Goldman Sachs and the Aluminum Warehouses: Part 3

Fight disinformation: Sign up for the free Mother Jones Daily newsletter and follow the news that matters.


Why does Goldman Sachs own a big aluminum warehousing business that it deliberately runs poorly? Yesterday I suggested that Goldman couldn’t possibly have any interest in the warehousing business per se, so instead their interest must have something to do with trading profits to be made by controlling and manipulating physical stocks of aluminum.

Today, Izabella Kaminska of Alphaville confirms that this is the case. But how and where does Goldman make money? I can’t pretend to follow every twist and turn of Kaminska’s explanation, but here’s my take on the basics.

Suppose that aluminum sells for $1,800 per ton on the spot market, but a contract for December delivery sells for $2,000. There’s a moneymaking opportunity here: buy the aluminum now, warehouse it, and simultaneously forward sell it at a premium. As long as your storage and financing costs are low, you’re guaranteed to make money.

This condition is commonly called contango, and it’s not unusual in commodities markets. Goldman was able to profit from this—their financing costs were already low, and buying the warehouse business provided them with low storage costs—but that’s not the whole story. It turns out that lots of Goldman customers wanted to get in on this action too, but they were limited by the fact that contango plays were a big drain on their balance sheets. To help out, Goldman “created a business in freeing up the balance sheets of those firms which were encumbered by large but clearly profitable contango trades, by financing these trades and taking them off-balance sheet in return for some of the contango margin.” In other words, Goldman helped its customers expand their trading positions in return for a cut of the profits. Owning the warehouses was key to this.

There are six paragraphs of detailed explanation that follow this, and I might as well just fess up that I don’t understand them. Click the link if you’re more finance savvy than me and want to know more. The end result, says Kaminska, was “the mass encumbrance of physical commodities for the purpose of collateralising implied future demand from retail and pension funds — which would otherwise take the shape of a much less tangible and uncollateralised futures investment.”

Roger that. In any case, Kaminska suggests that this would basically be OK except that:

  1. The process creates the means by which speculation does end up driving and influencing physical prices (rather than being priced off physical realities)
  2. There is a fiduciary issue because banks have an incentive to maintain the illusion of physical scarcity to mislead investors. This is so that pension and institutional money keeps flowing into commodities so that synthetic yields can be extracted from the flows to be handed over to the sell-side and/or commodity industry. It is, in effect, a stealth yield transfer from those who have been sold the myth that commodities are a viable (and scarce) asset class to those who have too many commodities to sell. Further perpetuated, we should add, by the myth that commodities can protect wealth from inflation.
  3. The dark inventory hoards can be used to the trading advantage of the banks.

Point 3 has to do with the practice of reclassifying inventory as either public or private. By manipulating apparent inventory levels, Goldman and its customers can benefit when markets are in contango and when they’re in the opposite, or backwardation, state:

When it suits an institution to benefit from a move towards backwardation, public inventory will be taken dark, and positions established to benefit from an apparent destocking effect — even though the collateral is not heading to market at all. When it suits an institution to benefit from a move towards contango, dark inventory will be taken public, presenting the appearance of a sudden surplus and glut in supply (even though the glut was always there).

This is the other reason why owning warehouses became so appealing. It’s much harder to keep inventory out of sight of public eyes if you’re dependent on the LME warrant system or third-party providers.

Bottom line: you just knew that this whole thing had to be some insanely complicated trading ploy, and you were right. It’s complicated enough that I still don’t really understand the details. In a nutshell, though, if you control the inventory of a commodity, you can make a lot of money. Speculators have known that for a very long time, but the old, crude days of simply cornering a market are gone. These days, markets are manipulated in much more sophisticated ways. As always, though, you and I are the ones who pay the price.

AN IMPORTANT UPDATE

We’re falling behind our online fundraising goals and we can’t sustain coming up short on donations month after month. Perhaps you’ve heard? It is impossibly hard in the news business right now, with layoffs intensifying and fancy new startups and funding going kaput.

The crisis facing journalism and democracy isn’t going away anytime soon. And neither is Mother Jones, our readers, or our unique way of doing in-depth reporting that exists to bring about change.

Which is exactly why, despite the challenges we face, we just took a big gulp and joined forces with the Center for Investigative Reporting, a team of ace journalists who create the amazing podcast and public radio show Reveal.

If you can part with even just a few bucks, please help us pick up the pace of donations. We simply can’t afford to keep falling behind on our fundraising targets month after month.

Editor-in-Chief Clara Jeffery said it well to our team recently, and that team 100 percent includes readers like you who make it all possible: “This is a year to prove that we can pull off this merger, grow our audiences and impact, attract more funding and keep growing. More broadly, it’s a year when the very future of both journalism and democracy is on the line. We have to go for every important story, every reader/listener/viewer, and leave it all on the field. I’m very proud of all the hard work that’s gotten us to this moment, and confident that we can meet it.”

Let’s do this. If you can right now, please support Mother Jones and investigative journalism with an urgently needed donation today.

payment methods

AN IMPORTANT UPDATE

We’re falling behind our online fundraising goals and we can’t sustain coming up short on donations month after month. Perhaps you’ve heard? It is impossibly hard in the news business right now, with layoffs intensifying and fancy new startups and funding going kaput.

The crisis facing journalism and democracy isn’t going away anytime soon. And neither is Mother Jones, our readers, or our unique way of doing in-depth reporting that exists to bring about change.

Which is exactly why, despite the challenges we face, we just took a big gulp and joined forces with the Center for Investigative Reporting, a team of ace journalists who create the amazing podcast and public radio show Reveal.

If you can part with even just a few bucks, please help us pick up the pace of donations. We simply can’t afford to keep falling behind on our fundraising targets month after month.

Editor-in-Chief Clara Jeffery said it well to our team recently, and that team 100 percent includes readers like you who make it all possible: “This is a year to prove that we can pull off this merger, grow our audiences and impact, attract more funding and keep growing. More broadly, it’s a year when the very future of both journalism and democracy is on the line. We have to go for every important story, every reader/listener/viewer, and leave it all on the field. I’m very proud of all the hard work that’s gotten us to this moment, and confident that we can meet it.”

Let’s do this. If you can right now, please support Mother Jones and investigative journalism with an urgently needed donation today.

payment methods

We Recommend

Latest

Sign up for our free newsletter

Subscribe to the Mother Jones Daily to have our top stories delivered directly to your inbox.

Get our award-winning magazine

Save big on a full year of investigations, ideas, and insights.

Subscribe

Support our journalism

Help Mother Jones' reporters dig deep with a tax-deductible donation.

Donate