Bashing JPMorgan, Goldman Sachs Won't Help LME, Aluminum Premiums

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Why is the US Federal Reserve looking into reviewing whether Goldman Sachs, JPMorgan and other banks can hold physical commodities such as gas, aluminum and the infrastructure in which to store them?

Because of facts like these: a Euromoney article reports that according to the Aluminum Association, the US aluminum supply totaled 18.3 billion pounds (8.3 million tons) in 2009, with industry sources putting Goldman Sachs holding some 25% of it.

The article went on to speculate that a rapid exit from their positions could precipitate a collapse in prices, but in reality it is unlikely the banks would liquidate their positions. Their trading positions and commodities business division are lucrative businesses in their own right and the banks are much more likely to put them up for sale than simply liquidate them.

For example, JPMorgan’s warehousing business is estimated to have contributed some $250 million of revenue annually.

JPMorgans of the World: Not Only Game in Town

Would the world be a safer place without these major players’ direct involvement as position takers and operators of infrastructure?

To some extent, yes, but as they are only one of several players – hedge funds and traders also hold material, speculate or invest in the same way. Removing the banks won’t in and of itself stop the stock and finance model that has contributed to the high physical premiums.

Forcing the warehouse operators to load out material on demand has issues around access and the practicality of handling large volumes over a short space of time, but some such measures are required if the LME is to have any relevance as a market that can realize a true and fair market price.

Reducing banks’ involvement in the metals markets would reduce the number of major players holding large market moving volumes, but there would remain others. The current focus on the major ex-merchant or investment banks, therefore, has more to do with political posturing than a genuine desire to create a fair and open market for commodities.

Read more from Stuart Burns.

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One Comment

  • The current focus on the major ex-merchant or investment banks, should be about the pursuit of two objectives.
    A) the avoidance of a major moral hazard. To over-simplify: Banks have access to funding at preferential rates/terms from the government via the fed window, and/or via deposits which they accept due to their banking license. (with an implicit guarantee from the government, and by extension the taxpaying public). This was granted to incentivize lending to American businesses and consumers to stimulate economic growth. When that money is instead utilized by the banks to both distort a market and profit by that distortion, and drive up prices that taxpaying businesses and consumers alike pay for materials and goods it is problematic. The result being that such commercial bank participation in the commodity markets has three negative implications. 1-The funding they have been given access to isn’t being utilized for it’s intended purpose, business and consumer lending, 2-Them funding they have been given is being used to distort a market at the expense of the public who consume those goods, and whose tax revenue funds the implicit guarantee, and fed access the commercial banks rely upon. And if the banks happen to execute wrong and suffer a catastrophic loss, the victims of their folly are at peril as they will be forced to fund the bailout or FDIC insurance claims, or both. 3-because they are using their available funding to participate in the manipulation of a commodity market, that money isn’t all being lent to businesses and consumers to stimulate economic growth as it was intended.
    B) Without the commercial banks participating in the manipulation of the commodity markets, the markets would have less “congestion” and would function better for the participants who need them for fundamental business purposes. I think this augment, but not perfect “fairness”. This is not to say that they would function perfectly, as there are certainly large players who can exert great influence, but at least the numbers would be thinned, and those that were exerting influence would be doing so with private money and exposure, not public. exposure, leveraging instruments intended to incentivize economic growth, not market manipulation.


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