Goldman Sachs Aluminum Shuffle

[AEON]

Here's a recent article on Goldman Sach's Aluminum Shuffle

We really need to remove the laws that allow banks to also be traders. But who is willing to stand up to them? It appears that neither Democrats or Republicans want to risk losing big bank donations. Until they are willing to do so - things will not change in a meaningful way.

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. It also increases prices paid by manufacturers and consumers across the country.

[anitram]

Originally Posted by AEON

allow banks to also be traders. But who is willing to stand up to them?

Elizabeth Warren is probably a good starting point.

[AEON]

Originally Posted by anitram

Elizabeth Warren is probably a good starting point.

I liked her interview on CNBC that went viral.

[deep]

She is also of indigenous american heritage, since we are in the mood to champion minorities.

[digitize]

I honestly don't see the connection between reinstating Glass/Steagall and Goldman manipulating the aluminum forward market.

[AEON]

Originally Posted by digitize

I honestly don't see the connection between reinstating Glass/Steagall and Goldman manipulating the aluminum forward market.

I think she was being used an example as someone willing to take on the Big Banks.

[digitize]

Originally Posted by AEON

I think she was being used an example as someone willing to take on the Big Banks.

I know, I was referring to your comment:

We really need to remove the laws that allow banks to also be traders.

I don't mean to sound... well, mean... because I am not unsympathetic to this cause. I'm honestly just a little confused.

[nbcrusader]

I didn’t see anything inherently wrong with a bank owning Metro International – any owner of Metro International could play the same game with the storage rental fees. It looks as if the problem is with the regulations of the London Metal Exchange (the “Exchange”). Add the Exchange getting a percentage of warehouse rental fees; the Exchange has an incentive to keep the relationship going.

Allowing another exchange to offer a competitive process for buying & selling of metals may be the solution. Or wait for end users to continue to increase purchases directly from suppliers and bypass the commodity market altogether.

Additional regulations are not a panacea – it just takes a little time for smart people to find the loop holes or establish new business structures to deal with the regulations.

[AEON]

Originally Posted by nbcrusader

I didn’t see anything inherently wrong with a bank owning Metro International

I think I might have to disagree with that. I really don't think it's wise to have banks own much of anything. Their "charter" is to safely hold funds and manage loans. If banks get into trading - especially too big to fail style trading - they can pretty much bet on anything. If they win, they win. If they lose, they win. Perhaps I'm missing something here - but that doesn't seem like a good idea.

Additionally - in this example, Goldman uses the funds collected by customers to buy a company to control a price of a commodity and then trade with those same customer dollars for and against that price that they are in full control of...is that capitalism?

I used to be a die hard Ayn Rand style capitalist (well, about 20 years ago). Now, I'm leaning toward the first chapter in the Book of Acts.

All the believers were together and had everything in common. They sold property and possessions to give to anyone who had need. ACTS 2:44-45

[AEON]

Originally Posted by digitize

I know, I was referring to your comment:



I don't mean to sound... well, mean... because I am not unsympathetic to this cause. I'm honestly just a little confused.

What is your question? Which part is confusing? Goldman is a bank that takes the money from clients to buy companies in order control prices (why else would a bank buy a trucking company?) and then creates markets for those clients and then manipulates that market with the very companies they bought (shipping inventory from to place with the trucks they own to artificially create demand which increases price) and then trades against those customers which siphons wealth from clients, consumers, and the government into their own business and those proceeds are then used to buy even more companies to control more prices and create more markets...and of course some of that cash tucked aside for campaign contributions to make certain the Game of MORE continues...

More, more more...

[digitize]

My question is this: what would not allowing banks to be traders do about this problem?

This activity is something that investment banks (such as Goldman) will always do, even if they can neither hold a prop trading division nor own a commercial bank (which is what would happen if the Volker Rule and a new Glass-Steagall were applied, and Goldman continued under its dubious designation as a bank). It's flow trading, which puts it long aluminum (by owning aluminum in its warehouses) and short aluminum (by selling forward contracts for it), hedging risk and giving Goldman a cut in the middle. And even if Goldman is fixing prices, they are still providing value to customers, by removing exposure to fluctuating commodities prices at a price lower than any one customer could achieve, thanks to scale. So, while what Goldman is doing is bad (especially if it entails any collusion from Morgan Stanley, JP Morgan, and the like), it's still likely a net benefit for its customers, and applying even the most stringent of bank-breaking-up rules won't get rid of this activity, because it's very standard and fairly economically vital.

