gold Update - 22nd Oct 16
Stock Market Investment Success Through the “Investment Rule of 72” - 21st Oct 16
The Final Bottom in Gold - WHEN - 21st Oct 16
Gold Green Lights Upleg - 21st Oct 16
Demand for US Mints Silver Eagles has ‘Returned with a Vengeance’ - 21st Oct 16
Central Bankers Can't Stop The Death Blow Of The Post US Election Recession - 21st Oct 16
The Fortune at the Bottom of the Pyramid: Golden Opportunity for Frontier Asia - 21st Oct 16
Have You Taken These 4 Simple Steps to Improve Your Trading? - 21st Oct 16
The Stock Market is an Accident Waiting to Happen - 20th Oct 16
It's Rally Time for Gold and Silver Equities - 20th Oct 16
Cashless Society – Risks Posed By The War On Cash - 20th Oct 16
China's insane Housing Market Will Tumble and Crash in 2017 - 20th Oct 16
Donald Trump Bounces Going into 3rd and Final US Presidential Election Debate - 20th Oct 16
Attention Please: Phase Two of the Gold and Silver Train Now leaving the Station. All Aboard? - 19th Oct 16
How to Successfully Trade a Stock Market Crash - Black Monday October 19th 1987 - 19th Oct 16
Tesla, Apple and Uber Push Lithium Prices Even Higher - 18th Oct 16
Silver, Debt, and Deficits – From an Election Year Perspective - 18th Oct 16
UK Property Market: Slow Growth Does Not Equate To Decline - 18th Oct 16
Trump Election Victory is in Your Power - 18th Oct 16
Stock Market More to Come! - 18th Oct 16
This Past Week in Gold and Silver - 17th Oct 16
A Falling Stock Market Cannot Be Allowed - Financial Repression Is Now “In-Play”! - 17th Oct 16
Commodities, Forex and Stock Market Trend Forecasts - 17th Oct 16
Stock Market Crash..or No Crash? - 17th Oct 16
A perspective on risk rally – Risks abound but Stock Market is Confident - 17th Oct 16
Bank of England Blames Brexit for Sterling Drop Inflation, Masks QE Money Printing Cause - 17th Oct 16
From Piety to Pride to Pity, America's Racial Divide - 17th Oct 16

Free Instant Analysis

Free Instant Technical Analysis

Market Oracle FREE Newsletter

The Power of the Wave Principle

Derivatives Disaster: Deriving The Truth

Companies / Corporate Earnings May 19, 2007 - 11:10 AM GMT

By: Rob_Kirby


In an article I penned two weeks ago, I discussed the misfortunes of the Bank of Montreal [BMO] and their costly foray into Natural Gas derivatives trading. In that piece I wrote what are now some rather prophetic words in my assessment of BMO and their 450 million “charge” against 2 nd quarter earnings, when I opined;

“This means that the BMO's ‘long natural gas position' was almost certainly a MUCH BIGGER LOSS – at one point in time – than they are admitting to us now.

BMO's year end is Oct. 31. I'm left wondering why they did not report a bigger loss last quarter.”

Then, this week, BMO announced they REALLY lost 680 million and they are now going to “restate” 1 st quarter earnings.

Amazing, eh?

But I suspect something is still not quite right.

You see folks, what has befallen BMO is not dissimilar to that which befell Amaranth. They made a rather large bet on the direction in price of a vital commodity – no doubt based on their fundamental views of its value – and lost.

The BMO was Amaranth's prime Canadian broker. Could they have been trading on the coat tails of Amaranth? Who knows?

But what we do know is that ‘the other side' of Amaranth's ‘losing long natural gas derivatives bets' was none other than J.P. Morgan Chase. In fact, it was J.P. Morgan Chase – and their ‘short position' that ultimately ‘ absorbed ' Amaranth's long position in the wake of their demise.

Getting back to the BMO, in an April 30 Bloomberg article dealing with this fiasco, it was revealed that,

“Bank of Montreal managed its trades according to a value- at-risk, or VaR, a model that gauged how much the bank could lose in a day if markets moved against it. The company increased its commodities VaR to C$5.9 million in 2006 from C$1.3 million in 2004, according to Dominion Bond Rating Service.”

