CFTC Probes Aluminum Warehouse Schemes As Producers Go Unnoticed

Everybody loves to hate a big bank. And everybody loves to hate a bank that ‘manipulates metals markets.’ The ridiculously slow aluminum load-out schemes, inflated Midwest premium prices (even in a world awash with the light metal) and the “speculation” that has become a regular part of the industrial buyers’ daily routine have all created discontent among the masses.

Whether the Goldman-Sachs and JPMorgans of the world have done anything illegal, we can’t say – after all, the Federal Reserve said it “is reviewing a 2003 regulatory decision that allowed Wall Street investment banks to enter into the commodities business.” Perhaps that’s a follow-on to the dismantling of the Glass-Steagall Act.

Has this one regulatory decision caused commodity volatility? That’s for another post, though certainly it has likely caused some of the volatility. (China demand, the market herd effect, supply shortages and interest rates likely play a much larger role than this one regulatory decision.) So when the Commodity Futures Trading Commission (CFTC) decided to send letters ordering the key players to retain emails, documents, etc., an investigation may come in the near future.

“Okay, so what?” you say…

Any aluminum buyer has known for years the LME warehouse system seems rigged. What many of the stories fail to explain, however, involve the actors or the stakeholders of such a scheme. Let’s take a look at our cast of characters in this play:

  • Lead Role: The evil traders – the speculators (though not really evil, of course, but they do tend to take a lot of the blame)
  • Supporting Role: The big banks – the warehouse owners who comply with the rule of the law (LME rules), but not necessarily the intent (let’s move material to other warehouses or load out the minimum quantities required only)
  • Guest Star: The aluminum producers (largely left out of all stories involving the LME warehouse scheme, but who receive ‘benefits’ by supporting the warehousing scheme)
  • Our True Protagonist: The downstream buyers

Much of the warehouse drama has focused on the banks – and the banks will continue to take the whipping (again, the public loves to hate them). The “financialization” of the manufacturing industry irks the masses. But nobody has paid much heed to the benefits bestowed upon the aluminum producers – who may have received incentives from the banks to continue producing metal for storage in these warehouses. This last point appears to form the basis of the CFTC inquiries.

Moreover, producers benefit directly from an inflated or, let’s say, ‘above the historical average’ MW premium price. That premium, along with the underlying metal cost, gets passed down through the supply chain. So the producers also benefit greatly from this market distortion – after all, that’s what this inflated MW premium is, because certainly demand has little to do with it.

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According to a Reuters story, if an investigation ensues, it would serve as the first by any regulator into this controversy. Whether or not the CFTC will find any illegal activity remains unclear.

Of course, if it looks like a duck, swims like a duck, and quacks like a duck…

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