This weekend the New York Times wrote a story about Metro International Trade Services, a Detroit-based aluminium storage company owned by Goldman Sachs.
The way the NYT tells it, Goldman is shuffling the commodity around its own warehouses in order to increase demand for the commodity, thus impacting the price of the commodity.
Goldman shot back, arguing that customers control flows in and out of the warehouses since they own the actual commodity. Additionally, Goldman said the commodity is suffering from weak demand, which has been reflected in the beating its spot price has taken since February when it was at $2,100 a ton to now, when it sits below $1,775 a ton.
Because of an obscure (to us laymen) trading phenomena, they could both be right. It could be that Goldman is impacting the price of the commodity, but not because of something as simple as a warehouse shuffle.
The trading phenomena is called contango. It’s what happens when the curve showing the spot price of a commodity (the price at which you can buy a commodity at a give time) is less than the futures market’s price for the commodity.
The spot price merely considers the value of the commodity, the futures price factors in the spot price, the theoretical minimal return on investment an investor can expect, and time to maturity of the contract (that includes storage/convenience costs).
Izabella Kaminska got super technical with it in a post of FT Alphaville. She pointed out that during a contango, anyone housing the asset can make a profit by forward selling it on the futures market, then they can essentially let the owners of the asset pay rent until it has to be delivered.
Regulation demands that Goldman move the aluminium around after a certain amount of time, and that’s why there’s all the trucking rigmarole. That isn’t, however, what impacts price. The game changer is the fact that the market paying futures prices for the commodity, eventually impacts the spot price of the commodity.
“They [Goldman] can influence the price heavily because they affect a price where the entire market pegs,” said Jeffrey Carter, a former board member of the Chicago Mercantile exchange and writer of the blog, Points and Figures. “The key is where is the market pegged. Using the same logic, think about LIBOR, the financial crisis and the Eurodollar contract. The banks fixed the rate and under reported where it was. That allowed them to have cheaper borrowing costs when they should have seen skyrocketing borrowing costs.”
Goldman would argue that they don’t own enough aluminium to make a difference, since Metro is just one company in a big London Mercantile Exchange system. Additionally, 95% of the world’s aluminium doesn’t go through the warehouse system at all.
It’s hard to tell, though, because this market is so murky. Trading houses can change the classification of commodities from public inventory to private “dark inventory” and vice versa when they’re being pre-sold (as they are in this case), according to the FT.
“The best remedy is a transparent public market, accessible by anyone (speculators included),” said Carter. “That means trading isn’t secret, there isn’t any way to game the system (which is what Goldman was doing). The market needs to be marked to market, cleared and settled each day by an independent, objective third party. That will bring some discipline, because of approved delivery facilities and transparent rules.”
We’ll know more about that in September, as the Federal Reserve reconsiders the 2003 ruling that allowed banks like Goldman to step into this business (and own physical commodities) in the first place. You can bet that the banks won’t take it lying down though.
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