Commodity Merry-Go-Round

cropped-bob-shapiro.jpg   By Bob Shapiro

Insider Trading is illegal in the United States. For those who are new to the concept, if you know market affecting information before it is generally available to the public, that’s insider trading.

If you know a company is about to report surprisingly lousy (or great) earnings, and you trade ahead of the information being released, that’s insider trading. If you trade on a crop report before the report is

released, that’s insider trading. Researching already public information, and drawing inferences from that information, is NOT insider trading.

There is a US Senate investigation going on to determine if several big Wall Street banks are guilty of manipulation within the commodities markets and making profits from their own actions – in other words insider trading. The banks include Goldman Sachs, Morgan Stanley, and JP Morgan-Chase.

Telling a Secret

These banks have branched out into businesses related to, but outside, their normal areas of providing loans and helping companies get financing. One area is in the warehousing of the various commodities, and this opens the possibility for mischief.

They own many (most?) of the warehouses for commodities such as aluminum. Producers and other current owners of aluminum need a place to store the metal while they are waiting for it to be sold to somebody who will use it in a manufactured good (eg. Soda Cans).

Users will be nearer one warehouse than another, so deliveries may be made from there to save freight. Sometimes space in one warehouse is not available, so inventory may be moved around. The owner of a warehouse wanting additional inventory might offer an incentive to the owner of the aluminum if he will transship the metal to a different location.

While that commodity is being moved on a truck, it is not available for delivery. If a lot of inventory is on trucks being moved, there could be a temporary shortage. It appears that Goldman Sachs, for example, has offered sufficient incentives to aluminum owners to have trucks working overtime.

Truck Traffic

By some estimates, it could take up to two years to get aluminum, that you’ve bought, delivered. Some users have said off the record that they were so desperate that they paid bribes to get delivery.

A shortage also will send the price that buyers are willing to pay higher. And, to protect against running out, a buyer might buy enough to create a stockpile. The extra buying – artificially higher demand – will raise the price further.

The big Wall Street banks buy commodities for customers, but they also buy for their own accounts. Being able to control the availability also makes them able to manipulate the price. Trading on this kind of information falls within Insider Trading.

Numerous cases of market manipulation have been found in European markets, but here in the US, though complaints to the regulators are made, little or nothing is done about it. Occasionally, a firm will receive a fine which is only a fraction of the profits they derive from these activities. So far, nobody has gone to jail, so the market manipulations continue.

Action Item: Investigate the Regulators.

  • Congress should exercise greater oversight of the Regulators
    • Complaints should be reviewed on a regular basis
    • If the Regulator was wrong due to negligence, then both the Regulator and the company regulated should suffer sanctions
    • If the Regulator was wrong due to conflict of interest, then in addition, the Regulator should be fired with possible prosecution

While over-Regulation should be avoided, criminal activity must be punished in a way so that the criminal activity will stop. Please read CNN’s Story: Did Goldman Sachs Rig Commodity Markets?


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