Energy & Infrastructure Bet Blows Up... At Least For One Hedge Fund

One of the macro things that was popular in the last 2 years was the infrastructure boom thesis (I'm going to leave out energy for the time being.) This hypothesis was based on the view that the world was short of infrastructure and needed hundreads of billions in investments. Think of the internet infrastructure thesis in the late 90's, which postulated that we needed hundreads of billions invested to increase internet accessbility. There is some merit to the infrastructure strategy but I have always been skeptical of the timing. Namely, I have always felt that this is a theme that will take a long time--10 to 20 years--to play out, which essentially means that profits will come slowly. It isn't a scheme to get rich quick.

Something that always made me skeptical of the infrastructure boom is the seeming ignorance of government finances. Almost all of the infrastructure was expected to be financed by governments yet most governments out there, right from USA to Mexico to India, don't have any money. Even the much hyped countries running current account and fiscal surpluses like Russia and China are not what they seem. People seem to assume that central bank reserves, built up through trade surpluses, are the same thing as government cash, when in fact they are not. A lot of this money cannot be spent, and, instead, must be kept as reserves for emergencies, or to defend the currency, or some such deed. For example, a lot of people say that USA needs hundreads of billions of dollars of infrastructure spending. Ok, fine. But who is going to pay for them? Many municipalities and state governments are running into financial problems, including the wealthy state of California.

Anyway, it looks like the infrastructure boom is blowing up, without it even materializing at all. This could be the rare case of stock prices being bid up to the stratosphere without the actual economy being built up. A hedge fund seems to have suffered massive losses and this may not be temporary:

Tontine Associates, a $10 billion Greenwich, Conn.-based fund, told investors on Friday that it expected to show a 2008 loss through Sept. 30 of 65%, according to two people familiar with the fund's performance.

Tontine builds large, concentrated positions in companies central to the big-picture investment thesis of the fund's general partner, former Smith Barney analyst Jeffrey Gendell. That kind of focused strategy can pay off big when a manager's vision is spot on.

...

Lately, Gendell has wagered on a worldwide economic boom, investing heavily in global energy services and infrastructure companies.

That looked like a sound strategy until a few months ago. No longer. Tontine's massive positions in companies such as U.S. Steel, iron miner and processor Cleveland Cliffs and tire manufacturer Goodyear have gone terribly.

As growth in the global economy started showing signs of a slowdown, and as investors began to worry that capital-intensive companies might have their access to bank lines and the debt markets constricted, Tontine's portfolio suffered sharp hits.

There is still some merit in the infrastructure thesis but it will have to be a long-term play. I also think it has to be focused on specific regions of the world. I don't think you can bet on a large steel producer on the basis that there is going to be greater need due to building of roads, airports, and so forth. Instead, one may have to bet on a regional steel company, or a specialized architectural or construction firm. Anyway, that's my thinking right now.