Federal Reserve may force financials out of the commodity business, ending the commodity super-cycle
First of all, read the New York Times story. It’s an outrage.
The story of how this works begins in 27 industrial warehouses in the Detroit area where a Goldman subsidiary stores customers’ aluminum. Each day, a fleet of trucks shuffles 1,500-pound bars of the metal among the warehouses. Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again.
This industrial dance has been choreographed by Goldman to exploit pricing regulations set up by an overseas commodities exchange, an investigation by The New York Times has found. The back–and-forth lengthens the storage time. And that adds many millions a year to the coffers of Goldman, which owns the warehouses and charges rent to store the metal.
Normally, I only care about what some thing like this means for the markets (and I’ll get to that) but since it’s the weekend and markets are closed I’ll afford myself an opportunity to be disgusted by this story. The two central characters in this story are Goldman Sachs and the exchanges, you couldn’t pick two businesses that pretend to worship at the alter of Austrian economics more than those two. Goldman represents the pinnacle of financial speculation — the so-called efficient allocation of capital. Exchanges represent openness, efficiency and fairness.
I don’t have any problem with what Goldman stands for but this is the exact opposite. It’s deliberately wasting energy, creating inefficiency and exploiting it. This is the exact thing type of thing people at Goldman accuse government bureaucracies of, but this is even worse because it was done on purpose with the singular aim of driving up costs for everyone to enrich a select few.
Will there be any consequences?
It’s easy to be cynical because Wall Street has torched consumers so many times an escaped with only fines, or less. Moreover, nothing described here was illegal. But Goldman is an easy target and this time I think, Congress and the regulators will take action.
First of all, this story will stay on the front page this week because Congress is holding hearings this week on allowing financial firms to own warehouses, pipelines and other commodity-related assets. Second, late on Friday — perhaps because they got wind of this story — the Fed made a one line announcement saying it’s “reviewing” the 2003 decision that allowed banks to operate in commodity markets.
“The Federal Reserve regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies,” the surprise statement said.
The announcement came directly out of left field; the New York Times story frequently mentions that the Fed was/is happy with the decision.
The Fed appears to have no plans to require the banks to sell their storage facilities and other commodity infrastructure assets, according to people briefed on the issue.
There are also signs of panic from Goldman in the NYT story.
In filings with the S.E.C., Goldman has said it plans by early next year to store copper in the same Detroit-area warehouses where it now stockpiles aluminum. On Saturday, however, Michael DuVally, a Goldman spokesman, said the company had decided not to participate in the copper venture, though it had not disclosed that publicly. He declined to elaborate.
What will it mean for markets?
This could be a game-changer in the commodities market. This story is limited to aluminum but financials are now deeply involved in all aspects of the commodity market. The Glencore-Xtrata merger, completed only in May, was criticized as simply a scheme to exploit warehousing and supply capacity. In other words, nobody knows how deep the rabbit hole goes and if regulators get serious, traders will dump commodities and ask questions later.
Events have already been put into motion that mean the commodity super-cycle is ending but this could be one of those flashpoint events that marks a watershed. If prices have been artificially inflated, companies like Australia’s BHP Billiton have benefited tremendously. If commodity prices fall and shares of BHP drop, this could be a bad week for the Australian dollar.
If it creates broader uncertainties in the financials, it could lead to a ‘risk off’ environment. Oil could be another victim, the Brent-WTI spread was due to supply bottlenecks but now there will be questions if it was due to natural forces or something more sinister. Maybe the rapid collapse of the spread was from nefarious traders rushing to the exits?
In short, these revelations and the swift reaction point to a rough time ahead for commodities and it could spill beyond that to financials and risk trades. Steer clear of AUD and favor USD and JPY.