By Barani Krishnan

August 4, 2006

NEW YORK, Aug 4 (Reuters) - News that a U.S. hedge fund was closing after taking heavy losses has dealt a fresh blow to the $1.3 trillion hedge fund industry but would not slow it much, analysts said on Friday.

MotherRock LP, a $500 million fund, was crippled by estimated losses of between $85 million and $235 million from bad bets on natural gas contracts traded on the New York Mercantile Exchange (NYMEX), traders said on Thursday.

Reports of its impending closure sent a buzz through an industry desperate for positive headlines since the colossal losses and bad publicity suffered by many hedge funds in May.

Still, analysts said investors were flocking to the hedge fund world in spite of knowing little about it and playing the energy markets -- or better still commodities -- remain a magnet for many.

"It's a brutal market but the money continues to flow in here," said Stephen Schork, analyst and publisher of
The Schork Report, an intelligence service for energy market investors.

Schork said hedge funds were estimated to own 2.4 times more barrels in NYMEX crude oil contracts than actual physical barrels of oil deliverable to the market.

"The long-term perspective for the energy market is a very long bull run. So, the lesson from MotherRock, if there's one, is 'buyer beware'. It's a classic risk-rewards scenario. The potential rewards are tremendous. So are the risks," he said.

Hedge funds such as MotherRock are loosely regulated investment partnerships that use complex methods such as short-selling, arbitrage and derivatives to profit from any market. They never reveal their positions unless required by commercial arrangement.

One fund manager said a lesson for MotherRock was it could have hedged into other commodities and funds.

"MotherRock was a single-manager fund. If nothing else, their blow-up supports the need for diversification," said the fund manager who declined to be quoted.

Traders said MotherRock was believed to have been selling natural gas short -- meaning it was bearish -- when prices suddenly spiked in the last two weeks.

Gas futures hit a peak of above $15 per million British thermal units (mmbtu) in December, after which it fell some 60 percent as a mild winter left a huge overhang of gas in storage. A moderate spring that followed -- and early summer weather -- helped drive inventories to record highs.

But after a 19-month low of about $5.30 in early July, gas prices rebounded some 40 percent to above $7 per mmbtu, as record heat spread from California to New York and kicked up demand to cool homes and businesses.

EXPERIENCE DOES NOT EQUAL SAFE

MotherRock -- formed in 2004 by J. Robert Collins, the former president of NYMEX -- did not return Reuters' calls for comments.

Analysts said the incident showed investments in hedge funds were not necessarily made safer by experienced traders, and investors had to be responsible for their own money.

"I think a lot of the risk comes through the fact that you don't really know what you're getting," Gary Weiss, author of "Wall Street versus America", a book on big corporate wrongdoings, said on a CNBC chat show.

"I think these hedge funds should only be for people who really can afford to lose," said Weiss, disagreeing with new trading conditions that allow investors with as little as $9,000 to come into hedge funds.

Others said they didn't expect the MotherRock demise to have a major impact on the energy trading market.

"There are a lot of commodity specialty funds now and this is a relatively small one," said Jonathan Farber at Lime Rock Partners, a $2 billion energy buyout and venture fund.

Farber said he didn't expect a rash of other meltdowns because natural gas trading firms recognize that natural gas has "extremely high volatility" and hedge themselves against trading risks.

Schork had a different view. "I actually have clients speculating that MotherRock is not the only fund that's imploded. It's like the cockroach theory: A light has been turned on and MotherRock has been exposed. Just when the light turns on, all the other roaches go scurrying under the refrigerator."

"I wouldn't be surprised if and when -- and it doesn't necessarily have to happen this week -- we find out another fund out there has been mortally wounded.

((Additional reporting by Dane Hamilton in New York and Jonathan Leff in Singapore))

((Editing by Marguerita Choy; Reuters Messaging: barani.krishnan@reuters.com, +1 646 223 6192))