As a Bubble Bursts, Funds Feel the Burn

Commodities Caught Investors off Guard

NEW YORK -- The deflating commodities bubble is claiming its first casualties as large investment funds absorb staggering losses from bad bets that prices for oil, precious metals and grains would keep going up.

Hedge fund operator Ospraie Management notified investors last week that it was closing its flagship fund after August losses in energy, mining and other natural resource-related stocks that left the fund down nearly 40 percent year-to-date. It's thought to be the first hedge fund to go bust in this latest commodities boom as prices come crashing down after a historic bull run earlier this year.

And the bloodletting may have only begun. Wall Street analysts say similar trouble looms for other funds that got caught up in the exuberance of the boom but were too late getting out.

They say Ospraie illustrates one of the hard lessons from the commodities bubble: Many money managers have never been through a commodities boom and so were ill-prepared for the hyper-volatility associated with hard assets.

"You're always going to have victims when a market comes down this fast," said Phil Flynn, energy analyst at Alaron Trading. "People stayed at the party for too long."

As commodity prices soared in the first half of the year, hedge funds and other big institutional investors plowed money not only into oil, gold, copper and corn, but also into more obscure assets such as cocoa, lead and pork bellies.

That, analysts say, helped drive a wedge between the commodities' trading prices and their real prices as reflected by actual supply and demand -- foreshadowing the violent correction of recent weeks. Since surging to a record $147.27 a barrel on July 11, crude oil has tumbled more than $40, or 27 percent. Gold has declined 22 percent from a March 17 record of $1,033.90 an ounce. Corn has dropped 31 percent from a June record.

At the same time, companies heavily reliant on commodities have seen their stock prices hammered. Oil and gas explorer XTO Energy has fallen 32 percent in the past eight weeks, Potash Corp. of Saskatchewan has dropped 27 percent, and aluminum producer Alcoa has slid 11 percent.

The pullbacks have been exacerbated by a widening global economic slowdown that has dented demand for energy and raw materials.

For funds such as Ospraie that invested heavily in commodities-related stocks, the whiplash of the market's reversal was stunning.

By early August, Ospraie's flagship fund had $2.8 billion invested, but it had a negative return of 26.72 percent after commodities and related equities fell into a six-week tailspin "characterized by some of the sharpest declines in these sectors in the past 20 years," the fund's founder, Dwight W. Anderson, said in a letter to investors obtained by the Associated Press.

The losses left the fund down 38.6 percent so far in 2008.