July 31, 2013
The practices and methods of manipulating commodity markets, is a staple topic in financial journalism. Options, futures and exotic forms of derivatives, often put under the microscope, gives rise to calls for substantive regulation. One area of the commodity trade, seldom examined is that involved with physical commodities trading. With much fanfare, Under Siege, JPMorgan to Quit Physical Commodities, a Reuters announcement has many seasoned street professionals shocked.
"JPMorgan Chase & Co is exiting physical commodities trading, the bank said in a surprise statement on Friday, as Wall Street's role in the trading of raw materials comes under unprecedented political and regulatory pressure.
Although the commodity division's $2.4 billion in reported revenue last year surpassed those of long-time rivals Goldman Sachs Group Inc and Morgan Stanley combined, some have queried its profitability due to the costs of running a huge logistical operation. One analyst estimated that physical trade accounted for half or more of overall commodities revenue."
A little background provides context. The excellent financial site Naked Capitalism illustrates one aspect of the art of manipulation. The article, SEC Gives JP Morgan and Other Big Banks License to Manipulate Commodities, reasons that the business of physical commodity storage is very different from a free enterprise marketplace.
"The SEC has paved the way for investors to take a direct stake in commodities, rather than through commodities futures. The agency gave the green light to JP Morgan to launch a fund whose shares would be backed by warehoused copper. The implications are not pretty. Per Khan:
In practical terms, the SEC handed traders at J.P. Morgan control over 20 to 30 percent of the copper available for immediate delivery from the London Metals Exchange -- the commercial market where companies that use copper go to procure last-minute supplies.
The investors purchasing shares in J.P. Morgan's fund won't be buying copper to use, but to store. The intricacies of the fund are complex, but its underlying rationale is straightforward: the more shares investors buy, the more copper is taken off the market. And the more copper that is taken off the market, theoretically the more valuable the copper and the shares become.
"Allowing investors to speculate in the futures market created horrific price volatility," said Michael Greenberger, a law professor at the University of Maryland and former director at the CFTC. "Here, you're allowing investors to intervene with physical supplies. We'll see a double whammy."
Policy analyst Lina Khan continues to make her case in her original essay, JP Morgan Gets a Big Holiday Gift From the SEC.
"Speculators have been limited to trading in futures, which are forms of bets that link only indirectly with physical supply of copper. Two weeks ago, however, the SEC blessed a controversial fund designed by J.P. Morgan Chase that, for the first time, will let investors buy shares backed by physical, warehoused copper, to use as a form of investment.
The change may seem arcane. But long-time participants in the copper market say the effects will be immediate: Manufacturers looking to make productive use of copper will find themselves competing with speculators backed by some of the richest banks and funds in the world, raising prices for many consumer products. The long-term result may be even more disturbing: The SEC's ruling all but invites bankers to increase speculation in other, even more essential goods, like grain and oil."
So why would the "House of Morgan" want to exit another component business that multiplies the synergistic relationship, which enables the systematic control of price movement? In another Reuter Analysis: JPMorgan Faces 'Hard Sell' in Crowded Market for Commodity Traders states: "The Federal Reserve is reconsidering a landmark 2003 decision that first allowed banks to trade physical commodities, in addition to traditional derivatives."
Here resides the rub. Remember the double whammy that Professor Greenberger alludes, seems to have a real world dark side. Again, Reuter provides an underlying factor in J P Morgan's decision process.
"The bank is said to be in talks over a $400 million deal to settle allegations that it manipulated power markets; the metals warehousing industry is under public and political scrutiny over allegations that long queues are driving up prices."
With the vertical integration of finance after the repeal of Glass-Steagall, the too big to fail culture, opened the door to investment banksters for becoming legal monopolists in areas of business, foreign to traditional banking practices. In the Bloomberg article, JPMorgan Mulls Physical Commodities Exit Amid US Review, the risk of mixing distinct and separate business functions and allowing financial institutions umbrella sanctions, only leads to higher prices.
"Physical commodities trading "is where it becomes more controversial," said Brad Hintz, a bank analyst with Sanford C. Bernstein & Co. in New York. "Is that necessary in order to be a player on the risk side, is it necessary for the financing?"
Some lawmakers and customers have said banks can take advantage of their multiple roles to manipulate prices and get an information edge."
These multiple roles are crucial failures of mega banking. In the aftermath of the "London Whale" fiasco, the concern that JPMorgan Chase: Out of Control, needs a total evaluation. Josh Rosner author and research consultant offers a sober assessment.
"In our reviews we could not find another "systemically important" domestic bank that has recently been subject to as many public, non-mortgage related, regulatory actions or consent orders. The firm's pride in a disputable "fortress balance sheet" – which underestimates their off-balance sheet risks – appears to have given investors false comfort. Poor risk management and control failures are almost always the major drivers of capital destruction."
The complexity in all the factors that make up the prices of commodities seems too complicated for any algorithm program to compute. However, it is an easy leap to understand that when a bank controls the actual warehouse storage of physical commodities, that speculative risk diminishes as trading manipulation intensifies. J P Morgan just might be looking at the Goldman Sachs aluminum scandal with concern and apprehension.
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