Big Changes Ahead for Commodity Price Manipulation

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Sunday’s New York Times story on the shenanigans played by Goldman Sachs Group Inc. (NYSE: GS) at its aluminum warehouse in Detroit is nothing especially new. What is new is that the Times has now found the story.

Goldman has been playing games with aluminum stockpiles since at least 2010, shortly after the bank acquired warehousing company Metro International Trade Services. In 2011, Coca-Cola Co. (NYSE: KO) filed a complaint with the London Metals Exchange (LME) accusing Metro of accepting aluminum for storage at its warehouses and then essentially refusing to let the stuff out.

The effect of Metro’s delaying tactic is to increase the amount of fees it — and Goldman — can collect for storing the aluminum and to raise aluminum prices. Users of aluminum, like Coca-Cola, can either wait up to 16 months to get a delivery or they can seek out aluminum providers like Alcoa Inc. (NYSE: AA) and Rio Tinto PLC (NYSE: RIO) and pay the higher spot price the producers demand. Consumers of course pay the final tab.

In 2011, Metro rented its aluminum warehouse space for $0.42 per ton per day. With capacity for 1.5 million tons, that alone works out to around $230 million a year. But the real money lies in the financialization of the warehouse inventory.

The Financial Times’ Alphaville blog has an excellent summary of how this entirely legal manipulation works financially. In short, when it looked like commodity prices would rise forever, passive commodity investors (speculators) like pension funds and exchange-traded products were willing buyers of either the physical commodity or the futures, providing both liquidity and profit for the banks, which could sell the derivatives to investors or hedge prices for an oil company or aluminum miner.

But the party may be over.

On Friday, the U.S. Federal Reserve said it would review a decision it reached in 2003 that determined that some commodity activities are complementary to financial activities and that the Fed would allow bank holding companies to participate in those activities. In addition to Goldman, J.P. Morgan Chase & Co. (NYSE: JPM) and Morgan Stanley (NYSE: MS) also own metals warehouses or crude oil storage tanks.

The Senate Banking Committee will begin hearings tomorrow on whether banks should be allowed to own physical commodities or their warehouses or power plants. The outcome may be in doubt, but one thing is certain: the banking industry is not going to improve its image as a result.

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