So, it now appears that BMO, SOMEHOW, managed to lose 680 million bucks with a VaR of C$5.9. 

Now, let's stop to consider that the other side of those trades, namely, J.P. Morgan Chase has a derivatives book in the neighborhood of 68 TRILLION in notional and VaR of U.S.$88:

Read about VaR here . [pg. 5 of pdf. doc.]

So, now ask yourself this question: Using an ‘apples to apples' comparison - if the BMO lost 680 million with a VaR of 5.9 $CAD – what kind of loss could we expect to see from good ole J.P. Morgan if they ever “got-it-wrong” with a VaR of U.S.$88? Doing some quick ‘back of the envelope' math [not even accounting for exchange, which increases the number]:

88 / 5.9 = 14.92 x 680 million = 10.1 BILLION

Isn't math fun?

Amaranth's well publicized failure – resulting from a ‘long natural gas position' – became public knowledge in the Sept. 06 time frame. Sept. 06 falls within decline “B” on the chart above. Conventional mainstream financial media accounts at the time were rife with claims that Amaranth's difficulties were “one off” in nature – and the steep declines in natural gas prices would/should not meaningfully affect ‘ANYONE' other than this rouge trading entity.

September 23, 2006
Amaranth : Lessons on Hedge Fund Failures

“The difficulty of Amaranth has three notable features. First, there was no market panic. It caused barely a ripple. Those who believe a hedge fund failure could take down our financial system are... well... silly.”

The Pundits Were At Least Partially Wrong – Maybe Very Wrong

For anyone who adheres to logic or reason - the chart above clearly shows that to incur losses trading Nat. Gas from the ‘long side' of the magnitude that BMO is now reporting [680 million at last count] – one would NECESSARILY have been “LONG NATURAL GAS” through one or both of the circled steep price declines depicted on the chart above [A and/or B].

What this means is that the BMO incurred their losses BEFORE their year end. So now, shouldn't we really be asking the question, Why weren't these losses reported in Q4 when they were incurred – and in all likelihood – were still much greater than they are being admitted to now?

Because derivatives are classified as “off-balance sheet items”, institutions like the BMO, Amaranth, Enron et al have the ability to play “shell games” with their unrealized profits/losses and effectively prolong [or time, perhaps?] the exact time when they assimilate/admit [mark-to-market] their impact back into the balance sheet.

The fundamental difference between a banking institution and a non banking institution being that latter is usually more levered - unless of course we're talking about J.P. Morgan Chase - than the former and therefore ‘more beholding' to the banking entity.

In the case of J.P. Morgan Chase, one can only wonder if this applies and is perhaps the real reason we've never heard of a J.P. Morgan “oops”,

“President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye.”

Perhaps some people never catch colds.

The notion that trading losses inflicted on “hedge funds” could not bring down the financial system is beyond silly – it fact, it's MORONIC. The BMO [a publicly traded bank] has CATEGORICALLY incurred substantial losses trading Natural Gas derivatives and they've kept this all a private matter – seemingly – for AT LEAST two quarters!

Yeah be they who create the money out of thin air!

Why BMO Waited to Acknowledge Losses

This is a question that only BMO management can truthfully answer. It would appear that – under the circumstances – likely contributing factors might have been:

  • not wanting to report such sudden “steep losses” so close to YEAR END – in an ‘otherwise' profitable year and negatively impacting generous year end bonuses.

  • not wanting to acknowledge “steep losses” in Natural Gas trading at the same time as Amaranth was collapsing to avoid being ‘painted with the same brush' and possibly having their share price beaten up in equity markets.

  • BMO's new chairman, Bill Downe, was “announced” to succeed former chairman, Tony Comper, on November 29, 2006 – effective March 1, 2007. Down is the former head of Capital Markets – the same division of the bank where the now 680 million losses have occurred. Would admission of these or steeper losses back in November 06 have interfered with planned succession of the chairmanship?

The really BIG and most important question – in my mind - is how and why did regulators ever allow J.P. Morgan Chase to inflict such damage on these players?

By Rob Kirby

Rob Kirby is the editor of the Kirby Analytics Bi-weekly Online Newsletter, which provides proprietry Macroeconomic Research.

Many of Rob's published articles are archived at , and edited by Mary Puplava of

© 2005-2016 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife