We recently speculated what the impact of a Fed surcharge on merchant banks might do to both LME aluminum inventory levels, not to mention MW premiums and even aluminum prices for that matter. Readers can catch the first part of that interview here. This is the second part of our interview with our own Stuart Burns…
MM: As we like to say around here, the devil is in the details. Given that some of these banks are dipping twice, it seems as though the Fed would only want to levy a surcharge on the metal in warehouses. So what kind of impact do you think this would have on stock levels?
SB: Insomuch as it dissuades the likes of Goldman Sachs and JP Morgan from holding metal themselves, it may reduce inventory levels– but these banks are smart. If there is a way around it, they will find it. There are two dynamics, as you rightly observe. In time, they may be pushed to sell their warehouse assets, and then another market player could move in. Glencore or Noble or Trafigura could pick up the bank warehouses, in which case it’s business as usual, and we substitute one monopolist for another. If the banks are encouraged to exit metal trading, that’s a different issue and could reduce (not remove, as there are still many hedge funds and other financial players) the demand for the stock and carry trade in aluminum. Will it be a game changer? My belief is no, but it will be a step in the right direction and may usher in a period of additional caution among the financial community engaged in this stock and carry trade into thinking who next is going to be squeezed out.
MM: How quickly do you think an announcement of a rule with an effective date in the future will impact LME aluminum warehouse stock levels?
SB: We have seen physical premiums drop 10-15% over the last month or two just on the rumor of changes in the LME load out rules, so there could be a reaction even before a firm decision is taken on these Fed surcharge rules. Markets move as much on sentiment as on fact. However, I doubt it will be dramatic, simply because big as Goldman Sachs and JP Morgan are, they are the market in totality.
MM: If you were the US government, what other policy alternatives might you consider?
SB: Good question. Governments are rightly wary of getting directly involved in markets, but whether banning warehouse firms from also owning metal (and pipeline owners from also trading oil, etc.) would work is debatable. Goldman Sachs would argue they own the metal but Metro owns the warehouse. The fact Goldman Sachs owns Metro still allows distance between the two. If Goldman sold a 51% share in Metro, would they still “own” Metro? I like the Fed’s proposal because it dissuades all involvement rather than trying to micromanage who does what.