Aluminum Warehouse Queues a Symptom, Not the Cause, of Higher Premiums

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As we reported last week, Carl Levin’s Permanent Subcommittee On Investigations will be grilling banks on their involvement in the physical commodities business in general and their metal warehousing activities centered around the London Metal Exchange in particular, this week Reuters reports.

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Ahead of the hearing, the committee released a detailed 403-page report that criticized how banks purchased and exploited huge commodity stockpiles. In particular it raised the Fed’s concerns about two areas, firstly a possible weakness in banks’ ability to withstand a major catastrophe and, secondly, it examines intricate details of Metro International Trade Service‘s multimillion dollar payments to maintain the long wait times and, hence, bolster income.

Most of the big banks such as JPMorganChase and MorganStanley have since either downgraded their involvement or exited the business altogether but Goldman Sachs remains very much involved with commodity trading, including warehousing, as a core activity. Goldman rigorously refutes any wrongdoing, Chris Wibbelman, president and CEO of Metro International Trade Services LLC said it plays by the rules and contributes to jobs in the Detroit area.

Unfortunately, the firm is probably right in that respect, the rules clearly had gaping holes in them allowing operators to honor the letter if not the spirit of the law. As such, prosecution has proven very difficult, not just because no laws appear to have been broken but because a basic tenet of the complaints – that warehouse queues have directly acted to artificially raise prices has proved to be hard to prove. Warehouse queues have decreased since the early part of this year and, yet, aluminum prices have continued to rise – both on the LME and the more murky physical delivery premium charged by holders of the metal for prompt delivery.

It would appear, in retrospect, that the queues, while engineered by warehouse operators to extract ongoing rents from warrant holders waiting to take delivery of their metal, are as much a symptom of deeper underlying dynamics than they are the cause. Although the market was in oversupply, the stock and finance trade was soaking up metal creating a near invisible sinkhole and making the physical market tight enough that physical delivery premiums could be charged – by warehouse operators and producers alike.

As Craig Pirrong, a finance professor at the University of Houston, is quoted in the article as saying, “In some ways, this is fighting last year’s war,” and although the report will grab the headlines, little is likely to come out of it that will materially effect the aluminum market.

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