[anitram]

Seems like you've assumed that the benefits of scale + decreased price fluctuation leaves customers better off. But the argument (which is supported by pretty reasonable data) is that through this warehouse hoarding, they've actually kept aluminum prices artificially inflated. Maybe your calculus is that even the inflated prices are better than a fluctuating market, but I'm not sure data exists to support that argument in this case.

Doesn't pass the smell test to me.

[AEON]

Thank you for this well thought out response. It's very informative. It certainly seems you know your economics and finance - would you mind clarifying some of these points to help me understand? Thanks

Originally Posted by digitize

This activity is something that investment banks (such as Goldman) will always do,

I think we can agree that while this may be likely, "will always do" anyway is not a valid reason (at least morally).

Originally Posted by digitize

even if they can neither hold a prop trading division nor own a commercial bank (which is what would happen if the Volker Rule and a new Glass-Steagall were applied, and Goldman continued under its dubious designation as a bank).

If the Volker Rule and the new Glass-Seagall can't be effective, is there any other means to prevent banks from also trading? Or, are you contending it is a vital component of a modern economy. If so - do you think there should be ANY oversight or regulations to control what they do? (given how vital they are)

Originally Posted by digitize

It's flow trading, which puts it long aluminum (by owning aluminum in its warehouses) and short aluminum (by selling forward contracts for it), hedging risk and giving Goldman a cut in the middle.

This concept I'm vaguely familiar with. This is what they refer to as the "spread" - correct? Except in this particular case - they used bad accounting practices (or whatever you want to call this aluminum shuffle) to report their inventory. Do you think that banks need to actually own and control the commodity? Shouldn't they be limited to "marrying" buyers and sellers?

Originally Posted by digitize

And even if Goldman is fixing prices, they are still providing value to customers, by removing exposure to fluctuating commodities prices at a price lower than any one customer could achieve, thanks to scale.

Prices seem to fluctuate anyway - but I guess you're claiming they would fluctuate more if banks like Goldman weren't removing as much exposure that would otherwise exist.

Originally Posted by digitize

So, while what Goldman is doing is bad -

Okay - we've got some common ground here...

Originally Posted by digitize

it's still likely a net benefit for its customers, and applying even the most stringent of bank-breaking-up rules won't get rid of this activity, because it's very standard and fairly economically vital.

I keep hearing how standard and vital this activity is. I'll have to do some macro-finance reading, but I wonder if it is only standard and vital because they (along with the legislative process that allows them to directly fund campaigns which places Goldman loyal legislators into power to create laws and regulations that are pro-Goldman) have built a financial and economic system that requires them to be standard and vital - that makes them the necessary middle man.

Would you agree there is currently something off with the flow of capital? - that wealth is flowing to some people/companies/investors in a historically unsustainable manner and speed?

[nbcrusader]

Originally Posted by AEON

I keep hearing how standard and vital this activity is. I'll have to do some macro-finance reading, but I wonder if it is only standard and vital because they (along with the legislative process that allows them to directly fund campaigns which places Goldman loyal legislators into power to create laws and regulations that are pro-Goldman) have built a financial and economic system that requires them to be standard and vital - that makes them the necessary middle man.

Commodity markets are the modern day equivalent of centralized trading hubs. The markets are standard and vital to the extent it allows globalized trading with more uniform exchange. Breaking up centralized marketplaces would create larger discrepancies in information flow, giving financial institutions greater opportunity to exploit imbalances between markets. The problem in this situation (and, I think we can all see a problem with an entity profiting with no discernible benefit to the market) lies with the rules of the London Metal Exchange.

And there is nothing to suggest this is permanent in any way. It would be helpful to learn how the biggest users of aluminum would change their sourcing strategies to lower costs.

[AEON]

Originally Posted by nbcrusader

Breaking up centralized marketplaces would create larger discrepancies in information flow

Even in today's Information Technology/Business at the Speed of Thought world?

[nbcrusader]

Originally Posted by AEON

Even in today's Information Technology/Business at the Speed of Thought world?

That's how we ended up with "program trading". Minor discrepancies between markets were exploited by automated trading routines.

Break up a centralized commodities market (not sure what that would accomplish) and you create a situation ripe for alternative means of profit making.

[AEON]

Originally Posted by nbcrusader

That's how we ended up with "program trading". Minor discrepancies between markets were exploited by automated trading routines.

Break up a centralized commodities market (not sure what that would accomplish) and you create a situation ripe for alternative means of profit making.

I know we can never outlaw greed, but there must be a way to limit the damage it can do to others. Instead of the Separation of Church and State - we need a new rally cry - the Separation of Bank and State.

Perhaps something will organically evolve on the fringes - something like BitCoin or some other alternative. Of course, I'm still optimistic that the Age of Abundance is just around the corner - but I would rather not go through these birthing pains.

