Sunday, July 21, 2013

The Metals Warehousing Racket

Here's the aluminum warehousing Goldman Sachs scam the NY Times reported in a simple (to me) rundown so even Harvard educated Slate writers can follow it.

1. Banks use the FED's ZIRP easy money to finance deals to buy metals at the spot cost. The buyer also makes a forward contract sale to take advantage of a metals market in contango. Aluminum has been in wide contango for a while (Google contango).
2. The short distance between the warehousing locations in Michigan to Midwest US galvanizing centers means that the merchant premium will be higher than the contango (Google Index Universe contango report).
3. The buyers stack up metal in the warehouse. The warehousers offer incentives of $230/ton for the traders to renew their leases.
4. Prices are depressed, stable and occasionally declining. The big banks can then play games in the paper market to fiddle with the cost of a metal knowing that warehouses they control have enough metal to artificially make supply look high while backing up any contracts that may force delivery.
5. Rinse, lather, repeat. How many end demand users are going to strike deals directly with producers. Not many, but some are trying.

Seriously, look at this link, scroll down to the storage charts. Notice the giant jump in '08-'09 once ZIRP got going. Look at the spot price over that time as well. Coincidence?

"How come no one has started up a new warehouse to compete and stop this game? Arf, arf, I don't know how to Google and do shallow research despite being a journalist." - Sorry, for that horrible journalist mocking.

Here's why:

1. Self-Interest: The LME runs the racket and is also a collector of 1% of all rent earnings. Changing things will reduce revenues.
2. Rules and Regulations: The LME has registered warehouses. Once must be approved and registered with the LME to be a metals warehouse for the warrants of their metals.
3. Big Barrier: The LME is only accepting "applications for the listing of new warehouses from existing approved warehouse companies".
4. Goldman Sachs bought the warehouse Metro International Trade Services which holds many of the US based sheds in 2010.
5. LME isn't going to upset the situation and lose their 1% of outsized fees. Plus, LME isn't going to approve any new warehouses that aren't from a firm that is already approved and operating them.

It is effectively a cartel with an extremely high barrier to entry.

*Hi Slate Readers. This is pretty easy to explain if someone knows markets and economics, as well as how to use "Google". Guess philosophy majors with no experience in the markets, finance or working real jobs should be writing about the markets, finance or economy.

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