[digitize]

AEON, to try to respond to all of your post...

Would you agree there is currently something off with the flow of capital? - that wealth is flowing to some people/companies/investors in a historically unsustainable manner and speed?

I don't know about unsustainable (you probably are right, but I'm not 100% sure), but there's definitely something bad going on in this regard in the developed world. What exactly is the cause and how exactly to stop it, I'm not totally sure, because I'm torn on a lot of issues myself.

Let me clarify my thoughts on Goldman in this specific case, though. The reason of which I am aware (there could be others) why Goldman and other investment banks store a lot of commodities is for forward contracts, a type of derivative. Forward contracts are used to hedge against resource prices rising. For instance, Coca-Cola is heavily dependent on aluminum. If the price of aluminum today is something that they can make good profits at while charging prices that don't cause consumers to abandon them, they can sign a contract with Goldman Sachs (or Morgan Stanley or JP Morgan or Deutsche Bank or Citigroup or whatever) to lock in buying aluminum for some fixed period of time at today's prices. Under such a contract, Coca-Cola will not be exposed to price increases, but will not receive the benefits of price drops. This creates stability for both Coca-Cola and their customers, and customers of competitors, because they are most likely using these contracts as well.

The reason why Coca-Cola does this instead of just buying and storing a ton of aluminum themselves now is because Goldman has the benefit of scale, and can do this for less than Coca-Cola. Goldman does this for a bunch of other clients, and has significant infrastructure that allows them to store aluminum cheaply. There is a spread between what it costs them and what they charge, but, if it gets to the point where Coca-Cola can store aluminum more cheaply than they can get a foeward contracts, then it's irrational for Coca-Cola to used a forward contract. If Coca-Cola does so in spite of it being more expensive, then that's there own idiocy and I have no sympathy.

Even if Goldman is increasing prices with creative accounting measures, as long as they are selling forwards more cheaply than the Coca-Cola could store aluminum, then they are still providing benefit for both them and the Coca-Colas of the world. So, is what they're doing wrong and anti-competitive? Absolutely. But I don't think that the practice of selling forward contracts is bad. They provide stability at a price lower than hoarding aluminum could generate.

This concept I'm vaguely familiar with. This is what they refer to as the "spread" - correct? Except in this particular case - they used bad accounting practices (or whatever you want to call this aluminum shuffle) to report their inventory. Do you think that banks need to actually own and control the commodity? Shouldn't they be limited to "marrying" buyers and sellers?

There's a derivative called a futures contract that does what you're suggesting here. Goldman sells them as well. Goldman can sell Coca-Cola a contract promising future delivery of x tons of aluminum at y date, and then they turn around and hedge that with a different party (or, more likely, parties) who will provide them the mathematical equivalent of x tons of aluminum at y date as well. In reality, no aluminum would change hands, but the equivalent money would flow to the right margin accounts. Goldman still charges a spread here, although this market may be more competitive, because it happens on exchanges. It's a company's choice which market they engage in, but I imagine that the forward market is somewhat cheaper, because Goldman doesn't have to worry about counterparty risk if they are storing the metal themselves (I could be wrong on this, though). Forward contracts are also more customizable, as they are over-the-counter, while futures are all sold on exchanges.

Prices seem to fluctuate anyway - but I guess you're claiming they would fluctuate more if banks like Goldman weren't removing as much exposure that would otherwise exist.

Yes, definitely.

So, my feelings are this: what Goldman did was wrong. However, this (as in, selling forward contracts in general) is an activity that provides much stability, and is good overall for both investment banks and producers. No currently proposed regulations would get rid of it, and I wouldn't advocate getting rid of it. It's not really causing the world's problems, as least as far as I can tell. So the best course of action, to me, does not seem to be creating laws that try to get rid of forward contracts. I guess it's best to go after Goldman and others for this specific instance (I don't doubt that there's some collusion going on, which allowed this to happen). Will that actually change anything? I don't know. But I don't like the idea of trying to get investment banks to give up forwards altogether.

[digitize]

Originally Posted by anitram

But the argument (which is supported by pretty reasonable data) is that through this warehouse hoarding, they've actually kept aluminum prices artificially inflated.

Is that by reducing the supply so much that it affects the market/spot price, or by just increasing the cost of carry? If it's the former, then I've misunderstood everything, and disregard everything that I've said. My impression from the NYTimes article was that it's just the latter, but I could be totally wrong.

[ntalwar]

Goldman posted a rebuttal to the article:

Goldman Sachs | In The News - Goldman Sachs and Physical Commodities